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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

Corporate Average Fuel Economy (CAFE) regulations constrain automakers to produce vehicles whose average efficiency exceeds a minimum standard. A “loophole" in the program allows firms to relax this constraint by producing gasoline-ethanol flexible-fuel vehicles, which are credited with far better mileage than they actually achieve. In this paper, we demonstrate that when firms use this loophole, they reveal the marginal cost of complying with the standard. This is because firms equate the marginal cost of relaxing the constraint via the loophole with the marginal cost of complying through other means, such as selling smaller vehicles or installing fuel-saving technologies. We show that under certain conditions the marginal cost of relaxing the constraint via the loophole is a simple function of readily available parameters. We demonstrate empirically that these sufficient conditions hold in recent years for major U.S. automakers. We calculate that the cost of increasing CAFE standards by one mile per gallon is between $8 and $28 in lost profit per vehicle for domestic automakers. These costs are far lower than other recent estimates based on more complicated methodologies. Unlike these other estimates, our costs are well below the noncompliance penalty of $55, which should serve as a plausible upper bound, and which has been used as a cost parameter in previous research. More generally, the loophole methodology we develop here may help reveal marginal compliance costs for other regulations whose costs are otherwise difficult to gauge.

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Bibliographic Info

Paper provided by Harris School of Public Policy Studies, University of Chicago in its series Working Papers with number 0901.

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Date of creation: Jan 2009
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Handle: RePEc:har:wpaper:0901

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Keywords: CAFE; fuel efficiency; loopholes;

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References

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  1. Parry, Ian W.H. & Walls, Margaret & Harrington, Winston, 2007. "Automobile Externalities and Policies," Discussion Papers dp-06-26, Resources For the Future.
  2. 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.
  3. Holland, Stephen P. & Knittel, Christopher R & Hughes, Jonathan E., 2008. "Greenhouse Gas Reductions under Low Carbon Fuel Standards?," Institute of Transportation Studies, Working Paper Series qt9gh5b4rv, Institute of Transportation Studies, UC Davis.
  4. Andrew N. Kleit, 2004. "Impacts of Long-Range Increases in the Fuel Economy (CAFE) Standard," Economic Inquiry, Western Economic Association International, vol. 42(2), pages 279-294, April.
  5. James M. Sallee, 2011. "The Surprising Incidence of Tax Credits for the Toyota Prius," American Economic Journal: Economic Policy, American Economic Association, vol. 3(2), pages 189-219, May.
  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. Sarah E. West & Roberton C. Williams III, 2005. "The Cost of Reducing Gasoline Consumption," American Economic Review, American Economic Association, vol. 95(2), pages 294-299, May.
  8. 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.
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Citations

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Cited by:
  1. James M. Sallee & Joel Slemrod, 2010. "Car Notches: Strategic Automaker Responses to Fuel Economy Policy," NBER Working Papers 16604, National Bureau of Economic Research, Inc.
  2. Soren T. Anderson & Ian W. H. Parry & James M. Sallee & Carolyn Fischer, 2011. "Automobile Fuel Economy Standards: Impacts, Efficiency, and Alternatives," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 5(1), pages 89-108, Winter.
  3. James Sallee, 2010. "The Taxation of Fuel Economy," NBER Working Papers 16466, National Bureau of Economic Research, Inc.
  4. Huse, Cristian, 2014. "Fast and Furious (and Dirty): How Asymmetric Regulation May Hinder Environmental Policy," MPRA Paper 48909, University Library of Munich, Germany.
  5. Thomas H. Klier & Joshua Linn, 2012. "Using vehicle taxes to reduce carbon dioxide emissions rates of new passenger vehicles: evidence from France, Germany, and Sweden," Working Paper Series WP-2012-09, Federal Reserve Bank of Chicago.
  6. Xavier d'Haultfoeuille & Pauline Givord & Xavier Boutin, 2012. "The environmental Effect of Green Taxation : The case of the french "Bonus/Malus"," Working Papers 2012-13, Centre de Recherche en Economie et Statistique.
  7. Soren T. Anderson, 2010. "The Demand for Ethanol as a Gasoline Substitute," NBER Working Papers 16371, National Bureau of Economic Research, Inc.
  8. Mark R. Jacobsen, 2013. "Evaluating US Fuel Economy Standards in a Model with Producer and Household Heterogeneity," American Economic Journal: Economic Policy, American Economic Association, vol. 5(2), pages 148-87, May.
  9. Fraas, Arthur G. & Harrington, Winston & Morgenstern, Richard D., 2013. "Cheaper Fuels for the Light-Duty Fleet: Opportunities and Barriers," Discussion Papers dp-13-28, Resources For the Future.
  10. Liu, Yimin & Helfand, Gloria E., 2012. "A hedonic test of the effects of the Alternative Motor Fuels Act," Transportation Research Part A: Policy and Practice, Elsevier, vol. 46(10), pages 1707-1715.
  11. Huse, Cristian & Lucinda, Claudio, 2013. "The Market Impact and the Cost of Environmental Policy: Evidence from the Swedish Green Car Rebate," MPRA Paper 48905, University Library of Munich, Germany.
  12. Lawrence Goulder & Mark Jacobsen & Arthur van Benthem, 2009. "Unintended Consequences from Nested State & Federal Regulations: The Case of the Pavley Greenhouse-Gas-per-Mile Limits," Discussion Papers 08-049, Stanford Institute for Economic Policy Research.
  13. Lawrence H. Goulder & Mark R. Jacobsen & Arthur A. van Benthem, 2009. "Unintended Consequences from Nested State & Federal Regulations: The Case of the Pavley Greenhouse-Gas-per-Mile Limits," NBER Working Papers 15337, National Bureau of Economic Research, Inc.
  14. James M. Sallee, 2013. "Rational Inattention and Energy Efficiency," NBER Working Papers 19545, National Bureau of Economic Research, Inc.
  15. Shanjun Li & Joshua Linn & Erich Muehlegger, 2012. "Gasoline Taxes and Consumer Behavior," NBER Working Papers 17891, National Bureau of Economic Research, Inc.

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