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. Tuckster says:

    The implications for governmental control are also vastly different between CAFE and gas taxes. The externalities of gas consumption would rationally be imposed by the government. Direct industry manipulation is a horrible idea, however, as even an agency of car experts can’t predict the future of the car industry (thank god–look what happened in the private market). It’s like price-fixing.

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  2. Chris says:

    Did you happen to think of anyone outside the northeast?

    Most places in the US don’t have mass transit and couldn’t have effective mass transit even if the demand was there. In all but the few places that do have effective mass transit raising the gas tax would only have the effect of making people poorer. It wouldn’t reduce the numbers of miles driven in a meaningful way due to there not being any other alternate form of transportation available. If the gas tax was particularly high for a long enough period of time it would potentially help to change patterns in where people live vs work, but that would take a lot longer than the time it would take to replace cars with the new CAFE standard.

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    • James says:

      Hidden due to low comment rating. Click here to see.

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      • JimFive says:

        Of course, when gas goes to $6/gal and Joe is paying $2400/yr in gas he can no longer afford to save the money to buy the 50 mpg car. The idea that the 25mpg used car is going to more expensive than the 50mpg car is absurd. So, no, he’s not $400/year richer. If he’s lucky the car payment + insurance equals the gas savings and he breaks even.

        JimFive

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      • James says:

        “The idea that the 25mpg used car is going to more expensive than the 50mpg car is absurd.”

        Easily disproven by checking your local Craigslist. eBay motors, or any other site with a good selection of used cars.

        Or you can look at new car prices. Seems like a simple rule of thumb that (barring a few outliers like the Tesla), the more a car costs, the worse the gas mileage. (It’d be interesting to see this as a graph, but a quick search doesn’t find one.)

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  3. robu says:

    Why is it that the government always tackles the supply and not the demand? Drug War-> go after the supply (cartels, smugglers, etc.) and ignore the demand (drug users). Aren’t we repeating that with CAFE->go after the supply (auto companies) and ignoring the demand (car owners/purchasers)? By enforcing a CAFE number, aren’t you just guaranteeing that the car companies have to sell more unprofitable vehicles for every high profit vehicle (remember that it is an average….)?

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  4. Alia D. says:

    I’ve hear it argued that one effect of CAFE is forcing families that needed the option of seating up to 7 or 8 people from station wagons, which count as cars under CAFE, to SUVs which don’t count as cars under CAFE, thus resulting in a substitution of a less fuel efficient vehicle for a more fuel efficient car. Even if SUV and mini vans were pooled with cars I would speculate that some of the demand for larger vehicles is being driven by the desire to facilitate carpooling. And two smaller, more fuel efficient, vehicles might end up using more gas then the same trip in one larger vehicle. So using regulation to force up average fuel efficiency per car could actually force down the fuel efficiency per transportation tasks in certain scenarios

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    • Joshua Northey says:

      40% of miles driven are single occupant. 7 or 8 person families are fairly uncommon.

      All the 7 and 8 person families can keep their SUVs or station wagons, or dump trucks if we can get the commuters to use a vehicle that is more appropriate for their needs (something the size/power of a motorcycle).

      I bike to work through rush hour and at rush hour 85% of the cars are single-occupant and probably 95% of them are not carrying enough cargo to justify the size vehicle they are using.

      A huge over-engineering of the problem of getting from A to B. Each person surrounded by hundreds of pounds of metal and several cubic feet of machine, when they have 1 200lbs person and a handbag 9 times in 10.

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      • BikerDad says:

        Yes, key word is “at rush hour.” However, we don’t use our vehicles just during rush hour. We use them for family vacations, (find a car that can carry a family of four, and tow a 9,000lb trailer…), for running the kids to and fro, for helping your brother move, etc.

        For the vast majority of consumers, the overriding, often unvoiced, feature of a vehicle is flexibility. Will this vehicle do 95% of what I want to do with it?

        IF y’all want to solve transportation “problems”, you really should start by asking what transportation consumers WANT. Get your solutions in accord with those, and you’ll be successful. Ignore what consumers want, and you’ll be in for a world of hurt.

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  5. Radhik Hairam says:

    Fuel consumption is highest in USA due to heavy utilization of cars! Elementary, yes; but the aspect I wish to emphasize is that most of them are occupied by one person who drives himself/herself. Why this extravaganza? Small cars with only two seats may be a solution, with higher mileage true; but they will be v light and cannot assume high speeds witnessed now! Majority of work force use cars singly and that leads to more usage of gas, as also parking space and allied problems; WHY not introduce Metro Bus Service in Major cities and ensure that is used by office goers, by some suitable means; tax their cars more IF they are used for office trips ! Difficult? Introduce Office transport at regular intervals so that flex time operations are also rendered feasible and employees are forced to use it to save money on gas and thereby help green peace movement and reduce consumption; May appear too simple, but surely deserve to be given a thought; MUST reduce traffic or road for results!

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  6. IE says:

    Increase the gas tax, but lower the income tax (or send out tax rebates), making it tax revenue-neutral.
    That would decouple the gas tax issue from the usual more taxation vs. less taxation debate. That’s the only way to make politically acceptable in the current environment.

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  7. Spokane Al says:

    I wonder about the additional impact on food and everything else that often travels on roads to reach our tables/stores etc if gas taxes are raised. By only measuring the impact on driving due to increased taxes, aren’t we missing a large piece of the puzzle?

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  8. MeanOnSunday says:

    Fuel efficiency of US cars is terrible compared to those in Europe. I was just in England for a couple of weeks and drove one of the larger VW models (since I had 4 passengers and a lot of luggage). I averaged 39 mpg, driving mostly on small one lane roads. My Dad is currently driving a Citroen (diesel) and averages 52 mpg with very little highway driving. This totally kicks the butt of the similarly sized “eco-wonder” Prius which has a 42 mpg rating.

    The technology is obviously already available and without the added cost of electric/hybrid engines.

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    • John B says:

      A good point—but you are missing the big picture.

      The reason European cars get better mileage is that they have fewer mandates and regulations than the US. You cannot legally drive the European cars in the US.

      The US “Smart Car” gets much better mileage in Europe because the one sold here has to be modified to meet additional US requirements.

      I am not saying the US modifications are not good–but there is a price. Much lower fuel mileage.

      Allowing the cars made in Europe and the far east to be sold here would do more to increase gas mileage than any CAFE standard and any gas tax.

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