Fuel Economy Standards

Fuel economy standards were introduced in the mid-1970s in the wake of the OPEC oil embargo as part of an effort to reduce U.S. oil dependence. Decades later, improving fuel efficiency in order to reduce greenhouse gas emissions became an additional goal of the program. In 2010 and 2012, the Environmental Protection Agency (EPA) and National Highway Traffic Safety Administration (NHTSA) came together to issue new regulations governing light-duty vehicle carbon dioxide emissions and fuel efficiency for the period 2012-2025. Known as the National Program, the rules envisioned significant improvements in efficiency, growing from a targeted performance of 30.1 miles per gallon (mpg) in 2012 to an estimated combined fleet average of 54.5 mpg in 2025—an increase of 81 percent.

One important feature of the National Program is that it is attribute based, making it unique from past fuel economy rules. Under an attribute-based approach, a particular characteristic is used to sort vehicles into groups with differing requirements. In this case, the attribute is the “footprint,” which is the rectangle formed by the four points where a vehicle’s tires touch the ground. Each motor vehicle footprint bin is required to achieve increasing levels of efficiency annually over the course of the National Program, with smaller vehicles facing steeper increases and larger vehicles facing more modest requirements. An automaker’s compliance level is determined by the average fuel economy or greenhouse gas (GHG) efficiency produced by the mix of vehicles it sells in a given year. In other words, each automaker has individually tailored compliance and performance levels based on the vehicles it produces and sells.

The regulators based their estimates of future achieved efficiency levels—as well as program costs and benefits—on a wide range of assumptions, including projections of continuously rising oil and gasoline prices over the coming decades, consumer preferences for cars or trucks, and consumer willingness to pay for efficiency.

Many of these assumptions – notably, the assumption that fuel prices would remain high – have been proven incorrect. This has a major impact on cost-effectiveness: as fuel prices rise, consumers tend to prefer more efficient vehicles because the fuel savings associated with such vehicles are greater. Gasoline prices, however, are extremely volatile, presenting a serious challenge for regulations that are dependent on that price signal to achieve their optimal cost-effectiveness and environmental benefits. If gasoline prices are higher than expected at the time the rules are written, consumers will opt for vehicles that are even more efficient than the rules require, suggesting that the rules are too lenient and are missing out on potentially greater fuel and emissions savings. If prices are lower than expected, consumers will demand less efficient vehicles, raising compliance costs for automakers who must reduce prices for their most efficient models.

For this and other reasons, a wealth of academic literature suggests that fuel-economy standards are a costly and suboptimal approach to regulating environmental harm from GHG emissions.

EPIC research is providing insight on the efficiency of fuel economy standards and how they can be improved. EPIC Executive Director Sam Ori and Director Michael Greenstone, along with Harvard Professor Cass Sunstein, have laid out proposals to improve the policy. Namely, their white paper suggests three improvements:

• Regulate expected CO2 emissions directly. Standards would be equalized to treat light trucks and larger vehicles with the same level of stringency as they treat other vehicles.
• Estimate and target a vehicle’s lifetime emissions. Current standards based on fuel efficiency alone would be replaced with expected lifetime emissions, incorporating consideration of vehicle usage.
• Develop a robust cap-and-trade market to reduce compliance costs. The EPA would establish a nationwide cap on lifetime vehicle emissions and allow automakers to trade credits more flexibly.

Another study, co-authored by Harris Pubic Policy Associate Professor Koichiro Ito, identifies an inefficient feature of fuel standards: basing them on an attribute—in the case of the United States, that attribute is a vehicle’s size. His study finds that size-based standards incentivize automakers to increase the size of their vehicles in order to fall into a less stringent compliance category.

“As automakers like Ford dramatically boost production of their pickups and SUVs, it’s clear that there is more driving their decisions than consumer preferences alone. Policy plays a substantial role, as our study indicates.”

– Koichiro Ito, Associate Professor, Harris Public Policy

Because of the uncertainty of gasoline prices, another study, co-authored by Harris Public Policy Professor Ryan Kellogg, examines the impact these volatile gasoline prices have on fuel economy standards. To dampen the impact, he proposes a novel, market-based alternative: indexing the standard to rise and fall with the price of gasoline. When gasoline prices are high, the standards would ratchet up to become binding, achieving maximum, cost-effective fuel and emissions savings. When gasoline prices are low, the standards would ratchet down, avoiding overly burdensome costs for automakers.