In December talks in Paris involving more than 200 countries may result in a new agreement aimed at reducing carbon emissions. In the months leading up to the conference, The Economist is publishing guest columns by experts on the economic issues involved. Here, Arthur van Benthem of the University of Pennsylvania and Mathias Reynaert of the Toulouse School of Economics explain why a fuel tax is a more efficient way to reduce emissions from vehicles than fuel-economy standards.
TRANSPORT is responsible for about 20% of global greenhouse gas emissions. To save the climate, transportation is an obvious and visible target for regulators. Fuel-economy standards, requiring a minimum sales-weighted average miles per gallon (mpg) rating of new cars, are a popular tool around the world. In August 2012, president Barack Obama touted his new fuel-economy standard of 54.5 mpg by 2025. Regulators in China, Europe, India and Japan are all aiming for at least 55 mpg by 2020.
Empirical evidence shows that fuel-economy standards have succeeded in reducing carbon-dioxide emissions from passenger cars. One recent study indicates that they force carmakers to offer more fuel-efficient cars and sell fewer gas guzzlers. In the meantime, consumers benefit from lower fuel expenses. According to the American government, the average middle class family will only have to spend about two thousand dollars more on a new car that will save them six thousand dollars in fuel costs. As an added bonus, lower fuel consumption makes the economy less dependent on unfriendly foreign regimes. And all this happens without anyone writing a tax check to the government.
So what’s not to like about fuel-economy standards? They suffer from three fundamental problems.
First, they do not affect driving behavior. If anything, they will cause more traffic. Fuel-efficient cars are cheaper to drive, so people will drive more. Economists call this the rebound effect. For example, the American government assumes that this cancels at least 10% of expected carbon-dioxide savings, based on an influential study by Kenneth Small of the University of California-Irvine and Kurt Van Dender of the OECD, a club of rich countries. The foregone emissions saving is not the only concern: more driving also adds to congestion on busy roads in densely populated cities. Second, standards apply only to new cars and it takes a long time for the vehicle fleet to turn over and the expected carbon-dioxide savings from the standards to fully kick in. Third, economists Mark Jacobsen of the University of California, San Diego and Arthur van Benthem of the University of Pennsylvania, recently measured another unintended consequence from fuel-economy standards. Such standards require new technologies which make new cars more expensive. This increases the demand for used cars and therefore their resale value. As used car prices increase, people tend to maintain them better. So old gas guzzlers stay on the road longer. The result is that about 15% of the expected fuel savings leak away through the used-vehicle market.
Worse still, more problems have shown up when policy makers implement fuel-economy standards. The standards require testing the fuel economy of each vehicle, which is done using dubious testing procedures. The tests take place under very stylised driving conditions with all ancillary equipment turned off. Fuel-economy ratings are often much above the fuel-economy realised on the road. In an ongoing class action suit against carmakers Fiat and Volkswagen in Italy, consumer-rights groups claim that several vehicles have a fuel economy that is 20% to 50% lower than the official rating.
Next, these regulations often contain several loopholes that cause severe distortions. The high market share of SUVs in America is at least partly attributable to their special treatment. SUVs are classified as “light-duty trucks” which face less stringent fuel-economy standards than passenger cars. As a result, manufacturers have faced continuous incentives to sell more SUVs or even redesign passenger cars such that they count in the SUV category. A famous example is the PT Cruiser, which Chrysler successfully marketed to the regulators as an SUV by making the rear seat removable. As vehicles above 3.8 tonnes were long exempted from the American regulation, manufacturers started producing enormous vehicles such as the Hummer to avoid any fuel-economy rules. Japan sets separate standards by vehicle weight bins, with less stringent mpg targets for heavier cars. An analysis by Koichiro Ito of Boston University and James Sallee of the University of Chicago has shown how this gives incentives to manufacturers to add weight. The average car is heavier than before the regulation.
So what’s a better policy? Most economists believe there is an easy answer: we should increase the tax on fuel. A University of Chicago survey showed that 93% of economists would prefer a petrol tax over a fuel-economy standard (but only 23% of non-economists felt this way).
A petrol tax has all the same benefits of a fuel-economy standard without suffering from any of its flaws. A tax encourages consumers to choose a greener car, in particular those consumers who drive and pollute a lot. Increased demand for fuel economy encourages manufacturers to invest in new technologies. A fuel tax does not rely on dubious testing nor does it create distortive loopholes. On top of that, a tax encourages drivers of all cars, new and used, to drive less and save fuel. Even better, a petrol tax raises revenue which can be productively used to reduce income taxes or provide rebates to those hardest hit by the policy.
Economists have estimated that per gallon of fuel saved, fuel-economy standards are between two and ten times as expensive as a fuel tax. In fact, most studies conclude that standards are so expensive that their cost to society exceeds the value of the carbon saved. The sad truth is that, in most countries, higher fuel taxes are an uphill battle politically. That is a really expensive attitude. At a minimum, such countries should eliminate all loopholes form their fuel-economy standards. They should keep the standards “plain vanilla”: no differences in standards for small or large cars and no weight cutoffs. A single fleet-wide average standard is simple and harder to manipulate. But really, the time has come to let our aversion against fuel taxes go. “Tax” is an ugly word, but both the climate and the economy would be relieved.
