Study Calls into Question Fuel Economy Regulation Benefits

May 29, 2013

James Valvo

In August 2012, the Department of Transportation and Environmental Protection Agency (EPA) finalized another increase in the government-mandated corporate average fuel economy standards (CAFE).  The Obama administration claimed that the new 54.5 mpg mandate for cars and light trucks will “save consumers more than $1.7 trillion at the gas pump and reduce U.S. oil consumption by 12 billion barrels.”  Lisa Jackson, then-EPA administrator, claimed that “fuel efficiency standards … are another example of how we protect the environment and strengthen the economy at the same time.”  Of course these effects are not created in a vacuum; the higher CAFE standards will drive up the average price of a new vehicle by nearly $3,000, according to the National Automobile Dealers Association.  And so it always goes with new regulations: some government-proclaimed benefits on one side, and costs paid by citizens on the other.  This cost-benefit analysis, hopefully, informs the regulatory decision-making process.  However, a new study finds that between 13-23% of the supposed benefits never materialize, calling the benefit claims into question.

Mark Jacobsen and Arthur van Benthem released a new working paper through the National Bureau of Economic Research analyzing the purported benefits of increased CAFE standards, including saving on gasoline and reduced air pollution.  Jacobsen and van Benthem sought to measure the effect of higher CAFE requirements and the rate at which people replace their cars.  Theoretical economic research has long understood that higher CAFE means higher prices and that in response people will buy fewer cars and those who own cars will replace them less frequently.  However, the Jacobson-van Benthem study is the first to empirically research the issue and measure the effect.

The study, which spanned a 17-year data set covering the entire country, outlined the effect they were trying to study as follows:  “new vehicle prices rise due to tightened fuel economy regulation, the prices of used vehicles also increase in equilibrium. This gives used vehicle owners an incentive to postpone the decision to scrap their vehicles, leading to a larger and potentially less fuel-efficient used vehicle fleet.”  The amount of projected increased fuel economy that is not realized due to this postponement is called “leakage” and properly accounting for it is a critical aspect of the cost-benefit analysis that should be conducted for any significant regulation.

The study found that “13-23% of the expected fuel savings will leak away through the used vehicle market.”  The data also show and the study’s findings were adjusted for the fact that people are 11% more likely to hold onto more fuel-efficient used vehicles.  This loss of supposed fuel savings from increased CAFE is compounded by what is known as the “rebound effect.”  This well-studied effect describes how drivers increase the distance they drive when they are in a more fuel-efficient vehicle.  Numerous studies have measured this effect and a 2012 paper by Yale Economics Professor Kenneth Gillingham found a 15% rebound effect, a response he said shows that “in the medium-run there is still a clear response.”

These two effects work in concert to undermine the initial claims about how much money people will save when government increases CAFE standards.  On one end of the spectrum, the higher price of new cars traps people in older, less-efficient, used cars longer, increasing their fuel consumption.  On the other end of the spectrum, people who are able to afford the more expensive and relatively more fuel-efficient new cars tend to drive those cars further than they otherwise would have; this also decreases the purported savings.

These effects are not isolated to adjustments to supposed monetary savings.  Because the Jacobson-van Benthem study focused on fuel consumption, the leakage and rebound effect both also impact vehicle emissions, air pollution and related health claims.  The authors write: “Our findings also suggest an interesting overlap with the literature on local air pollution: Many of the gross polluters in terms of smog and ozone precursors tend to be the very oldest vehicles on the road.”  Higher CAFE standards have the perverse incentive of keeping drivers in older, more polluting cars longer.  Thus, the same 13-23% leakage effect impacts claimed air pollution reductions and related health claims.

Subjecting regulations to honest cost-benefit analysis is crucial to making good rules.  When the costs are obvious and people’s behavioral reactions to those new costs are not well understood, we end up with regulations that sound great in a press release but never live up to their advertising.  The Jacobson-van Benthem study brings further clarity to the negative impacts higher CAFE standards have on the new and used vehicle markets.

Mr. Valvo is director of policy at Americans for Prosperity. Follow: @JamesValvo


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