CAFE Standards

What are the benefits and costs? Should we even be doing CAFE?

Prepared for Prof. J. Doucet

BUEC 562, Section Z6 April 17, 2002

By

Alex Frei

TABLE OF CONTENTS CAFE – An Attempt to Encourage Oil Conservation by Imposing Fuel Economy Standards..................................................................................................................................1 Current CAFE Standards.......................................................................................................2 The Use of Alternate (Dual or Flexible) Fuel Credits under AMFA ..................................2 New Proposed Regulation .......................................................................................................3 Monetized Benefits of Increased Regulation (CAFE 36) .....................................................4 Other Non-monetized Benefits ...............................................................................................5 Costs of Increased Regulation ................................................................................................6 Benefit – Cost Trade-off ..........................................................................................................8 Policy Recommendations ........................................................................................................8 Conclusions.............................................................................................................................10 Counterpoint 1 .......................................................................................................................11 Counterpoint 2 .......................................................................................................................12 APPENDIX A – Light Duty Automotive Technology and Fuel Economy Trends ..........13 APPENDIX B – Article – Pitting Conservationists against Soccer Moms .......................14 APPENDIX C – New Canadian Government SUV Rules..................................................15 APPENDIX D – Gasoline Prices and Gasoline Tax Rates for Selected Countries ..........16 APPENDIX E – Bureau of Transportation Services fuel consumption and travel tables, Federal Highway Administration Statistics and my tables showing extrapolation of these data. ...............................................................................................................................17 APPENDIX F – CAFE 20.7 Industry and Public Comments............................................18 REFERENCES ......................................................................................................................19

CAFE Standards Page 1 April 2002 Proponents of fuel efficient vehicles want more pressure applied to automobile manufacturers to increase America’s vehicular fleet fuel efficiency. Opponents believe “we don’t need to tell Americans to eat your spinach”1, implying that no such regulation should be thrust on the American public. This paper provides a backdrop to the issue by first reviewing the development of Corporate Average Fuel Economy (CAFE) standards and its current implementation. Then it examines current proposed regulations and the benefits and costs of these regulations. Stakeholders’ interests on both sides are explored, as well as distributional effects of the regulations. Finally policy recommendations are made based on the findings. The current CAFE regulation is discussed from a benefit and a cost point-of-view. Monetary data for public benefits and costs are not available in the literature.2 In addition, I could not find sufficient literature on the industry costs, probably because their time horizons are not that long. (GM indicates that their model planning horizon does not go past 2008 because of overwhelming economic and consumer preference uncertainty). I have derived some numerical data on benefits and discussed costs in a qualitative manner. Even though this approach does not provide a direct comparison of benefits and costs, the salient points for and against regulation become clear.3 In a qualitative manner I am then able to draw some policy recommendations vis-à-vis CAFE standards. The geopolitical arena has changed since the original implementation of CAFE standards in 1975. Vehicle fuel economy and dependence on foreign oil remain important issues, however they may be partly overshadowed by greenhouse gas (GHG) emissions issues, in particular the focus of the Kyoto Protocol. A discussion of CAFE standards therefore necessitates consideration of the wider environmental issues today. This wider context is reflected in my policy recommendations. CAFE – An Attempt to Encourage Oil Conservation by Imposing Fuel Economy Standards In 1970 the American Congress established the EPA with one of its responsibilities being to regulate motor vehicle pollution. As a response to the oil embargo of 1973/74 and the ensuing energy crisis, the Energy Policy and Conservation Act created the Corporate Average Fuel Economy (CAFE) program where mandatory fuel economy standards were set for passenger cars and light trucks in 1975. The intent was to reduce domestic oil consumption by increasing the fuel efficiency of the American passenger vehicle fleet.

1 Dallas Morning News, March 14, 2002 quoting Senator Christopher Bond, R-Mo. 2 Data are not available for CAFÉ for the past six years. Federal funds that would have allowed NHTSA to “collect and analyze data had been restricted under the CAFE freeze for the preceding six fiscal years (to 2001 - resulting in their inability) at this time to determine what are the benefits to the light truck purchaser”. NHTSA 2001, Section IV. 3 The benefits and costs of both regulations are essentially the same, but differ in magnitude and perhaps scope. Therefore, in a qualitative sense, comparing the two different regulations allows one to draw meaningful conclusions even with insufficient quantitative data. The more stringent regulation, CAFÉ 36, provides greater benefits at greater cost, as is self-evident. Greater discussion of the comparison is made in the benefit – costs section of the paper.

CAFE Standards Page 2 April 2002 The mechanism for establishing and implementing these regulations was carried out by three groups: Congress, the National Highway Traffic Safety Administration (NHSTA) of the Department of Transportation and the Environmental Protection Agency (EPA). Congress and the NHTSA set the CAFE standards. The NHTSA assesses any penalties associated with non-compliance. The EPA is responsible for establishing test procedures, collecting data and confirming manufacturers’ averages. In 1970, there were 111,242,000 vehicles registered in the US, which travelled 1,786,375 million kilometres using 349,503 million litres of fuel, with an average fuel economy of 5.1 kms/litre (12 mpg).4 CAFE set standards for new vehicles from domestic car manufacturers at 18 miles per gallon (mpg) in 1978, rising to 27.5 mpg in 1985. Fuel economy for vehicles increased from 1975 until the peak in 1988 and remained relatively constant thereafter. The average fuel economy for the entire fleet has declined almost 8 percent from it’s peak in 1988 to today.5 The decrease is mostly attributed to the increasing share of light trucks in the domestic vehicle fleet. Americans are more dependent on foreign oil than before. In 2000, passenger vehicles accounted for approximately 40% of all US oil consumption6 and the US imported approximately 58% of it’s oil requirements. Current CAFE Standards Two classes of passenger vehicles are subject to CAFE standards − cars and light trucks. The fuel economy for a manufacturer’s entire line of cars must exceed 27.5 mpg and 20.7 mpg for light trucks. These standards have been unchanged since 1988. Manufacturers can be penalized for failure to meet the standard. Penalties by law7 are currently $5.50 per vehicle sold for each 0.1 mpg under the standard.8 Within each passenger vehicle class, two vehicle fleets are defined: ‘domestic’ and ‘import’. Vehicles with 75% or more US/Canadian content are considered ‘domestic’, and those with less than 75% US/Canadian content are considered ‘imports’. If a manufacturer has both ‘domestic’ and ‘import’ fleets, both fleets have to qualify separately under CAFE.9 The ‘Big 3” plus Honda, Mazda, Nissan and Toyota have separate import and domestic fleets. From model year 1983 to 2000 none of these manufacturers paid a fine under CAFE standards.10 The Use of Alternate (Dual or Flexible) Fuel Credits under AMFA In 1988 Congress enacted the Alternative Motor Fuels Act (AMFA) to further reduce fossil fuel consumption. The intent was to complement the improvements in light vehicle fuel efficiency and the corresponding conservation of domestic energy resources. Credits could be

4 These figures include personal passenger vehicles, buses and trucks. Bureau of Transportation Services 5 EPA 2001, pp. ii 6 EPA 2001, pp. i 7 40 CFR 578.6 (h) 8 EPA 2000 9 ITA 10 NHTSA 2002, Appendix B

CAFE Standards Page 3 April 2002 earned by manufacturing alternate fuel vehicles and these credits used to offset fuel economy shortfalls in the three previous or subsequent model years. The AMFA was set up so that vehicle manufacturers could use the alternate fuel credit to relax the effect of the CAFE standard on the rest of their fleet. Alternate fuels under AMFA are methanol, ethanol and natural gas. Vehicles powered by electricity, liquid petroleum gas (LPG) and bio-diesel are not covered by AMFA. The alternate fuel that manufacturers build engines for is EM85, a mixture of 85% ethanol and 15% gasoline. Vehicles so equipped can burn either gasoline or EM85, and are therefore called dual fuelled. Manufacturers do not make engines which burn other AMFA approved fuels. Vehicles which use alternate fuels are collectively referred to as Flexible Fuel Vehicles (FFVs). Ford and Daimler Chrysler manufacture enough of these vehicles so that they are near the 0.9 mpg benefit allowed by law, while GM is at a lower level. In model year 2000, 8% of all light trucks were dual fuelled as were 1.4% of cars.11 Because there are only 121 EM85 refuelling stations in the US, only 0.22% of highway fuel used is alternate fuel (3.3 million gasoline gallon equivalents in 2000)12. The AMFA has been controversial and the debate about alternate fuel credits and mpg targets continues today. The alternate fuel credit system has resulted in a 1% increase in petroleum consumption and a slightly less than 1% increase in greenhouse gases. In July 2001 the National Academy of Science’s report on CAFE recommended that the credits for dual fuel vehicles be eliminated. Despite this recommendation, in August 2001 the Securing America’s Future Energy (SAFE) Act bill was passed in the House of Representatives, which includes a provision to extend the dual fuel CAFE credits through the 2008 model year. It is now on the Senate’s legislative calendar. New Proposed Regulation New energy legislation is currently being debated in the Senate to bring all passenger vehicle CAFE standards, including both cars and light trucks, to 36 mpg by 2015. 13 (I refer to this as CAFE 36). As with previous CAFE standards, the harmonic average fuel economy of the manufacturer’s fleet is used. It is more difficult to achieve than an arithmetic mean. For example, to achieve a CAFE standard of 27.5 mpg, two 35 mpg vehicles must be sold for every 20 mpg vehicle.14

11 NHTSA 2001, Section III, Findings 12 It is interesting to note that Detroit has manufactured over 1.2 million EM85 vehicles from 1997 to 2000, giving them CAFE mileage credits while EM85 refuelling facilities are almost non-existent. Therefore these vehicles are fuelled solely on gasoline. EM85 vehicles have poorer mileage than if the vehicle was designed for gasoline fuel only instead of dual fuel. It is a perverse increased fuel consumption effect of this regulation. This effect of conflicting policies has been noted by researchers at the World Resources Institute. 13 Another related regulation currently being debated is the extension of the light truck fuel economy of 20.7 mpg to 2004. This is not explicitly discussed in this paper. 14NCEE 2001

CAFE Standards Page 4 April 2002 Monetized Benefits of Increased Regulation (CAFE 36) In 2000 there were 2,766,917 million vehicle miles travelled and 162,260 million gallons of fuel were consumed.15 This is an average fuel economy of 17 mpg for the entire American passenger vehicle fleet. The average passenger vehicle fuel economy for new vehicles in 2001 was 20.4 mpg. The difference between these two figures is the distribution of vehicle age in the entire fleet. In 2000 there were 15,216,153 new passenger vehicles in the total US fleet of 221,206,000 passenger vehicles.16 I have taken Bureau of Transportation statistics from 1960 to 1998 and extrapolated them to 2015, the year when the CAFE standard of 35 mpg for all light vehicles is to be in full effect. I have projected the future base case by looking at population growth, number of registered vehicles, number of miles driven per year and fuel consumed per year. I have extrapolated values for 2015 under current regulations. The base case consumption will rise from 158,557 million gallons of fuel used in 221 million vehicles with a fleet mileage of 16.6 mpg in 2000 to 194,066 million gallons of fuel used in 275 million vehicles with a fleet mileage of 17.5 mpg in 2015.17 If we assume that the new vehicle fuel economies will respond in a similar time frame to CAFE standards from 1976 to 1988, vehicles will achieve 23/25 x 36 = 33.1 mpg ratings by 2015 for new vehicles, slightly below the standard, as was the case in 1988. If we discount this fuel economy level to account for the average fleet age in a similar manner to the effect in 1988, we would estimate the fleet fuel economy to be:

The [average for entire fleet (1988)/CAFE weighted average requirement (1988)] x CAFE weighted average 2015 = (16.47/[0.70x27.5+0.3x20.5])x36 = (16.47)/[25.4]x36 = 23.3 mpg.

With an estimated 3,399,027 million miles expected to be driven in 2015, this would be a reduction of 3,399,027 million/17.5 gallons - 3,399,027 million/23.3 gallons = 194,230 million gallons - 145,881 million gallons = 48,349 million gallons of fuel saved in 2015 alone! This corresponds to a reduction of 48,349 million/42 x0.818 = 920 million barrels of crude oil per year, or 2.52 million barrels per day – 10.3% of the estimated 24.5 million barrels per day of US oil consumption in 2015. In today’s dollars, this is a savings to consumers of 1.2 x 48,349 million = USD58.0 billion in one year alone in reduced fuel costs.19 This is a saving of USD58.0 billion/307 million people = USD189 per capita per year in today’s dollars in 2015.

15 Federal Highway Administration’s Highway Performance Monitoring System (HPMS) 16 NHTSA 2002 17 Refer to Appendix E for Bureau of Transportation fuel consumption and travel tables, Federal Highway Administration Statistics and my tables showing extrapolation of these data. 18 This conversion assumes that 1 barrel of crude oil produces 0.8 barrels of gasoline on average. 1 barrel = 42 US gallons. 19 Based on an average fuel price of USD1.20 in the US today, and that inflation effects on the present value of the fuel costs and savings cancel out.

CAFE Standards Page 5 April 2002 In addition to consumer savings, refiners will not have to add refinery capacity, eliminating this cost. Based on my estimate of refinery addition costs of USD1 billion per 100,000 barrel per day capacity, the savings due to a reduction in required capacity of 2.52 million barrels per day equates to USD25.2 billion in savings. Other Non-monetized Benefits CAFE standards have the desirable side effect of reducing all polluting emissions related to burning of gasoline in internal combustion engines. Emissions such as hydrocarbons (HC), carbon monoxide (CO), nitrogen oxides (NOX) and carbon dioxide (CO2) are all reduced with the reduced gasoline consumption. GREET model 1.5a, NHTSA’s full life cycle model using a 100-year time horizon, estimates that light vehicles fuelled by gasoline produce 11.155 kilograms per gallon CO2 equivalent emissions.20 At 48,349 million gallons saved per year, this is an annual benefit of 539 million tonnes of CO2 equivalent emissions per year. There are many other benefits from associated pollutant reduction, but these are outside the scope of this paper. Since the 1950s metropolitan air quality has been linked to vehicular emissions. Ozone is the main component of smog and is a product of reactions involving HC and NOX in the presence of sunlight. In addition to being unsightly, the ozone in smog is a potent upper respiratory tract irritant that causes lung damage and other respiratory problems. There is not a direct correlation between the amount of gasoline burned in a city and the concentration of ground level ozone because of many factors such as engine tune, operating range and ambient weather conditions. Nevertheless there is a relationship between it and fuel consumption. Fewer HC and NOX emissions will be emitted as less gasoline is burned. It is not within the scope of this paper to quantify the health, building erosion and other benefits from reduced metropolitan smog; however these benefits are known to exist. There are also benefits which accrue to the manufacturers:

“Qualitatively, we can identify the associated benefits to the firm as … the avoidance of regulatory penalties for non-compliance, and the gain in revenues associated with presenting an environmentally responsible image to consumers.”21

The final major benefit is intangible. September 11, 2001 brought to the fore the issue of security and American dependence on foreign (non-North-American) oil. The chart below shows the effects of declining domestic production and increasing consumption. In 1990 47% of US oil was imported. By 2000 this had risen to 58%. By continuing these trends, I project that the portion of imported oil will be 68.5% in 2010, with the US consuming 21.3 million barrels per day.22 This is shown graphically on the next page.

20 NHTSA 2002, Note 15. 21 Callan and Thomas, pp. 637 22 IEA 2000, Tables 6, 11. As a different data set has been used from other estimates in this paper, projections may be different.

CAFE Standards Page 6 April 2002 In order to assure a supply for America’s increasing oil appetite, American soldiers and money are needed to stabilize world politics. Reducing the American demand for oil lessens the need for such costly intervention. The benefits of CAFE standards are widely distributed, primarily to the public, although some benefits accrue to private firms. Drivers would pay less for fuel because of lower fuel consumption (prices assumed constant). Americans in general benefit by better air quality and the associated reduction in health problems. Citizens of the world benefit by a reduction in GHG emissions and the attendant issues, plus perhaps a more politically stable world. Manufacturers benefit by reductions in production costs and an improved image.

The Growing American Dependence on Foreign Oil

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Costs of Increased Regulation There are several costs associated with implementing CAFE standards. The main cost implications are summarized below.

CAFE Standards Page 7 April 2002 The costs of meeting CAFE standards will be directly borne by automobile manufacturers.

“On the cost side, the firm has to assess the search costs in identifying available options, the administrative costs in analyzing these options, engineering design expenses, and the expenditures to implement the strategy such as retooling or capital investment”.23

To meet more strict standards, vehicles will need to be redesigned and significant development will be required to reduce vehicle weight and increase engine efficiency. Some of the engineering and retooling costs will be offset by incremental reduction in material costs generated from the more widespread use of lighter materials and less steel. Depending on the price elasticity of demand, a greater or lesser portion of these costs will be eventually passed on to consumers in terms of higher prices. If the standards are set too high too quickly they could “substantially degrade the financial health of … a majority of the motor vehicle industry. After a point, the only compliance option available would be restricting product offerings with the necessary closure of assembly plants and loss of jobs”.24 There is the potential cost of job loss and a reduction in economic output (GDP). A subtler potential cause of employment loss is the increase in cost of manufacturing which reduces domestic manufacturers’ global competitiveness. Customers could be driven away, leading to less production and job losses. Some opponents to CAFE standards argue that to meet the standards vehicles would need to be made smaller and lighter. If this is the case, the reduction in size may mean less safe vehicles and a limitation on the kind of vehicles that consumers can buy.25 From an economic point-of-view this is a decrease in the utility to the consumer, which is a societal cost borne by consumers. I consider this an intangible cost, as it definitely exists, but is hard to monetize. On the other hand there is evidence that SUVs in particular are less safe than other vehicles in terms of deaths due to rollovers. NHTSA statistics indicate 37% fatality rates compared to 15% fatality rates for cars.26 Decreasing the SUV proportion of the passenger vehicle fleet might therefore decrease societal costs, so this may be a benefit. Sufficient lead time must be allowed to make the changes required. A major change to vehicle design takes several years. Fuel efficiency gains at the margin become increasingly costly and take longer to develop. If the legislation implements fuel economy increases at too fast a pace, sub-optimal technological solutions may be implemented, possibly at greater cost to manufacturers and consumers, while not actually reducing emissions. An example is the large increase in production of FFV vehicles, which provide very high CAFE credits to

23 Callan and Thomas, pp. 637 24 Letter from Reginald Macklin, DaimlerChrysler to NHTSA, Feb. 25, 2002 25 An Associated Press article of March 13, 2002 depicts the issue of SUV and minivan moms having to sacrifice safety and room in a vehicle to satisfy conservationists. Refer to Appendix B for a reprint of this article. 26 Edmonston, Phil pp. 34

CAFE Standards Page 8 April 2002 manufacturers, but in fact are less fuel efficient than vehicles with engines designed for gasoline only.27 Perverse effects of legislation can create costs not benefits. New car emission regulations increase the cost of these cars, shifting the supply curve of these cars to the left. Consumers will substitute used cars for new car purchases and these older cars would have worse fuel economy than new cars.28 This effect can be considered a cost of the regulation. The regulation’s effectiveness would be weakened. The direct costs of CAFE standards are narrowly distributed, primarily to automotive manufacturers. Consumers also bear the costs through higher vehicle prices and less choice. From a perspective of global warming, CAFE standards put a disproportionate burden on manufacturers and drivers. Benefit – Cost Trade-off The benefits of the CAFE 36 regulations are large and broadly distributed. Reduced fuel costs to consumers, a lesser dependence on foreign oil and a cleaner environment add up to very large benefits. The costs of increased regulation are mostly borne by manufacturers and perhaps their employees. Some of the costs will be passed on to consumers in terms of higher vehicle prices. Interestingly, manufacturers do not oppose higher standards per se, but rather oppose the speed of implementation. One could argue that is a never ending complaint and in the absurd would lead to no regulation.29 I however disagree. I think that in the long run manufacturers stand to gain as much as they lose. Therefore the costs of regulation are reduced to legislative, administrative and enforcement costs. These are relatively small costs when compared to the monetized benefits. As mentioned above, I have not found sufficient data to do a direct comparison, but I would suggest that the social benefits, which include all externalities, far outweigh the social costs. This is especially true when the greater context of global warming and GHG reduction is brought into the equation. Policy Recommendations The policy recommendations I would make are as follows:

� Scrap CAFE standards � Hike gasoline taxes in a series of steps

27 Engine design compromises, allowing the vehicles to run on either EM85 or gasoline, reduce the fuel efficiency when operated on gasoline. This is the fuel actually used in almost all cases. 28 Refer to Callan and Thomas, pp 339, Figure 12.3 for a more detailed description of this effect. 29 One would expect very strong opposition by manufacturers to any regulation which imposes costs on them while the benefits are very broadly distributed. Public choice theory, as outlined in Parkin and Bade, page 420, suggests that when benefits (or costs) of a regulation accrue to a small group and costs (or benefits) are widely distributed; the small group will have a large incentive to lobby the government in support of their interests.

CAFE Standards Page 9 April 2002

� Eliminate FFV credits � Eliminate distributive effects by implementing a broad-based carbon tax to work in

harmony with the gasoline tax and worldwide GHG reduction efforts � Monitor the effects of these two policies to determine when the desired level of fuel

efficiency and GHG emission reduction is reached The CAFE standards are the tail wagging the dog. CAFE standards at first reduced fuel consumption per vehicle, but with an increasing proportion of ‘light trucks’ being sold and steady growth in the total miles driven, fuel consumption keeps going up. CAFE standards are an inefficient and ineffective way of reducing domestic fuel consumption. Instead of forcing fuel economy increases in such an indirect way, the same ends can be better achieved by increasing gasoline prices. General Motors points out that “history has shown that with lower fuel prices, consumers tend to demote fuel economy in their purchasing decisions. As a result, manufacturer fleet averages have tended to under-perform relative to forecasts.”30 Their argument is that consumers must drive the demand for more fuel efficient vehicles. To a great extent I agree. I believe that gasoline prices need to be increased to spur consumers to select more fuel efficient vehicles. Should that approach be taken, CAFE standards may turn out to be irrelevant, as consumers will demand more fuel efficient vehicles, regardless of their size, and manufacturers will respond. In this scenario, a gasoline tax would be a mechanism to internalize the pollution externality of consumption. This would then let market forces decide the optimum level of fuel consumption and manufacturers would therefore respond to this market force by producing more fuel efficient vehicles. Gasoline prices need to be increased gradually, to the point where they reflect the true social cost of use. I suggest that the target ultimate tax levels ought to be below those of more densely populated nations, perhaps at the USD34 cents per litre range. As of 1998 American taxes were approximately USD9 cents/litre.31 I suggest a gradual increase in tax level (3.4 cents/year for 10 years), so that consumers have the opportunity to adjust to increased fuel prices by changing their driving habits and upgrading their fleet of existing vehicles. This would ultimately provide government revenues of 34 cents/litre x 158,557 million gallons x 3.78 gallons/litre (assuming fuel consumption remains at 2000 levels) = USD126 billion per year. This revenue could primarily be used to reduce income taxes, lessening the impact on consumers and reducing some of the distributive effects of the tax. Some of the revenue stream would be needed to administer the regulation. Flexible Fuel Vehicle credits have had the perverse effect of increasing gasoline consumption, while providing unrealistic credits to the automotive industry. They are counter-productive and need to be eliminated. This is irrelevant if CAFE standards are scrapped.

30 Letter from Alan Weverstad, General Motors Corporation to NHTSA, Feb. 25, 2002 31 Refer to Appendix D, for charts of gasoline prices and gasoline tax rates for selected countries. I have used an exchange rate of CAD1.60 = USD1.00.

CAFE Standards Page 10 April 2002 A broad based carbon tax on other fossil fuels should be implemented. This would eliminate the unfair distributive effect of a gasoline tax. Industry segments which rely heavily on coal or oil would then also carry the burden of GHG emission reduction. The two taxes would have to work in concert to achieve the desired level of GHG emission reduction. As these taxes will have an economic impact they must also be harmonized with worldwide GHG reduction efforts such as the Kyoto Protocol. In order to achieve sustainable development, it would be counterproductive to negatively affect American competitiveness by implementing these taxes out of sync with the rest of the world. To keep a level playing field in a global sense, carbon taxes must be carefully coordinated with other environmental efforts both domestically and globally. The whole tax process would have to be monitored so that allocative efficiency could be achieved, or as a minimum, the desired reduction achieved at the lowest cost. Since government regulation is notorious for not achieving an efficient solution, a recursive approach with a mechanism for fine-tuning would help reduce or eliminate this problem. Conclusions CAFE regulations are aimed at reducing fuel consumption of the American passenger vehicle fleet. From 1975 to 1988 CAFE standards achieved an improvement in fleet fuel economy from 17 mpg to 22 mpg. Since 1988 the fuel economy of each class of vehicles has remained unchanged. However, light trucks have been an increasing portion of the fleet, with lower mileage ratings, leading to an overall decrease in fleet fuel consumption since then. At the same time there has been an increase in the total number of vehicles, the number of vehicles per capita and an increase in the number of miles driven leading to more fuel being consumed. At the same time domestic oil production has been steadily declining. The net effect is that Americans are more dependent on imports than before. CAFE regulations are firmly in the political arena, suggesting that they may not be an optimal solution to reducing American oil consumption. I believe that they do not adequately incorporate the environmental and political externalities associated with consumer transportation and fuel consumption. To better internalize these social costs CAFE standards should be scrapped and replaced by a well implemented gasoline tax system and a complementary carbon tax system. Interaction with the Kyoto protocol and global GHG emission reduction efforts must be harmonized.

CAFE Standards Page 11 April 2002 Counterpoint 1 As with many environmental questions, issues surrounding CAFE standards can be emotionally charged and subject to political lobbying. I believe several issues put forward by different stakeholders merely obfuscate the underlying need for greater conservation of the world’s increasingly scarce resources of oil. To a great extent I consider the American obsession with individual rights tantamount to squandering resources. From my perspective this is implicit in the growth in popularity of SUVs32 when there is no real need for the vast majority of these vehicles. (By no real need, I mean that SUVs are designed for off-road use and most never see ice or snow or travel on a gravel road). The whole issue about fuel economy is intricately linked to issues of ambient air quality degradation, greenhouse gas formation, development in environmentally sensitive areas, global economics and world political stability. All these issues are externalities to consumption, which I think are generally not considered when a person buys a vehicle with low fuel efficiency. I think the dynamic is that the costs are not near at hand, are hard to quantify, and really require intellectual exercise to understand how they relate to the purchase of a person’s vehicle. In contrast the benefits are obvious: more room and greater perceived safety, even though it’ll cost more in gas. In a sense the environmental externalities exhibit a free rider problem. I would imagine that even if an individual person wanted to consider helping the environment, they would think about the effect of their one purchase and realize, correctly, that giving up this one SUV won’t have any effect on the environment when everyone else is buying one. So why choose something I want less, to have an insignificant effect on the environment? Unfortunately when this individual (rational) choice is taken in it’s societal aggregate, the effect is profound and significant. That is the essence of the free rider problem. I offer the following opinions about two other issues:

� Vehicle safety – size counts. I think this issue is motivated by ignorance and fed by fear. In a traffic accident, all else held equal, the more massive the vehicle, the less the likelihood of injury to the occupants. This is an inevitable outcome of the laws of physics. However, this approach encourages an escalation of size of vehicles that could essentially know no bounds. We would see a gradual increase in the size of vehicles, in a form of one-upmanship. The results could become quite absurd. The person who acts on this safety tactic is really saying that ‘I will exercise my right to greater safety even if it makes me more dangerous to others’. Perhaps our society operates at this base level, but I don’t really believe that. I think that people who (consciously or unconsciously) behave in this way are not really thinking about what they are doing. They are having a knee jerk reaction out of ignorance.

� Vehicle safety – a lighter car is a weaker car. Materials science has provided us with incredible advances in high-strength, lightweight materials. The space program, the civilian aerospace industry and the automotive industry have made remarkable technological strides in materials. Composites, especially fibre reinforced plastics, provide greater strength at a fraction of the weight and at a lower cost than steel.

32 Refer to Appendix A, Highlight #2 chart

CAFE Standards Page 12 April 2002

Ceramics provide more durable engine components that weigh less. Structural design innovations have lead to safer cars by utilizing ‘crush zones’ to absorb impacts, using less steel. Steel components rust, while composites don’t – composites provide longer lasting structural elements. Since weight is saved, fuel economy is greater. So is safety. The original CAFE standards produced technological innovation that created a three-way winning situation: greater fuel economy, better cars and lower production costs.

Counterpoint 2 The Canadian government has just announced that SUVs and minivans will now be classified as cars, and will therefore have to meet EPA CAFE standards for cars. Refer to Appendix C for a reprint of the article. I believe there are two problems with this regulation. First, this regulation is out of sync with the American market, so it will place a disproportionate burden on Canadian consumers in the form of unduly high vehicle prices. The current CAFE standard is 27 mpg for cars and 20.7 mpg for light trucks. The program is to be phased in between 2003 and 2008. Light truck manufacturers will have to make large investments in technology and vehicle redesign to meet these standards, for the relatively small Canadian market. Since there is no equivalent American legislation, the costs of these developments will have to be borne only by Canadian consumers. Americans will benefit from these changes, but quite reasonably can refuse to pay for them. In this way this legislation is unfair to Canadian consumers by placing a disproportionate financial burden on them. Second, I believe that using fuel economy standards is putting the cart before the horse. As discussed above, I believe that the most appropriate way of internalizing the environmental externalities is to impose a user-pay tax on gasoline. I believe that this tax is the most direct method of tightly associating the environmental costs with the benefits of use. If gasoline prices are higher, consumers will demand safer, more fuel efficient vehicles. Without direct regulation, manufacturers will supply what is demanded – more fuel efficient, safe cars. The net result will be a decrease in fuel consumption and it’s attendant reduction in oil consumption, and a reduction in greenhouse gas emissions and airborne pollutants.

CAFE Standards Page 13 April 2002 APPENDIX A – Light Duty Automotive Technology and Fuel Economy Trends33

33 EPA 2001

CAFE Standards Page 14 April 2002 APPENDIX B – Article – Pitting Conservationists against Soccer Moms

CAFE Standards Page 15 April 2002 APPENDIX C – New Canadian Government SUV Rules34

34 Yahoo News

CAFE Standards Page 16 April 2002 APPENDIX D – Gasoline Prices35 and Gasoline Tax Rates36 for Selected Countries

35 M.J. Ervin, Slide 23 36 RFF

CAFE Standards Page 17 April 2002 APPENDIX E – Bureau of Transportation Services fuel consumption and travel tables37, Federal Highway Administration Statistics38 and my tables showing extrapolation of these data.

37 Bureau of Transportation Services 38 FHWA

CAFE Standards Page 18 April 2002 APPENDIX F – CAFE 20.7 Industry and Public Comments39

39 NHTSA 2002

CAFE Standards Page 19 April 2002 REFERENCES Bureau of Transportation Services, www.bts.gov/btsprod/nts Appendix B Table 4-9M Callan and Thomas, “Environmental Economics and Management”, Second Edition, Harcourt College Publishers, 2000 EPA 2000, 40 CFR Part 86 RIN #2060-AH06, www.epa.gov.otaq/reqs/ld-hwy/cap2k-p.pdf EPA 2001, EPA420-S-01-001, www.epa.gov/otac/cert/mpg/fetrends/s0100.pdf IEA 2000, International Energy Agency, Annual Statistical Supplement for 1999 (2000 Edition), August 9, 2000. FHWA, Federal Highway Administration Highway Statistics 2000 ITA, International Trade Association, www.ita.doc.gov/td/auto/cafe.html Edmonston, Phil, Lemon-Aid for New Cars and Minivans 2002, Stoddart Publishing Co, 2001 M.J. Ervin, M.J. Ervin & Associates talk to Northern Alberta Economic Society, September 2001 NCEE 2001, National Center for Environmental Economics, yosemite.epa.gov Economic Incentives for Pollution Control - Section 6.1.13 Corporate Average Fuel Economy Standards NHTSA 2001, National Highway Traffic Safety Administration www.hhtsa.dot.gov/cars/rules/rulings/CAFE/alternatefuels/exec-summary.htm NHTSA 2002, National Highway Traffic Safety Administration, Report to Congress, March 2002 Parkin and Bade, Microeconomics: Canada in the Global Environment, 4th Edition, Pearson Education Canada Inc., 2000 RFF, Resources for the Future, Parry and Bento 2000, Table 1 www.rff.org Yahoo News, http://ca.yahoo.com, Thursday April 4, 2002