Fuel Efficiency Standards Vs. Gas Tax

A great post, “CAFE Standards,” from James Hamilton at Econbrowser on how fuel efficiency standards (technically, corporate average fuel efficiency, or CAFE) work and their effects in practice. He in turn cites research by Marc Jacobsen, an economics PhD at Stanford.

I found it useful to understand a bit more about how these standards are applied, particularly since the popular press generally glosses over these details.

Econbrowser provides a very good summary of the paper, but let me highlight the key points:

• “Almost all the profit impact of CAFE is borne by domestic firms.” Japanese automakers are already fuel-efficient; tightening the standards doesn’t affect them. The European car makers pay fine rather than changing their cars.

• CAFE costs six times as much as gas taxes for the same amount of fuel use reduction.

Why the continued reliance on CAFE, if it is so inefficient? Because the costs aren’t visible to the consumer, while gas taxes would be. Better to do something that pretends to solve the problem, but doesn’t annoy voters, than do something effective that might force people to change behavior. Except this strategy, ironically, does hurt Detroit automakers, and so is detrimental to some American workers.

From Econbrowser:

Featuring prominently in the new energy plan from President Bush is a call for changes in the corporate average fuel efficiency (CAFE) standards that the Administration claims could reduce U.S. gasoline consumption by 5% over the next 10 years. Here are some of the reasons I’m not thrilled by that suggestion.

CAFE standards are based on the premise that auto manufacturers and consumers are making inappropriate decisions about the kind of vehicles that get produced. The clearest way to motivate this from an economic perspective would be to suggest that there are costs to using gasoline beyond those paid directly by consumers, such as a geopolitical cost when the U.S. relies on imported oil or possible consequences for the world climate. But if that is the motivation, an economically more efficient way to accomplish the objective would be to tax the gasoline use itself so that the after-tax price paid by consumers completely reflects whatever these true costs are deemed to be. This has the benefits of providing an incentive not just to purchase more fuel-efficient cars, but also to encourage more fuel conservation in the use of the existing fleet through such measures as driving slower, driving less, or getting more of the existing mileage from the more fuel-efficient vehicles. And it allows consumers and firms the maximum flexibility to figure out how to do this in the least disruptive way.

When you force consumers to buy something other than their first choice, the consequences may not be quite what the policy-maker originally envisioned. One example sometimes given is the shift to SUVs. Because the initial CAFE standards were different for “light trucks” as opposed to “cars”, one way Detroit responded to CAFE was to create a new supersized vehicle that in practice is used the way a “passenger car” used to be, but that wasn’t similarly regulated. A second example of a possible unintended consequence of tightening CAFE is that if American cars no longer have the characteristics sought by consumers, they will buy more imports.

There is an interesting new study of this by Mark Jacobsen, an economics Ph.D. student at Stanford whom we’re trying to persuade to join our faculty at UCSD. Jacobsen notes that auto producers generally fall into one of three groups, as exemplified by Toyota, Ford, and BMW in the diagram below. The fleet of a Japanese producer like Toyota usually has an average fuel economy that is higher than the existing CAFE standard, meaning that a modest increase in the standard would not affect them directly. European producers like BMW fail to meet existing CAFE standards, and choose to just pay the fine that is required for any company that fails to comply. The third group is the U.S. producers like Ford, who feel that violating the CAFE standards would expose them to unwanted publicity, litigation, or further undesirable legislation, and therefore stay just inside the standard. It is thus the U.S. auto producers who do the adjusting when CAFE standards are tightened.

Jacobsen builds a detailed model of the American new and used car market based on the choices consumers make between different kinds of cars. His simulations suggest that one consequence of tightening CAFE standards is an increase in the number of imported cars and a decrease in the fuel efficiency of those cars. Essentially the European producers have an advantage over the American producers in being more willing to flaunt their violation of the CAFE standards, and the Japanese producers have the advantage of selling enough compact vehicles to be allowed to expand less-efficient models such as the Acura. Thus, people who like bigger cars end up buying more of them from the importers when the standards are tightened.

Overall, Jacobsen estimates that a one-mile-per-gallon increase in the required average corporate fuel efficiency would increase the average fuel-efficiency of all new cars sold by 2.5%. However, since most of the older cars would still be on the road, Jacobsen estimates that during the first year, total U.S. gasoline consumption would decline by only 0.8%. He estimates the costs of this 1 mpg tightening of CAFE would be $20 billion in the first year, with these first-year costs shared about equally between U.S. consumers and producers. For comparison, Jacobsen claims that a gasoline tax could accomplish the same first-year effect at an efficiency cost of significantly less than $1 billion.

Over time, the fuel savings from tightening CAFE would of course increase, but even after 10 years, Jacobsen concludes that that a gasoline tax could accomplish the same thing at 1/6 the cost.

Although it is hard to motivate CAFE from sound economic principles, somehow it has political staying power. The public evidently sees the costs associated with CAFE as borne by “somebody else” whereas they know they pay the gasoline taxes themselves. But here’s another possible proposal that might be suggested by Jacobsen’s research. Why not start decrying the fact that some of those foreign companies are failing to comply with our existing CAFE standards, and claim that what we need to do is get more serious about enforcing these, and raise the payment required per vehicle of any company that fails to meet the standards? In practice, this would amount to either raising the tax on BMWs, or forcing the European importers to sell some more fuel-efficient vehicles. Ford and GM would be spared, as long as they continue to stay within the existing standards.

Maybe not a proposal that an economist would love. But a politician might. And it seems that’s the name of the game here.

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