Thursday, December 10, 2015

Mandated Fuel Economy and Why the Government Should Scrap CAFE Standards

I'm one for wanting to protect the environment. After all, we only have one environment. If we mess it up, the planet becomes uninhabitable. However, we cannot let feelings for wanting to preserve the environment muddle our sense of what makes for good environmental policy. If we do, all we get in return is feel-good policy that most probably worsens the quality of life. It's something to keep in mind when looking at a policy like the U.S. government's Corporate Average Fuel Rate (CAFE) standards.

Congress passed the first set of CAFE standards back in 1975, which have been regulated by the Department of Transportation (DoT) ever since. Every so often, Congress at least been mindful enough to update the standards. While there were environmental concerns about increasing fuel emissions, the primary concern in 1975 was dealing with oil shortages in light of the Arab Oil Embargo. Although we don't have to deal with an oil embargo in 2015, legally requiring certain mileage standards sounds intuitive enough. Not only do better fuel standards consume less of a scarce resource, but it also releases less harmful emissions into the atmosphere. After all, looking at the historic average fuel efficiency of light-duty vehicles, it has increased [for passenger cars] from 24.3 miles in 1980 to 36.0 in 2013 (DoT).

While one might be prone to attribute increased fuel efficiency to CAFE standards, causation is tenuous. I can just as easily attribute the increased fuel efficiency to technological development. As a matter of fact, a 2015 news release from a study conducted by the National Academies of Sciences shows that most of the reduction in fuel consumption from 2015 to 2025 will not come from CAFE standards, but from technological improvements in gasoline internal combustion engines. An economist from MIT actually found that if CAFE standards did not exist, fuel economy would have increased by 60 percent [instead of the 15 percent that by which it increased] (Knittel, 2011). More to the point, these standards introduce penalties in order to incentivize more fuel efficient cars. This doesn't act as a direct subsidy, but indirectly attempts to affect producer behavior with some negative reinforcement. Does said negative reinforcement have the desirable effects?

The Heritage Foundation recently released a policy analysis on how bad policies increase the cost of living for the American people. One of those policies was the implementation of CAFE standards. According to Heritage Foundation calculations, CAFE standards cost the American people $55 billion per annum, which comes out to $448 per household.

This research also found that prior to Obama's 2009 mandate to add an extra nine miles to fuel efficiency over a five-year period, automobile prices were decreasing. Only after Obama's mandate did automobile prices start to rise again. If government mandates expect that rapid growth in such a short time, especially considering that it takes time to develop, test, and incorporate such changes, it's no surprise automobile prices shot up once the mandate took effect. Fuel economy standards will continue to add costs. According to a report from the Center for Automotive Research (CAR, p. 27), the 2017-2025 CAFE standards will add anywhere from $3,734-9,790 on the sticker price of the car, depending on automobile type. Another factor to consider is that enough automobile manufacturers would rather pay CAFE fines, which also begs the question of how much CAFE standards affect fuel economy.

Price increases affect the consumer with what is called price elasticity of demand. Essentially, price elasticity is the sensitivity to which a consumer responds to price changes [in form of a ratio to change of price to change in quantity]. The greater the shock is to the consumer, the higher the price elasticity of demand. Automobiles are more likely to generate a higher price elasticity of demand because a 10 percent change in an expensive purchase is going to be more impactful than a 10 percent price change in bananas. Raising the price on an elastic good either means not purchasing a new automobile or delaying the purchase by driving around a clunker. A study from the National Bureau of Economic Research (Jacobsen and van Benthem, 2013) not only confirms that CAFE standards caused enough of a price increase to postpone scrapping their old cars, but that 13 to 23 percent of the expected gains from fuel efficiency are lost because of the used vehicle market.

There is more than the sticker price of the automobile to consider. CAFE standards could very well cost lives. How so? In order to meet fuel economy standards, the most efficient way for automobile OEMs to do so is to make the vehicles lighter (e.g., converting steel to aluminum). Weight disparities create greater risk for those driving lighter cars. For instance, the National Academics Press found that making automobiles killed up to 2,600 additional individuals in 1993, and the Cascade Policy found that CAFE standards took up to 4,500 lives in 1997.

Even if you want to argue that there are net benefits to CAFE standards (e.g., Council on Foreign Relations, ConsumersUnion), I would still argue that better policies could be implemented, especially since consumers are more likely to put emphasis on the upfront costs of increased cars versus the longer-term fuel efficiency savings (Sallee et al., 2015). We can talk about feebates, but I would put more emphasis on the fuel tax, specifically on reforming the fuel tax to be more efficient. In comparison to other policy alternatives, fuel economy standards are six to fourteen times more expensive than a consumption-reducing tax (Karplus et al., 2013). But simply saying "let's increase the fuel tax" might not cut it. As I have brought up in the past, we should replace the fuel tax with a mileage-based user fee. A mileage-based user fee would be an improvement over the status quo, thereby removing the magnitude of the issues behind CAFE standards while accomplishing its primary goals.

3-4-2016 Addendum: The Heritage Foundation just realized a policy brief showing how, among other things, CAFE standards increase the sticker price of an automobile by $3,400 while only reducing the global temperature by a couple-hundredths of a degree Celsius at best.

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