Air pollution causes considerable damage to human health, flora and fauna, and materials. The damage costs are externalities to the extent that these costs are not reflected in the prices of goods. When making decisions that affect the emission of pollutants, the damage costs, also called external costs, should be considered. The external costs can be internalized via taxes, tradable permits, or other environmental regulations..

In recent years, there has been much progress in the analysis of environmental damage costs due mostly to several major projects evaluating the external costs of energy in Europe (ExternE 1995, 1998, 2000, 2004) and also in the United States (Lee 1994; Rowe et al. 1995). Of these projects the ExternE (External Costs of Energy) Project of the European Commission has the widest scope and is the most up to date. This paper, authored by participants of all ExternE Projects since 1992, presents an overview of the methodology and the results.

The quantification of damage costs has many important applications:

• Guidance for environmental regulations (e.g., determining the optimal level of the limit for the emission of a pollutant)

• Finding the socially optimal level of a pollution tax

• Identifying technologies with the lowest social cost (e.g., coal, natural gas, or nuclear power for the production of electricity)

• Evaluating the benefits of improving the pollution abatement of an existing installation such as a waste incinerator

• Optimizing the dispatching of power plants

• "Green accounting," i.e., including corrections for environmental damage in the traditional accounts of GNP

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