Replacing fuel-economy rules with clean tax cuts

The federal approach to fuel-economy regulation is a bad deal for Americans. Consumers pay for costlier vehicles, but receive few discernable benefits. Making the situation worse is that fuel-economy rules have become a mess of shifting administrative responsibilities among opportunistic regulators. We need a new approach.

Federal fuel-economy standards have been around since 1975. The Corporate Average Fuel Economy (CAFE) regime, originally introduced to limit reliance on foreign oil, has grown more demanding over time. Current targets require automakers to field fleets with average fuel economy of 54.5 miles per-gallon by 2025.

However, today’s fuel-economy requirements extend beyond CAFE standards. Most notably, in 2007, the U.S. Supreme Court ruled that the Environmental Protection Agency must regulate CO2 and other greenhouse-gas (GHG) emissions if the agency found they endanger human health and welfare. Given the link between carbon emissions and fuel economy, efforts to adjust automotive technologies to address one unavoidably influences the other. When combined with longstanding efforts by the State of California to address auto emissions, where automakers once had only a single regulator for fuel-economy matters, there now are three: the EPA, the California Air Resources Board (CARB) and the National Highway Traffic Safety Administration (NHTSA), which oversees CAFE.

While current law requires each of these three rulemaking bodies to coordinate—in an effort to avoid imposing divergent standards on the auto industry—this “trilateral” approach to regulation creates uncertainty. In recent years, the EPA and CARB, in particular, both developed and promulgated emissions standards to compel levels of fuel-economy performance beyond those detailed in authorizing legislation. Moreover, the EPA took certain brazen actions in the closing days of the Obama administration that left a pressing need to address both the substance and structure of the automotive industry’s CAFE and emissions standards.

The Trump administration took some steps in its early days to roll back the EPA’s action, but we clearly have reached an inflection point. Assuming that fuel-economy standards are here to stay, we need a better approach. Toward that end, this paper evaluates the current trilateral regulatory structure and proposes a supply-side alternative called “clean tax cuts” (CTCs). Administered by a single body, CTCs would achieve meaningful reductions in GHG emissions, while limiting the current standards’ distortionary effects.

The proposal is to offer tax relief to automakers, tied to the degree to which those manufacturers develop less carbon-intensive fleets. The system would provide for cuts in the marginal rates assessed for taxes on capital, including the corporate income tax paid by the automaker and the dividend, capital gains, estate and earned interest taxes paid by its shareholders and bondholders.

This paper posits CTCs are a more flexible and efficient approach to limit problematic emissions. It would allow manufacturers to consider the degree to which investments in a cleaner fleet are efficient, given the tax incentives, and would align manufacturers’ incentives to innovate more effectively than the current CAFE and GHG metrics do.

It is time to go from three regulators to one, and from the crisis-borne policies of prescription to one focused on innovation.

Image by Orlando_Stocker

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