Achieving Economic Prosperity and Climate Protection [ PDF ]

In this Newsletter:

A Practical Roadmap for Efficient Vehicles

By Danny Reed

Scientific evidence, as evaluated by the IPCC, makes overwhelmingly clear that climate change is an imminent threat to human society. Today, America faces a debate concerned with what role federal and state governments should play to most effectively reduce greenhouse gas emissions. At the forefront of this dispute is the question of alternative energy vehicles.

In the coming years, it is likely that there will be renewed federal efforts aimed at stimulating the production of efficient vehicles. However, history has already relegated a plethora of such legislation to the graveyard of failed policy. Especially considering the current economic crisis, policymakers seem likely to enact such policies cautiously, being careful to evaluate the potential for welfare gains and losses in all sectors. Efficiency standards, federal subsidies for R&D, gas taxes, and ‘feebates’ are examples of past policies enacted domestically and internationally in an effort to bolster vehicle efficiency. These examples of legislation provide valuable lessons that can enable policymakers to produce a well-balanced approach to the issue of efficient vehicles going forward.

Will the Market Naturally Provide Efficient Vehicles?

Traffic A serious issue facing policymakers is whether or not the market would ever naturally offer improved efficiency in vehicles. There are many indicators that portend a market failure in this regard. For example, evidence suggests that consumers normally undervalue the long-term financial savings of more efficient vehicles (Greene). In addition, a study released by the National Research Council in 2002 found that a variety of technologies with the potential to “boost fuel economy” could easily be implemented with a fuel savings benefit that would exceed the cost by between “0 and 50 percent” (Portney). Apparently because they were not convinced that implementing the innovations would be economically beneficial to them, auto manufacturers chose not to take these steps to improve fuel economy. Policymakers face the difficult task of adjusting market demand to stimulate greater efficiency in opposition to a natural environment that does not.

Federal Subsidies for R&D

In 1993, then-President Bill Clinton forged a groundbreaking partnership between auto companies and the federal government that promised alternative energy vehicles that “would get 80 miles per gallon, and be affordable” to consumers (Holzman). The ambitious plan to have alternative energy vehicles on the road by the year 2000 was officially called the Partnership for a New Generation of Vehicles (or the PNGV). Under the new partnership, the federal government and automakers spent roughly $600 million per year on research to develop efficient automobile technologies. The partnership was a welcome effort at a time when environmentalists were critically concerned with the need for alternative fuels and vehicles. In 1996, US vehicles burned 15 quadrillion British thermal units of gasoline, totaling two-thirds of the nation’s petroleum consumption (Holzman). Just four years after the initiation of the plan, the National Research Council reported that the program was doomed to failure. The study by the National Research Council established that none of the technologies would meet the technical or cost objectives set forth by the PNGV. Ultimately, the PNGV made some gains in technology, but many of these technologies were not manufactured or sold. The subsidies were just not enough of an incentive.

The shortcomings of the PNGV indicate that there are far too many competing technologies, far too many variables to control, and far too few public dollars to guarantee that such a program would result in a competitive alternative energy vehicle. Without a clear direction, competing technologies spread funds too thinly and no clear winner arose from the PNGV. However, there is reason to believe that the PNGV might have seen more success by aggressively intervening in the marketplace to bolster demand for more efficient vehicles.

Fuel Efficiency Standards

In 1975, Congress passed the Energy Policy and Conservation Act, which created the Corporate Average Fuel Economy Standards (or CAFE) program. Higher gas prices in combination with the new standards had “a significant effect on fuel economy” (Portney). According to the EPA, average new passenger vehicle MPG rose from “17 MPG in 1978 to more than 22 MPG in 1982, an increase of more than 30 percent” (Portney). Perhaps even more significant are the increases that occurred after 1982. Following 1982, gas prices began a significant decline leading many to expect a corresponding decline in MPG. However, vehicle efficiency statistics shocked many analysts and continued to climb until 1987.

While CAFE was successful in improving average MPG, it was not without its imperfections. Some argue that CAFE standards might spur innovations and welfare gains in the vehicle sector by encouraging R&D. However, others warn that unnaturally forced R&D comes at a cost. That cost might manifest itself in “crowding out” R&D ventures within other sectors of the economy (Portney). Such an effect might risk damaging an already fragile economy.

Another possible downside to mandated efficiency standards such as CAFE is the so-called “rebound effect,” which suggests that greater efficiency creates an incentive to drive more (Portney). One study estimated the initial rebound effect due to higher CAFE standards to be about 10-20 percent or more (Portney). When considering the proportional welfare loss due to “increased traffic congestion” and “traffic accidents,” this rebound effect reveals itself to be a real challenge (Portney).

Gas Taxes

The PNGV and CAFE standards might have benefited from cooperative market-altering policies. Gas taxes offer governments a revenue stream while having the effect of artificially inflating gas prices. Two studies by the National Research Council and the Congressional Budget office claim that an increase in the national gas tax would have the effect of reducing gas consumption at a lower cost than tightening CAFE standards (West).

Evidence indicates that less driving has the positive side effect of encouraging “labor supply” because gas and leisure are “relative complements” (West). As people spend less time in transit, they have more time for leisure or labor. An increase in gas taxes would “likely lead to a welfare gain” with no corresponding rebound effect (West). The study concludes that it is “highly unfortunate that policymakers have focused on CAFE” (West).

Despite these upsides, a higher gas tax might not be politically expedient. The same study that praises the gas tax for its potential concedes that “gas taxes seem to be politically infeasible” (West). Without public support, a gas tax might not be a plausible solution. In addition, some critics of the gas tax claim it is regressive and hurts low income Americans disproportionately. Just like the PNGV and CAFE programs, the gas tax is not without its weaknesses.

‘Feebates’

Feebates are relatively new to the United States, though they have already been implemented in France and Canada. A feebate is a market-based policy in which vehicles with MPG above a given “pivot point” are charged fees, while vehicles below the pivot point are awarded rebates. The fact that consumers seriously undervalue the lifetime savings of greater efficiency creates a real difficulty for policymakers. Feebates offer an attractive solution to this market failure.

Studies indicate that within a short period, feebates would be capable of inducing significant increases in fuel economy, with minimal corresponding reduction in overall vehicle sales (Greene). In fact, the same study demonstrates that a $500 feebate would achieve major daily fuel savings in a relatively short span of time, significantly reducing emissions and demand for oil (Greene).

Another attractive feature of feebates is that they can be easily crafted to be revenue neutral for the government enacting the measure. In a time when governments face mounting debts and budget difficulties, a revenue neutral feebate might present an attractive solution.

Conclusion

The strengths and weaknesses of these different shades of policy substantiate the need for a well-rounded approach to stimulating efficient vehicles. There is no perfect policy, but past policies provide a model for a new comprehensive, integrated strategy for the transportation sector. With a soaring federal deficit, policymakers face a unique challenge. They must implement measures that are not only effective, but also affordable.

Considering the current economic crisis, revenue-neutral feebates are the most reasonable policy. While a feebate should be the heart of this integrated policy, gas taxes, subsidies, and efficiency standards could serve as much needed support. Gas taxes would buffer welfare losses from a potential rebound effect. Efficiency standards could serve as a failsafe to ensure efficiency does not drop too low. Research subsidies could spur innovation, but should be used with great discretion considering budget shortfalls.
All of these have a place in modern policy – but that place should be carefully considered with an eye to the past while being conscious of current economic difficulties.

The Obama Administration has already taken promising steps to encourage vehicle efficiency. On January 26, Obama instructed the new head of the Environmental Protection Agency to allow states to set tighter emission standards on light vehicles. In doing so, Barack Obama has erased any doubt about his plans to put a green agenda at the heart of his presidency.

Works Cited

Greene, David, Philip Patterson, Margaret Singh, Jia Li. "Feebate, rebates, and gas-guzzler taxes: a study of incentives for increased fuel economy." Energy Policy 33.6 (2005): 757-775.

Holzman, David. "A Driving Force." Environmental Health Perspectives 105.6 (1997): 582-587.

Portney, Paul, et al. "Policy Watch: The Economics of Fuel Economy Standards." The Journal of Economic Perspectives 17.4 (2003): 203-217.

West, Sarah and Roberton III Williams. "The Cost of Reducing Gasoline Consumption." The American Economic Review 95.2 (n.d.).

Michael MacCracken’s Proposal

Michael MacCracken, Chief Scientist of the Climate Institute, has offered an innovative policy proposal to reduce greenhouse gas emissions from vehicles. MacCracken suggests that a cap and trade system could serve as a substitute for other programs aimed at reducing greenhouse gas emissions from vehicles. The proposed plan would allocate greenhouse gas emission permits at no cost to vehicle manufacturers. The emission permits, covering all vehicles in use that manufacturers have produced, would be valid for a predetermined time period. The amount of allowances associated with the permits would depreciate each year in order to decrease overall emissions over time. These allowances would be tradable, allowing manufacturers a level of flexibility by providing a temporary alternative means of compliance. The program would incorporate both new and old vehicles, thereby compelling manufacturers to improve the performance of new vehicles, purchase and retrofit older vehicles, and promote policies to reduce emissions. Auto manufacturers would also have greater incentive to encourage customers to use alternative fuels such as biofuels.
For more information, see Dealing with Transportation Emissions in Climate Change Legislation.

Spring 2009 Climate Alert