The Obama Administration’s regulations intended to force very rapid increases in vehicle fuel economy are adding thousands of dollars to the prices of new cars. Vehicle prices are rising in ways that are consistent with the predictions of studies undertaken several years ago. It is likely that the regulations are adding at least $3,800 (perhaps much more) to the average price of new vehicles, thus pricing many Americans out of the new car market altogether.

The Corporate Average Fuel Economy (CAFE) standards were originally put in place in order to reduce America’s dependence on foreign oil. Economists have roundly rejected the wisdom of that goal. Under the Obama Administration, CAFE standards have become a tool for combatting global warming, at which they are utterly ineffective. Americans are paying excessively for regulations that fail any reasonable cost-benefit test. The CAFE standards should be scrapped.

Rising Regulation

Originally implemented for Model Year 1978, the CAFE standards were developed at a time of massive disruptions in world oil markets, such as the Arab oil embargo of 1973, and widespread concern about what was believed to be America’s excessive dependence on foreign oil. Rather than trusting the international market to clear with higher prices encouraging new exploration and greater and more diverse supply, the U.S. government enacted Byzantine standards that attempted to drive technological change directly, but whose main effect has been to thwart the market’s ability to deliver products most preferred by consumers. The regulations require that each manufacturer’s fleet of new cars have average fuel economy above a certain level, with extensive instructions for computing the average and exemptions for certain types of vehicles. Manufacturers have found work-arounds to thwart the intent of the regulations. For example, the standards raised the price of large cars, such as station wagons, relative to light trucks. As a result, automakers created a new type of light truck—the sport utility vehicle (SUV)—which was covered by the lower standard and had low gas mileage but met consumers’ needs.[1] Other automakers have simply chosen to miss the thresholds and pay fines on a sliding scale.

In 2009, the Obama Administration implemented regulations required by Congress under the Energy Independence and Security Act of 2007,[2] and consequently raised the CAFE standards by approximately 9 miles per gallon (mpg) through Model Year (MY) 2016.[3] In addition, starting with MY 2011, the average fleet economy calculation changed. Under the new standard, cars and trucks with larger footprints are allowed to operate less efficiently, giving an incentive to carmakers to spread out the wheels of their vehicles.

The regulatory push will not stop with MY 2016 vehicles. In 2012, the Administration finalized extremely rigid regulations for vehicles in MY 2017 and beyond.[4] These new regulations will require an average fleet efficiency of 49.6 mpg in MY 2025.[5]

Predictions

After the policy change in 2009, several economists and engineers modeled the likely effect of the tightening standards. All of them found that the CAFE standards are much more costly than their alternative, a direct gasoline tax that would reduce fuel use by the same amount.

Kate Whitefoot, Meredith Fowlie, and Steven Skerlos modeled the ways that car design could respond to the standards in effect for MY 2014. They found that the tightening of the regulations since 2009 would cost consumers an additional $59 billion per year.[6] Projected to MY 2016 and adjusted for inflation, the annual estimated cost to consumers is $82.5 billion.[7]

Thomas Klier and Joshua Linn compared automakers’ reaction to higher fuel standards in the short run (when they can change only prices) and the medium run (when they can change both prices and vehicle design).[8] They find that companies and consumers are worse off on account of the regulations in both scenarios, but the medium-run scenario is worse for consumers. They estimate that a 1 mpg tightening of the standard would cost consumers $7.81 billion annually.[9] Projecting the estimate to match a 9 mpg regulatory change and adjusting for inflation, the cost estimate grows to $61.2 billion per year.

Mark Jacobsen also modeled the CAFE standards increase, distinguishing between different automakers and including the used car market in his model.[10] He found that domestic automakers and consumers would bear almost all the costs of the regulations. Consumers’ losses add up over time as the costs of the new regulations work their way through the used car market. After 10 years’ adjustment, the burden of the regulations will fall most heavily on households with incomes below $25,000.[11] Jacobsen’s estimate of the total consumer cost of a 1 mpg increase in CAFE standards after 5 years is $20.87 billion per year,[12] almost triple the comparable estimate of Klier and Linn. For the 9 mpg regulatory change through MY 2016, adjustments bring the annual consumer cost to $186.1 billion.

In all three papers, the consumer costs are measured as “consumer surplus” or “equivalent variation.” These are important theoretical concepts that fail to translate directly into price changes.[13] Nonetheless, consumer surplus is strongly related to prices, and it is difficult to imagine that the price change could be substantially less than the consumer surplus loss per unit sold.[14] If demand is flexible, however, the price change could be quite a bit higher. All three papers take into account the value of fuel efficiency to consumers, which also tends to make consumer surplus loss per vehicle smaller than the average price change.

In the most modest of the estimates, the consumer surplus loss per new vehicle sale is over $3,800.[15]

Data

It is impossible to say exactly what automobile prices would have been in 2015 if CAFE standards had remained unchanged. Evidence from pre-2009 trends and international comparisons suggest that vehicle prices would have continued to fall relative to other prices in the economy.

The Bureau of Labor Statistics measured the quality-adjusted average price of new vehicles and found that from the mid-1990s until 2008, when CAFE standards were mostly static, the average vehicle price fell steadily. CAFE standards for light trucks (but not cars) gradually rose from MY 2005 to MY 2010.[16] In 2007, Congress mandated large increases in fuel efficiency, and automakers may have begun to take the coming standards increases into account when making long-term design investments.[17]

Since 2009, the average vehicle price has risen steadily, as Chart 1 shows. Although one cannot prove that the price increase occurred because of the tightening of CAFE standards, the increase is consistent with researchers’ earlier predictions of the effects of the new regulations.

Nominal prices continued to rise during the recovery. By the third quarter of 2015, prices were 8.7 percent above the pre-recession level.[18] If the 2001–2007 trend had continued, prices would have been 14.8 percent lower than they are.

Although nominal prices are simple to measure, it is even more revealing to look at how vehicle prices changed relative to the prices of other goods (i.e., the general inflation rate). Consumers do not buy cars in a vacuum; they need to know how many other products they could buy instead of a new car. Taking overall inflation into account, vehicle prices would have been 21.3 percent lower than they are if pre-recession trends had continued. [19]

Of course, relative prices can change for all sorts of reasons. If the sudden trend change in 2009 was because of tighter CAFE standards, we should not see a similar trend break in the prices of similar goods or of vehicle prices in other countries.[20]

The most similar category of goods to vehicles might be “Furnishings and Durable Household Equipment,” also shown in Chart 1, which declined along with vehicle prices from the mid-1990s to 2009. At that point, the series diverged: vehicle prices began rising at the average rate of inflation while furniture and appliance prices continued to decline. If vehicle prices had tracked furniture and appliance prices since 2007, they would be 23.4 percent lower than they are today.

International evidence shows that vehicle price trends shifted in 2009 only in the U.S. and Canada, which implemented a standard very similar to CAFE at the same time as the U.S.[21]

Chart 2 shows relative price trends in the U.S. and six other developed countries.[22] In three eurozone countries, the price of vehicles decreased slightly relative to the overall price level before 2007 and continued to decline through the recession. In France, relative vehicle prices began rising moderately in 2012; in Italy, the prices began rising in 2013. In four English-speaking countries, relative vehicle prices fell rapidly through 2008. The global commodity price swings of 2008 and 2009 led to large movements in relative prices. After those swings, Australian and British vehicle prices resumed their rapid decline relative to overall price levels. In the U.S. and Canada, the decline stopped outright.

If U.S. prices had continued to track U.K. prices since 2007, vehicle prices would be 13 percent lower than they are now.[23] U.S. prices would be 24.8 percent lower had they tracked Australian prices.

More importantly, international evidence fails to show any systematic trend shift circa 2009. If rising U.S. vehicle prices were due to material costs, technological changes, or global demand changes, similar trends would be occurring abroad. There is nothing to show that such is the case.

Price Impact

The quality-adjusted price of an average new vehicle sold in the U.S. is about $6,200 above trend. Price indices that followed comparable trends through 2007—vehicle prices in the U.K. and Australia, and the U.S. price of household durables—have continued to follow their trendlines. If vehicle prices in the U.S. had followed one of those trends, the average car would be $4,000 to $7,100 cheaper today.[24]

Table 1 shows the price deviations from the various trend comparisons.

The price impacts relative to trends and reasonable comparisons are in the same range as the per unit losses in consumer surplus in the scholarly predictions of the effects of the CAFE standard increase.

Climate Impact

Despite the original intent of the CAFE standards (to reduce dependence on foreign oil), it is clear that the Environmental Protection Agency’s current goal for the standards is to decrease carbon-dioxide emissions. The Obama Administration has optimistically claimed that the change in the standards through 2016 will decrease global temperatures by 0.007 degrees to 0.018 degrees Celsius in 2100.[25]

Predictions of the economic cost or benefit of higher global temperatures vary widely.[26] In a widely read survey article, Richard Tol, a lead author of Intergovernmental Panel on Climate Change assessment reports, reviewed estimates of a 2.5 degree Celsius increase in average world temperature on world gross domestic product (GDP).[27] The estimates ranged from an increase of 2.3 percent to a reduction of 4.8 percent. The average of the reported studies was a loss of 0.91 percent of world GDP.

Using the central estimate, the CAFE standards’ trivial moderation of warming would lead to a benefit equal to 0.0065 percent of world GDP in 2100. Any benefit in the same order of magnitude as this undiscounted, distant gain to GDP would be more than offset by the massive losses the strict CAFE standards are already imposing on U.S. consumers each year.

The $61.2 billion cost to U.S. consumers estimated by Klier and Linn represents 0.054 percent of 2015 global income.[28] The new CAFE standards thus fail a cost-benefit test by a large margin,[29] even using climate models that are favored by global warming hawks and ignoring the job losses, lower incomes, and lost lives that CAFE standards also cause.[30]

Unintended Consequences

The CAFE standards are not only an extremely inefficient way to reduce carbon dioxide emission but will also have a variety of unintended consequences.

For example, the post-2010 standards apply lower mileage requirements to vehicles with larger footprints.[31] Thus, Whitefoot and Skerlos argued that there is an incentive to increase the size of vehicles.[32]

Data from the first few years under the new standard confirm that the average footprint, weight, and horsepower of cars and trucks have indeed all increased since 2008, even as carbon emissions fell, reflecting the distorted incentives.[33]

Another well-known flaw in CAFE standards is the “rebound effect.” When consumers are forced to buy more fuel-efficient vehicles, the cost per mile falls (since their cars use less gas) and they drive more. This offsets part of the fuel economy gain and adds congestion and road repair costs. Similarly, the rising price of new vehicles causes consumers to delay upgrades, leaving older vehicles on the road longer.

In addition, the higher purchase price of cars under a stricter CAFE standard is likely to force millions of households out of the new-car market altogether. Many households face credit constraints when borrowing money to purchase a car. David Wagner, Paulina Nusinovich, and Esteban Plaza-Jennings used Bureau of Labor Statistics data and typical finance industry debt-service-to-income ratios and estimated that 3.1 million to 14.9 million households would not have enough credit to purchase a new car under the 2025 CAFE standards.[34] This impact would fall disproportionately on poorer households and force the use of older cars with higher maintenance costs and with fuel economy that is generally lower than that of new cars.

CAFE standards may also have redistributed corporate profits to foreign automakers and away from Ford, General Motors (GM), and Chrysler (the Big Three), because foreign-headquartered firms tend to specialize in vehicles that are favored under the new standards.[35] Jacobsen predicted that after 10 years under the new standards, GM and Chrysler would each lose over 10 percent of their profits, Ford would lose 0.5 percent, and European and Asian automakers would increase their profits at least 3 percent.[36] He projected that the Big Three would reduce their production of “large, high-horsepower” vehicles to meet the standard while importers would increase their market share in that area, which further “harms the efficacy of CAFE in reducing gasoline use.”[37]

Conclusion

CAFE standards are costly, inefficient, and ineffective regulations. They severely limit consumers’ ability to make their own choices concerning safety, comfort, affordability, and efficiency. Originally based on the belief that consumers undervalued fuel economy, the standards have morphed into climate control mandates. Under any justification, regulation gives the desires of government regulators precedence over those of the Americans who actually pay for the cars. Since the regulators undervalue the well-being of American consumers, the policy outcomes are predictably harmful.

• Economists and engineers accurately predicted that the MY 2016 standards would hurt consumers by at least $3,800 per car;
• Since the Obama-era standards took effect, average new car prices have risen to $6,200 above trend;
• CAFE standards will continue to tighten, reaching 49.6 mpg in 2025;[38]
• The higher prices will force millions of lower-income households out of the new-car market;
• CAFE standards have a trivial impact on global warming—hundredths of a degree at most; and
• Regulation limits consumers’ choices regarding safety, comfort, and affordability.

Congress should repeal the CAFE standards immediately, which would save 2025 car buyers at least $7,200 per vehicle. Failing that, this or any future Administration has the authority to rewrite the regulatory rule for future model years, taking consumer costs into account and easing the standards, potentially to 27.5 mpg, which would save 2025 car buyers at least $5,900 per vehicle.[39] Freezing the standards at the MY 2016 level would save future buyers at least $3,400 per vehicle.

The new CAFE standard is just one more example of the regulatory burden the government imposes on American households. From dishwashers with interminable cycle times[40] to requirements that gasoline be diluted with corn ethanol,[41] the mandates imposed by the federal government increase consumer costs and reduce consumer choices.

—Salim Furth, PhD, is Research Fellow in Macroeconomics in the Center for Data Analysis, of the Institute for Economic Freedom and Opportunity, at The Heritage Foundation. David W. Kreutzer, PhD, is Senior Research Fellow for Energy Economics and Climate Change in the Center for Data Analysis.

Appendix

Chart 2 Sources

Australian Bureau of Statistics, Consumer Price Index, “Table 13: CPI: Group, Expenditure Class and Selected Analytical Series Index Numbers, Seasonally Adjusted, Weighted Average of Eight Capital Cities,” September 2015, http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6401.0Sep%202015 (accessed November 4, 2015); Statistics Canada, “Table 326-0020 - Consumer Price Index,” http://www5.statcan.gc.ca/cansim/a26?id=3260020 (accessed November 4, 2015); National Institute of Statistics and Economic Studies, “Consumer Price Index (Monthly, All Households, Metropolitan France, Base 1998) - COICOP Classification: 07.1.1.1 - New Cars, 1999–2015,” http://www.insee.fr/en/bases-de-donnees/bsweb/serie.asp?idbank=000638803 (accessed November 4, 2015); Statistisches Bundesamt, “Retail Price Index,” https://www.destatis.de/EN/FactsFigures/NationalEconomyEnvironment/Prices/ConsumerPriceIndices/Tables_/RetailPrices.html (accessed November 4, 2015); Italian National Institute of Statistics, “Prices,” I.Stat, http://dati.istat.it/?lang=en (accessed November 4, 2015); Office for National Statistics, “Consumer Prices Indices,” http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/september-2015/tsd-consumer-price-indices-september-2015.html (accessed November 4, 2015); and Bureau of Labor Statistics, “Consumer Price Index: All Urban Consumers (Current Series),” http://www.bls.gov/cpi/data.htm (accessed November 18, 2015).

Table 1 Sources

Australian Bureau of Statistics, Consumer Price Index, “Table 13: CPI: Group, Expenditure Class and Selected Analytical Series Index Numbers, Seasonally Adjusted, Weighted Average of Eight Capital Cities,” September 2015, http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6401.0Sep%202015 (accessed November 4, 2015), and U.S. Department of Commerce, Bureau of Economic Analysis, “National Data: Section 2 – Personal Consumption Expenditures: Table 2.4.4U. Price Indexes for Personal Consumption Expenditures by Type of Product (A) (Q) (M),” http://www.bea.gov/iTable/iTable.cfm?ReqID=12&step=1#reqid=12&step=3&isuri=1&1203=2016 (accessed November 4, 2015).