Policies for the mitigation of acid rain

Policies for the mitigation of acid rain

Policies for the mitigation of acid rain A critique of evaluation techniques Hadi Dowlatabadi and Winston Harrington Many regulations designed to red...

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Policies for the mitigation of acid rain A critique of evaluation techniques Hadi Dowlatabadi and Winston Harrington

Many regulations designed to reduce the emissions of precursors to acid rain have been introduced in the US Congress. The relative merits of these regulations are being evaluated through cost-benefit analysis. The approaches adopted so far fail to provide an adequate guide for public policy decisionmaking. The reasons for this failure include the absence of reliable benefit measures and appropriate cost measures. We discuss these failings and propose techniques that may in the future be able to provide a better guide to the public policy decisionmaker. Keywords: Acid rain;

Cost-benefit analysis; Economic models

Legislation designed to attain the National Ambient Air Quality Standards, passed by the US Congress in 1970, has entailed the imposition of pollutant emission standards on existing and new industrial and electric utility boilers. A 1977 amendment to these standards has led to additional controls on electricity generation technology - specifically, the mandatory investment in flue gas desulphurization (FGD) equipment for new power plants. Regulations are now being proposed to further reduce the emissions of precursors to 'acid rain', chiefly sulphur dioxide (SO2) and nitrogen oxides (NOx). If promulgated, these regulations are likely to have significant implications for the economy in general and the energy sector in particular. Total US emissions of SO2 are estimated to have been about 24.5 × 106 metric tonnes (t) in 1980 - of which 17.5 x 106 t were from electricity utilities, t The various emission reduction policies suggested for the electricity generation sector aim to reduce Hadi Dowlatabadi and Winston Harrington are Fellows in the Energy and Materials and the Quality of Environment Divisions respectively, Resources for the Future, 1616 P Street NW, Washington, DC 20036, USA.

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annual SO2 emissions to 5.5-12.5 x 10~' t. Such ambitious environmental protection goals can be achieved through two strategies - investment in new capital designed to clean up combustion gases, or switching to fuels with lower sulphur content. However, the scale of investments required, and the disruption to the primary fuels market, represent major shocks to the economy, especially the energy sector. The perceived severity of these shocks has necessitated a close examination of various policy options. These policy choices would normally be examined in a cost-benefit framework. However, while the estimates of benefit measures are still controversial, a political will for action has gathered momentum. Consequently, it has been important to have estimates of the cost of a policy. These cost estimates provide a measure of the sacrifice required for a given emission reduction target. In addition, calculations of 'cost effectiveness' (such as reduced emissions or reduced acid burden, normalized by cost) provide a way of comparing alternative policies. In this paper we examine the adequacy of the available tools for the assessment of regulations designed to reduce precursors to acid rain. Here, an overview of cost estimation models is followed by a discussion of the distinction between expenditures and costs, and direct and indirect costs.

COSTING VARIOUS POLICY OPTIONS Cost estimates are generated through the use of detailed national models of the electric utility and coal industries. Ideally, these models should reproduce prices and constraints faced by decisionmakers, and be able to mimic their decisions. These decisions should include the level of new capacity investments, operation of plants, fuel procurements and invest-

0301-4215/89/020116-07503.00 © 1989 Butterworth & Co (Publishers) Ltd

Policies for the mitigation of acid rain

ment in pollution control equipment. However, as in all computer models, the need to retain computational manageability has dictated constraints on the level of detail represented, the domain encompassed, and the solution methodology. More specifically, despite great complexity, any given model is only capable of handling a subset of the noted decision variables. A typical tradeoff is often made between the level of detail at the plant and the number of plants modelled simultaneously. For example, in some models detailed representation of available coal supplies, distinguished by grade and geographic origin, is excluded to model investment decisions and plant operations over many interconnected electric utilities. A model using less detailed coal data does provide some information on least-cost strategies that employ interregional power and emission trading. However, any conclusion from such a modelling exercise about coal acquisitions would be questionable. The manageability consideration also plays a significant role in the fidelity with which a model represents reality. Here, a reductionist approach often prevails. For example, in the suite of models used to assess the costs of acid rain regulations, such reductionism has led to a complete decoupling of the industries engaged in coal and electricity production. However, not only are long-term supply contracts the norm between coal producers and electric utilities, some mines and utilities are owned by the same holding company. Hence, fuel switching strategies are likely to face a great deal more resistance than predicted. The computational manageability constraint has also meant that most of the models have been formulated as linear programmes (LPs). Alas, while the proven solution algorithms for LPs have made these the favoured formulations, their structure is restrictive. These models calculate electricity prices but meet exogenously determined electricity demand levels. They dispatch power, but none has incorporated the fact that a power plant's performance characteristics are a function of its operating level. 2 Finally, in addition to the problem of unknown future input prices, some of the data employed in the models are inaccurate. The list of inaccurate data includes the level of power plant emissions in 1980, and the technical characteristics of existing power plants. The former data are used extensively to establish a baseline for emission reductions, and their inaccuracy could play an important role in the apportionment of the emission reduction burdens. The effects of the latter inaccuracy are more difficult

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to predict. 3 These can be expected to result in predictions that may be accurate in the national aggregate, but less than satisfactory as a guide to regional emission control strategies. In general the LP formulations are suitable for exploration of least-cost strategies for groups of plants, and simulation models provide detailed cost estimates at the plant level. Today, probably the two most widely used cost models are the Coal and Electric Utilities Model (CEUM), and the National Coal Model Version 5 (NCM-5). 4 These LP models are designed to represent the national coal market, with particular attention paid to the fuel procurement decisions of the largest customer, the electric utility industry. In these models, the economic consequences of any acid rain policy can be examined through modification of the constraints or the objective function. In addition to the crop of LP models available there is also a number of process simulation models which mimic the detailed engineering and economics of the operation of individual electricity generation plants. Unfortunately, all these models are the products of separate research efforts. Consequently, it has not yet been possible to establish a common ground and utilize the power of a suite of models constructively. In their present state each model is an incomplete microcosm. Nonetheless, the models have been exercised repeatedly and the findings have been widely distributed.

PERCEIVED WISDOM Largely through the use of these models, a rough consensus has emerged on a number of issues. •





First, the marginal costs of cutting emissions of both SO2 and NO× increase rapidly, especially for emission reductions of SO2 (in excess of 8 x 106 t/year). Second, for the scale of policy most often examined, a reduction of 8 x 106 t/year in SOz emissions, 5 the cost estimates are in the range of $2-4 x 109/year (1986 values). Third, it is most cost effective to allow utilities maximum choice in the selection of methods for limiting emissions - confirming the belief of most economists that decentralized approaches to emission reduction and, in particular, emission fees or marketable permits, are more cost effective than a 'command and control' strategy. However, considerable disagreement exists over the extent of the potential cost savings.

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Poficies for the mitigation of acid rain





Fourth, for emission reductions up to 8 × 106 t/year, the utilities will overwhelmingly choose fuel switching, if permitted to do so. Fifth, although alternatives permitting fuel switching will result in higher total coal mining employment than policies requiring scrubbing, employment among miners of high-sulphur coal will decline under these policies. The burden of fuel switching falls on the owners of these mines and their employees. Thus, one of the most important dimensions of the policy choice involves a trade-off between cost effectiveness and equity.

The extent to which the conventional wisdom is accepted, even taken for granted, by all participants in the acid rain policy debate is evident in one of the most contentious issues of that debate, whether to allow coal users (mainly electric utilities) 'freedom of choice' in meeting sulphur dioxide limitations, or force them to adopt a particular technological approach. More specifically, should high-sulphur coal users be permitted to switch to low-sulphur coal to meet emission limitations, or should they be encouraged to continue to burn high-sulphur coal and install expensive F G D equipment? If forced scrubbing is more expensive than fuel switching, but only moderately so, why not require it and avoid the havoc in high-sulphur coal markets that is certain to result from a policy allowing free technological choice? On the other hand, if it is much more expensive, why not allow fuel switching and perhaps use part of the savings to compensate or retrain the miners left unemployed? 6

MISPLACED CONFIDENCE Unfortunately, as noted above, the confidence in the results of these large-scale LP and simulation models is unwarranted, and as a result the conventional wisdom may be mistaken. It should also be noted that, despite their enormous size and complexity, these models are partial equilibrium models. They allocate coal and electricity production assuming no change in the rest of the economy. For marginal changes this is not a bad assumption, but large-scale fuel switching is not a marginal change. These indirect effects, if sufficiently large, can redound upon the decisions of the coal and electricity utility industries, and such effects are not accounted for by partial equilibrium models. A further difficulty with these models is a conceptual problem regarding the nature of 'cost'. This 118

arises because of a tension between the two principal uses of the models. For while these models were designed with the positive objective of predicting firm-level decisions, they are now being used for the objective of evaluating those outcomes in a normative context. For the original purpose, private costs faced by utilities and coal producers are sufficient. For the normative objective, on the other hand, the total social cost is required.

CALCULATION OF SOCIAL COSTS Social cost is the totality of the goods and services that must be given up by society in order to implement the policy in question. What is called 'cost' in these models, and is used for 'cost effectiveness' comparisons among policies, falls short of social costs on two counts. •



First, the estimated expenditures in market transactions are not necessarily the same as the social costs associated with those transactions. This distinction between costs and expenditures is considered in greater detail below. Second, these comparisons fail to include the costs imposed on all those affected. The LP results only record estimates of expenditures of the two most visible entities, the coal and electric utility industries. These are sometimes called the direct costs of acid rain policy. Not counted are the indirect costs associated with economic decline in high-sulphur coal regions and with expansion in low-sulphur coal regions. These costs include the costs of direct and induced unemployment, household migration, worker retraining, new housing and new public infrastructure. 7 For the most part, these costs are reflected in market transactions, but some transcend the market, such as the human cost of losing a job or being forced to move from one community to another. There also may be consequences that only affect costs in the long run. Investment in acid rain reduction is not available for other uses, and can put the economy on a slower growth path.

EXPENDITURES V COSTS Another all too common failure in policy analysis has been the failure to distinguish carefully between costs and expenditures, which are technically quite ENERGY POLICY April 1989

Policies" for the mitigation of acid rain

distinct. Expenditure is simply the money required in a transaction to procure a good or service. Cost is measured by what must be given up by the individual or society in order to gain a unit of the resource. The two concepts are obviously related, in as much as a payment is usually necessary to induce the owner of a resource to commit it to some socially useful activity. Moreover, observed expenditures are about the only data we have on what the costs really are. Perhaps because of the seductive availability of expenditure data, estimation of cost is generally regarded as the 'easy' part of benefit-cost analysis. All too often, the benefit side gets all the attention because of the difficulties of determining the value of outputs not traded in markets. Conceptually, the cost estimation problem is the mirror image of the benefit estimation problem, one of determining the area under the supply curve rather than the area under the demand curve. The same problems that arise when estimating benefits from expenditure data can come up on the cost side as well. Many factors can contribute to a disparity between costs and expenditures. Here, market failure is the most prominent factor. Thus, unless the external effects of coal production, such as acid mine drainage, are internalized, the social cost of coal will exceed the price. On the other hand, if mine owners or the railways have monopoly power, they will be able to charge coal users a price that exceeds the cost. In summary, the distinction between costs and expenditures also reflects a partial v total analysis. In a general equilibrium model an expenditure by one party is income to another. In a partial analysis, on the other hand, it is tempting to count an expenditure as a cost if the recipient is outside the boundaries of the model.

THE CBO AND ADL STUDIES T o illustrate these points, two studies that have focused on a comparison of fuel switching and forced scrubbing strategies are examined here in more detail. The first is a study of direct costs by the Congressional Budget Office (CBO) 8 and is based on an LP model as described above. The second study, prepared by Arthur D. Little Inc ( A D L ) , 9 focuses on indirect costs while using a much simpler method to determine direct costs. Table 1 shows some of the CBO results for policies achieving an 8 x 10 6 t/year reduction in

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Table 1. CBO cost estimates, 8 x 10 s t S02 emission reduction. Policy

Policy Policy Policy Policy

Total programme Cost Mining employment cost a effectiveness changes (1995) Four key ($ x 10 a) (S/t) Total states II-1A b 20.4 270 +600 - 1 4 100 II-1B c 23.1 306 - 3 600 11 600 III-1Ad 22.3 291 - 5 0 0 - 1 0 800 III-1B" 30.0 389 +1 100 - 4 500

aReflects net present value of sum of annual utility expenditures including subsidies but not taxes - incurred between 1986 and 2015, discounted to 1985 dollars. A real discount rate of 4.78 was used in the calculation. t'Utilities allowed to choose compliance strategy. cUtilities required to use same type of coal as used in 1985. d90% FGD capital cost subsidy. eSame as III-1A, but both capital and operating costs of FGD subsidized. Source: Congress of the United States, Congressional Budget Office, Curbing Acid Rain: Cost, Budget, and Coal-Market Effects, US Government Printing Office, Washington, DC, 1986.

sulphur dioxide emissions. This table gives CBO's estimate of the total cost of the programme in present value terms, the cost effectiveness in discounted dollars/t of SO2 removed, and projected mining employment changes both in total and in the four states where most high-sulphur mining jobs are at risk (Ohio, Pennsylvania, Indiana and Illinois). A D L ' s estimates of cost and employment effects are presented in Table 2. The two policies studied by A D L closely resemble policies I I - I A and II-1B of CBO respectively. The CBO study confirms the perceived wisdom that a policy allowing fuel switching is the most cost effective. However, it should be noted that the difference in cost between II-1A and I I I - 1 A is not very great - less than 10%, but the savings in high-sulphur mining jobs, and hence in high-sulphur coal production, is larger, of the order of 25%. This suggests that a relatively small decrease in the assumed cost of flue gas desulphurization, or increase in the assumed cost of fuel switching, would have a large effect on the least-cost strategy. If so, then use of economic incentives would result in a greater use of F G D and less use of fuel switching than currently imagined. Let us now turn to the A D L study, where the balance is tipped the other way. Here, the difference in direct costs between the two alternatives is about $3 x 10 9, about the same as that between the 'total programme costs' of CBO Policies II-1A and II-1B, although in absolute terms the A D L figures are about 50% higher. However, A D L estimates that inclusion of indirect costs increases the cost of a fuel switching policy from $34 x 10 9 t o $46 x l 0 9, and a forced scrubbing policy from $37 x 10 9 t o $40 X 10 9. Thus, while the less expensive strategy for the

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Policies for the mitigation of acid rain Table 2. ADL estimates. Impact of alternative acid rain control strategies on total compliance costs and employment (relative to base case of no acid rain policy)

Compliance costs (Present value, 1985 $ x 109) Industry adjustment costs Electric utility costs Mine closure costs Subtotal Community adjustment costs Household/Worker costs Private/public development costs Subtotal Total compliance costs

Fuel switching alternative (FSA)

Technology-based control (TBC)

TBC-FSA

$33.0 1.3 34.3

$36.7 0.4 37.1

$3.7 -0.9 2.8

1.2

0.3

-0.9

10.2 11.4

2.7 3.0

7.5 -8.4

$45.7

$40.1

$5.6

+ 100 -25 700

2 900 9 600

3 000 +16 100

+29 700 - 5 3 500

+30 800 - 1 3 600

+ t 100 +40 100

Employment effects (Number of jobs in 1995) Coal mining Total Four key states All employment Total Four key states

Source: Arthur D. Little, Inc, Economic Impacts of Acid Rain Control Strategies, Final Report to Consolidated Coal Company, 1985.

utilities is to switch fuels, the more cost-effective public policy is to require installation of F G D systems. This is noteworthy as this finding challenges the conventional wisdom, and flies in the face of economists' general preference for decentralized approaches to emission reduction over 'commandand-control' approaches. However, the A D L study suffers from both empirical and conceptual problems. This large and detailed model, in this case an input-output formulation, requires vast numbers of ill-defined coefficients. Input-output models are based on the axiom that the proportions of the various inputs are fixed regardless of the price of inputs and the level of outputs. This assumption of a 'Leontief technology' is reasonable and useful when the changes envisioned are small, but is difficult to justify otherwise. Furthermore, examination of the deatils of the direct cost reveals some common misconceptions regarding the nature of costs. For example, the 'mine closure costs' in Table 2 are based on an engineering cost estimate (not shown) of closing a 1 x 106 t/year mine. The major components of the 'costs' are: $5.0 x 10 6 for 'loss of coal resources'; $4.5 × 106 for 'unfunded black lung liabilities'; and $2.8 x 106 for 'life and medical benefits'. These entries are not costs. The coal resources are not going to disappear. Closing the mine will not increase the incidence of black lung disease, so it 120

hardly makes sense to count such liabilities as costs. Both this entry and the life and medical benefits are transfers from the mining firm to its employees, but social costs they are not. Indeed, if we remove the entries that are obviously not social costs, the 'mine closure costs' are reduced from $18.6 x 1()¢' to $0.9 x 10~'. The big differences between the two policy alternatives are in the coal mining employment effects. While both studies agree that total employment in mining will increase slightly under fuel switching and decline a bit more under a forced scrubbing policy, the CBO study sees only a modest difference in the four high-sulphur mining states. In the A D L study, however, predicted job losses for the fuel switching alternative are almost three times those of the forced scrubbing alternative, "~ or 25 700 versus 9 600. The truly dramatic employment effects found by A D L were in total regional employment changes, derived by applying employment multipliers to changes in mining employment. As shown, total employment under the fuel switching policy is down by over 50 000 in the four key states in 1995, compared to the no-policy base case. Hence, forced scrubbing would save over 40 000 jobs. To get estimates of employment losses analysts must make assumptions, first about the relationship between coal production and coal employment, and secondly, about the relationship between coal mine and total employment. With respect to this second ENERGY POLICY April 1989

Policies for the mitigation of acid rain

element, the A D L study makes a leap of faith in assuming a linear relationship between mining employment and total employment. To get some idea of the difficulty of developing such relationships, consider the relative productivity of underground coal~mines in the USA across states and through time. In 1984 the productivity across states varied from a low of 0.94 t/man-hour in Pennsylvania, to a high of 3.1 t/man-hour in Vermont. The productivity in Eastern Kentucky has risen from a low of 1.25 t/man-hour in 1978 to a high of 2.11 t/man-hour in 1984.11 Evidently, the productivity of coal miners is much more heterogeneous, both geographically and through time, than is often assumed. Similar difficulties arise in the estimation of employment multipliers. A comparison of coal mining employment changes in Ohio counties between 1974 and 1982 to changes in total employment reveals no pattern. This should not be surprising, since in only two counties do coal miners account for over 5% of the employed. Consequently, a reliable employment multiplier cannot be estimated, and there is a suggestion that employment in coal mining is so insignificant in most counties that mining lay-offs should be easily absorbed by the local economy.

anyway; acid rain policy only influences their location of incidence. For clues to the indirect costs of the policy, we should instead look at sites where the policy is causing assets to be 'underemployed'. In the extreme, any house that has to be abandoned as a result of the policy implies a house that has to be built elsewhere. More generally, the local decline in the value of real estate may be a useful estimate of the cost of the policy. In principle, the same considerations apply to public investment such as roads and schools. But the task of determining the decline in the value of public facilities when population declines is much more difficult, because markets for the affected facilities do not exist. In short, the difficulties of determining these indirect costs are so severe that policy analysts have chosen to ignore them. That does not mean that such costs do not exist. For choosing among policies that do not have appreciable differences in their spatial or regional economic implications, these indirect costs may not make much difference to policy evaluation. But for policies where the spatial implications are important, ignoring indirect costs can lead to the adoption of misguided policies.

CONCLUSION INDIRECT COSTS The A D L study makes much of the costs not borne by the electric utility and coal industries. Indeed, such costs are decisive in their analysis. The qualitative point being made is a valid one. Indirect costs are likely to be substantial for any outcome, such as fuel switching, which requires the relocation of a large number of families. These costs include the cost of new homes for the relocating workers, their moving costs, and the cost of additional public infrastructure, such as roads, schools and water supply. In addition, these increases have a further indirect impact in the private economy, as retailing and other local services must be expanded to meet the increased demand. However, these costs are not the sum of the value of new houses, commercial developments and public infrastructure - as calculated in the A D L study. ~2 The place to look for indirect costs is where employment is in decline. The reason is that expansion of 'fully employed' housing, commercial development and public infrastructure is driven by population growth, which is unlikely to be affected by the choice of acid rain policy. That is, many of these development costs would occur

ENERGY POLICY April 1989

Ultimately, it seems that these large-scale models can be faulted on two general grounds. First, they have introduced a false element of precision into the policy debate. Thus, it is largely taken for granted that allowing utilities to choose their method of emission reduction will result in a massive increase in low-sulphur coal use, at the expense of highsulphur coal. But this conclusion is based on model outcomes suggesting something like a 10-20% cost advantage, in the aggregate, for fuel switching over forced adoption of FGD. It is doubtful whether the resolution of the model really permits distinctions as fine as this. Therefore, while fuel switching is perhaps the most likely result of such a policy, it is by no means a foregone conclusion. One result of the near-universal acceptance of this prediction is the mis-specification of the problem facing the high-sulphur coal industry. With the problem thought to be exclusively an unemployment problem among high-sulphur mines, the options discussed for mitigating this outcome have naturally concerned unemployment, through such means as retraining or relocation assistance. The fact is, a freedom of choice policy could be harmful to the

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high-sulphur coal industry even if few jobs are lost. That such fuel will require extensive cleaning, either before or after combustion, is the equivalent of a tariff. In fact, offering retraining or relocation assistance could discourage miners from accepting lower wages, thus retarding market adjustments and making the model outcome a ~elf-fulfilling prophecy. If help for high-sulphur coal miners is desired, then perhaps direct wage subsidies would be more suitable, since they would permit wage adjustments. A second fault of these models is that they are based on inadequate notions of cost. For LP models the cost is limited to the direct engineering estimates of the cost burden on the coal and electric utilities industries. This is, to begin with, probably a serious under-estimate, in as much as the costs imposed on other parties - the indirect costs - are omitted. Even worse, the omitted costs are probably not random across policies. Modelled outcomes are systematically biased against some policies - in this case, against policies requiring little spatial re-allocation relative to those requiring a lot. Bringing indirect costs into the analysis is difficult, and attempts to do so have largely been unsuccessful. Arthur D. Little's estimate of indirect costs suggests that such costs are a substantial part of the total. In their analysis, however, social costs are badly confused with expenditures and transfer payments. All these limitations do not mean that large, comprehensive simulation models have no role to play in acid rain policy analysis. The LP models especially can be very useful. What else offers the prospect of simulating the moves of the major players in the coal and electric utility market? However, a little more diffidence with respect to model outcomes would be appropriate. Above all, far more attention must be paid to their sensitivity to the multitude of assumptions required, rather than

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to the comparison of outcomes for policies that are often only marginally different. This work was partially supported by the J. Howard Pew Freedom Trust. The authors are grateful for insightful comments from John Ahearne, Joel Darmstadter, Richard Gordon, Irving Hoch, Allen Kneese, Hans Landsberg, and Paul Portney. The usual disclaimers apply.

1See, Emissions, Costs and Engineering Assessment, Work Group 3B, United States-Canada Memorandum of Intent on Transboundary Air Pollution, June 1982. 2This refinement is in fact possible within the confines of an LP formulation - see H. Dowlatabadi, Electricity Interchange Between Integrated Grid Systems, PhD thesis, Cambridge University, UK, 1984. 3Much of the inconsistency in data is due to variations in firm-level interpretation of questionnaires. 4CEUM is a product of ICF, a Washington, DC consulting firm; NCM-5 has been developed by the Energy Information Administration. Both are descendants of the original National Coal Model, developed in the mid-1970s to help see the USA through the energy crisis. 5There is a great deal of flexibility available in meeting an 8 x 106 t/year emission reduction goal. Tighter emission constraints can only be met through additional investments in FGD equipment. 6Paul R. Portney, 'How not to create a job', Regulation, AEI Journal on Government and Society, November-December 1982, pp 35-38. 7There also may be indirect beneficiaries, such as real estate owners and agents in areas about to become boom-towns, and tenants in the areas about to become ghost-towns. 8United States Congressional Budget Office, Curbing Acid Rain: Cost, Budget, and Coal-Market Effects, US Government Printing Office, Washington, 1986. 9Arthur D. Little, Inc, Economic Impacts of Alternative Acid Rain Control Strategies, Final Report to Consolidated Coal Company, 1985. I°ADL did not single out these four states as CBO did; the numbers in Table 2 were taken from tables on individual states for purposes of comparison with the CBO study. 11Figures taken from Irving Hoch, Richard Gordon and Winston Harrington, Policy Affecting The Coal Industry, Resources for the Future, Washington, DC, April 1988, Table 4-35. ~l'hese estimates were taken from The Costs of Sprawl, Real Estate Research Corporation, April 1974, and adjusted for inflation.

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