The tough economics of fuel economy standards – niskanen center

The EPA has released a proposed rule that would freeze corporate average fuel economy (CAFE) standards at 37 miles per gallon, rather than allowing them to rise to the Obama administration’s target of 54 MPG, as currently scheduled. The administration’s proposal has the cute name of Safer and Affordable Fuel-Efficient Vehicles Rule , or “SAFE Vehicle Rule,” for short.

The proposed rule has been widely panned by environmentalists, and rightly so. However, the critics of the rule are wrong simply to defend the existing CAFE standards. The EPA’s analysis of the flaws of those standards is justified. But neither the EPA nor its critics are reaching the right conclusion, which is that we should repeal CAFE standards and replace them with a carbon tax — one tough enough to reduce carbon emissions by as much, or more, without the unintended consequences.


The biggest problem with CAFE standards as a tool for reducing greenhouse gas emissions is that they encourage fuel saving only at the dealership, not at the pump. Once a consumer buys a low-mileage vehicle, the cost of driving an extra mile goes down, thereby reducing the incentive for fuel-saving measures like moving closer to work, working at home, riding the bus to work, or consolidating errands. The tendency of more fuel-efficient vehicles to induce additional driving is known as the rebound effect . More vehicles on the road, in turn, means an increase in accidents – one of the safety issues raised by the EPA in defense of the SAFE Vehicle Rule.

The variable that is most critical to the size of the rebound effect is the how much more people will drive when it costs them less to do so – what economists call the elasticity of demand. For example, if a 10 percent improvement in fuel efficiency (assuming no change in the price of fuel) would cause a 3 percent increase in driving, the elasticity would be -0.3. The increased miles driven would partly offset the improvement in miles per gallon, so that total fuel consumption would decrease by only about 7 percent. If the elasticity were only -0.1, then fuel consumption would fall by 9 percent in response to a 10 percent improvement in fuel efficiency.

The fact is, we don’t really know what that critical elasticity is — only that averaged over all drivers, it is negative. Numerical estimates differ widely. Plumer draws our attention to some small estimates, while the EPA cherry-picks the largest ones (I have covered this debate more extensively at Economonitor ). But both sides miss the point: We know for sure that the number of miles driven goes up when the cost per mile goes down, and vice versa. That means that the number of miles driven goes up when CAFE standards are tightened.

Elasticity also matters when the cost of fuel rises, as it would with a carbon tax. However, using a tax to raise fuel prices at the pump has a different set of impacts on vehicle choice and driving behavior. If we take -0.3 as our estimate of elasticity, a tax that raised the price of fuel by 10 percent would still reduce total fuel use by 3 percent. But now consumers would respond to the tax partly by buying moderately more efficient vehicles and partly by driving them less, rather than by buying super-efficient vehicles and then driving them more, as would happens with a 54 MPG CAFE standard. We don’t know with certainty how large a tax would be needed to save the same amount of fuel as the Obama-era CAFE standards, but economist Noah Kaufman makes a rough estimate of $50 per ton, or about 50 cents per gallon of gasoline. Vehicle turnover

The global information firm IHS Markit reports that the average age of vehicles on the road has, in fact, risen by a full two years since 2002, but the trend in price is another matter, Data from the Bureau of Economic Analysis and AxelGeeks (reported here from WGNTV.com ) show that the inflation-adjusted price of new cars actually fell by some 13 percent over the same period. Why, then, are original owners hanging on to their cars longer and why are used cars being kept in service longer before they are junked? IHS Markit points to improvements in vehicle quality, not price, as the main reason. Lighter vehicles

The EPA argues that strict CAFE standards further hurt safety by encouraging manufacturers to make lighter vehicles, even though, it claims, heavier vehicles are safer. It is true that in a head-to-head between a Ford Expedition Max (5,700 pounds) and a Ford Fiesta (2,500 pounds), you definitely want to be driving the Max. But, as Plumer points out, the Max makes driving safer only for its own occupants, while reducing the safety of those in the Fiesta. If the administration really cared about safety, it seems that the best way would be to reduce the total range in vehicle size.

Higher fuel prices induced by a carbon tax ought to do just that, since they would discourage the purchase of gas-hungry SUVs. A study from Resources for the Future found that between 2003 and 2007, gasoline prices accounted for about half of changes in market share between SUVs and smaller cars. However, that study also found that over time, CAFE standards have blunted the effect of fuel prices, so that SUVs have remained popular no matter what.

Of course, some people would always want an SUV to tow the family boat to the lake or a pickup to haul lumber to the construction site. Even so, a carbon tax would help. For one thing, it would increase the incentive for manufacturers to make such large vehicles lighter to save on fuel, for example, by replacing steel components with aluminum. In addition, for families that have both a Max and a Fiesta in their driveways, higher fuel prices would increase the incentive to leave the Max parked when there is no need to tow a boat or haul a whole soccer team to a game.

But, wouldn’t a carbon tax also encourage people to buy more of the smallest vehicles? Wouldn’t that offset any benefits from a reduction in the chance of being T-boned by a monster SUV? Not necessarily, since, CAFE standards already encourage the purchase of the smallest vehicles, despite low gas prices. Wards Auto , another leading source of industry information, asks why car companies keep making small cars at all, when all the glamor is with larger vehicles. Number one on their list of explanations: Selling small cars, even at a slim profit margin, or none, lets carmakers comply with the CAFE system and sell more Maxes.

On balance, then, the best way to improve safety would be to eliminate CAFE standards and replace them with a carbon tax. Doing so would make for fewer ultra-heavy vehicles while eliminating the incentive to manufacture ultra-light vehicles and sell them at a loss. Meanwhile, all vehicles, especially the largest ones, would be driven fewer miles, for a net gain in highway safety. Electric vehicles

Although it is not strictly a safety issue, Trump administration officials also object to the way CAFE standards favor electric cars. Writing in the Wall Street Journal , Transportation Secretary Elaine Chao and EPA administrator Andrew Wheeler argue that “to meet the previous administration’s fuel-economy and greenhouse-gas standards, manufacturers would have to produce vehicle lineups that are 30 percent electric or more over the next seven years — far more vehicles than buyers are likely to want.”

It may very well be that people don’t want that many electric vehicles given today’s low gasoline prices, although they would probably want more if a carbon tax raised the price of gasoline. However, that is only part of the story. Replacing CAFE standards with a carbon tax would not only have an impact on how many electric vehicles were sold, but also on who buys those vehicles and where.

The problem with electric vehicles, as even their fans point out, is that they are only as efficient as the power you use to charge them. As the Sierra Club notes in a consumer guide to buying electric vehicles, “When coal plants supply the majority of the power in a given area, electric vehicles may emit more CO2 and SO2 pollution than hybrid electric vehicles. Learn where your electricity comes from” before you buy, they warn.

Electric vehicles are a case where a carbon tax would make a triple play. First, it would encourage people to buy efficient vehicles in general, electric vehicles included. Second, it would establish incentives that would concentrate electric vehicle purchases in the areas where renewable power is abundant, since where the electric supply relies heavily on coal, electric vehicle buyers would have to pay for the carbon emissions at charge-up. Third, over time, a carbon tax would put pressure on utilities to switch away from carbon-intensive electricity, at which point electric cars would make sense everywhere. The bottom line

There is no reason why we can’t have safe highways and a clean environment. The solution is obvious: Get rid of CAFE standards and replace them with a carbon tax of equivalent rigor. That would give us less pollution, fewer miles driven, and a selection of safe vehicles driven by economic realities and consumer choice rather than by bureaucratic whim.