Floyd Reports

The 1973 Yom Kippur War pitting Israel against Syria and Egypt motivated an Arab petroleum boycott, instigating congressional passage of the 1975 Corporate Average Fuel Economy standards. Known by its acronym, CAFE, the program does not man­date that every car sold in the United States be parsimonious but defines an average that each manufacturer’s cars must attain.

At the time, Republican and Democratic commentators anticipat­ed both major and collateral benefits. First, cars burning less fuel would reduce dependence on petroleum imports from potentially hostile na­tions. Second, CAFE would force domestic manufacturers to devote a higher percentage of output to small cars, curtailing loss of domestic au­tomobile sales and jobs to imports. In 1975 hardly anyone had heard of global warming or worried that car­bon dioxide emissions might pose a threat to human welfare, but it seems obvious that reducing petroleum consumption would reduce carbon emissions from that source.

Whatever one’s view of the merits of the triad — reducing imports of foreign petroleum, curtailing substi­tution of foreign for domestic au­tomobile production, reduction of carbon dioxide emissions — CAFE defined an excessively costly path to­ward those goals and led to perverse unintended consequences. Congress ignored people’s predilections to seek alternative ways to satisfy legislative­ly discouraged preferences. A more successful and less costly approach would merely define goals, use pric­es to properly align private incen­tives with those goals, then permit individuals to determine how best to make whatever adjustments they deem desirable.

Congress recognized that GM, Ford, and Chrysler each engaged in substantial automobile produc­tion abroad. Indeed, at that time, Ford, not Toyota or Volkswagen, was the largest car producer outside the United States. Gasoline taxes and hence retail prices throughout the rest of the developed world were a multiple of those in North America, while streets were narrow and park­ing scarce. Therefore, like the distri­bution of output of foreign manu­facturers, the Big Three biased their offshore production toward the small cars that most foreign buyers wanted.

Congressional fear that the Big Three would meet CAFE require­ments by increasing imports from their offshore operations led to the definition of separate pools — in order to avoid substantial fines, a pro­ducer had to satisfy the miles per gallon standard for one pool of domesti­cally produced automo­biles and separately for a distinct pool of those from abroad. Vehicles defined as light trucks soon became a third pool, with more lenient standards than are imposed on cars. Perversely, the distinction between light trucks and cars did not hinge on function or appearance, but on vehicle weight — once a model’s weight (and thus its fuel consumption) became high enough, it became a “light truck” ruled by more forgiving CAFE stan­dards.

The initial impact of CAFE on domestic producers was straightfor­ward: to satisfy the mandates, they had to produce fewer large cars and more small ones, artificially increas­ing the prices of large domestic cars and decreasing the prices of compet­ing small, imported models.

Almost exclusively, foreign com­panies had been exporting small cars to the United States and had no diffi­culty in meeting CAFE standards. In 1983, for instance, domestic produc­tion (at 24.4 mpg) failed to meet the CAFE standard (26.0 mpg) but im­ports easily exceeded the mark (32.4 mpg). Given the constrained ability of domestic producers to compete in one segment, the imports soon rec­ognized the attraction of designing larger cars than were demanded in their home markets in order to reap the increasing large-car profit mar­gins in the United States.

As CAFE standards gradually tightened, people who might have purchased a large domestic car (had its price not increased) opted instead for one of the increasingly large im­ports. CAFE induced domestically produced cars to burn less fuel, but perversely in­duced the average foreign import sold in the United States to burn more. Ac­cording to data from the National Highway Traffic Safety Administration, the proportion of U.S. import sales that fall in large car segments has grown from about 5 percent upon CAFE’s implementa­tion to a level that fluctuates around 90 percent today. Over the same pe­riod, the import share of U.S. auto­mobile sales exploded. In retrospect, the loss of sales and jobs to imports was not discouraged but encouraged by CAFE.

A parallel transition occurred as some buyers switched from heavier varieties of domestic cars such as station wagons to even more fuel-thirsty “light trucks” such as SUVs and vans. Combining the impact of increasingly fuel-efficient domestic cars with decreasingly fuel-efficient imports, and taking account of the shift of sales toward imports and small trucks, the aggregated CAFE average achieved by vehicles sold in the United States fell continu­ously between 1987 and 2004. In 2005 world petroleum prices began a sharp upward climb and new car buyers became more interested in fuel-efficiency, but the Organization of Petroleum Exporting Countries deserves more credit than CAFE for that.

Congress ignored an obvious alternative policy that could have achieved better results with less disruption, an alternative long used throughout the developed world beyond North America — in­crease fuel taxes (gradually so people can adapt), and increase them sub­stantially (to encourage more fuel-efficient replacements). The congres­sional error was to force unwelcome changes in vehicle supply that car buyers have resisted rather than in­ducing demand changes. As one easily confirms when vacationing in Europe or Japan, with higher gaso­line prices even well off car buyers want fuel-efficient cars. The result­ing retail price increase of gasoline would have contributed to the U.S. treasury rather than those of OPEC nations. Offshore and onshore pro­duction would have faced identical constraints, light trucks the same as cars, gutting artificial incentives for buyers to hop from one CAFE pool to another.

Some drivers would continue to drive large cars, but CAFE also per­mits that, and those drivers get off cheap because gasoline prices gross of tax are low by world standards. More­over, when CAFE molds the mix, low fuel prices generate perverse after-pur­chase incentives even for fuel-efficient models — the car burns less fuel, re­ducing the per mile cost of driving and thus encouraging owners to drive additional miles. The proper focus is aggregate gallons of fuel consumed, not miles that one of those gallons can move a car. CAFE reverses the criteria.

Can the poor afford increased fuel taxes? The tax would be borne dis­proportionately by wealthier drivers — very few poor people drive Hum­mers. If Congress did not squander the funds but used them to reduce or eliminate other taxes, there is no reason anyone need be worse off. Individuals would consume less fuel — which after all is the goal — but compensatory decreases in other taxes would provide an offsetting ad­vantage.

CAFE leans only on the vehicle sector, indeed only a part of the ve­hicle sector. There are moves afoot to give heavier vehicles their own stan­dards (37 years after CAFE was insti­tuted!), but railroads, barges, airlines, and so on also consume petroleum. Moreover, for at least some uses vari­ous fuels are substitutes in either pro­duction, consumption, or both. For example, the proportion of a barrel of petroleum distilled into fuel oil rather than gasoline is a choice vari­able, within limits. CAFE pressures people to conserve the gasoline they burn in their cars, but unlike a com­prehensive fuel tax provides no in­centive to conserve the oil or meth­ane that heats homes, the electricity that cools them, nor long-distance flights.

More subtly, the arbitrary CAFE pools alter the mix of vehicles in inane ways. A population of cars that consumes X gallons of petroleum combined with a population of light trucks consuming Y gallons has the same impact on security from hostile nations and carbon dioxide emis­sions as cars consuming Y gallons and light trucks consuming X gallons — it is X + Y either way. Congress and NHTSA cannot judge how best to produce cars or vehicle mix, and should not micromanage this major sector of the economy. Had Congress opted for a fuel tax instead of CAFE mandates, the automobile industry and their customers would have cho­sen the mix — an identical benefit at substantially lower cost.

Am I being naive? Like most citi­zens, I lack insight into the shadowy internal workings of legislatures. Spe­cial interests, obscure to the rest of us, have their own reasons and bet­ter ability to force government policy away from superior options.

Perhaps it is unrealistic to expect Congress to institute one tax and use the proceeds to mitigate another. Certainly, increasing fuel taxes while retaining CAFE would be absurd, dooming a stressed economy to the disruptions of both. Nonetheless, CAFE is a placebo, creating an illu­sion of progress while little good and much harm results. All hope is lost if, for fear of seeming naive, one does not call this failed policy for what it is — a fool’s errand.

As has been understood since the 19th century, any command-and-control regulation is bereft of infor­mation it needs to attain its goal, and at least one of several incentive-compatible alternatives inevitably dominates. Seriously addressing the triad of goals defined at the outset of this article requires a radical tacti­cal alteration. The government can­not patch CAFE’s gushing leaks with Band-Aids of ever more dictatorial constraints, but needs to align indi­vidual incentives with public goals. CAFE has not been, nor ever will be, nor possibly could be, the bringer of the public benefits its proponents claim. Congress should relinquish the acronym to its proper claimants — small-scale purveyors of beverage and sustenance.

David D. Haddock is Professor of Law and Professor of Economics at North-western University in Illinois. He is also a Senior Fellow at PERC – The Property and Environment Research Center of Bozeman, Montana.

Photo credit: terrellaftermath