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Using Loopholes to Reveal the Marginal Cost of Regulation: The Case of Fuel-Economy Standards

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  • Soren T. Anderson
  • James M. Sallee

Abstract

Estimating the cost of regulation is difficult. Firms sometimes reveal costs indirectly, however, when they exploit loopholes to avoid regulation. We apply this insight to fuel economy standards for automobiles. These standards feature a loophole that gives automakers a bonus when they equip a vehicle with flexible-fuel capacity. Profitmaximizing automakers will equate the marginal cost of compliance using the loophole, which is observable, with the unobservable costs of strategies that genuinely improve fuel economy. Based on this insight, we estimate that tightening standards by one mile per gallon would have cost automakers just $9-$27 per vehicle in recent years. (JEL L51, L62, Q48)

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 101 (2011)
Issue (Month): 4 (June)
Pages: 1375-1409

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Handle: RePEc:aea:aecrev:v:101:y:2011:i:4:p:1375-1409

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  1. James M. Sallee, 2011. "The Surprising Incidence of Tax Credits for the Toyota Prius," American Economic Journal: Economic Policy, American Economic Association, American Economic Association, vol. 3(2), pages 189-219, May.
  2. Stephen P. Holland & Christopher R. Knittel & Jonathan E. Hughes, 2007. "Greenhouse Gas Reductions under Low Carbon Fuel Standards?," NBER Working Papers 13266, National Bureau of Economic Research, Inc.
  3. Sarah E. West & Roberton C. Williams III, 2005. "The Cost of Reducing Gasoline Consumption," American Economic Review, American Economic Association, American Economic Association, vol. 95(2), pages 294-299, May.
  4. Parry, Ian W.H. & Walls, Margaret & Harrington, Winston, 2007. "Automobile Externalities and Policies," Discussion Papers, Resources For the Future dp-06-26, Resources For the Future.
  5. Tol, Richard S. J., 2005. "The marginal damage costs of carbon dioxide emissions: an assessment of the uncertainties," Energy Policy, Elsevier, vol. 33(16), pages 2064-2074, November.
  6. Austin, David & Dinan, Terry, 2005. "Clearing the air: The costs and consequences of higher CAFE standards and increased gasoline taxes," Journal of Environmental Economics and Management, Elsevier, vol. 50(3), pages 562-582, November.
  7. Andrew N. Kleit, 2004. "Impacts of Long-Range Increases in the Fuel Economy (CAFE) Standard," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 42(2), pages 279-294, April.
  8. Rubin, Jonathan & Leiby, Paul, 2000. "An analysis of alternative fuel credit provisions of US automotive fuel economy standards," Energy Policy, Elsevier, vol. 28(9), pages 589-601, July.
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