This paper investigates the impact of strengthening vehicle emission regulation on economic activities. The government attempts to use three regulation measures to protect air quality from transportation emission. The measures include the aggregate limit (bubbles), the vehicle emission standard, and the fuel quality standard. Especially, we focus on the economic impact of reducing sulfur content in diesel fuel quality standard. Sulfur content in diesel fuel is one of the main factors in worsening local air quality. The emission from diesel vehicle accounts for 51.8% of total vehicle emission in Korea. If sulfur content reduction regulation is implemented, then the petroleum industry should build more facility to produce low sulfur content diesel, leading to additional production costs and increasing prices and decreasing outputs. We use computable general equilibrium model to analyze how the sulfur reduction regulation affects economic activities and trace out local emission reduction cost and GDP loss. And we suggest the tax-recycling mechanism to mitigate the negative economic costs due to the sulfur reduction regulation. (c) 2004 Published by Elsevier Ltd.