CAFE Standards Increase: An Econometric Cost-Benefit Analysis

Introduction: The NCEP Proposal and CAFE Standards

Rising gas prices within an era of severe economic trauma caused by international oil price shocks have prompted Congress and the National Commission on Energy Policy (NCEP) to work toward viable solutions. In December 2004, the NCEP released a document entitled "Ending the Energy Stalemate: A Bipartisan Strategy to Meet America's Energy Challenges." In it, the NCEP proposed a 36% increase — equivalent to 10 miles per gallon for cars and 8 miles per gallon for light trucks — in the Corporate Average Fuel Economy (CAFE) standards for light-duty vehicles (LDVs). These increases are to be phased in over the period from 2010 to 2015. The impact upon national fuel standards as well as the environment will be substantial, and it is necessary to evaluate the actual quality of this proposal against economic metrics. The actual impact upon the environment of NCEP's proposed CAFE standard increases must be fully analyzed in order to understand the implicit details associated with them.

NCEP's suggested increase is not entirely new; many previous attempts have been made to raise CAFE standards to meet higher fuel efficiency requirements for LDVs. However, the economic costs associated with such increases have consistently dampened congressional interest. For years, the automobile industry has fought against rising CAFE standards through various tactics, citing competitive disadvantages relative to European and Japanese manufacturers. The advent of hybrid technology has reinvigorated the CAFE debate and contributed to the NCEP's recommendations for increased fuel economy within the LDV sector.

The CAFE standards, when originally instituted in 1975 and subsequently updated, were intended to serve as an industry-wide filter to raise national fuel efficiency standards for automakers. Current levels are set for LDVs at 20.7 miles per gallon, with a manufacturer fleet average of 27.5 miles per gallon. The proposed changes accorded by the NCEP would have a dramatic impact on fuel efficiency. However, the central question is whether such changes will actually produce a positive and efficient impact on the environment — a question that can only be answered through thorough econometric analysis.

Projected Environmental and Fuel Efficiency Benefits

The first step is to examine the implications of the proposed CAFE standard increases for the future of vehicular fuel use. A 36% increase in CAFE standards for LDVs will affect petroleum use and imports, vehicle miles traveled, and vehicle costs. As a single factor affecting automobile production and the broader economy, several analytical implications follow. First, a 36% CAFE standards increase will result in a reduction of petroleum consumption within the United States. Figures are projected to drop by 0.61 million barrels per day in 2010 and could decrease by as much as 1.61 million barrels per day by 2025 — corresponding to an approximately 5.8% decrease in petroleum consumption. This will also affect the import share of petroleum products, allowing it to fall from 62.4% to 61.6% by 2015.

The impact of NCEP's CAFE proposal will also be substantial for the fuel efficiency of new LDVs by 2015. New LDVs on average would achieve a higher efficiency of 6.8 miles per gallon, up 26.2% over current standards. Although these figures fall below the projected thresholds of the CAFE increase, the current fleet of LDVs already tests at significantly lower levels than the projections described by the NCEP. The combined implications of reduced petroleum dependence and greater LDV fuel efficiency include a substantial lowering of overall U.S. CO2 emissions — specifically, a reduction of 79 million metric tons in 2015, and 242 million metric tons by 2025, representing a 2.8% difference.

Economic Costs to Consumers and the Auto Industry

Although the above metrics suggest numerous positives to the NCEP's proposed CAFE increase, this does not mean the changes come without significant costs. The cost burden placed on consumers is substantial: the average price of new LDVs would increase by approximately $1,400 per vehicle by 2015, correlating to nearly $12 billion in additional consumer expenditure in that year alone. The cost burden on consumers is one of the central complaints raised by the automotive industry against any increase in CAFE standards.

A further problem is that a CAFE standards increase will have a severe impact on LDVs currently in production. The majority of LDVs produced in the United States do not meet the specifications needed for CAFE compliance and would therefore face a significant financial burden. A cost-benefit analysis using econometrics reveals important details about the cost structure required for environmental improvement.

To meet the standards proposed by the NCEP, two steps would need to be taken for LDVs. Models that cannot meet the standard would have to be discontinued, or production would need to be reduced to bring fleet averages in line with requirements. According to an analysis of the NHTSA database, 36 light truck models would fail to satisfy the projected changes proposed under the CAFE increase, with little or no ability to close the gap (these models average 18.6 MPG). For the purposes of this analysis, these models are treated as discontinued with no chance of recovery. For instance, the Dodge RAM 1500 currently achieves 18.2 MPG, and its projected requirement would be 24.6 MPG by 2015. A 10-mile-per-gallon increase cannot be attained given the vehicle's curb weight constraints, making discontinuation the likely outcome under the proposed CAFE rules.

Using a least-squares regression line to examine the relationship between fuel efficiency and cost-effectiveness reveals a clear pattern: fuel efficiency is maximized at the expense of high input costs, with a 10% increase in cost yielding only a 4.865% increase in fuel efficiency. This implies that for LDVs to meet the specified requirements, they would need to undergo nearly a 20% overall cost increase. The implications from an efficiency perspective are considerable. In 2002, consumers purchased a total of 1,219,815 light trucks exceeding the current NCEP limitations. The majority of these LDVs would have no ability to meet specified standards without dramatic cost increases. Applying the proportional ratio of the CAFE standards increase, a linear growth equation can express the overall cost per vehicle and per population for LDVs under this policy.

By 2025, the average price of new LDVs is projected to be approximately 4.2% above current forecast levels. The impact is slightly lower than in 2015 because technological progress will reduce some of the burden placed on automotive manufacturers. Nevertheless, the costs of such a policy will be significant: LDV sales are projected to fall in proportion to price increases, with 910,000 fewer units sold — approximately 5% lower than current projections — by 2015. Between 2016 and 2025, LDV sales are expected to be 4.3% below current projections.

Conclusion: Cost-Benefit Assessment of CAFE Increases

The present discounted value analysis of the proposed CAFE standard changes makes it evident that there is no favorable cost-benefit outcome associated with NCEP's recommendations. While CO2 emissions reductions attributable to CAFE standard increases in LDVs could reach as much as 6% by 2025, the social costs associated with such a move are substantial. Data shows that CAFE standard increases would make vehicles significantly more expensive for consumers to purchase. At the same time, the emissions benefits of greater miles per gallon exhibit diminishing returns: the largest gains occur in the first five years, when the most polluting LDV models are discontinued and removed from the active fleet. Consequently, CAFE standards do not incentivize the automotive industry to develop more efficient vehicles; instead, they push manufacturers into discontinuing LDV product lines because the cost of continued production would be prohibitive.

The ultimate result is that CAFE increases lack a cohesive strategy for improving industry-wide efficiency while simultaneously avoiding reduced consumer spending in the LDV sector. This cannot be achieved under the current NCEP recommendations from a cost perspective. From an efficiency analysis perspective, NCEP's suggestions rank, at best, in the middle of the pack relative to other proposed environmental protection mechanisms. Given that this is a high-cost solution that achieves only moderate environmental protection, it is not an efficient policy instrument from an environmental econometric standpoint.

The fundamental problem from an econometric point of view is that a 36 MPG CAFE standard is not a feasible target. The EIA estimates that LDVs will only be capable of reaching 30 MPG by 2015 at the current rate of technological advancement. Current technology will not be sufficient to meet the CAFE targets for light trucks of 10 miles per gallon by 2015, making this an infeasible goal. The NCEP's targets can only be reached if both the automotive industry and individual consumers absorb the enormous cost of transformative change. The ratio of cost to benefit is significantly skewed toward high costs and only moderate gains. As this analysis has clearly demonstrated, more effective methods exist for meeting the NCEP's stated goals. Furthermore, CAFE standards unfairly place the burden on a small percentage of individuals and families rather than distributing responsibility equitably across the population. This disproportionate demographic burden makes the proposed CAFE standard increases even more inequitable and ultimately undermines the policy's legitimacy as a national environmental strategy.