Here is a clear example of the government dictating a politically correct, but economically suboptimal solution to an externality associated with using oil.
Today the DOT’s National Highway Traffic Safety Administration (NHTSA) and EPA, establish increasingly stringent fuel economy standards under NHTSA’s Corporate Average Fuel Economy program and greenhouse gas emission standards under the Clean Air Act for 2012 through 2016 model-year vehicles.
Starting with 2012 model year vehicles, the rules together require automakers to improve fleet-wide fuel economy and reduce fleet-wide greenhouse gas emissions by approximately five percent every year. NHTSA has established fuel economy standards that strengthen each year reaching an estimated 34.1 mpg for the combined industry-wide fleet for model year 2016.
The EPA standards require that by the 2016 model-year, manufacturers must achieve a combined average vehicle emission level of 250 grams of carbon dioxide per mile. The EPA standard would be equivalent to 35.5 miles per gallon if all reductions came from fuel economy improvements.
The government’s purpose can be seen in the following statement from the press release:
The rules could potentially save the average buyer of a 2016 model year car $3,000 over the life of the vehicle and, nationally, will conserve about 1.8 billion barrels of oil and reduce nearly a billion tons of greenhouse gas emissions over the lives of the vehicles covered.
The economically optimal way to conserve oil and reduce greenhouse gas pollution is to tax it, but this is less politically acceptable. The political problem is that the tax is visible, but the regulation costs are hidden. Sadly, we will all pay more to meet this oil and CO2 objective with this new CAFE standard than with a direct tax. If everyone could easily assess the hidden costs of this regulation, then the tax would seem cheap and we’d all agree to accept it. But how can we make the hidden cost of the regulation more clear?
The other significant mistake of this policy is that the increased fuel economy results in consumers driving farther and more often so the savings are overstated. A report by the NAS pointed out many such unintended and suboptimal results of the 1975 CAFE standards.
We can save more oil, CO2, and money by taxing the externalities, than by dictating this marginally effective solution with its hidden costs.