Highlights 

The Regulation

• The National Highway Traffic Safety Administration (NHTSA) proposes to establish higher corporate average fuel economy standards for light trucks for model year 2008-2011.

Our Findings

Corporate average fuel economy CAFE standards supplant consumer preferences regarding vehicle attributes with NHTSA-defined criteria. In the absence of a clearly defined market failure, this is bound to make consumers worse off. Yet, NHTSA concludes that its "reformed" CAFE standards for light trucks "carefully balance the cost of the rule with the benefits of conservation," and are set at a level that "maximizes net benefits."

• NHTSA's economic model does not separate the externality benefits (due to market failure) from internalized benefits, but the bulk of the benefits appear to derive from assumptions about how consumers should be valuing fuel efficiency versus other attributes. This is problematic, because the fundamental premise of benefit-cost analysis is that all benefits and costs must be valued according to the consumers' own preferences.
• The most obvious flaw is NHTSA's use of a 7 percent discount rate, which simply substitutes the government's preferences for consumers'. An honest benefit-cost analysis cannot just set aside individual preferences, such as the discount rate; nor can it ignore them, as NHTSA's analysis does with other vehicle attributes that consumers value.

By the Numbers

Our Comments develop five technical limitations in the NHTSA analysis; each of which could reverse its conclusion that the reformed standards will offer net benefits.

• NHTSA does not present a separate dollar estimate of the externality benefit. With this component of the total benefit apparently only assumed, NHTSA has not justified that government regulations in the form of reformed standards produce benefits in excess of costs.
• The 7 percent discount rate used in its cost-benefit calculations is too low when calculating the present value of an investment to consumers. A higher and more appropriate discount rate reverses the finding of net benefits.
• The NHTSA analysis is likely incorrect when it assumes that manufacturers and customers will not respond to the reformed standards by producing and selecting vehicles with an increased footprint. In contrast, some measure of "mix shifting" is inevitable, and significant mix shifting is highly plausible. NHTSA benefits are therefore overstated.
• NHTSA bases its benefit calculations on projected gasoline prices of $1.51 to $1.58 per gallon. Current higher prices, along with consumer response to the uncertainty of future gasoline prices, are encouraging a market response that reduces the benefits that NHTSA assigns to its proposed regulations.
• CAFE requirements retard equity, and are highly regressive. CAFE requirements place a relatively large burden on low and middle income households in terms of both higher initial investment cost, and in terms of reduced value of future benefits.

Recommendations

NHTSA should validate its model by demonstrating that, in the absence of market failures, fuel economy standards will not produce net benefits. Once it has done that, it can introduce market failures-the alleged external benefits of increased energy security and reduced fuel use-and try to determine if these external benefits might be of sufficient magnitude to overcome the net loss to consumers and justify mandatory standards. Our analysis suggests that this is unlikely, however. Specifically:

• NHTSA should recognize the degree of uncertainty and volatility surrounding its gasoline price forecast of $1.58 per gallon. This single figure is the basis of its cost-benefit calculations, making its conclusions highly tentative. NHTSA should delay implementing its reformed CAFE requirements until gasoline prices return to the level assumed by NHTSA in its analysis.
• NHTSA should acknowledge its arbitrary discount rate assumption, and should explicitly recognize that higher discount rates reverse its benefit-cost conclusion.
• NHTSA should acknowledge the equity retarding effects of its proposed regulation, and particularly the high burden that it places on low and medium income households. NHTSA should recognize the powerful market incentive to bypass the intention of the regulation by manufacturing and purchasing vehicles with larger footprints.
• NHTSA should explicitly recognize the inherent limitations and second best property of any technical standards in achieving reductions in gasoline use.