Yale Economist on Flaws, Big and Small,
In Trump’s Fuel Economy Rollback Plan

In an interview, Kenneth Gillingham, a Yale economist and co-author of a new Science paper on the Trump administration’s proposed fuel economy rollbacks, describes some of the flaws with the plan — and what it would take to pass fuel efficiency standards that are grounded in sound economic theory.
A centerpiece of the Obama administration’s climate policy was the adoption of ambitious new fuel economy standards. The Trump administration is trying to roll them back.
Kenneth T. Gillingham
Kenneth Gillingham
Analyses produced by each administration of the impacts of those proposed standards by 2025 reached starkly different findings: while the Obama administration concluded that the standards would create a net benefit of $87.6 billion, a Trump administration analysis found that it would produce a net loss of $176.6 billion.

A recent paper by a team of leading economists, including Yale’s Kenneth Gillingham, concludes that the Trump administration’s analysis is fatally flawed and misleading. While they also find problems with the analysis under the Obama Administration, they argue that the current administration’s analysis has even deeper issues and fails to advance the public understanding of the true costs and benefits of fuel economy standards. The paper is published in the journal Science.
In an interview, Gillingham describes some of the flaws with the recent Trump analysis and how the federal government might pass strong new fuel efficiency standards grounded in sound economic theory.

What were the fuel efficiency standards passed by the Obama administration?

Kenneth Gillingham: In 2012, the Obama administration developed standards that would continually rise, especially between 2022 and 2025, reaching an average of around 54.5 miles per gallon by 2025. In January of 2017, the administration issued a draft Technical Assessment Report [TAR], which included an analysis indicating that the 2022 — 2025 standards were technologically feasible and that the benefits would exceed the costs. And that was the final document on fuel economy standards by the Obama administration.
When the Trump administration came in they had choices. They could go with the findings of the TAR and allow the process to continue. Or they could change it, which would require them to initiate a new rulemaking process. They chose to do the latter, proposing to effectively freeze the standards at model year 2020 levels all the way through 2026. The analysis of their proposed rule came out this past August (2018).

What were the different assumptions between the two administrations that led to such different conclusions?

Gillingham: One of the biggest differences is how they modeled the cost of adding technologies to improve fuel economy. The Trump administration used a different vehicle design model than had been used previously. It turns out that this new model is a restrictive model that limits automaker options in the technologies they can add, thus leading to higher costs than if all technologies were available.
A second big change was that they doubled the “rebound effect.” The rebound effect tells you that when you improve fuel economy you’re making it cheaper to drive — the cost per mile is lower — and thus people are going to drive more. The Trump administration analysis went from a 10 percent rebound to a 20 percent rebound, and in doing so argued that the Obama standards would lead to increased traffic fatalities. A key legal justification used by the Trump administration for rolling back the standards is that it would save 12,700 lives. Of those, the rebound effect accounts for about half, so doubling the rebound effect was important for arguing for the rollback.
A third factor is that they basically gutted the social cost of carbon, scaling it down from $48 per metric ton to $7 per metric ton. So the greenhouse gas benefits went from $27.8 billion to $4.3 billion. But if they had only changed the social cost of carbon and nothing else, the Obama standards would still have large, positive net benefits overall.
The fourth, and most pivotal, change is that they added a new vehicle scrappage model. In essence, they reasoned that if new cars are more expensive due to the standards, people are going to buy fewer of them. This affects used cars, because some of the people who would have bought new cars instead will buy used cars. That makes used car prices go up, which also means that some people who have an old or damaged car, and have to decide if they should repair their vehicle or scrap it, will decide to scrap it.
That final piece is important because the Trump administration analysis is basically saying that the Obama era standards are going to lead to more old cars on the road. I wouldn’t disagree with the conclusion that if you increase the price of new cars you’ll have more old cars on the road. But their model had new car prices go up and used car prices go up, and yet somehow the total number of cars got bigger. In other words, they made all cars more expensive and yet somehow they’re saying more people will have cars. This flies in the face of economic logic.

So on this last one, while the principle makes sense, it’s the equation that you found flawed?

Gillingham: Yes, you could say that they are botching the equation. The result is that they end up having 6 million missing vehicles in their rollback, and this allows them to say, “Look, the rollback’s going to have all these benefits because these old cars aren’t going to be on the road anymore whereas they would have been on the road under the Obama standards.” But that just doesn’t make sense.
And this really matters. The bottom line is that if those 6 million missing vehicles were included in the analysis, there would be $90 billion less in benefits of the rollback from the reduced fatalities and property damages. So they’re giving their rollback an extra $90 billion in gains — or adding $90 billion in costs to the Obama-era standards. That’s a huge amount of money.

You don’t endorse either analysis. What does an analysis grounded in sound economic principles look like?

Gillingham: There are some assumptions that are made in either analysis that my co-authors and I don’t feel are very realistic.
One assumption has to do with how firms comply with new standards. In both analyses, at the agencies have firms comply by adding new technology that improves fuel economy but are basically holding all other attributes of vehicles as constant. One effect of this is that it raises the costs of standards. Say you’re an automaker and you’re trying to decide how to comply with the standards. You can either add really expensive technology or you can change other attributes of the vehicle — make it a little more aerodynamic, for example. Yet both analyses do not allow you to change these other attributes. You can’t alter performance to meet the standard. You can’t change the price of the vehicles to sell more efficient ones. These are things that automakers most definitely do to comply with standards. So in this sense, neither analysis captures automaker behavior very well.

What message do these analyses send to automakers?

Gillingham: I think automakers are in a bind right now. Many — but not all — of the automakers would like to see fuel economy standards relaxed or gone because that’s going to provide them with a bit more flexibility to maximize their profits. But they also don’t like the bad publicity. So it’s been very interesting to see that the automakers themselves have chosen to come out against the rollback of fuel economy standards. Each of the major automakers — GM, Ford, Honda, and others — have officially opposed the rollback. However, the Alliance of Automobile Manufacturers, which is the trade group for all of the major auto manufacturers, has come out strongly in favor of the rollback.
What I think it comes down to is that the automakers don’t like the bad publicity but, for at least most of the automakers, they won’t complain if their trade group supports the rollback. This allows them to keep their hands clean and focus on all of the good things they are doing in their press releases. They can publicly say, “We have all these new electric vehicle technologies and we’re helping the environment and are opposed to the rollback…” while still supporting the Alliance of Automobile Manufacturers that has strongly come out in favor of the rollback. There is a bit of a perplexing disconnect.

How had the potential for stricter fuel efficiency standards changed the auto sector during the Obama era?

Gillingham: Over the past decade we have seen average fuel economy standards increasing in the U.S. I think they have at least partially contributed to the increase in the availability of many different electric vehicle models, because EVs are generously compensated with fuel economy credits under the standard. On the other hand, they may also have played a role in influencing GM and Ford to move away from their passenger car vehicles and into all crossovers and SUVs, because those vehicles tend to be larger and face less stringent standards. So I think the standards are part of the reason for the shifts that we are seeing.

In this paper, you and your co-authors recommend the use of “safety valves.” What are those and how can they change the market?

Gillingham: Safety valves are widely used in cap-and-trade systems to put a lid on costs if they are getting very high. For example, California’s cap-and-trade system, under Assembly Bill 32, has a feature wherein if the price of permits rises above a certain level, then companies can buy any number of additional permits for that cost. So it stops further rises in the cost of emissions. Similarly, there’s something called a ‘floor’ wherein if the price of emissions permits drop below a certain point, then the price is not permitted to drop any further. Floors are intended to maintain environmental integrity of the policy, while safety valves are intended to keep the policy politically feasible and not harm the economy too much. So the way California does it is they have this safety valve to prevent costs from running wild, and a floor to prevent more emissions than is economically sensible.
If the Trump administration and automakers really are worried about costs, my coauthors and I suggest implementing a similar safety valve. There’s something under the fuel economy standards program called “credits,” in which if you are an automaker and your vehicle achieves an efficiency that exceeds standards, then you get credits that are tradable. We’re proposing that if prices of that credit get really high during the ramp-up of Obama era standards — which would happen if those standards are getting really expensive — then you can apply a safety valve that allows companies to get more credits for the safety valve price. This puts a lid on costs. This would provide some regulatory certainty to the automakers. At the same time it would maintain the environmental integrity of the policy by still having steadily increasing standards, rather than a rollback. And the bottom line is that the best estimates suggest that the standards will be far less costly than the Trump administration or the Alliance of Automobile Manufacturers suggests they will be.
– Kevin Dennehy    kevin.dennehy@yale.edu    203 436-4842
PUBLISHED: January 8, 2019
Note: Yale School of the Environment (YSE) was formerly known as the Yale School of Forestry & Environmental Studies (F&ES). News articles posted prior to July 1, 2020, refer to the School's name at that time.