New research published in the December 2018 issue of The Economic Journal compares the impact of the two main kinds of environmental policies for reducing carbon emissions from new vehicles: fuel efficiency standards for manufacturers; and consumer taxes or subsidies. The study by Isis Durrmeyer and Mario Samano analyses the gains and losses for consumers, car manufacturers and carbon emissions across the two types of regulation, as well as the impact on innovation.

In the United States, the ‘corporate average fuel economy’ (CAFE) standards impose a minimum threshold of fuel efficiency for manufacturers, with a fine to be paid for non-compliance. Other countries, such as France and Sweden, have introduced rebates (subsidies) for fuel-efficient vehicles combined with fees (taxes) on less fuel-efficient cars – a mix of policies known by the portmanteau term ‘feebate’ (fee plus rebate).

The new study develops a framework for comparing the total economic gains from the two types of policies for both the United States and France. The authors show that standards policies are consistently dominated by feebate policies in both countries but the effects vary across manufacturers: standards policies favour manufacturers that are close to the standard; while feebate policies make manufacturers of fuel-efficient cars better off and generate fewer losses for manufacturers of the most fuel-inefficient cars.

The economic analysis takes account of the fact that cars are differentiated goods and therefore imperfect substitutes for one other. This has two consequences for environmental regulation:

  • First, not all individuals will switch towards purchasing fuel-efficient vehicles when a tax levied on low fuel-economy cars is introduced.
  • Second, car manufacturers will change their pricing strategies in response to the regulation.

By analysing consumers’ preferences and manufacturers’ pricing strategies, the authors are able to simulate the effects of different levels of stringency of the two types of policies – feebate and standards. To make them comparable, they simulate feebates and standards that lead to the same level of average gains in fuel efficiency and raise the same tax revenue.

By keeping those two main outcomes constant across the policies, the authors can concentrate on the comparison of gains and losses for consumers, car manufacturers and carbon emissions avoided across the two types of regulation.

Both policies generate economic losses that increase with policy stringency. But the losses from a standards policy in the United States are 10% higher than those from an equivalent feebate policy. In France, this difference is larger at 70%.

The researchers also study the features of the new formats of CAFE standards in the United States. Allowing for trading of credits of fuel efficiency among car manufacturers on top of the regular standard makes the two regulations strictly equivalent. Attribute-based standards weaken the stringency of the traditional CAFE standards policy for the United States but not for France.

Finally, it is very likely that environmental regulation triggers innovation. One possibility the authors investigate is the introduction of hybrid versions of existing car models. In this scenario, the feebate regulation generates net gains in both markets while the standards have positive effects only in the United States and only when accounting for the benefits from the reduction in carbon emissions.

Moreover, if a gasoline tax were put in place to achieve the same improvements in fuel efficiency and reductions in emissions as the CAFE standards and the feebate, it would be necessary to have a fuel tax of 32% in the United States and 15% in France. These numbers indicate a non-negligible effect on taxes if this were the preferred policy to be used.

In summary, these results suggest taking a step back in the design of environmental policies aimed at reducing greenhouse gas emissions from cars. Some policies perform consistently better than others even if the underlying markets are very different.

To Rebate or Not to Rebate: Fuel Economy Standards versus Feebates’ by Isis Durrmeyer and Mario Samano.