Volatile gasoline prices have caused regulators and carmakers alike to question the cost and effectiveness of fuel economy standards, with some arguing they are too stringent and others saying they should be even stronger. As the Trump administration takes a closer look at the rules, a new study in the Journal of Public Economics evaluates the current approach and proposes a novel, market-based alternative: indexing the standard to rise and fall with the price of gasoline.

“Based on past fluctuations, gasoline prices over the next ten years could be anywhere from more than twice what is expected to less than half what is expected,” says Ryan Kellogg, a professor at the University of Chicago Harris School of Public Policy and author of the study. “The reality is, we just don’t know what the cost of gas is going to be, and the success of fuel economy standards hinges on that price signal. Indexing the standards to rise and fall with the price of gasoline provides a sensible approach to account for this large unknown.”

If gasoline prices are higher than expected, consumers will opt for vehicles that are even more efficient than the rules require, suggesting that the current fixed 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.

Kellogg’s evaluation shows that allowing the standard to rise and fall with the price of gasoline more closely equates the costs and benefits. 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.

“By allowing fuel-economy standards to adjust in tandem with the price of gas, such a policy would fully leverage consumers’ willingness to pay for more fuel efficient cars when gasoline prices are high and avoid saddling automakers with excessive compliance costs when fuel prices are low,” says Kellogg.

The current standards do aim to provide the flexibility needed to account for unpredictable gasoline prices. For example, the standards are footprint-based, meaning that vehicles with a relatively large wheelbase are assigned a relatively less stringent standard. This allows consumers to choose gas-guzzling cars when gasoline prices are low, and choose vehicles that offer greater efficiency when gasoline prices are high.

Kellogg evaluates this approach and finds it is not enough to compensate for the distortions to vehicle size that are introduced by a footprint-based standard. Instead, his approach would allow automakers to adjust vehicle production volumes to more closely match consumer preferences. For example, automakers could manufacture more gas-guzzlers when gasoline prices are low and more efficient models when gasoline prices are high. In the medium term, an indexed standard could potentially allow for even greater flexibility—though it would be important to ensure that standards only adjusted incrementally, to avoid implementing a set of standards in a given year for which automakers had not produced suitable vehicles.

“This is potentially a solution that could satisfy automakers—who right now say complying with fuel economy standards is too expensive—while also delivering the maximum benefits for consumers and the general public by reducing greenhouse gas pollution at the lowest cost,” Kellogg says. “Without the political will for a strong gasoline tax, this market-based approach is the best option. And, it doesn’t require new legislation from Congress.”

Areas of Focus: Energy Markets
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Energy Markets
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Fossil Fuels
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Transportation
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Climate Economics
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Climate Economics
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Climate Law & Policy
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Fuel Economy Standards
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Fuel Economy Standards
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