A number of countries now regulate the fuel economy of new, light-duty vehicles, while others regulate the rate of carbon dioxide (CO2) emissions per mile, which is almost equivalent. These regulations have two main rationales.

First, they require automakers to design more fuel-efficient vehicles or shift sales toward more efficient models. This lowers CO2 emissions, reduces dependence on oil markets subject to economic and political uncertainty, and mitigates other externalities associated with petroleum consumption. Note, however, that these regulations are limited to improving fuel economy in new automobiles; they do not encourage other forms of conservation or affect other sectors. In contrast, direct taxes on oil or carbon raise fuel prices for everyone who consumes it. Thus, they promote fuel economy in new automobiles, discourage driving by owners of new and used vehicles alike, and reduce emissions and oil use beyond the automobile sector. In fact, automobiles account for “only” about 20 percent of CO2 emissions and 45 percent of oil use, both in the United States and worldwide.

Second, fuel economy standards might address a market failure that arises when consumers misperceive the benefits of improved energy efficiency—that is, when they do not pursue cost-effective opportunities to improve energy efficiency to the extent they should. This rationale is controversial because information dissemination programs may deal with consumers’ misperceptions more efficiently than fuel economy standards. Moreover, not all empirical studies find that consumers undervalue energy-efficiency improvements. And even when consumers neglect apparently cost-effective opportunities, this behavior may reflect unmeasured costs rather than a market failure.

This paper, from Resources for the Future, discusses fuel economy regulations in the United States and other countries. It first describes how these programs affect fuel use and other dimensions of the vehicle fleet. It then reviews different methodologies for assessing the costs of fuel economy regulations and discuss the policy implications of the results. It also compares the welfare effects of fuel economy standards with those of fuel taxes and assess whether these two policies complement each other. Finally, It reviews arguments in favor of a “feebate” system, which imposes fees on inefficient vehicles and provides rebates for efficient vehicles.

Image credit: Asian Development Bank