Robert Stavins thinks an increased gasoline tax or cap-and-trade would make Obama’s tougher auto efficiency standards redundant. This offers an excellent illustration of how even economists who are not market fundamentalists can miss the way well-designed regulation improves economic efficiency.
Yes, cap-and-trade or a rising gasoline tax will reduce driving and gasoline use. But because drivers respond slowly and reluctantly to price increases it takes large surcharges to produce small decreases in use. How much consumer demand drops in response to price increases is called “elasticity” in economic jargon. Total U.S. consumer response to price increases shows about a 50% elasticity, meaning that it takes about a 72% increase in prices to produce a 36% reduction ins use.
The combination of existing auto standards and Obama’s new efficiency requirements will increase the gas mileage of existing vehicles by just less than 36% at a cost of around $1,300. Achieving the same gas savings via price increases alone would require increased costs over the life the car equivalent to a net present value of $2,650. (Assuming a car that is driven 150,000 miles and lasts 20 years, just under a 72% increase would add slightly over $1.97 per gallon to gas prices. Over the lifetime of the car this equals $4,252. But that is a flow, not an upfront price like CAFE. So discounting that 20 year cash flow at 5%, we end up with a $2,650 present value of that cost – still more than double the cost of CAFE standards.)
To save time in comments, lets deal with some of standard objections that are sure to occur in the form of FAQ.
Frequently Asked Questions
Question) Efficiency standards don’t do anything for existing cars. Plus higher upfront prices may discourage new car purchase. Plus more efficiency makes driving cheaper. Nyah! Nyah! Regulation is inferior! Red Tape! Awk! Damn bureaucrats! Pieces of eight! Awk! Pieces of eight! Awk!
Answer) We need BOTH increased gasoline prices and efficiency regulations to reduce auto emissions at the lowest cost. Regulations don’t do anything for existing cars, but they save tons with new car purchases. (We also need public investment, or we won’t get better mass transit, bike and walking paths or even electric cars.)
Cars tend to be kept alive until repair costs and economic risks from having unreliable transportation drive people to buy new ones. And not all that $1,300 is paid by the consumer. Some of it is eaten in slightly lower profit margins by manufacturers. So what you may end up with is delaying new car purchases by six months or a year. Even that is not all net loss. It takes energy to make a new car as well as to drive one.
Counter-pressure from slightly cheaper driving is real but not significant. No matter how cheap driving gets people do want to end up somewhere, not just spend all their waking hours driving around in circles. Nobody has yet documented increased mileage that comes anywhere close to making up the savings from auto efficiency savings. But obviously increased prices reduce this further. Like prices, regulations don’t work with perfect efficiency. But nobody has documented those imperfections eating up the more than 100% difference in cost per emission cut.
Auto efficiency standards and increased fuel prices are not substitutes for each other but complements. They are synergistic. Each makes the other work better than either alone
Question) Energy prices dropped and driving did not increase. Your elasticity figures are obsolete.
Answer) Consumers change behavior in response to changes in income as well as changes in prices. A not-quite-the-great-depression will depress gasoline demand quite even when prices drop. Or, to translate the preceding sentence into economic jargon: own price elasticity and income elasticity have to be solved as simultaneous equations.
Question) Prices rule! we don’t need no steenkin regulations!
Question) Regulations rule! We don’t need no steenkin prices!
Answer) Read the post. We need both. They work better together.
Question) Why are you worrying about such tiny cuts. We need much more, much faster!
Answer) Yes, we do. But the auto efficiency proposal makes real cuts even if nowhere near what is needed. It is a small part of what really needs to be done, and does not stand in the way of doing the rest. And it provides a clue as to the role standards based regulations will have to play.