The Senate has passed legislation that would significantly increase motor vehicle fuel economy, although the jury is out as to whether it will reduce fuel consumption. For example, one of the predictable consequences of higher CAFE standards is that vehicle miles traveled will increase. We’ve posted on this and other predictable consequences.
Today we summarize some elementary principles in the economics of regulation. They suggest why Congress is enamored of CAFE standards rather than other tools that would more effectively and efficiently reduce gasoline consumption, their stated objective.
For the new standards to make economic sense, Congress must believe at least the following statements are true:
- Much higher average motor vehicle fuel economy is in the national interest.
- The free market will not produce much higher average motor vehicle fuel economy.
Stipulating for the purpose of discussion that these statements are true, regulation thus is needed. Otherwise, consumers will continue to purchase relatively low-mpg vehicles that satisfy their preferences, in which they trade off fuel economy for other vehicle attributes including safety, comfort, performance and practical utility.
There are two general regulatory approaches available: command-and-control and economic incentives. Command-and-control comes in two flavors: design standards and performance standards. Design standards dictate how regulatory objectives must be achieved. Performance standards dictate what regulatory standards must be achieved but permit regulated parties to choose for themselves the means by which they do so. There are also two types of economic incentives: charges on the activity deemed undesirable and transferable permits limiting the amount of the undesirable activity that is permissible. A gas tax is an example of a charge on the undesirable activity, which in this case is burning gasoline. A transferable permit would allocate the right to burn gasoline and allow permit holders to freely buy more if they want or sell those they decide they don’t need. Economists have shown that economic incentives achieve any regulatory objective at lower cost, and that in theory charges and permits are equivalent tools. (They vary considerably in implementation because, among other things, they have different transactions costs and create different incentives for private- and public-sector rentseeking. A gas tax is easy to implement but a gasoline consumption permit scheme is not. A gas tax generates revenue to the government, but a gasoline consumption permit scheme would not unless permits were auctioned. If they are not auctioned, competition over the rents from initial assignment can be fierce and ugly. Governments can become dependent on the revenue from a gas tax, which backfires if consumers respond by reducing consumption.)
CAFE standards are an example of command-and-control regulation using an incomplete performance standard. It is inherently less efficient than an economic incentive would be at achieving Congress’ desired reduction in gasoline use. It is also less transparent. It shifts visible responsibility for the pain consumers will experience from Congress to motor vehicle manufacturers. (Transferable permits also have the attribute of shifting visible responsibility. Consumers do not observe the activity behind the scenes that leads to the price changes they experience.)
Details on how CAFE works are here. Each motor vehicle manufacturer must achieve the specified fleet average or pay a fine, but differences in manufacturers’ costs and market niches are not taken into account. Manufacturers of limited production low-mpg vehicles simply pay the fine. For a Maybach, the penalty is $5.50 x 10 x (27.5 – 11) ~ $1,000. The MSRP for a “stripped” 2007 Model 57 is $335,000.
Manufacturers that exceed the standard generate credits for use in later years. They cannot sell these credits, either to other manufacturers or to pro-fuel economy interest groups that might want to “retire” them. If credits could be freely traded, any standard could be achieved at lower cost or a higher standard could be achieved at the same cost. If they could sell excess credits, manufacturers of low price, high-mpg vehicles could reduce their prices and sell more low-price, high-mpg vehicles.
One principle advantage of economic incentives is that it puts consumers in charge of making tradeoffs. Not only can they choose how to balance fuel economy with other attributes such as safety, comfort, performance and practical utility, but they also can trade off fuel efficiency with vehicle miles traveled. For example, they can choose to own a high-mpg vehicle and drive it more or a low-mpg vehicle and drive it less.
Command-and-control regulation denies consumers many of these choices. They are compelled to trade off safety, comfort, performance and practical utility subject to a constrained minimum level of fuel efficiency. They are not permitted to trade off fuel efficiency and vehicle miles traveled.
Command-and-control regulation is appropriate if policy makers do not want consumers to have the freedom to make these tradeoffs. Through CAFE, Congress achieves this restriction on freedom by deterring manufacturers from producing the mix of vehicles that consumers want. Because manufacturers will be compelled to produce more vehicles that consumers don’t want and fewer vehicles that consumers do want, they are likely to overprice low-mpg vehicles and underprice high-mpg vehicles. The magnitude of this cross-subsidy depends on how much consumers’ preferences differ from those of the Congress.
Thus far, the debate over CAFE has not included any of these issues. The debate has focused on the presumptive reductions in fuel consumption that higher standards will achieve, and motor vehicle manufacturers’ presumed culpability for supplying the mix of vehicles that consumers want. Fuel consumption reductions will be less than forecast, for the reason we’ve previously outlined. Consumer preferences are what they are, and it is a strange business indeed that chooses not to provide what consumers actually want.
On the other hand, an effective and efficient economic incentive, such as a gas tax, is politically very unpopular. A New York Times poll conducted in 2006 revealed a huge majority of respondents were opposed to a gas tax, though news coverage of the poll was consistently misleading. John Whitehead quotes from the Times article in which the results were characterized in more optimistic terms:
Eighty-five percent of the 1,018 adults polled opposed an increase in the federal gasoline tax, suggesting that politicians have good reason to steer away from so unpopular a measure. But 55 percent said they would support an increase in the tax, which has been 18.4 cents a gallon since 1993, if it did in fact reduce dependence on foreign oil. Fifty-nine percent were in favor if the result was less gasoline consumption and less global warming. The margin of sampling error is plus or minus three percentage points.
We’re always skeptical of polls, and especially those in which respondents are asked to make hypothetical costly decisions. Nevertheless, opposition to increased gas taxes is such a consistent polling outcome that there is little grounds for believing that the public secretly wants higher gasoline prices. A May 2007 Minnesota poll showed a bare majority stating a willingness to pay five cents more to fund transportation improvements. A May 2007 Utah poll found just 13% willing to state support for supporting an increase of “as much as 25 cents per gallon” to fund transportation projects. In both cases, the benefits to be achieved were (literally) more concrete than such matters as energy independence or mitigating global climate change.
Liberal columnist Jonathan Alter has written that a gas tax to reduce CO2 emissions is “DOA”:
Think of the energy that has been wasted in recent years calling for a gas tax. New York Times columnist Tom Friedman alone seems to advocate it every week or so. So does every other “responsible” energy plan. Only one problem: Not Gonna Happen. Look at the public furor over current gas prices that has Congress running for cover. The idea of adding a dollar-a-gallon tax at the pump is deader than Phil Leotardo in the final episode of “The Sopranos.”
He offers a number of ideas, but what all of them have in common is that they would be less effective, less efficient, and more apt to require linguistic mischief to deflect responsibility away from Congress when prices rise. For example:
The reason a gas tax or any other carbon tax is political poison is that people don’t trust the government to spent their money wisely. (Sen. Chris Dodd, for instance, has proposed that the proceeds from a carbon tax be dedicated to fund alternative energy sources. Nice idea, and give him credit for guts not shown by the other presidential candidates. But it won’t fly.) So instead of “taxes,” think “charges” or “assessments.” And instead of “government spending” or “tax breaks,” think “dividend checks” every month, perhaps through debit cards. For you. For everyone. Think free money.
CAFE is an example of a regulatory instrument that is clearly inefficient at achieving the public purpose of reducing motor vehicle fuel consumption. Given predictable adaptive responses, it might not even be effective. It’s conceivable that a relatively small gas tax would achieve an equal reduction in motor vehicle fuel consumption. But CAFE has the important political advantage of shifting to others the responsibility for achieving the desired public purpose and blame for the high cost and reduced freedom of choice that consumers will experience.