Monday, January 26, 2009

CAFE Standards vs Carbon Tax

It would be very difficult and/or expensive for U.S. government policy to help the not-quite-bankrupt U.S. auto industry. The Obama Administration has taken the apparently contradictory position of supporting a bailout of unprofitable U.S. automakers, while simultaneously trying to destroy their business model. In this second point, I am speaking of Barack Obama’s decision today to mandate high CAFE standards (at least 35 miles per gallon) by 2011. Generally, the more profitable vehicles sold by U.S. automakers are the ones that consume more fuel – This is where they seem to have a slight comparative advantage over their foreign competitors. It is conceivable that if CAFE standards were lifted, Ford and GM would be able to survive as specialized producers of larger vehicles, ceding the small car market for Japanese and European competitors. As I understand it, Ford and GM currently lose money producing small fuel efficient cars in order to make their fuel efficiency numbers meet the current CAFE standards. Raising CAFE standards will further distort the companies, making them even more ridiculously unprofitable.

To me, corporate fuel efficiency standards just seem like confused/bad government policy. If one is worried about the United States using too much gasoline, it would make sense to directly raise the price of gasoline until the point where you think the country is using the correct amount. Ideally, you should come up with a value of the harm caused to the country by carbon emissions and dependence on foreign oil and turn it into a unit cost tax on sales of fuel. Under such a carbon tax system, people who use gasoline would bear the appropriate whole cost of their decision. People would make rational decisions based on the new prices: In the short-term, they might drive less or buy more fuel efficient cars (remember 6 months ago?). In the long-term, there would be incentives to move closer to work and for communities to be less spread out. The cost would be born directly and proportionally by users of gasoline, rather than indirectly by all members of society. Also, the government would raise some money out of it and would be able to use these funds to provide relief in any number of ways (such as slightly lower income taxes). So, in total, there is no net cost to society, but a net gain from more rational and transparent decision making.

Federal fuel efficiency standards due not create the incentives for such market adjustments. They just make it much more difficult to buy new less fuel efficient cars, no matter how many kids you have to transport to a soccer match. So, the price for vehicles will go up, but because the amount of fuel used per vehicle will go down (more fuel efficient cars use less), the price of fuel will fall and it will be cheaper for everyone to drive extra miles. So, a significant percentage of the fuel savings from more efficient cars will be eaten up by additional driving. The added expense for new cars will mean there will be more old cars staying in use longer. These cars may burn fuel and pollute more, but they would now have a relatively cheap upfront cost, and cheap fuel. So, we’ll end up with more and older cars on the road, which we would expect to intensify other highway problems like congestion and accidents.

So, with CAFE standards there will be somewhat less gasoline used, but this will be outweighed the deadweight loss to auto-producers and consumers. Also, there is no money raised by the government to compensate the relative losers from this policy. Of course, the government will bail-out the auto producers anyway, but the funds for this will come from other sectors of our already ailing economy. Perhaps the hike to CAFÉ standards is good politically in that it provides cover for the auto bailout, but it is definitely bad policy. Barack Obama told reporters today “Our goal is not to further burden an already struggling industry; rather it is intended to help the auto industry prepare for the future.” If the auto industry emerges in a few years, it will be because an incredible amount of money will have been spent on this concentrated special interest. It will be good for it to look different, so politicians can claim they have reformed it, even at the cost of a huge waste of public resources.

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