Proposal Advocates Cap-and-Trade for Fuel Economy

This week  Cass Sunstein of Harvard Law School and Michael Greenstone and Sam Ori of the Energy Policy Institute at the University of Chicago released a policy proposal discussing an alternative way of regulating fuel economy in the U.S. The proposal would do three things: regulate expected fuel consumption/GHG emissions directly, use data to estimate a vehicle’s lifetime fuel consumption/GHG emissions and create a robust cap-and-trade market to reduce compliance costs.

• Regulate expected fuel consumption/GHG emissions directly, without differentiation based on the source vehicle. It would remove the separate treatment of cars and light trucks and size categories. The authors note that currently, the efficiency standards treat cars and light trucks differently, providing standards for light trucks that are more lax. The result is that the ability to achieve policy goals is highly dependent on the price of gasoline, which is determined globally, and consumer preference about vehicle type and size, which is not controlled by government. The authors say:

“We recommend that vehicle efficiency standards treat fuel consumption/GHG emissions identically, regardless of whether they are emitted from a car or light truck and regardless of the vehicle’s footprint. Such a reform would meet a fundamental economic principle that the best way to achieve a goal is to target it directly.”

• Use data to estimate a vehicle’s lifetime fuel consumption/GHG emissions. The authors say that vehicle efficiency regulations are targeted at miles-per-gallon benchmarks, but ignore differences in miles that vehicles will be driven over their lifetime. “As a matter of policy, this does not make sense. For example, the typical Honda Civic being retired today has been driven 169,000 miles over its lifetime, whereas the average Mitsubishi Mirage has been driven 92,000 miles. The models have nearly identical fuel efficiency, but vastly different lifetime fuel consumption. Efficiency is therefore more valuable in terms of fuel reductions with the Civic than with the Mirage.

“We recommend that each vehicle be assigned estimated lifetime fuel consumption and GHG emissions and this, rather than fuel economy, be the target of regulations. EPA and [the National Highway Traffic Safety Administration, NHTSA] already use estimates of car and light truck lifetime miles to estimate the benefits of the rules, but assume that the number is identical for all cars and trucks respectively. Yet, there are now several data sets that can be used to develop reliable estimates of lifetime vehicle miles traveled (VMT) by model. Furthermore, important new research demonstrates that regulating vehicles on the basis of a combination of efficiency and usage would be vastly superior to regulating efficiency alone, which captures only one-fourth to one-third of potential emissions reductions.”

• Create a robust cap-and-trade market to reduce compliance costs. With a regulatory system based on vehicles’ lifetime fuel consumption and GHG emissions, it might be natural to set automaker-specific limits. However, the authors notes, this raises the possibility that some automakers would face high compliance costs simply because of their expertise in manufacturing particular types of vehicles. A solution to this problem is to set a cap that applies across all manufacturers and then allow trading.

“We acknowledge that the term ‘cap and trade’ has become controversial in recent years. We hope that it will be less controversial here, where the goal is to take an existing program, with existing mandates, and make it far more flexible and far less costly. We recommend the establishment of a cap-and-trade market for expected GHG emissions across all car and light truck sales annually.  Credit trading, banking, and borrowing are already legal and embedded in the existing EPA and NHTSA programs, providing the needed framework for establishing a cap-and-trade system. Each year’s cap would be set consistent with U.S. policy goals.

 

The sale of each vehicle would require holding permits for that car’s projected lifetime fuel consumption. The permits could be distributed through some combination of allocations to automakers and auctions that could raise revenue for the U.S. Treasury or be used to ensure that the program does not have adverse distributional consequences. For example, the allocations could be used to compensate automakers that would otherwise be unfairly harmed by the program. Importantly, such a regulatory approach would retain the technology-neutrality of efficiency standards. But because it would more directly target fuel use and emissions, it would not only reduce costs, but also provide an incentive for automakers to develop and sell low- or zero emissions vehicles, including those powered by electricity or hydrogen.”