Raising MPG Standards: The Second-best Solution to a Gas Tax Increase

(Comstock)

It got surprisingly little press coverage given the degree to which it will affect our lives (thanks, pesky world economic meltdown), but in case you missed it, the Obama administration recently worked out a compromise with the major automakers that will dramatically raise the corporate average fuel economy (CAFE) standards.

The new regulations mandate that the mix of new cars sold in the year 2025 must achieve about 54.5 miles per gallon (though if you read the fine print you’ll see that credits for various other green innovations mean that actual fuel economy will be more like 40 MPG.) For reference, the auto fleet currently on the road gets about 27 MPG. It’s a well-done agreement that will help avoid well-done citizens as global warming accelerates.

Before proceeding, let me note that I am strongly in favor of this policy. The problem of excessive fossil fuel use in transportation is multidimensional: if the issue of global warming doesn’t move you, the thought of Hugo Chavez and Mahmoud Ahmadinejad using our own hard-earned dollars to tweak our geopolitical noses should.

However, it is worth noting that raising CAFE standards is what political scientists and economists call a “second-best” solution; we could be doing considerably better if we thought all of this through more clearly.

This is not because CAFE doesn’t work; it does. In 1975, a few years before CAFE was implemented, average MPG for new cars and light-duty trucks was 13.1. In 2010 it was 22.5. Can this be attributed to CAFE? To a large degree, yes, as this graph makes clear:

CAFE standards were aggressively increased from 1978 to 1984, and, as the chart above shows, fuel economy responded. However, from 1985 until 2007 CAFE standards were no longer raised meaningfully—and MPG flatlined. The table makes it pretty clear that the CAFE standards created a floor under MPG for a 25-year period, when low gas prices (remember those?) rendered consumers otherwise indifferent to fuel economy.

So what’s the problem with raising CAFE today?

There is a long history of debate on whether “command and control” regulations (like raising CAFE standards) are a good way to bring about change. The other option is the use of price signals—which in this case would be increased fuel taxes—to influence consumer behavior.

Regulations do have some attractive features. For example, we can directly target what, when, and how much improvement we are getting. If we want fuel economy of 55 MPG, we can decree and achieve it with greater certainty than if we try to monkey around with prices.

However, in theory at least, economists generally prefer to do things with price signals as opposed to regulatory standards. Why?

Price signals inflict pain on consumers, but let them figure out what form they want to take it in. They in turn force producers to respond to their (altered) demand, but allow producers leeway in how that demand is met. This allows consumers and producers to change behavior in the most efficient possible manner.

Instead of CAFE, why not just raise the gas tax and let drivers figure out whether they want smaller cars, lighter cars, less powerful cars, more expensive cars, shorter-range cars, or, crucially, cars that are just as heavy, powerful, and cheap—but which get driven less?

This raises the true problem with CAFE. It misses out on a potentially key part of the solution to reducing fuel use: driving less. In fact, ironically, increased CAFE standards will have a perverse and unwelcome effect; better fuel economy will increase the fixed cost of driving (i.e. vehicle prices) but will actually reduce the marginal cost (i.e. fuel expenditures). To a degree, less thirsty cars will actually cause people to increase the number of miles they drive (as I’ve written about here).

With increased gas taxes, on the other hand, less driving will be part of the consumer’s toolkit. Some who absolutely need vehicles with poor fuel economy will have the option of avoiding the tax by driving less instead. As long as their fuel use goes down, why not give them that choice? Greater economic efficiency would result. In fact, the Congressional Budget Office ran the numbers in 2004 and found that cutting fuel use through taxes was considerably cheaper in the long run than raising CAFE.

Reducing driving through a higher gas tax would have other important benefits that improving fuel economy does not, like congestion relief and accident reduction. I personally am more sympathetic to automobility than most of my colleagues in my field, and I have faith that technological ingenuity will deal a powerful and probably decisive blow to our emissions problems. But raising the price of driving above current levels is pretty much a no-brainer; it has support that stretches across ideological lines in the transportation field, even among those like me (and even among carmakers such as GM) who do not see exchanging cars for biodegradable pogo sticks as the only possible solution to our transportation problems.

Another advantage of a gas tax increase is that it would start working today. Since the car fleet takes so long to turn over (according to the US Department of Transportation, automobiles these days stay on the road an average of about 12 or 13 years), it will be a very long time before the new CAFE standards actually translate into meaningful changes in emissions. But increasing the gas tax would have immediate effects.

(Some might object that fuel taxes are regressive and would hurt the poor, and to an extent they would be right. However, the rich drive considerably more than the poor, taking some of the stink off. And paying for many of the new fuel-economy technologies CAFE will result in will be regressive too.)

Thus CAFE might be a second-best policy: good, but not as good as we could have. Then why are we using CAFE while gas taxes stay laughably low by developed-world standards? Obviously, and understandably, because voters hate taxes. If anything, the political winds are blowing towards a lower gas tax, not a higher one.

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  1. Alan Moore says:

    A first year stat’s student would call foul on your cause-effect relationship claims.

    “Can this be attributed to CAFE? To a large degree, yes, as this graph makes clear”

    That graph shows NOTHING other than they both went up at the same time. You present no evidence that one caused the other. It is possible for consumer demand for higher MPG effected the auto industry, that tightened budgets caused the increase, or that auto companies attempting to differentiate themselves from other auto manufactures caused the increase. There are WAY to many variables that you have’t tested for for make this claim.

    I appreciate the analysis that you have done here in saying price side demand could better encourage higher MPG standards, but your claim of cause-effect relationship is pitiful.

    Well-loved. Like or Dislike: Thumb up 24 Thumb down 16
    • James says:

      But you forget that a lot of us were actually around in those days, and were able to examine all those other variables for oourselves.

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      • Gary L. says:

        In his defense, the inflation adjusted cost of gasoline tracks pretty closely with the graph above. Surely any Freakonomist is going to look at a conclusion drawn from a set of data, and consider the other possibilities.

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      • Travis says:

        On the other hand, the CAFE standards were (are) law that the automakers had no choice in following. Perhaps the other potential effects influenced the decision of the automakers to comply with the CAFE standards, rather than choose another route such as litigation claiming them as unconstitutional etc., but it’s quite hard to argue that the CAFE standards were not the catalyst to the increased fuel economy, particularly given the other indications (such as the fact that the fuel economy stabilized around the cafe standards, rather than some other number).

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      • Eric says:

        True, but then the graph should have shown a line with CAFE requirements in the different years. We know it would have shown the same sort of trend, but we could have seen it more clearly if the chart was more tailored to the point being made.

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  2. Steve says:

    There is a lot more talk about fuel prices these days than there is real price sensitivity. Based on the current fleet average MPG and a roughly12,000 miles of driving per year average, increasing fuel prices by $1 per gallon will cost the consumer less than $40 per month. Because the price is so low, compared to other expenses, there is little sensitivity, so the oil companies have been able to garner huge relative profits. Increasing taxes will price fuel at a point of higher sensitivity, forcing oil companies to be more price competitive.

    Therefore, the amount of the actual price increase paid at the pump will probably be significantly less than the total increase in taxes. This would be a net win for consumers, either in reduced taxes elsewhere or increased services, such as alternative transportation.

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    • Gary L. says:

      “Based on the current fleet average MPG and a roughly 12,000 miles of driving per year average, increasing fuel prices by $1 per gallon will cost the consumer less than $40 per month.”

      This is predicated on the assumption that the only fuel cost a consumer incurs is the cost of adding fuel to their own tank. This, of course, is incorrect, since increased fuel costs increase the cost of almost all goods. That said, I agree with you in principle. One way or another, increased fuel costs will cause consumers to demand increasingly efficient vehicles. I see no sense in sending that windfall to dictators with questionable (at best) intentions, when the same shift in consumer demand can be achieved through methods that keep those dollars here.

      I like to think of it as a “Cash for Clunkers” type policy, only better designed.

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  3. Clancy says:

    I think we need some kind of “arms reduction agreement” where liberals agree that some regulations are bad and conservatives agree that some taxes are good. If we can do this, we will be on the road to a more efficient government that does more to make life better and costs less.

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  4. Skip says:

    With the way our political system works, with its rewards for politicians who cater to the fickle winds of voter opinion, controlling behavior by increasing direct costs to voters will rarely work. No matter how much better the solution, increasing a direct voter cost is nearly always less popular and therefore dead-on-arrival for politicians. It’s too bad, but as long as we tie political success only to voter opinion, we’re stuck with less-efficient regulation.

    There’s also the issue of entrenched interests fighting against the regulation, so often we end up in a position where politicians fail to solve the problem entirely. They can’t raise costs if they want to keep voter opinion, and they can’t regulate without upsetting the entrenched interests and losing influence and campaign money. Thus the long delay in getting tougher regulations in place.

    All this is a pretty sad commentary on how our political system works, but unfortunately changing it has the same restrictions. Either unpopular or defeated by the entrenched interests.

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    • cackalacka says:

      Yep, a higher fuel tax can smooth supply/demand fluxuations, repair bridges in Minnesota (and maybe build a few more) and are infinitely more sensible than cafe or the proposed ‘GPS tax’ (tax on mileage.)

      It is possible for responsible tax policy to be phased in so it doesn’t crush the working poor, and it is possible for taxes to be a sensible instrument to determine rational behaviors.

      Damn shame that half the political infrastructure here in the states has sworn a blood oath to Grover Norquist and is plays policy like some UWF cage-fighting. Up-and-comers in other parts of the world will continue to play the long game; meanwhile we’re not paying the bills, rewarding shoddy domestics (that whinged up a storm about CAFE) while telling Johnny Refinance, “Sure you can finance that SRT8, it will have no consequences for your checkbook/neighbors safety/air; after all it’s got a HEMI!”

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  5. Mike B says:

    It;s not a good solution when it comes to actually paying for the roads people use. In fact higher millage will only make the problem worse as cars can travel further on their paltry 18 cent/gal tax payment. :-(

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  6. Mark Brucker says:

    Excellent points. I’d add that the increased driving will increase a lot of environmental problems. Not only will it reduce the benefits that would occur for global warming with a gas tax. It will almost certainly increase air pollution, including air toxics, water pollution, and hazardous wastes. It will also, as you noted, increase collisions. Which means more deaths, injuries, pain and suffering, etc. And the increased mileage and wrecks will increase costs for road maintenance, for emergency services, and health care.

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  7. Deron says:

    Why not apply a license plate tax based on the weight of the vehicle, and push towards toll roads that charge more for peak times?

    At least it could be argued that users would be bearing the cost of wear and tear.

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    • Nanno says:

      Funny you should say that, in the Netherlands we actually have a sort of license plate tax called “motorrijtuigenbelasting” (“motorvehicletax”) based on the weight, type of use (business or personal), type of fuel, age (over 25 and first registered before 1987 are excluded) and province (equivalent of a State, it’s more expensive in more densely populated areas) and then there is a second tax called BPM that is (now) based on the energy efficiency of the vehicle (until 2010 adjusted for its relative weight and size).

      Now the best thing is, as all this seems logical, our government wants to move towards a system of “tax per kilometer”. Which takes away the incentives for alternatively powered, light and efficient vehicles.

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  8. James says:

    “…why not just raise the gas tax and let drivers figure out whether they want smaller cars, lighter cars…”

    Because drivers do not get to choose what kind of cars they drive. They can only choose from what the auto industry is willing to produce. The American auto manufacturers are – and have been for half a century – only interested in building large, heavy, unresponsive vehicles (despite unmistakable market signals starting from the original VW Beetle), and spending uncounted billions on advertising in order to persuade the hard-of-thinking majority that those are what they really wanted all along.

    Hot debate. What do you think? Thumb up 13 Thumb down 16
    • Ross says:

      Can you please supply some evidence for your claim there is unmet demand for more fuel efficient vehicles? It has been my experience that people buy the largest, heaviest, most powerful vehicle they can afford.

      The sentiment that people would naturally buy fuel efficient vehicles of only the Evil Corporations would make them reminds me of the frequent lament on the comments board at the YMCA: “Why don’t you put healthy snacks in the vending machines?” The response: “Because when we do, no one buys them.”

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      • James says:

        How about the fact that people HAVE been buying the somewhat more fuel-efficient vehicles produced by foreign automakers, and have been doing so since the first VW Beetle came ashore back in the ’50s. We can draw a line from the Beetle through the Honda Civic to the Toyota Prius. Along the way we could ask why the American manufacturers who owned the market half a century ago have lost half of it to foreign automakers, whose base products were smaller and more fuel-efficient than anything Detroit built.

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      • Mark Brucker says:

        TV ads suggest that the manufacturers think people really care about fuel mileage. They keep harping on xx miles per gallon…often stretching the truth in trying to get buyers…..

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