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Study concludes that automakers tweak vehicle fuel economy to qualify for more favorable treatment; focus on “car notches”

For more than 30 years, auto companies have done just enough to improve fuel economy of vehicles in order to lower tax rates and increase rebates imposed by governments in the United States and Canada, according to a study by Joel Slemrod, professor of business economics at the University of Michigan’s Ross School of Business, and colleague James Sallee, assistant professor at the University of Chicago’s Harris School of Public Policy.

In response to federal policies to boost gas mileage, manufacturers have changed vehicle weights, improved tire-rolling resistance and added aerodynamic features to push fuel-economy rates past government-mandated thresholds. In their study, Slemrod and Sallee focus on “car notches”—where small changes in behavior lead to large changes in tax liability or the amount of a subsidy—in policies intended to encourage the production and use of fuel-efficient vehicles.

Car notches are the small trigger points in the numerical values of fuel economy (say, the difference between 22.5 mpg and 22.4 mpg) that lead to large changes in tax liability or the amount of a subsidy.

In spite of having a bad reputation among economists, policy notches are ubiquitous. They induce actors to change their behavior just enough to be situated on the beneficial side of a notch. In the case of car notches, a vehicle manufacturer may have an incentive to marginally re-engineer its cars so as to just qualify for a more advantageous policy category.

—Joel Slemrod

“[Car] notches imply large, capriciously varying, local incentives to make small changes in behavior for relatively large private, but not social, rewards. Such behavioral responses erode the intended welfare benefits of policies, whose notch features are presumably justified by the increased salience and administrative convenience of policies that appear as step functions rather than smooth, continuous schedules.”
—Sallee and Slemrod

Slemrod and Sallee studied the behavioral responses to the US Gas Guzzler Tax of 1978, which penalizes cars with low fuel economy, and the Canadian “feebate” program of 2007, a set of taxes and rebates that together act to encourage the purchase of more fuel-efficient vehicles. They also addressed another notch-like aspect of fuel economy—publicly disclosed and highly visible integer fuel economy ratings that provide information to prospective car buyers.

Under the US Gas Guzzler Tax, the amount of the tax is a notched schedule in fuel economy, so vehicles with very small ratings differences may be subject to discretely different taxes. For example, a car with an 18.5 mpg US (12.7 L/100km) rating is subject to a $2,100 tax, while a car with an 18.4 mpg (12.8 L/100km) rating is subject to a $2,600 tax, so that a tax increase of $500 is triggered by a decrease of just 0.1 mpg. Under the Canadian feebate program, cars that get 43 mpg, for example, qualify for a $2,000 rebate, while cars that get 42 mpg receive a $1,500 rebate. Likewise, vehicles getting less than 18 mpg are taxed up to $4,000.

Using data from Corporate Average Fuel Economy (CAFE), the US Environmental Protection Agency (EPA), Internal Revenue Service (IRS) and the Canadian government, the researchers found that automakers produce and sell a significant number of “extra” vehicles with fuel economy ratings just on the tax-favorable side of a notch than otherwise would be expected—and more than those cars just below a notch that are subject to a higher tax.

We observe this behavior not only in response to explicit notches in tax and subsidy policies, but also in response to implicit presentation notches, where government policy dictates what information a firm must provide to consumers.

—Joel Slemrod

Slemrod and Sallee say that since automakers are required to round off mpg values on fuel economy labels for consumers, this results in a presentation notch at every .5 mpg (permitting automakers to round up in their calculation of fuel economy).

The researchers say that automakers can boost fuel economy by producing lighter-weight vehicles of the same model to create a better fuel economy rating or by simply modifying a vehicle to improve its fuel economy by recalibrating the engine, using low-friction lubricants, modifying the tires or making small aerodynamic changes. All of this behavior is perfectly legal, they add.

Key aspects of American and Canadian vehicle fuel economy policy are designed with notches, so that many vehicles face no incentive to incrementally improve fuel economy, but others face large and varying incentives for improvement. In this paper we show that the policy notches have real consequences, as there are significantly more vehicles produced (and purchased) just on the policy-beneficial side of the notches than otherwise would be expected. We observe this behavior not only in response to explicit notches in tax and subsidy policies, but also in response to implicit presentation notches, where government policy dictates what (coarse) information a firm must provide to consumers. We develop a simple framework within which the negative welfare effects of local manipulation can be calculated, a framework which may prove useful in a variety of contexts as it can be utilized with only ex post data.

Future fuel economy policies are likely to increase the importance of notches. The state of California recently explore [sic] a comprehensive feebate program with notches, and similar legislation has been introduced in the U.S. Senate. The EPA is considering the adoption of a letter grade system with grading notches that would rate vehicles by fuel economy and emissions. Recent CAFE reforms have dramatically tightened its standards in a way that increases the value of moving vehicles over the light-truck classification notch. Policy notches may have administrative or salience benefits, but for notches to be warranted, these benefits must outweigh the substantial inefficiency costs that we document here.

—Sallee and Slemrod

Resources

Comments

Herm

So what is wrong with this?

HarveyD

That being the case, USA/Canada governments should tighten up the existing standards as EU is doing.

jw-detroit

Herm, I think the issue they're getting at is that there's little incentive for the automakers to do anything beyond getting to a certain threshold value, and the jumps between those thresholds can be large.

For example, if a car gets 29.5 to 30.4 mpg, it's still reported as 30 mpg, but most likely the automaker will shoot for 29.5.

So the consumer can lose out ("loss of efficiency") OR the automakers can be using short-term thinking (small design tweaks) instead of long-term thinking.

I think their argument, one which most economists hold, is that a continuous incentive (instead of one based on threshold values with large gaps in between) offers a better situation, both for the automakers and car buyers.

Roger Pham

Hmm! Wondering what would car makers do if the Gov. enact a policy to adjust gasoline taxation so as to guarantee at least an 8% increase in the gasoline prices yearly? This would mean doubing the price of gasoline in 10 years...a change slow enough to allow most consumers and manufacturers to adapt without undue hardship to the economy.

This would create a major boost for the US economy:
1) cutting down on the hundreds ob billion of USD yearly for petroleum importation, keep the money here at home.
2) spurring major PRIVATE investments in alternative fuel and energy and infrastructure, thereby adding millions of new jobs to the economy.

Yes, alternative energy will be more expensive than petroleum, however, the PRIVATE money spent will be on job creation here at home, saving billions of government monies used for job creation and economic stimulus, and adding millions to the payrolls and income tax coffer to the IRS yearly.

HarveyD

Excellent idea RP. The trick will be to convince the other 99+% who want to lower gas taxes instead. No government has tried to touch it in the last 15+ years and with another Fed election coming..... I would not expect it. Democracy and common sense do not always go together.

Mannstein

@ Roger Pham

You forgot one little but important detail. The US consumer is broke so who is going to buy these altenative energy more expensive new products?

As a matter of fact when Helicopter Ben Beranke is done with the dollar we'll be lucky to afford a bicycle.

Peter_XX

In Europe, many member states have incentives for cars with CO2 emissions below 120 g/km. Not surprisingly, you find many car models at - or slightly below - this limit. Very few cars have CO2 at 121 g/km. Sometimes, there are limitations in tire size, use of tow bar, etc. and modifications such as a lower chassis, aerodynamic features etc. to avoid exceeding this limit. Nothing wrong with that but a sliding scale for the incentives might be fairer after all.

mahonj

I think you want a "notchy" scale with bands at 100 120 140 etc.
Then every few (say 5) years, you drop the bands by 10 or 20 gms.
The car companies will optimise their vehicles and testing strategy, but what would you expect.
The introduction of various, similar schemes in Europe has caused the Co2 levels of new cars to decline quite sharply in Europe.
One somewhat counterproductive outcome (in terms of air quality) has been a continent wide switch to diesel cars (especially in the mid - larger car brackets), which was probably not intended when the Co2 based legislation was pushed through by the greens.

Roger Pham

US consumers are broke?
Only the unemployed and under-employed!!!
Those would welcome the massive job-creation effect of the move to alternative energy.

Increase the price of gasoline does not mean increase the cost of transportation. Efficiency gains and the arrival of lower-cost alternative fuels will neutralize the rise in the cost of fossil fuels.

If low-cost alternative fuels do not arrive soon enough, the poors may be given small funds to offset these energy expenses...these funds are funded by the rise in gasoline tax and payroll taxes and income taxes...

In fact, rising fuel taxes is the best way to control the rising consumption of gasoline, thereby keeping gasoline prices from soaring due to soaring and uncontrolled demands. Either you'll pay uncle Sam, or you'll pay OPEC... eitherway, you will pay. Now, which shall it be?

Engineer-Poet

GMC Yukon: $38535, 15/21 MPG in the 2WD.

Chevy Aveo: $12725, 27/35 MPG.

Forcing people to look for fuel savings also saves them money from the moment of purchase.

Scott

@ Roger Pham

Increasing Gasoline Taxes by 8%. We call this a "Fuel Duty Escalator" in the UK and this is why we now pay close to $8 per gallon. This is why people cannot afford to travel to work or run a business, or worse than that be able to visit friends and relatives.

It's a highly regressive policy that hits the poorest hardest, even those who have relatively small and efficient vehicles. The elite, in the meantime shrug off a $200 fill up as small change. There is something very wrong and unequal about that. It's now cheaper to fly to Rome than it is to fill up a car.

Despite years of above inflation increases in fuel prices, vehicle efficiency has only increased due to Eurpean Regulations on CO2 which have placed the onus on automakers to make more efficient cars. Its a more socially neutral policy.

Herm

Scott, is not green to be traveling that much.. it is proper that the masses stay near the village they were born in.

Roger Pham

@Scott,

All the fuel-efficient vehicles and technology today are the direct results of high fuel prices in Europe and Asia. Innovations in fuel efficiency such as diesel, turbocharging, and hybrid vehicle came from Europe and Asia, where fuel prices are very high. Whereas in America, Detroit are busy building high-profit-margin large gas-guzzlers, quite oblivious to the reality of petroleum supply. Americans are increasing their driving distances daily by moving out the suburbs, requiring driving distances 40-50 miles daily on average! Urban Sprawl!!! All fueled by the illusion of cheap and infinite petroleum supply!!!!

Guest what? Reality came and bit hard...2008...Massive restructuring of the American auto industry...lots of pain and suffering...! Major failures of most segments of the economy precipitated by the precipitous and unrelenting and sudden rise in the price of petroleum...Tens of millions of American people out of jobs...US gov. is running unprecedented budget deficits now and for decades to come!!!!

Must we continue to live the same way to see history repeat itself again?

Scott

Roger - its about a fair fuel price and fair levels of taxes and not about treating the motorist as a cash cow which is exactly what the UK Government has been doing. They passed a fair level of fuel tax long-long time ago which would even then been a big enough stick to persuade people to drive more efficient cars.

As well as increasing fuel above inflation, our government also levvies Value Added Tax (20%) on the fuel tax as well as the actual fuel cost. In other words it taxes a tax which is absurd. In April its looking to increase taxes above inflation again, at a time when prices are already rising anyway which is a very peverse logic.

Prices have already got to such a level where its having the effect of forcing people to stay at home away from work an families. This is in a country that has relatively compact settlements. However, with reference to Herms post, the days where many people lived and worked a couple of streets away are long gone for the majority so people have to travel. Contrary to belief, we have a poor public transport system outside major cities. Even in major cities public transport does little to help the late night shift worker get to work, because its not running, and often work is too far away to get to on foot or by bike. Outside major cities rural communities that rely on private vehicles in the remote parts of scotland are suffering and this is where the cost of fuel is already reaching £1.40 per litre (thats over $8.50 per US Gallon).

At a greater extreme, there has not been a rise on the number of people who are filling up without paying, stealing fuel from cars, driving without insurance or paying for annual Vehicle Taxes(to pay for the fuel instead). Obviously these are tactics that cannot be condoned but it goes to show how desperate things are, simply because a Government wrongly believes that a few pence levvied on a litre in tax every year will reduce oil consumption and save the planet.

This is why a fair price coupled with stricter standards of vehicle efficiency is a better approach. I personally would be happy to pay 88p per litre which equates to $5.35 per US gallon - eye watering by US standards but a fair price for us here in Europe. A fair price, combined with a better offer of efficient vehicles, driven by efficiency standards would be a much fairer approach, rather than a more eco-facist driven agenda for pricing people off the roads.

Again in relation to Herms post, I'm in a fortunate position where I live close to all the amenities I need in walking distance. I can get to Uni by Metro, but I actually walk 5 miles each way, partly because the money saved helps to fill my tank, I enjoy the walk, i get fit and I'm not crammed into a metal cage on a railway. Unlike Herm however, it doesn't give me the moral high ground to expect everyone to do the same, becasue the reality is that everyone can't. His narrow lens implies that people should just stay at home instead on Welfare.

Transport may be reliant on fossil fuels at present, icluding trains and buses, as well as cars. But beyond the zero sum a wide mix of technologies are emerging that will lower the carbon intensity of transport through biomass and microbial based fuels, electricity. If one day we can run around on sustainable fuels, I have a feeling that this won't suit the radical environmentalist ideology - people who think that we should just stay at home and eat worms!

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