Throughout the world there have been efforts to reduce gasoline consumption and carbon emissions by changing the cost per mile traveled. One of the reasons to justify such efforts is the concern that emissions from conventional vehicles, which is the second source of carbon emissions after the electricity sector in the U.S., may have serious consequences for the environment.

There are two major types of environmental policies that target carbon emissions from new vehicles: fuel efficiency standards that constrain manufacturers, and taxes or subsidies for cars buyers. In the U.S., the Corporate Average Fuel Economy (CAFE) standards impose a minimum level of fuel efficiency that each car manufacturer must reach with its overall fleet per year and a fine is paid in case of non-compliance. These standards have been in place since 1978 after the oil embargo from Saudi Arabia and have been strengthened twice during the past 40 years.

In contrast, other countries have introduced subsidies for fuel efficient and alternative fuel, hybrid, and electric vehicles. This is the case of Sweden with its “Green Car” rebates programme and of the “Running on Green Power” rebate programme for electric vehicles in Canada. The combination of fee and rebate schemes, known by the portmanteau feebate, has been in place in large jurisdictions, such as California in the U.S. and Wallonia in Belgium, and in entire countries, such as in France through the “bonus/malus” policy since 2008.

In our new article we compare the two types of policies, for both the US and France and at different levels of stringency. Our comparison keeps constant the two main outcomes of these policies: the fuel efficiency gains and the tax revenue. This allows us to concentrate on the comparison of gains and losses for consumers, car manufacturers and the carbon emissions avoided across the two types of regulation.

A key aspect of the study is that we take into account that cars are differentiated goods and therefore imperfect substitutes to each other. This has two consequences for environmental regulation. First, not all individuals will switch towards purchasing fuel-efficient vehicles when a tax levied on low-fuel economy cars is introduced. Second, car manufacturers will adjust their pricing strategies in response to the regulation.

We find that feebate policies are consistently better than CAFE standard policies in both countries. This is the case because the feebate policy directly affects all car manufacturers while the standard-type policies do not directly impact car manufacturers that are above the standard. However, the effects vary across manufacturers. Feebate-type policies make fuel efficient car manufacturers better-off and generate less profits losses for the least fuel efficient manufacturers but the standard-type policies favour car manufacturers that are close to the standard.

Both policies generate economic losses that increase with the policy stringency. However, the losses from a standard-type policy in the U.S. are 10 per cent higher than those of an equivalent feebate-type policy. In France, this difference is larger: 70 per cent. This gap is due to the differences in the fleet composition and consumers’ preferences in each country.

Over the past decade, the CAFE standards in the U.S. have gone through significant reforms to make them more flexible for manufacturers. One of such modifications is to allow for trading of credits of fuel efficiency among car manufacturers. Such setting, in addition of the regular standard policy, makes the CAFE standard equivalent to a feebate policy. Another reform consists of using attribute-based standards that impose lower fuel efficiency standards to larger cars. We find that such modification weakens the stringency of the policy for the U.S. but not for France.

It is very likely that environmental regulation triggers innovation. One possibility is the introduction of hybrid versions of existing car models. In this scenario, the feebate regulation generates net gains in both markets while the standard regulation has positive effects only in the U.S. and when accounting for the benefits from the reduction in carbon emissions.

We also compare standard and feebate policies to a fuel tax, which constitutes the simplest solution since it is based on car utilisation. However, if a gasoline tax was put in place to achieve the same improvements in fuel efficiency as the standard and the feebate regulations, it would be necessary to have a fuel tax of 32 per cent in the U.S. and 15 per cent in France. These high taxation levels would be necessary because fuel cost is a car characteristic that mildly affects the car purchase decision. These numbers indicate a politically-infeasible change in taxes if this was the policy to be used.

In summary, our research suggests to take a step back in the design of environmental policies aimed at improving fuel efficiency and reducing greenhouse gas emissions from cars. Some policies perform consistently better than others even if the markets are very different.

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Notes:

• This blog post is based on the authors’ paper To Rebate or Not to Rebate: Fuel Economy Standards Versus Feebates, Economic Journal, December 2018.
• The post gives the views of its authors, not the position of LSE Business Review or the London School of Economics.
• Featured image credit: Photo via Pxhere, under a CC0 1.0 licence
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Isis Durrmeyer is an assistant professor of economics at the Toulouse School of Economics in France. Her work focuses on the evaluation of environmental policies in the automobile industry.

Mario Samano is an associate professor of economics at HEC Montreal and Researcher at CIRANO. His work focuses on gasoline and electricity markets.

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