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. Chun says:

    While raising the gas tax would result in less miles driven, that still doesn’t change the political reality of the situation. Very few people in /any/ Legislative session (regardless of whether any particular party is in control) would be willing/able to raise the tax. Regardless of the logical/rational desires to do so.

    On the other hand, CAFE standards can be passed with relatively less opposition. While it may be in your opinion the Second Best option, it’s the option that will actually be accepted. And what this also means is that in the event that a compromise can be reached legislatively, you could also raise the fuel taxes. While it’d have a lessened impact than solely a tax increase, it would still change the math involved so that you could have a easier transition to more or equal mobility with less environmental harm.

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  4. Paul says:

    The gas tax approach won’t work well when cars are not gas powered, i.e. electric. Various approaches to mileage-based taxes have been floated over the past couple years (in Oregon or Wash. St. I believe) and have been shot down, but eventually the mileage-based tax will probably win out. The gov’t wins with it’s CAFE approach because it (1) increases nannystatism while appearing to look serious, and (2) doesn’t tie itself to the soon-to-die gas tax.

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    • Sam says:

      For it to be effective, the gas tax need not be any more than what it would take to cover all the external costs of gas consumption (pollution, foreign wars, damage to the environment …). Other forms of energy would be taxed (or not) based on their own external costs (e.g. tax the fuel used to power a coal or oil based electric plant).

      There are, of course, external costs of just having that vehicle on the road regardless of the energy source. So a perfect model would need to account for miles driven (and probably the weight of the vehicle and other factors that raise the external costs). Technology should be able to handle that efficiently – requiring each vehicle to have a GPS monitor would probably be cheaper than implementing and enforcing the somewhat arbitrary CAFE standards.

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  5. Mark H says:

    Even as far as top-down regulations go, CAFE standards are extremely ugly: when people get better mileage they drive more, which increases traffic accidents (and fatalities), congestion, and even some emissions, like NOx and carbon monoxide. This policy trades one externality for several larger ones.

    Contrary to what Morris is saying, if it’s not politically feasible for the government to enact a fuel tax (or cap & trade), CAFE is not a worthwhile second-best. Taking all externalities into consideration, cost-benefit analyses of CAFE come up extremely negative.

    For more info, Andrew Kleit has done some great research on CAFE. Here’s one of his papers on the subject: http://www.freepatentsonline.com/article/Economic-Inquiry/115635786.html

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    • James says:

      “…when people get better mileage they drive more…”

      Would you care to offer data to support this claim? And particularly that any extra amount driven is enough to offset the savings in consumption from the improved mpg?

      Quite intuitively, that idea really does not fly. First, the amount of driving people do obviously has an upper bound, due to the fact that there are only 24 hours per day, and some of them must be spent sleeping, eating, earning a living… Second, for many of us, driving is a more-or-less disagreeable chore. The primary “cost” of driving isn’t the gasoline, it’s the time we must spend doing it when we could be doing other things instead.

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      • Mark H says:

        From Morris’s article:

        “To a degree, less thirsty cars will actually cause people to increase the number of miles they drive”

        From the Kleit paper that I linked to:

        “CAFE standards put some or most new car buyers in more fuel-efficient vehicles. This lowers their marginal cost of driving and causes them to drive more, a phenomenon referred to as the rebound effect. A recent study Greene et al. (1999), accepted by NHTSA in its 2003 proceedings and whose results I employ, finds that for every 10% that fuel economy is increased, driving increases 2%.”

        CAFE standards almost certainly reduce the amount of fuel that is consumed–as you put it, I am not claiming that the extra amount driven is enough to offset the improved MPG. My claim is that there are other important driving-related externalities: when people drive more, they increase congestion, cause accidents, and release more VOCs, NOx, and CO (all of which is more thoroughly described in the Kleit paper). The cost of these exceeds the social benefit of the reduced gas consumption.

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  6. Michel says:

    Can this idea be tested by looking at countries where tax on fuel has actually been used as a means to lower fuel consumption. The Netherlands have been trying for quite some time. For your information, a gallon of petrol costs about 8.80$ a gallon. The difference between the price in the Netherlands and in the US is probably for over 90% caused by taxes.

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  7. Eric M. Jones. says:

    ….and when the population reaches 10 Billion?…..15 Billion?…20 Billion?

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  8. ben says:

    Good post, but I would switch : “the thought of Hugo Chavez and Mahmoud Ahmadinejad using our own hard-earned dollars to tweak our geopolitical noses should.” to…

    “the thought that the US toppled a secular democracy in Iran in the early 50′s and instated a religious totalitarian regime should.”

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