From: "Achanta, Chandana L." <Chandana_L._Achanta@omb.eop .gov>

To: "''james.tamm@dot.gov' (james.tamm@dot.gov)'" <jame s.tamm@dot.gov>, "'rebecca.yoon@dot.gov'"

<rebecca.yoon@dot.gov>, Ed Nam/AA/USEPA/US@EPA, Rob in Moran/AA/USEPA/US@EPA, "'Timothy.Mullins@ dot.gov'" <Timothy.Mullins@dot.gov>, William Charml ey/AA/USEPA/US@EPA, "'Steve.Wood@dot.gov'" <Steve.Wood@dot.gov> Date: 08/18/2012 09:24 PM Subject: Summary of interagency working comments received on draft final rule under EO 12866 review



## Please find attached additional interagency working comments received on draft final rule “Joint Rulem aking to Establish Light-Duty Vehicle Greenhouse Gas Emissio n Standards and Corporate Average Fuel Economy Standards” under EO 12866 and EO 13563 review. They are for your consideration and are subject to furt her policy review.

Thanks.

Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 reviewA.pdf

Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review.pdfFrom: William Charmley/AA/USEPA/US

To: "Achanta, Chandana L." <Chandana_L._Achanta@omb.eop .gov> Cc: Ed Nam/AA/USEPA/US@EPA, "''james.tamm@dot.gov' (jam es.tamm@dot.gov)'" <james.tamm@dot.gov>,

"'rebecca.yoon@dot.gov'" <rebecca.yoon@dot.gov>, Ro bin Moran/AA/USEPA/US@EPA, "'Steve.Wood@dot.gov'" <Steve.Wood@dot.gov>, "'Timothy.Mullins@dot.gov'" < Timothy.Mullins@dot.gov>, Margo Oge/DC/USEPA/US@EPA Date: 08/20/2012 03:14 PM Subject: Re: Summary of interagency working comments receive d on draft final rule under EO 12866 review



### Chandana,

Attached are EPA's responses to the material OMB pr ovided from the interagency review this past Saturd ay.

Draft EPA responses to OMB 8.18.2012 requests docum ent 1 of 2.docx

Draft EPA responses to OMB 8.18.2012 requests docum ent 2 of 2.docxSummary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

1 Below is a summary of interagency working comments received during EO 12866 and EO 13563 review of the draft final rule “Joint Rulemaking to Establish Light-Duty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fuel Economy Standards”. They are for your consideration and subject to further policy review.

Commenters provided the following suggested edits and comments on the sales and employment section.

1. Commenters noted that the discussion of the Center for Automotive Research (CAR) study on sales might be a little confusing. In this study, commenters noted that CAR estimates that additional safety features through 2025 will cost $1500 per vehicle.

NTHSA states that “NHTSA does not believe that the assumed safety mandates should be a part of this analysis without estim ating the benefits achieved by the safety mandates.” Commenters believe NHTSA should provide more explanation in this section. Commenters note that the baseline of the CAR study does not include $1500 for assumed safety improvements. Therefore, commenters believe the incremental change in sales for each level of fuel economy standard includes an additional $1500 in cost relative to the baseline along with the net cost of fuel economy.

Commenters suggest the following language to be included:

“The CAR study cannot be compared to other studies as it combines the cost of additional safety mandates along with fu el economy improvements. The CAR study likely underestimates sales, as it assigns no value to customer’s perceived values of additional safety features. In any case, unlike other analyses sales changes shown cannot be solely attributed to the rulemaking.”

2. Interagency commenters provided the following revised section for sales and employment for NHTSA. Commenters request agencies to make conforming edits to the preamble sections on sales and jobs and EPA’s RIA section on sales and jobs. Because of multiple edits, the following includes a simplif ied clean version of the section for your consideration.

***

The Impact of Higher Prices on Sales and Employment

The effect of this rule on sales of new vehicles depends largely on how potential buyers evaluate and respond to its effects on vehicle prices and fuel economy. The rule will make new cars and light trucks more expensive, as manufacturers a ttempt to recover their costs for complying with the rule by raising vehicle prices. At the sa me time, the rule will re quire manufacturers to improve the fuel economy of many of their models, which will lower the operating costs of the vehicles. The initial purchase cost of vehicles will increase, but the overall cost that includesSummary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

2 operating costs will decrease. The net effect on sales will depend on the extent to which consumers are willing to pay for fuel economy and their sensitivity to price changes, which is challenging to evaluate.

The agency anticipates that consumers will place at least some value on improved fuel economy,because it reduces the operating cost of the vehicles, and also because, based on recentlypromulgated EPA and DOT regulations, vehicles sold during 2017 through 2025 will display labels that more clearly communicate to buyers the fuel savings, economic, and environmental benefits of more efficient vehicles. We recognize, of course, that the magnitude of this effect cannot be predicted at this time, and that how much consumers value fuel economy is an ongoing debate. We also expect that consumers may cons ider other factors besides direct purchase price increases that affect the costs they pay for new vehicles, and have included these factors in the analysis.

There is a broad consensus in the economic literature that the price elasticity of demand for automobiles is approximately –1.0, 1, 2, 3, 4 meaning that every one percent increase in the price of the vehicle would reduce sales by one percent. NHTSA typically assumes that manufacturers will be able to pass all of their costs to improve fuel economy on to consumers. Elasticity estimates assume no perceived change in the quality of the product. The later discussion of consumer welfare, however, suggests that by itself, a net decrease in overall operating costs may not necessarily produce a net increase in sales. Many consumers are more affected by upfront cost than by overall cost, and thus may not be willing to purchase vehicles with greater fuel economy even when it appears to be in their economic interest to do so (assuming consumers’

1 Kleit, A.N. (1990). “The Effect of Annual Changes in Automobile Fuel Economy Standards,” Journal of Regulatory Economics , vol. 2, pp 151-172. Available at http://www .springerlink.com/content/m04787480k056018/ (last accessed August 1, 2012) or Docket No. NHTSA-2010-0131

2 Bordley, R. (1994). “An Overlapping Choice Set Model of Automotive Price Elasticities,” Transportation Research B , vol 28B, no 6, pp 401-408. Available at http://www.sciencedirect.com/science/article/B6V99- 466M3VD-1/2/3ecfe61bac45f1a fb8d9b370330e3f0c (last a ccessed August 1, 2012)

3 McCarthy, P.S. (1996). “Market Price and Income Elasticities of New Vehicle Demands,” The Review of Economics and Statistics , vol. LXXVII, no. 3, pp. 543-547. Available at http://econpapers.repec.org/article/tprr estat/v_3a78_3ay_3a199 6_3ai_3a3_3ap_3a543-47.h tm (last accessed August 1, 2012) or Docket No. NHTSA-2010-0131

4 This elasticity is generally considered to be a shor t-run elasticity, reflecting the immediate impacts of a price change on vehicle sales. For a durable good such as an auto, the elasticity may be smaller in the long run: though people may be able to change the timing of their purchase when price changes in the short run, they must eventually make the investment. Using a smaller elasticity would reduce the magnitude of the estimates presented here for vehicle sales, but it would not change the direction. A short-run elasticity is more valid for initial responses to changes in price, but, over time, a long-run elasticity ma y better reflect behavior; thus, the results presented for the initial years of the program may be more appropriate for modeling with the short-r un elasticity than the later years of the program. A search of the literature has not found studies more recent than the 1970s that specifically investigate long-run elasticities. See

., e.g. , Hymans, Saul H., “Consumer Durable Spending: Explanation and Prediction,” Brookings Papers on Economic Activity 1 (1970), which finds a short-run elasticity of auto expenditures (not sales) with respect to price of 0.78 to 1. 17, and a long-run elasticity of 0.3 to 0.46 (pp. 173-206). Available at: http://www.brookings.edu/about/projects/bpea/editions/~ /media/Projects/BPEA/1970%202/1970b_bpea_hymans_ac kley_juster.PDF or Docket No. NHTSA-2010-0131 (last accessed August 1, 2012)Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

3 discount rates are equal to standard social disc ount rates). For example, consumer valuation of fuel economy improvements often depends upon the price of gasoline, which has recently been very volatile. However, there is considerable uncertainty in th e economics literature about the extent to which consumers value fuel savings from increased fuel economy, and there is still more uncertainty about possible changes in cons umer behavior over time (especially with the likelihood of consumer learning), and whether and to what extent this final rule could bring about changes in consumer behavior. Thus, more specifically, the effect of this final rule on vehicle sales will depend upon whether the overall value that potential buyers place on the increased fuel economy is greater or less than the increase in vehicle prices as a result of this rule, and how automakers factor that into choo sing technologies and price setting for the various vehicle models incorporating those technologies.

How do consumers value fuel economy?

The first question to evaluate is how consumers value fuel economy, or more accurately, how they value fuel savings attributable to increased fuel economy. Two interrelated economic concepts bear on how consumers might value fuel sa vings. The first relates to the length of time that consumers consider when valuing fuel savings, or “payback period,” and the second relates to the discount rate that consumers apply to future savings. These two concepts are used together in our analysis below to determine consumer valuation of future fuel savings. The length of time that consumers consider when valuing future fuel savings can significantly affect their decision when they compare their estimates of fuel savings with the increased cost of purchasing higher fuel economy. There is a sign ificant difference in aggregate fuel savings if consumers consider the savings over 1 year, 3 years, 5 years, 10 years, or the lifetime of the vehicle as the relevant payback period. The discount rate that consumers use to discount future fuel savings to present value can also have a si gnificant impact. If consumers value fuel savings over a short period, such as 1 to 2 years, then the discount rate is less important. If consumers value fuel savings over a long period, then the discount rate is important.

The payback period and discount rate are conceptu al proxies for consumer decisions that may often be made without any corresponding explicit quantitative analysis. For example, some buyers choosing among some set of vehicles may know what they have been paying recently for fuel, may know what they are likely to pay to buy each of the vehicles considered, and may know some of the attributes—including labeled fu el economies—of those vehicles. Such buyers may then make a choice without actually trying to estimate how much they would pay to fuel each of the vehicles they are considering buying. In other words, for such buyers, the idea of a payback period and discount rate may have no explicit meaning. This does not, however, limit the utility of these concepts for the agency’s analysis. If, as a group, buyers behave as if they value fuel consumption considering a payback period and discount rate, these concepts remain useful as a basis for estimating the market response to increases in fuel economy accompanied by increases in price.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

4 Information regarding the number of years that consumers value fuel savings (or undervalue fuel savings) come from several sources. In past analyses NHTSA has used five years as representing the average payback period, because this is the average length of time of a financing
agreement. 5 We conducted a search of the literature for additional estimates of consumer valuation of fuel savings, in order to determine whether the 5 year assumption was accurate or whether it should be revised. A recent paper by David Greene 6 examined studies from the past 20 years of consumers’ willingness to pay for fuel economy and found that “the available literature does not provide a reasonable cons ensus,” although the author states that “manufacturers have repeatedly stated that consum ers will pay, in increased vehicle price, for only 2 - 4 years in fuel savings” based on manufacturers’ own market research. The National
Research Council 7 also used a 3 year payback period as one way to compare consumer valuation of benefits to a full lifetime value. A survey conducted for the Department of Energy in 2004, 8 which asked 1,000 households how much they would pay for a vehicle that saved them $400 or $1,200 per year in fuel costs, found implied payback periods of 1.5 to 2.5 years. In reviewing this survey, Greene concluded: “The striking similarity of the implied payback periods from the two subsamples would seem to suggest that co nsumers understand the questions and are giving consistent and reliable responses: they require payback in 1.5 to 2.5 years.” However,
Turrentine and Kurani’s 9 in-depth interviews of 57 households found almost no evidence that consumers think about fuel economy in terms of payback periods. When asked such questions,
some consumers became confused while others offered time periods that were meaningful to them for other reasons, such as the length of their car loan or lease.

The effective discount rate that consumers have used in the past to value future fuel economy savings has been studied in many different ways and by many different economists. Greene 10
examined and compiled many of these analyses and found: “Implicit consumer discount rates were estimated by Greene (1983) based on eight early multinomial logit choice models. ...The estimates range from 0 to 73% ... Most fall between 4 and 40%.” Greene added: “The more
recent studies exhibit as least a wide a range as the earlier studies.”

5 National average financing terms for automobile loan s are available from the Board of Governors of the Federal Reserve System G.19 “Consumer Finance” release. See http://www.federalreserve.gov/releases/g19/ (last accessed August 25, 2011). The average new car loan at an au to finance company in the first quarter of 2011 is for 62 months at 4.73 %.
6 “Why the Market for New Passenger Cars Generally Undervalues Fuel Economy”, David Greene, Oak Ridge National Laboratory, 2010, Pg. 17, http://www.internationaltransportforum.org/jtrc/Discussi onPapers/DP201006.pdf (last accessed August 8, 2012)

7 National Research Council (2002), “Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards”, National Academies Press, Washington D.C.

8 Opinion Research Corporation (2004), “CARAVAN” ORC study #7132218, for the National Renewable Energy Laboratory Princeton, New Jersey, May 20, 2004.
9 Turrentine, T.S. and K.S. Kurani, 2007. “Car Buyers and Fuel Economy,” Energy Policy , vol. 35, pp. 1213-1223.

10 “Why the Market for New Passenger Cars Generall y Undervalues Fuel Economy”, David Greene, Oak Ridge National Laboratory, 2010.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

5 This is an extremely broad range. With such uncertainty about how consumers value future fuel savings and the discount rates they might use to determine the present value of future fuel savings, NHTSA chose for purposes of this analysis to utilize the standard 3 and 7 percent social discount rates recommended by OMB guidance to ev aluate the costs and benefits of regulation. To the extent that some consumers appear to show higher discount rates, the analysis of likely sales consequences would be different.

This review leads us to conclude that consumer valuation of future fuel savings is highly uncertain, leading to different pote ntial scenarios of vehicle sales. A negative impact on sales is possible, because the final rule will lead to an increase in the initial price of vehicles if consumers don’t value the fuels savings or desire very short payback periods. In addition, sales decreases are possible if gasoline prices are lower than expected or technology costs are higher than expected. In these cases, the standards may require manufacturers to produce cars with higher than socially optimal levels of fuel economy. A positive impact is also possible, because the final rule will lead to a significant decreas e in the lifetime cost of vehicles, and with consumer learning over time, this effect may produce an increase in sales. Whether a change in sales will result from this final rule, or will resu lt from other factors that affect the way drivers consider fuel economy in their purchasing decisions, is subject to uncertainty.

The next question is how much manufacturers think consumers value fuel savings attributable to higher fuel economy:

Although some manufacturers have indicated in public remarks and/or confidential statements to NHTSA that their plans to apply fuel-saving technology depend on fuel prices and consumers’ willingness to pay for fuel economy improvements, the agency does not have specific and robust information regarding how manufacturers view consum ers’ valuation of fuel savings. Based on our review of the literature and available evidence, it is not at all clear how accurately manufacturers are accounting for consumer valuation of fuel economy in making their pricing decisions, nor how that accuracy will be affected in the future as manufacturers’ costs to produce vehicles rise in response to the final standards. In standard economic theory, if manufacturers believe that consumers value the fuel savings at a higher dollar level than the technology costs, then manufacturers’ profit motives would lead them to voluntarily add the cost-effective technologies to their vehicles in the absence of government mandates in the belief that their sales
would increase.

This concept ties into the basic question of whether manufacturers are providing the amount of fuel economy that consumers wish to purchase— whether there is matching between consumers’demand for fuel economy and the firms’ supply of fuel economy. It is possible that the lightduty vehicle market is currently operating according to standard theoretical economic principles, and manufacturers are providing exactly the amount of fuel economy that consumers wish to Comment [A1]: Interagency commenters requests clarity on whether it is necessary to include the preceding two sentences if this is the conclusion? Commenters request clarity on whether these can be deleted.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

6 purchase, because they perfectly understand consumers’ valuation of fuel economy. On the other hand, it is possible that manufacturers are not providing the exact amount of fuel economy that consumers wish to purchase (either too much or too little), because they do not have perfect information regarding consumers’ valuation of fuel economy. NHTSA does not know which scenario is correct today, and cannot predict which scenario will be correct in the future, but we evaluate both in the following sections in order to assess the range of potential sales impacts that
could be attributable to this final rule.

As discussed above, it is very difficult to determine how consumers will react to fuel economy improvements. Consumer consideration of fuel economy appears to evolve based on a variety of factors (fuel price, recessions, marketing), and c onsumers can react to changing factors rapidly, sometimes more rapidly than the industry is able to change its product offerings. There have been examples of periods when demand for fuel efficient vehicles exceeded the available supply of highly efficient vehicles, and other period s where very efficient vehicle models were introduced into the market and sales stalled. If manufacturers did not accurately forecast consumers demand for fuel efficient vehicles, manuf acturers’ investment in vehicle technologies would not result in desired payoff. It is im portant to note that investments in vehicle technologies are substantial. Manufacturers may lik ely to be particularly risk averse with regard to future changes in fuel prices, in large part due to the substantial capital investments. If a manufacturer invests substantially in fuel effi cient technologies expecting higher consumer demand than realized, then the manufacturer has incurred the costs of investment but not reaped the benefits of those investments. On the other hand, if a manufacturer does not invest in fuel efficient technologies, then the manufacturers may lose some market share in the short run if demand for fuel economy is higher than expected, but they still retain the option of investing in fuel efficient technologies. The predicted le vel of investment under uncertainty related to consumer demand for fuel efficient vehicles and ir reversibility of investment for fuel efficient technologies would be less than the predicted level of investment under no uncertainty and complete irreversibility.

In addition, there is reason to believe there may be risk aversion on the consider side. The simultaneous investment by all companies may also encourage consumer confidence in the new technologies. If only one company adopted new technologies, early adopters might gravitate toward that company, but early adopters tend to be a relatively small portion of the public. More cautious buyers, who are likely to be more numerous, might wait for greater information before moving away from well-known technologies. If all companies adopt advanced technologies at the same time, though, potential buyers may perceive the new technologies as the new norm rather than as a risky innovation. They w ill then be more willin g to move to the new technologies. As some commenters have pointed out, simultaneous action required by the rule may change buyers’ expectations (their reference points) for fuel economy, and investing in more fuel economy may seem less risky than in the absence of the rule. Further, the certainty of the regulations reduces the costs of meeting them, because there will be a) more economies of scale and more learning curve benefits due to greater cumulative production of fuel-efficient technologies and b) more incentive for automakers and suppliers toSummary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

7 invest in R&D to create future fuel-efficient technologies. 11 We note that this risk aversion by itself does not indicate a market failure; it is the fact that the risk aversion leads to underprovision of social benefits (eg, reduction in greenhouse gas emissions).

How did NHTSA/EPA attempt to calculate potential impacts of the final rule on vehicle
sales under the different scenarios discussed above?

Given the considerable uncertainty associated with consumer valuation of fuel savings and manufacturers’ understanding of that valuation, NHTSA sought to assess potential sales impacts under two possible basic scenarios: first, one in which the light-duty vehicle market is currently operating according to standard theoretical economic principles, and manufacturers are providing exactly the amount of fuel economy that consumers wish to purchase, because they perfectly understand consumers’ valuation of fuel economy; and second, one in which manufacturers are

not providing the exact amount of fuel economy that consumers wish to purchase (either too much or too little), because they do not have pe rfect information regarding consumers’ valuation of fuel economy. In the first scenario, manufacturers and consumers would behave as though they are assuming the same payback period (and/or discount rate) for fuel savings attributable to higher fuel economy; in the second, manufactur ers and consumers would behave as though they are assuming different payback periods (and/or discount rates).

For years, consumers have been learning about the benefits that accrue to them from owning and operating vehicles with greater fuel efficiency. Consumer demand has thus shifted towards such vehicles, not only because of higher fuel prices but also because many consumers are learning about the value of purchases based not only on initial costs but also on the total cost of owning and operating a vehicle over its lifetime. 12 This type of learning is expected to continue before and during the model years affected by this rule, particularly given the new fuel economy labels that clarify potential economic effects and should therefore reinforce that learning. Therefore, some increase in the demand for, and production of, more fuel efficient vehicles is incorporated
in the market driven baseline.

The time and fuel savings associated with opera ting more fuel efficient vehicles will be more salient to individuals who own them, causing thei r subsequent purchase decisions to shift closer to minimizing the total cost of ownership over the lifetime of the vehicle. Second, this

11 The literature reviewed by Popp, Newell, and Jaffe (2010) shows that environmental regulation has played an important role in inducing innovation that reduces the cost of achieving environmental goals; Popp (2011) provides evidence that consumer pressure alone is rarely sufficient to achieve broad diffusion of environmentally-friendly technologies.

12 “High Gas Prices Motivate Drivers to Change Dir ection.” Consumer Reports, May 2012. Available at http://www.consumerreports.org/content/cro/en/cars/fuel-ec onomy-survey-high-gas-prices-impact-drivers.html (last accessed August 1, 2012). Comment [A2]: Commenters request clarity on whether agencies should rely on consumer reports. Commenters note that when learning occurs demand for fuel economy should increase absent gas prices. Commenters note that there have been no empirical evidence to date that demonstrates that this phenomenon is anything other than responses to gasoline prices. Commenters request clarity on whether agencies have information to distinguish between responses to prices and learning.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

8 appreciation may spread across households through word of mouth and other forms of communications. Third, as more motorists experience the time and fuel savings associated with greater fuel efficiency, the price of used cars will better reflect such efficiency, further reducing the cost of owning more efficient vehicles for the buyers of new vehicles (since the resale price will increase).

If these induced learning effects are strong, the ru le could potentially increase total vehicle sales over time. These increased sales would not occur in the model years first affected by the rule, but they could occur once the induced learning takes place. It is not possible to quantify these learning effects years in advance and that effect may be speeded or slowed by other factors that enter into a consumer’s valuation of fuel efficiency in selecting vehicles.

The possibility that the rule will (after a lag for consumer learning) increa se sales need not rest on the assumption that automobile manufacturers are failing to pursue profitable opportunities to supply the vehicles that consumers demand. In the absence of the rule, no individual automobile manufacturer would find it profitable to move towa rd the more efficient vehicles mandated under the rule. In particular, no individual company can fully internalize the future boost to demand resulting from the rule. If one company were to make more efficient vehicles, counting on consumer learning to enhance demand in the future, that company would capture only a fraction of the extra sales so generated, because the learning at issue is not specific to any one company's fleet. Many of the extra sales would accrue to that company's competitors.

In the language of economics, consumer learning about the benefits of fuel efficient vehicles involves positive externalities (spillo vers) from one company to the others. 13 These positive externalities may lead to benefits for manufacturers as a whole.

We emphasize that this discussion has been tentat ive and qualified. Social learning of related kinds has been identified in a number of contexts, 14 and the agency expects that it will influence consumers’ future valuation of fuel economy.

Thus, while it is difficult to determine how consumers will react to fuel economy improvements attributable to the final rule, we believe that it is likely that consumers will learn more about and increasingly value fuel economy improvements in the future. If manufacturers assume that consumers value fuel economy less than consumers actually value fuel economy, there will be a

13 Industry-wide positive spillovers of this type are ha rdly unique to this situation. In many industries, companies form trade associations to promote industry-w ide public goods. For example, merchants in a given locale may band together to promote tourism in that locale. Antitrust law recognizes that this type of coordination can increase output.

14 See Hunt Alcott, Social Norms and Energy Conser vation, Journal of Public Economics (March 2011), available at http://opower.com/uploads/library/file/1/allcott_2011_jpubec_- _social_norms_and_energy_conservation.pdf (last accessed A ugust 1, 2012); Christophe Chamley, Rational Herds: Economic Models of Social Learning (Cambridge, 2004), available at http://bilder.buecher.de/zusatz /21/21995/21995098_le se_1.pdf (last accessed August 1, 2012)Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

9 demand pull for better fuel economy vehicles into the market, and by virtue of the final standards forcing manufacturers to increase better fuel economy product offerings, it is possible that sales
could increase as a result.

How did NHTSA/EPA illustrate these scenarios analytically?

The agency examined a number of cases to illustrate these scenarios. Sales impacts were
determined for 6 cases that are combinations of manufacturers’ beliefs of how consumers value fuel savings and consumers’ valuation of fuel savi ngs. The first two cases assume a flat baseline (no voluntary improvement in fuel economy above the MY 2016 standards by manufacturers absent new regulations), consistent with the agency ’s main analysis in this rulemaking. In these
first two cases we assume consumers value fuel sa vings for a 3 year period or a 5 year period (the average length of a loan), and we also determine the breakeven point of consumer valuation of fuel savings, where there would be no impact on sales, assuming all other factors remain
constant. As can be seen in Table VII-16 below, with a flat baseline and assuming that consumers consider fuel economy benefits over a 3 or 5 year period, benefits exceed costs to the point that consumers will purch ase more vehicles and sales will increase. NHTSA estimates a break-even point of 2.35 years for scenarios with a flat baseline; that is, if consumers value fuel savings over an average 2.35 years, neither an increase nor a decrease in sales is expected.

The next 4 cases assume that manufacturers will, absent new regulations, implement technologies in response to their belief that consumers have either a 1 year, 3 year, or 5 year payback period, and for 3 of these scenarios where the consumer also values fuel economy over the same payback periods assumed by manufacturers. For example, the agency also examined the impact on sales and employment under the se nsitivity analysis assumption that the baseline fleet included the manufacturers voluntarily implem enting any technology that had a 1 year or less payback period for consumers. In this analys is, the least expensive t echnologies relative to their effects on fuel economy improvement (those that had a consumer payback where fuel savings over the first year of use were higher than new vehicle price increases) were assumed to be voluntarily implemented by manufacturers, resulting in improved fuel economy in the baseline case which would have occurred without adoption of this rule. The same methodology was used in the cases where both manufacturers and consumers value fuel savings over either a 3 year period or a 5 year period. All three of these cases result in reductions in sales, with the impact decreasing as the manufacturer’s baseline increases from 1 year to 3 year to 5 years. In a final case we assume that manufacturers voluntarily implement any technology that had a 1 year or less payback period for consumers, but that consumers value fuel savings over a 3 year period. Under that case, the breakeven point for consumers is about 3.1 years – meaning that if consumers valued their fuel savings over 3.1 years in this scenario, there would be no impact onSummary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

10 sales; in other words if the payback period of the fuel saving technologies was less than 3.1 years, then the vehicle sales would increase and visa versa.

For the reader’s reference, Table VII-15 belo w shows the included combinations of payback periods assumed—for these different cases—to represent consumers’ and manufacturers’ decisions. The agency considered these differen t cases to represent an illustrative range of possible outcomes under the scenarios described above.

Table VII-15 Scenarios Considered for Sales Impact Analysis

Payback Period
Representing

Manufacturers’

Decisions Payback Period Representing Buyers’ Decisions

1 Year 3 Years 5 Years

0 Years (Flat) Included Included

1 Year Included Included

3 Years Included

5 Years Included

For the analysis for each of these cases, NHTSA makes several assumptions. For the fuel savings part of the equation, we used for a 5 year payback period as we have used in previous analyses. For the fuel savings part of the equa tion, we assumed as a starting point that the average purchaser considers the fuel savings they would receive over a 5 year timeframe. The present values of these savings were calculated using a 3 and 7 percent discount rate. We used a fuel price forecast that included taxes, because th is is what consumers must pay. Fuel savings were calculated over the first 5 years and discounted back to a present value.

The agency believes that consumers may consider several other factors over the 5 year horizon when contemplating the purchase of a new vehicle. The agency added some of these factors into the calculation to represent how an increase in t echnology costs might affect consumers’ buying
considerations.

First, consumers might consider the sales taxes they have to pay at the time of purchasing the vehicle. As these costs are transfer payments, th ey are not included in the societal cost of the program, but they are included as one of the increased costs to the consumer for these standards.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

11 We took the most recent auto sales tax by state 15 and weighted them by population by state to determine a national weighted-average sales tax of 5.46 percent (hereafter rounded to 5.5 percent in the discussion). NHTSA sought to weight sa les taxes by new vehicle sales by state; however, such data were unavailable. NHTSA recognizes that for this purpose, new vehicle sales by state is a superior weighting mechanism to Census population; in an effort to approximate new vehicle sales by state NHTSA studied the change in new vehicle registrations (using R.L. Polk data) by state across recent years and developed a corresp onding set of weights. The resulting national weighted-average sales tax rate was almost iden tical to that resulting from the use of Census population estimates as weights, ju st slightly above 5.5 percent. NHTSA opted to utilize Census population rather than the registration-based proxy of new vehicle sales as the basis for computing this weighted average, as the end results were negligibly different and the analytical approach involving new vehicle registrati ons had not been as thoroughly reviewed.

Second, we considered insurance costs over the 5 year period. More expensive vehicles will require more expensive collision and comprehensive ( e.g. , theft) car insurance. The increase in insurance costs is estimated from the average va lue of collision plus comprehensive insurance as a proportion of average new vehicle price. Collision plus comprehensive insurance is the portion of insurance costs that depend on vehicle value. A recent study by Quality Planning 16 provides the average value of collision plus comprehensive insurance for new vehicles, in 2010$, is $521 ($396 of which is collision and $125 of which is comprehensive). The average consumer expenditure for a new passenger car in 2011, according to the Bureau of Economic Analysis was $24,572 and the average price of a new light truck was $31,721 in $2010. 17 Using sales volumes from the Bureau, we determined an average passenger car and an average light truck price was $27,953 in $2010 dollars 18 . Average prices and estimated sales volumes are needed because price elasticity is an estimate of how a percent increase in price 19 affects the percent decrease in
sales.

15 See http://www.factorywarrantylist.com/car-tax-by-st ate.html (last accessed August 1, 2012). Note that county, city, and other municipality-specific taxes were ex cluded from NHTSA’s weighted average, as the variation in locality taxes within states, lack of accessible documentation of locality rates, and difficulty in obtaining reliable sets of weights to apply to locality ta xes complicates the ability to perform this analysis. Localities with relatively high automobile sales taxes may have relatively fewer au to dealerships, as consumers would likely endeavor to purchase vehicles in areas with lower locality taxes.

16 “During Recession, American Drivers Assumed More Risk to Reduce Auto In surance Costs,” Quality Planning, March 2011. See https://www.qualityplanning .com/media/4312/110329%20tough%20times_f2.pdf (last accessed August 1, 2012).

17 U.S. Department of Commerce, Bureau of Economic Analysis, Table 7.2.5S. Auto and Truck Unit Sales, Production, Inventories, Expenditures, and Price, Available at http://www.bea.gov/itable/ (last accessed August 1, 2012) 18 http://www.bls.gov/cpi/cpid11av.pdf, Table 1A. Consumer Price Index for All Urban Consumers (CPI-U): U.S. city average, by expenditure category and commodity and se rvice group, for new vehicles. (Last accessed August 1, 2012)

19 When estimating the sales impact, the price of th e vehicle was increased from these MY 2011 prices based on the costs of estimated safety and MY 2011-2016 fuel economy rules. See the cumulative impact section for an estimate of those costs. For passenger cars $871 was added to the average price of a MY 2011 passenger carSummary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

12 Dividing the cost to insure a new vehicle by the average price of a new vehicle gives the proportion of comprehensive plus collision insurance as 1.86 percent of the price of a vehicle. As vehicles’ values decline with vehicle age, comprehensive and collision insurance premiums likewise decline. Data on the change in insurance premiums as a function of vehicle age are scarce; however, NHTSA utilized data from the aforementioned Quality Planning study that cite the cost to insure the average vehicle on the road today (average age 10.8 years) 20 to enable a linear interpolation of the change in insurance premiums during the first 11 years of a typical vehicle’s life. Using this interpolation, as a pe rcentage of the base vehicle price of $27,953, the cost of collision and comprehensive insurance in each of the first five years of a vehicle’s life is 1.86 percent, 1.82 percent, 1.75 percent, 1.64 percent, and 1.50 percent, respectively, or 8.57 percent in aggregate. Discounting that stream of insurance costs back to present value indicates that the present value of the component of insurance costs that vary with vehicle price is equal to 8.0 percent of the vehicle’s price at a 3 percent discount rate.

Third, we considered that 70 percent of new vehicle purchasers take out loans to finance their purchase. 21 Using proprietary forecasts available from Global Insight, NHTSA developed an average of 48-month 22 bank and auto finance company loan rates for years 2017 through 2025, which – when deflated by Global Insight’s corres ponding forecasts of the CPI – is 5.16 percent. 23
In the construction of this estimate, NHTSA assu med an equal distribution of bank and auto finance company loans – an assumption necessitated by the lack of data on the distribution of the volume of loans between the differing types of creditors. NHTSA opted to adjust future loan rates using the CPI rather than the GDP deflator as this analysis is intended to facilitate further analysis from the perspective of the consumer, for which the CPI is the preferred deflation factor.

At these terms the average person taking a lo an will pay 13.7 percent more (undiscounted) for their vehicle over the 5 years than a consumer paying cash for the vehicle at the time of purchase. Discounting future loan payments at a 3 percent discount rate, a consumer financing a vehicle purchase pays 5.43 percent more as opposed to an all cash purchase. Taking into account

to make the total baseline price for MY 2017 $25,443 ($ 24,572 + $871), for light trucks $1,090 was added to the average price of a MY 2011 light truck to make the total baseline price for MY 2017 $32,811 ($31,721 + $1,090).
All of these values are in 2010 dollars.

20 See https://www.polk.com/company/news/average_age_of _vehicles_reaches_record_high_according_to_polk (last accessed August 1, 2012).

21 Bird, Colin. “Should I Pay Cash, Lease or Finance My New Car?” http://www.cars.com/go/advice/Story.jsp?section=fi n&story=should-i-pay- cash&subject=loan-quickstart&referer=advice&aff=sacbee, July 12, 2011, citing CN W Marketing Research. (Last accessed August 1, 2012)

22 No projections were available for rates of loan terms of 60 months. NHTSA compared the historical difference of 48-month and 60-month loan rates and determin ed the 48-month rate to be a suitable proxy for the 60- month rate.

23 Global Insight data are available on a fee basis at http://www.ihs.com/products/global-insight/countryanalysis/us-economic-forecasts.aspx. NHTSA analysis of fu ture auto loan rates is based on Global Insight data available as of March, 2012.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

13 that only 70 percent of vehicle purchases are financed, the average consumer would pay 3.80 (=0.70 * 5.43 percent) percent more than the retail price of a vehicle.

Fourth, we considered the residual value (or resale value) of the vehicle after 5 years and expressed this as a percentage of the new vehicle price. If the price of the vehicle increases due to fuel economy technologies, the resale value of the vehicle will go up proportionately. The average resale price of a vehicle after 5 years is about 35 percent 24 of the original purchase price. Discounting the residual value back 5 years using a 3 percent discount rate (=35 percent * .8755) gives an effective residual value of 30. 64 percent. Note that added CAFE technology could also result in more expensive or more frequent repairs. However, we do not have data to verify the extent to which this would be a factor during the first 5 years of vehicle life.

We add these four factors together. At a 3 percent discount rate, the consumer considers that he could get 30.64 percent b ack upon resale in 5 years, but will pay 5.5 percent more for taxes, 8.0 percent more in insurance, and 5.1 percent more for loans, resulting in an 12.0 percent return on the increase in price for fuel economy technology (=30.6 percent - 5.5 percent - 8.0 percent - 5.1 percent). Thus, the increase in price per vehicle would be multiplied by 0.88 (=1 - 0.12) before subtracting the fuel savings to determine the overall net consumer valuation of the increase of costs on this purchase decision. This process re sults in estimates of the payback period for MY 2025 vehicles of 2 years for light trucks and 4 years for passenger cars at a 3 percent discount

rate.

For ease of presentation, we combine the impact on passenger car and light truck sales for the Preferred Alternative only for the combined 9 year period of 2017-2025, and we compare the sales impact for both the MY 2010 baseline and for the MY 2008 baseline at the 3 percent and 7 percent discount rates. There is not a significant difference in sales impacts depending upon the baseline considered (2010 versus 2008) and the disc ount rate impact is predictable, with sales increasing to a lesser extent under a 7 percent discount rate than in the case of a 3 percent discount rate, since benefits are valued lower with a higher discount rate.

24 Consumer Reports, August 2008, “What That Car Really Costs to Own,” Available at http://www.consumerreports.org/cro/cars/pricing/what-tha t-car-really-costs-to-own-4- 08/overview/what-that-carreally-costs-to-own-ov.htm (last accessed August 1, 2012).Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

14 Table VII-16 Potential Sales Impact for Passenger Cars and Light Trucks

Vehicles in Thousands

2008 Baseline

Years Fuel Valued by Manufacturers Years Fuel Valued by Consumers MYs 2017-2025 Sales Impact (3% discount rate) (000’s) MYs 2017-2025 Sales Impact (7% discount rate) (000’s) 0 Flat 3 yr. 911 757 0 Flat 5 yr. 3,784 3,232 1 yr. 1 yr. -2,696 -2,322 1 yr. 3 yr. -360 -445 3 yr. 3 yr. -530 -542 5 yr. 5 yr. -3 -36
2010 Baseline 0 Flat 3 yr. 988 867 0 Flat 5 yr. 3,804 3,261 1 yr. 1 yr. -2,405 -2,611 1 yr. 3 yr. -50 -130 3 yr. 3 yr. -309 -314 5 yr. 5 yr. 124 94

What have commenters and other sources sa id in terms of potential sales impacts attributable to the final rule?

A recent study on the effects on sales, attributed to regulatory programs, including the fuel economy program was undertaken by the Center for Automotive Research (CAR) 25 . CAR examined the impacts of alternative fuel economy increases of 3%, 4%, 5%, and 6% per year on the general outlook for the U.S. motor vehicle market, the likely increase in costs for fuel economy (based on the NAS report, which estimates higher costs than NHTSA’s current estimates) and required safety features, the t echnologies used and how they would affect the market, production, and automotive manufacturing employment in the year 2025. The required safety mandates were assumed to cost $1,500 pe r vehicle in 2025, but CAR did not evaluate the value of those safety mandates to consumers. NHTSA does not believe that the assumed safety mandates should be a part of this analysis without estimating consumers’ valuation of those safety mandates.

25 “The U.S. Automotive Market and Industry in 2025,” Center for Automotive Research, June 2011, available at http://www.cargroup.org/assets/fil es/ami.pdf (last accessed August 1, 2012).Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

15 There are many factors that go into the CAR analysis of sales. CAR assumes a 22.0 mpg baseline, two gasoline price scenarios of $3.50 and $6.00 per gallon, VMT schedules by age, and a rebound rate of 10 percent (although it appears that the CAR report assumes a rebound effect even for the baseline and thus negates the impact of the rebound effect). Fuel savings are assumed to be valued by consumers over a 5 year period at a 10 percent discount rate. The impact on sales varies by scenario, the estimates of the cost of technology, the price of gasoline, etc. At $3.50 per gallon, the net change in consumer savings (costs minus the fuel savings valued by consumers) is a net cost to consumers of $359 for the 3% scenario, a net cost of $1,644 for the 4% scenario, a net cost of $2,858 for the 5% scenario, and a net consumer cost of $6,525 for the 6% scenario. At $6.00 per gallon, the net change in consumer savings (costs minus the fuel savings valued by consumers) is a net savings to consumers of $2,107 for the 3% scenario, a net savings of $1,131 for the 4% scenario, a net savings of $258 for the 5% scenario, and a net consumer cost of $3,051 for the 6% scenario. Thus, the price of gasoline can be a significant factor in affecting how consumers view whether they are getting value for their expenditures on technology.

Table 14 on page 42 of the CAR report presents the results of their estimates of the 4 alternative mpg scenarios and the 2 prices of gasoline on light vehicle sales and automotive employment.
The table below shows these estimates. The ba seline for the CAR report is 17.9 million sales and 877,075 employees. The price of gasoline at $6.00 per gallon, rather than $3.50 per gallon results in about 2.1 million additional sales per year and 100,000 more employ ees in year 2025.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

16 CAR report estimates of sales and employment impacts Impacts in 2025

Gasoline at $3.50 CAFE requirement of a 3% increase in

mpg per year CAFE requirement of a 4% increase in

mpg per year CAFE requirement of a 5% increase in

mpg per year CAFE requirement of a 6% increase in

mpg per year Sales (millions) 16.4 15.5 14.7 12.5 Employment 803,548 757,700 717,626 612,567

Gasoline at $6.00
Sales 18.5 17.6 16.9 14.5 Employment 903,135 861,739 826,950 711,538

Figure 13 on page 44 of the CAR report shows a graph of historical automotive labor productivity, indicating that there has been a long term 0.4 percent productivity growth rate from 1960-2008, to indicate that there will be 12.26 vehicles produced in the U.S. per worker in 2025 (which is higher than NHTSA’s estimate – see below). In addition, the CAR report discusses the jobs multiplier. For every one automotive manufacturing job, they estimate the economic contribution to the U.S. economy of 7.96 jobs 26 stating “In 2010, about 1 million direct U.S. jobs were located at an auto and auto parts manufact urers; these jobs generated an additional 1.966 million supplier jobs, largely in non-manufacturi ng sectors of the economy. The combined total of 2.966 jobs generated a further spin-off of 3.466 million jobs that depend on the consumer spending of direct and supplier employees, for a total jobs contribution from U.S. auto manufacturing of 6.432 million jobs in 2010. Th e figure actually rises to 7.96 million when direct jobs located at new vehicle dealerships (c onnected to the sale and service of new vehicles)
are considered.”

CAR uses econometric estimates of the sensitiv ity of new vehicle purchases to prices and consumer incomes and forecasts of income growth through 2025 to translate these estimated changes in net vehicle prices to estimates of changes in sales of MY 2025 vehicles; higher net prices – which occur when increases in vehicle prices exceeds the value of fuel savings – reduce vehicle sales, while lower net prices increase new vehicle sales in 2025. We do not have access to the statistical models that CAR develops to estimate the effects of price and income changes on vehicle sales. CAR’s analysis assumes continued increases in labor productivity over time and then translates the estimated impacts of hi gher CAFE standards on net vehicle prices into estimated impacts on sales and employment in th e automobile production and related industries. The agency disagrees with the cost estimates in the CAR report for new technologies, the addition of safety mandates into the costs, and various other assumptions.

26 Kim Hill, Debbie Menk, and Adam Cooper, “Contribut ion of the Automotive Industry to the Economies of All Fifty States and the United States,” The Center for Automotive Research, Ann Arbor MI, April 2010.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

17 Many commenters stated that they expected vehicle sales to increase as a result of the final rule, and cited an analysis conducted by Ceres and Citigroup Global Markets Inc. 27 that examined the impact on automotive sales in 2020, with a baseline assumption of an industry fuel economy standard of 42 mpg, a $4.00 price of gasoline, a 12.2 percent discount rate and an assumption that buyers value 48% of fuel savings over seve n years in purchasing vehicles. The main finding on sales was that light vehicle sales were predicted to increase by 6% from 16.3 million to 17.3 million in 2020. That analysis has subsequently been revised to predict a 4% increase from 15.8
million to 16.4 million. 28 Elasticity is not provided in the report but it states that they use a complex model of price elasticity and cross elasti cities developed by GM. A fuel price risk
factor 29 was utilized. Little rationale was provide d for the baseline assumptions, but sensitivity analyses were examined around the price of fuel ($2, $4, and $7 per gallon), the discount rate (5.2%, 12.2%, 17.2%), purchasers consider fuel savings over (3, 7, or 15 years), fuel price risk factor of (30%, 70%, or 140%), and VMT of (10,000, 15,000, and 20,000 in the first year and declining thereafter).

The UAW, along with NRDC and the National Wildlife Foundation, also submitted reports indicating their assessment that the additional technology content needed to meet higher fuel economy standards would lead to considerable sales and employment growth. For example, the 2010 UAW/NRDC/Center for American Progress st udy, “Driving Growth,” concluded that if 75 percent of the additional content needed for the vehicle fleet to reach an average 40 mpg by 2020 was produced in the U.S., as many as 150,000 jobs would be created. 30 Similarly, the 2011 UAW/NRDC/NWF study, “Supplying Ingenuity,” fo und that 504 facilities across 43 states employing over 500,000 people are devoted to researching, developing, or producing clean-car technologies, and that 67 percent of these jobs are related to advanced conventional technologies such as better engines and transmissions and components like electric power steering and highstrength steel. 31

27 “U.S. Autos, CAFE and GHG Emissions”, March 2011, Citi Ceres, UMTRI, Baum and Associates, Meszler Engineering Services, and the Natural Resources Defense Council, available at http://www.ceres.org/resources/reports/fuel-eco nomy-focus (last accessed August 1, 2012) 28 “ U.S. Autos & Auto Parts, Fuel Economy Focus: Industry Perspectives on 2020,” April 2012, Citi Ceres, UMTRI, Baum and Associates, Meszler Engineering Serv ices, an d the Natural Resources Defense Council, available at http://www.ceres.org/res ources/reports/fuel-economy-focus-i ndustry-perspectives-on-2020/ (last accessed August 14, 2012.)

29 Fuel price risk factor measures the rate at which consumers are willing to trade reductions in fuel costs for increases in purchase price. For ex ample, a fuel price risk factor of 1. 0 would indicate the consumers would be willing to pay $1 for an improvement in fuel economy that resulted in reducing by $1 the present value of the savings in fuel costs.

30 UAW/NRDC/Center for American Progress, “Driving Growth: How Clean Cars and Climate Policy Can Create Jobs,” March 2010.

31 UAW/NRDC/NWF, “Supplying Ingenuity: U.S. Suppliers of Clean, Fuel-Efficient Vehicle Technologies,” August 2011.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

18 Based on all of the above, what does NHTSA/EPA believe the likely impact on vehicle sales
attributable to this final rule will be?

While NHTSA conducted and considered a variety of vehicle sales “cases” as presented above, we do not believe that we can state with certainty that any given case is “correct” for the rulemaking timeframe. Given that this final rule af fects multiple years, many years in the future, and that during that time there will be a dyna mic situation occurring with dramatically changing fuel economy levels and technology being added to vehicles, we anticipate that consumers’ consideration of fuel economy will evolve over time. NHTSA believes that there is much uncertainty in how much consumers’ considera tion of fuel economy will change as a result of this final rule alone, as compared to other rules such as the MYs 2012-2016 CAFE and GHG emissions rules and the Fuel Economy Labeling rule, or manufacturers’ marketing efforts. We anticipate that manufacturers will be tracking c onsumers’ behavior and marketing their products to affect consumer behavior, as they always have. We have made several simplifying assumptions in order to estimate the potential impact on sales, but as discussed above, there are
uncertainties in how this final rule will affect sales and employment. We note, as is likely evident in the table above, that the impact on sales in this analysis is heavily impacted by the difference
between manufacturers’ beliefs of how consumers value fuel savings and consumers’ valuation of fuel savings.

This uncertainty, however, supports our conclusion in Section IV.F of the preamble that higher standards than the ones finalized in this rulemaking may not be economically practicable. The agency has tried to grapple with potential sales impacts as an important aspect of economic practicability, but reaching no definitive conclusi on, believes that a conservative approach will be most likely to help us avoid setting standa rds that are beyond what would be economically practicable, and thus beyond the maximum feasible levels. NHTSA will monitor sales trends going forward, and anticipates that the intervenin g years between this final rule and the future rulemaking to develop and establish final standards for MYs 2022-2025 will provide significant additional insight into the questions of how c onsumers value fuel savings associated with increased fuel economy, how manufacturers believe consumers value that fuel savings, and corresponding effects on vehicle sales attributable to CAFE standards.

As discussed elsewhere in the preamble and FRIA, the literature provides mixed evidence that consumers consistently value future fuel savings consistent with shorter payback periods and/or higher discount rate than the full lifetime value of fuel savings ov er the useful life of vehicles
discounted as the social discount rates. That also provides an explanation for one of the potential
reasons that manufacturers do not voluntarily provide all of the fuel saving technologies that are cost-effective and available, on a societal basis cons idered over the lifetime of the vehicle. In the past, consumers have not been willing to pay the additiona l price for such fuel economy improvements. One question is whether consumer s will place a greater value on fuel savings as a result of this rule, and only as a result of this rule. In the past, large spikes in gasoline prices and consistently high gasoline prices have spurred consumers to consider fuel economy moreSummary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

19 prevalent in their purchasing decisions. The agency believes that the new and improved fuel economy labels and the large increase in fuel economy required as a result of the MY 2012-2016 fuel economy standards, may all have an impact on consumer valuation of fuel savings. However, these effects are not due to this rule. This final rule with its very large increase in average fuel economy, as well as manufacturers marketing these increased fuel economy levels, should also have a significant effect on consum ers’ realization that fuel economy is changing rapidly and significantly. As a result, we be lieve consumers will pay more attention to fuel savings as a result of this final rule assuming that fuel prices do not decrease significantly, but there is uncertainty whether all sales impacts will be the result of this final rule alone.

It is possible that consumers will not demand in creased fuel economy even when such increases
would reduce overall costs for them. Some vehicle owners may also react to persistently higher vehicle costs by owning fewer vehicles, and keep ing existing vehicles in service for somewhat longer. For these consumers, the possibility exis ts that there may be permanent sales losses, compared with a situation in which vehicle prices are lower.

There is a wide variety in the number of miles that owners drive per year. Some drivers only drive 5,000 miles per year and others drive 25,000 miles or more. Rationally those that drive many miles have more incentive to buy vehicles with high fuel economy levels.

In summary, there are a variety of types of consumers that are in different financial situations and drive different mileages per year. Since consumers are different and use different reasoning in purchasing vehicles, and we do not yet have an account of the distribution of their preferences or how that may change over time as a result of this rulemaking, the answer is quite ambiguous. Some may be induced by better fuel economy to purchase vehicles more often to keep up with technology, some may purchase no new vehicles because of the increase in vehicle price, and some may purchase fewer vehicles and hold onto their vehicles longer. There is great uncertainty about how consumers value fuel economy, and for this reason, the impact of this fuel economy proposal on sales is uncertain.

Some commenters appear to agree with this conclusion, as evidenced above in the above discussion of comments from Ceres and the UAW. Others, including NADA, expressed concern that sales may fall.

How does NHTSA/EPA plan to address this issue in the future?

NHTSA is currently sponsoring work to develop a vehicle choice model for potential use in the agency’s future rulemaking analyses—this work may help to better estimate the market’s effective valuation of future fuel economy improvements. This rule did not rely on a vehicle choice model. With an integrated market share model, the CAFE model would estimate how the sales volumes of individual vehicle models would change in response to changes in fuel economy levels and prices throughout the light vehicle market, possibly taking into accountSummary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

20 interactions with the used vehicle market. Having done so, the model would replace the sales estimates in the original market forecast with those reflecting these model-estimated shifts, repeating the entire modeling cycle until convergi ng on a stable solution. We sought comment on the potential for this approach to help the agency estimate sales effects. Several commenters wanted the agency to either have the vehicle choice model go through a full peer review (the Alliance) 32 or to be provided for public comment and review (NRDC) before being used. There was wide disparity in the comments on the concept of using a vehicle choice model to estimate the impacts on sales. The Alliance supported the use of a vehicle choice model. The American
Fuel and Petrochemical Manufacturers 33 stated that it was concerned that the analysis is not
based on a model that considered consumer choi ces and the impacts on different industries and individual that would be affected. The Natural Resources Defense Council (NRDC) 34 and Union of Concerned Scientists (UCS) 35 did not support the use of a consumer choice model and stated that the agencies should not rely on a highly uncertain and idealized consumer choice model.
NRDC stated that a consumer choice model coul d only rely on stated or revealed preferences based on existing vehicles in the market place and such a model is inappropriate for standards that drive the use of new technology.

In response, NHTSA agrees that further work on the vehicle choice model is necessary, and is continuing to develop it. Section IV.C.4 of the preamble discusses the current progress with the choice model and next steps, and we refer the reader there for more information.

Potential Impact on Employment in the Automotive Industry in the Short Run

There are three potential areas of employment in the automotive industry that fuel economy
standards could affect. 36 We briefly outline those areas here.

1. The first is the hiring of additional engi neers by automobile companies and their suppliers to do research and development a nd testing on new technologies to determine their capabilities, durability, platform introduct ion, etc. The agency anticipates that there may be some level of additional job creation due to the added research and development, overall program management, and subsequent sales efforts required to market vehicles that have been redesigned for significant im provements in fuel economy, especially for revolutionary technologies such as hybrid and electric vehicles. In this respect, the final rule will likely have a positive effect on em ployment. At the same time, the levels of added employment are uncertain. In addition, it is not clear how much of this effort will

32 See Docket NHTSA 2010-0131-0262.

33 See EPA Docket EPA-HQ-OAR-2010-0799-9485.

34 See EPA Docket EPA-HQ-OAR-2010-0799-0284.

35 Id

. 36 For a general analysis of the potentially complex employment effects of regulation, see Morgenstern, Richard D., William A. Pizer, and Jhih-Shyang Shih. “Jobs Versus the Environment: An Industry-Level Perspective.” Journal of Environmental Economics a nd Management 43 (2002): 412-436 (Docket EPA-HQ-OAR2010-0799).Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

21 be accomplished by added employment and how much by diverting existing employees to focus on CAFE instead of other compan y priorities such as improved acceleration performance, styling, marketing, new vehicle concepts, etc.

2. The second area is the impact that new technologies would have on production employment, both at suppliers and at auto assemblers.. Added parts, like turbochargers, or complexity of assembly could have a positive impact on employment. The use of more exotic steels, aluminum, or other materials to save weight could affect the number of welds or attachment methods It is uncertain to what extent new CAFE technologies would require added steps in the assembly pr ocess that would necessitate new hiring, but generally when content is added, the number of employees in the supplier industry and on the assembly line goes up.

3. The third area is the potential impact that sales gains or losses could have on production employment. This area is potentially much more sensitive to change than the first two areas discussed above, although for reasons discussed above its estimation is highly uncertain. An increase in sales, produced for example by consumer attention to overall costs and learning over time, would have a positive effect on employment. A decrease in sales, produced by increases in initial costs, would have a negative effect.

We received a number of comments (from the Defour Group and some private individuals) asserting that there will be decreases in employment as a result of the costs of the rule, and a number of comments (from the United Auto Workers, environmental organizations, sustainable business groups, some private individuals, and ot hers) asserting increases in employment, based on the development of advanced technologies and the reduction in net costs due to fuel savings. An assessment by the Defour Group predicts a loss of 155,000 jobs in manufacturing and supply, plus another 50,000 in distribution. 37 A study by Ceres predicts job gains of 43,000 in the auto industry and 484,000 economy-wide. 38 Some comments cite a study by the Natural Resources Defense Council, National Wildlife Federation, and United Auto Workers that 150,000 auto workers already are working to supply clean, fuel-efficient technologies. 39 The differences in results for quantitative employment impacts are mainly due to difference in the price impacts. Estimates of decreases in employment commonly come from studies that use cost estimates higher than those estimated by the agencies, and sometimes lower benefits estimates, resulting in

37 Walton, Thomas F., and Dean Drake, Defour Group LLC (February 13, 2012). “Comments on the Notice of Proposed Rulemaking and Preliminary Regulat ory Impact Analysis for MY 2017 to 2025 Fuel Economy Standards.” Docket EPA-HQ-OAR-2010-0799-9319.

38 Management Information Services, Inc. (July 201 1). “More Jobs per Gallon: How Strong Fuel Economy/GHG Standards Will Fuel American Jobs.” Boston, MA: Ceres. Docket EPA-HQ-OAR-2010-0799- 0709.

39 Natural Resources Defense Council, National Wildlife Federation, and United Auto Workers (August 2011). “Supplying Ingenuity: U.S. Suppliers of Cl ean, Fuel-Efficient Vehicle Technologies,” available at http://www.nrdc.org/transportation/autosuppliers/files/Supp lierMappingReport.pdf (last accessed August 1, 2012). (Docket EPA-HQ-OAR-2010-0799)Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

22 reductions in vehicle sales. For instance, so me comments from individuals cite the National
Automobile Dealers Association and Center for Automotive Research for cost estimates of $5,000 to $6,000 per vehicle, much higher than those estimated by the agencies. Those studies commonly look at the employment associated with vehicle sales, but not the employment associated with producing the technologies needed to comply with the standards, or changes in labor intensity of production. Analyses that find increases in employment commonly start with increased vehicle sales as a result of the rule. Many of these analyses also note that even without increased unit sales, employment is likely to rise due to the additional technology content of the
vehicles sold 40 . In both cases, “multiplier” effects, which extend employment impacts beyond the auto sector to impacts on suppliers, other sectors, and expenditure changes by workers, lead to large estimates, either positive or negative, of the employment effects of the rule. We received the suggestion to include in our analysis an alte rnative scenario where there is less than full employment; the implication of less than full em ployment is that multiplier effects are more likely. While we examined all of these different employment estimates, we decided to continue using our methodology from previous analyses, with some updates to our method of calculating the impacts.

In order to obtain an estimate of potential j ob increases per unit sales increase, we examined recent U.S. employment (original equipment manufacturers and suppliers) and U.S. production. Total employment in 2000 reached a peak in th e Motor Vehicle and Parts Manufacturing sector of the economy averaging 1,313,500 workers (NAICS codes of 3361, 2, 3). Then there was a steady decline to 1,096,900 in 2006 and more rapid decreases in 2008, and 2009. Employment in 2009 averaged 664,000, employment in 2010 averaged 675,000 and employment in the first six months of 2011 has averaged 699,000. Table VII-16 shows how many vehicles are produced by the average worker in the industry. Averaging the information shown for the even years of 2000-2010, the average U.S. domestic employee produces 11.3 vehicles (the same number as in 2008 and 2010). Thus, assuming that a projected sales gain or loss divided by 11.3 would be one method of estimating the potential employment gain or loss in any one year. This provides a measurement in job years. This method underestimates the number of jobs per vehicle sold under the rule, because it does not take into acc ount the additional employment associated with the additional fuel-saving technologies.

We also examined the employment impact for production and non-supervisory workers from the
Bureau of Labor Statistics to see if there was a more direct link between their employment level and production than the white collar workers. There is a closer link between light vehicle production in the U.S. and the number of production and non-supervisory workers (for example, from 2002 to 2010, production fell by 44 percent; the number of production and non-supervisory workers in the industry fell by 44 percent an d the number of white collar workers fell by 31

40 UAW/NRDC/Center for American Progress, “Driving Growth: How Clean Cars and Climate Policy Can Create Jobs,” March 2010, p.11Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

23 percent). However, in some years (2004 and 2006) the white-collar jobs had a higher percentage loss than the blue-collar jobs. In this analysis, th e agency examines all jobs in the industry.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

24 Table VII-17 U.S. Light Duty Vehicle Production and Employment

U.S. Light Vehicle Production Motor Vehicle and Parts U.S. Employment 41 Production per Employee

2000 12,773,714 1,313,500 9.7 2002 13,568,385 1,151,300 11.8 2004 13,527,309 1,112,700 12.2 2006 12,855,845 1,069,800 11.7 2008 9,870,473 875,400 11.3 2010 7,597,147 674,600 11.3 Total/Average 70,192,873 6,197,300 11.3

The Administration projects that full employment will return in 2018. 42 When the economy is at full employment, a fuel economy regulation is unlikely to have much impact on net overall U.S. employment; instead, labor would primarily be shifted from one sector to another. These shifts in employment impose an opportunity cost on society, approximated by the wages of the employees, as regulation diverts workers from other activities in the economy. In this situation, any effects on net employment are likely to be transitory as workers change jobs ( e.g. , some workers may need to be retrained or require time to search for new jobs, while shortages in some sectors or regions could bid up wages to attract workers). On the other hand, if a regulation comes into effect during a period of high unemployment, a change in labor demand due to regulation may affect net overall U.S. employment because the labor market is not in equilibrium.

Schmalansee and Stavins point out that net positi ve employment effects are possible in the near term when the economy is at less than full employment due to the potential hiring of idle labor resources by the regulated sector to meet new requirements ( e.g. , to install new equipment) and new economic activity in sectors related to the regulated sector. 43 On the other hand, any reduction in demand due to higher cost vehicles may lead to a reduction in employment, but this employment reduction due to reduced unit sales woul d be at least partially offset by increased employment per vehicle sold (because of the addi tional fuel-saving technology content). In the

41 U.S. employment data is from the Bureau of Labor Statistics, available at http://data.bls.gov/timeseries/CES3133600101?data_tool=XGtable (last accessed Aug. 10, 2012)
42 http://www.whitehouse.gov/sites/defaul t/files/omb/budget/fy2013/assets/13msr.pdf

43 Schmalensee, Richard, and Robert N. Stavins. “A Guide to Economic and Policy Analysis of EPA’s Transport Rule.” White paper commissioned by Excelon Corporation, March 2011.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

25 longer run, the net effect on employment is more difficult to predict and will depend on the way in which the related industries respond to the regulatory requirements.

This program is expected to affect employment in the regulated sector (auto manufacturing) and other sectors directly affected by the final rule: auto parts suppliers, auto dealers, the fuel supply market (which will face reduced petroleum production due to reduced fuel demand but which may see additional demand for electricity or other fuels). As discussed in the CAR and Ceres reports above, each of these sectors could potentia lly have ripple effects throughout the rest of the economy. These ripple effects depend much more heavily on the state of the economy than do the direct effects. As noted above, though, in a full-employment economy, any changes in employment will result from people changing jobs or voluntarily entering or exiting the workforce. In a full-employment economy, employment impacts of this proposal will change employment in specific sectors, but it will have small, if any, effect on aggregate employment. This rule would take effect in 2017 through 2025; by then, the current high unemployment may be moderated or ended. The Congressional Budget Office has predicted full employment by
2018. 44 To the extent that full employment is achieved, increases in employment are not possible. For that reason, this analysis does not include multiplier effects, but instead focuses on employment impacts in the most directly affected industries. Those sectors are likely to face the most concentrated employment impacts.

Table VII-18 shows the potential impact on employment in job years. This table takes the results from sales and divides by 11.3 to obtain the impact on employment. To estimate the proportion of domestic employment affected by the change in sales, we use data from Ward’s Automotive Group for total car and truck production in the U.S. compared to total car and truck sales in the U.S. For the period 2001-2010, the proportion is 66.7 percent. We thus weight sales by this factor to get an estimate of the effect on U.S. employment in the motor vehicle manufacturing
sector due to this rule. As in the sales anal ysis, the table shows the potential impact for the preferred alternative for both the MY 2010 baseline and for the MY 2008 baseline at the 3 percent and 7 percent discount rates for 6 different cases.

Since the impact of this final rule on sales is ve ry difficult to predict, and sales have the largest potential effect on employment, the impact of this final rule on employment is also very difficult to predict. As with sales, the impact on em ployment is heavily affected by the difference between manufacturers’ investments in fuel-saving technologies 45 and consumers’ valuation of fuel savings. However, since any negative impact of the rule on unit sales is partially offset by

44 Based on the Congressional Budget Office January 2012 Report, “The Budget and Economic Outlook, Fiscal Years 2012-2022,” which predicted unemployment levels of 5.5% in 2018. See http://www.cbo.gov/publication/42905 (last accessed Aug. 10, 2012).

45 As discussed above, these investments are affected both by manufacturers’ beliefs about consumers’ valuation of fuel economy, and by competitive dynamics, si nce the industry is composed of multiple firms, each of which considers the case where a competitor that doesn’t invest ends up in a better position due to gas prices at the low end of the expected distribution.Summary of interagency working comments received on draft rule under EO 12866 and EO 13563 review. They are for your consideration and are subject to further policy review.

26 increased employment per vehicle sold, it is highly unlikely that the rule would lead to significant job losses in the short term in the automotive industry

### Summary of interagency working comments received on draft rule under EO 12866 and EO 13563
review. They are for your consideration and are subject to further policy review.



## Below is a summary of interagency working comments received duri ng EO 12866 and EO 13563 review of the draft final rule “Joint Rulema king to Establish Light-D uty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fu el Economy Standards”. They are for your consideration and subject to further policy review.

1. Baseline

Interagency commenters do not find the justific ation for a “flat” baseline compelling. The primary empirical evidence in s upport of a flat baseline appe ars be based on the experience during the period 1986-2003. Commenters question th e relevance of this period to projecting that, in the absence of further regulation, the market would supply no increases in fuel economy (beyond the minimum required in 2016) at any time before model year 2026. While it is true that from 1986-2003 most manufacturers did not s ubstantially exceed the applicable standards, commenters note that during that period real gas prices were lower than $2.00/gallon ($2012) and fell to as low as $1.45/gall on in the late 1990s. [EIA Short-Term Energy Outlook , Aug. 2012]

Commenters note that the choice of that period a ppears to be based on the relative stability of gasoline prices and the assumpti on that gasoline price stability is more predictive of fuel economy increases than is the gasoline price level. Commenters disagree that the stability of gasoline prices is, per se, more important. Economic theory suggests the demand for fuel economy would be greater in a world with stab le gasoline prices at $4.00 per gallon than one with prices fluctuating between, say, $1.50 and $3.00. Furthermore, more recent data (e.g., MYS 2009-11) show substantial “over-compliance” with CAFÉ standards. [BTS National Transportation Statistics 2012, Table 4-23] Commenters beli eve that this over-compliance is due in large part, if not to prim arily high gasoline prices. Gasolin e prices during re cent years are consistent with those projected for 2017 and beyond in the rule and substantially higher than those used to justify the claim that manufact urers are unlikely to produce fleets with fuel economy greater than those required for MY 2016.

Interagency commenters request th at agencies respond to these points in the Preamble and RIA sections regarding the baseline.

2. EPA description of the alternative baseline. In addition to address comment number 1 above, interagency commenters request EPA to include the following insert in EPA RIA 3.4.3.1:

Based on the historical data di scussed above, EPA believes that there is a very low likelihood that any manufacturers will volunta rily achieve higher fuel economy than their footprint-based targets relative to the projected fleet aver age 35.5 mpg level of MY 2016 standards in MYs

### Summary of interagency working comments received on draft rule under EO 12866 and EO 13563
review. They are for your consideration and are subject to further policy review.



## 2017-2025, in the absence of more stringent st andards. There are several reasons for this: gasoline prices through MY 2025 are projec ted to be only slightly higher than today’s levels, footprint-based standard s are constraining for all manuf acturers, and manufacturers may use future technology to support other vehicle attr ibutes preferred by consumers such as power and utility. In addition, even if some individual manuf acturers were to voluntarily over comply, it is possible that they would se ll their GHG credits to other manu facturers who might find that it is more cost-effective to purchase credits th an to continue to meet the 35.5 mpg level. [1] 

## We do note, however, that to date there have been no trad ing of credits. In this scenario, if all credits were sold to other manufacturers, there woul d be no meaningful impact on the agency’s projected costs and benefits. Bu t, the agency recognizes that it is possible that, under certain circumstances, there might be some industry-wi de over compliance. For example, oil prices much higher than projected by AEO 2012 early rel ease could lead to a higher baseline due to industry-wide over compliance. But under this hi gher baseline costs and benefits would both be lower and it is impossible to know whether net c onsumer and societal benefits would be higher or lower. NHTSA analyzed an alternative mark et-driven baseline as a sensitivity case in their RIA but the primary baseline that both agencies are using does not assume any fuel economy improvements absent regulation.

3. Interagency commenters provided the follo wing suggestions for NHTSA’s Preamble Section IV:

a. 

## Pg. 164, footnote 343 – “We emphasize, nevertheless, that the augural standards for MYs 2022-2025 represent the agency’s be st estimate judgment of wh at standards would be maximum feasible for those model years, based on the information before us today, if the agency had authority to set standards for 9 model years at a time.”

b. 

## Pg. 167 – Interagency commenters note that th e last sentence is very confusing and might not be necessary. Commenters also believe that the last sentence might be problematic because it seems to suggest th at, rather than the regulatory outcomes being different (stringency in creases at different rates ove r these time period) that the agency took a different approach in evalua ting the appropriate stringency of standards for these two periods, which commenters believe is not accurate. Commenters suggest the following edits: “The question of the tipping poi nt is slightly different in the context of the final standards and augural standards. The final standards for MYs 2017-2021 are nearer-term, albeit still several year s away; the augural standards for MYs 2022- 2025, clearly, are even more distant, and th e inputs that inform our balancing are less certain. Based on the information curren tly before the agency, we continue to believe that the standards as propos ed are maximum feasible for MYs 2017- 2025., but the relative stringency of the fina l and augural standards (both for cars and trucks) in those model years as compar ed to the other regulatory alternatives is different in the different phases. That is, the final standard s for cars and trucks

[1] 

### Oates, Wallace E., Paul R. Portney, and Albert M. McGartland. “The Net Benefits of Incentive

‐ Based Regulation: A Case Study of Environmental Standard Setting." American Economic Review 79(5) (December 1989): 1233

‐ 1242. (Docket No. EPA

‐ HQ

‐ OAR

‐ 2010

‐ 0799

‐ 0833).

### Summary of interagency working comments received on draft rule under EO 12866 and EO 13563
review. They are for your consideration and are subject to further policy review.



## may fall between different regulatory a lternatives in MYs 2017-2021 and in MYs 2022-2025. This is because the agency’s a pproach to balancing is different for the final standards and for the augura l standards, as discussed below.”

4. Commenters noted that the NHTSA RIA Executive Summary seems to have an error for NHTSA’s Total Cost=Total Benefit analysis . Commenters noted that the net benefits reported for this option are cl ose to (sometimes greater th an) the ‘max net benefits.’ Commenters request clarity on whether th ey should be close to zero since net benefits=TB-TC. Commenters no te that this approach seem s more consistent with the PRIA from November 2011. Commenters re quest NHTSA to provide additional explanation regarding what total costs and benefits represent.

## EPA Staff Draft – Deliberative Material – Do Not Ci te or Quote EPA Responses to Interagency Comments Received 8/18 /12

1 

# OMB Issue # 1- the Flat Baseline

OMB Stated - Interagency commenters do not find the justificatio n for a “flat” baseline compelling. The primary empirical evidence in suppo rt of a flat baseline appears be based on the experience during the period 1986-2003. Commenters question the relevance of this period to projecting that, in the absence of further regulati on, the market would supply no increases in fuel economy (beyond the minimum required in 2016) at an y time before model year 2026. While it is true that from 1986-2003 most manufacturers did not substantially exceed the applicable standards, commenters note that during that period real gas prices were lower than $2.00/gallon ($2012) and fell to as low as $1.45/gallon in the l ate 1990s. [EIA Short-Term Energy Outlook

, Aug. 2012] Commenters note that the choice of that period appears to be based on the relative stability of gasoline prices and the assumption tha t gasoline price stability is more predictive of fuel economy increases than is the gasoline price l evel. Commenters disagree that the stability of gasoline prices is, per se, more important. Economi c theory suggests the demand for fuel economy would be greater in a world with stable gas oline prices at $4.00 per gallon than one with prices fluctuating between, say, $1.50 and $3. 00. Furthermore, more recent data (e.g., MYS 2009-11) show substantial “over-compliance” with CA FÉ standards. [BTS National Transportation Statistics 2012, Table 4-23] Commenters believe that this over -compliance is due in large part, if not to primarily high gasolin e prices. Gasoline prices during recent years are consistent with those projected for 2017 and beyond in the rule and substantially higher than those used to justify the claim that manufacturers are unlikely to produce fleets with fuel economy greater than those required for MY 2016.

Interagency commenters request that agencies respon d to these points in the Preamble and RIA sections regarding the baseline.

EPA Response:

EPA disagrees with the interagency commenters. The interagency commenters “question the relevance” of the 1986-2003 time frame to predi cting the 2017-2025 timeframe because real gasoline prices were lower than $2 per gallon in th e 1986-2003 and are projected to be in the $4 per gallon range in 2025 and later. But the intera gency commenters failed to recognize that fleetwide CAFE levels were 23-24 mpg in the 1986-20 03 timeframe, while the assumed baseline for 2017 is 35.5 mpg, so the assumed baseline is al ready 50% higher than CAFE levels in the 1986-2003 timeframe. EPA notes that the very over compliance cited by the interagency commenters still leaves the industry below the 35.5 mpg level that is the assumed baseline for 2017, and EPA believes that some (and likely most i f not all) of this over compliance is due to the manufacturers expecting and preparing for more stringent standards in the future. EPA is not aware of any empirical evidence that consumers will demand, or automakers will provide, fuel economy levels in excess of 35.5 mpg at fuel prices similar to today’s fuel prices, and the interagency commenters have not provided any. EPA was very clear in the rulemaking package that we considered the 1986-2003 time frame to be r elevant to the 2017-2025 baseline for two reasons—relatively stable fuel prices (based on AEO projections) and flat standards—and the

## EPA Staff Draft – Deliberative Material – Do Not Ci te or Quote EPA Responses to Interagency Comments Received 8/18 /12

2 

## interagency commenters do not suggest any alternati ve historical time frame on which to learn how automakers would be likely to behave in the abs ence of rising fuel prices or standards.

OMB Baseline – Suggested Edits to EPA Final RIA

EPA description of the alternative baseline. In add ition to address comment number 1 above, interagency commenters request EPA to includ e the following insert in EPA RIA 3.4.3.1:

EPA Response – EPA is prepared to make the following edits to t his paragraph in RIA Section 3.4.3.1, shown in track changes against the interag ency suggestions.

“Based on the historical data discussed above, EPA believes that there is a very low likelihood that any manufacturers will voluntarily achieve higher fuel economy than their footprint-based targets relative to the projected f leet average 35.5 mpg level of MY 2016 standards in MYs 2017-2025, in the absence of more stringent standards. There are several reasons for this: gasoline prices through MY 2025 a re projected to be only slightly higher than today’s levels, footprint-based standards are const raining for all manufacturers, and manufacturers may use future technology to support other vehicle attributes preferred by consumers such as power and utility. In addition, e ven if some individual manufacturers were to voluntarily over comply, it is possible that they w ould sell their GHG credits to other manufacturers who might find that it is more cost-e ffective to purchase credits than to continue to meet the 35.5 mpg level. We do note, however, that to date there have been no trad ing of credits. EPA is aware of several automakers that have alread y purchased, or in the process of negotiating to purchase, credits for MY 2012. In this scenario, if all credits were sold to other manufacturers, there would be no meaningful impact on the agency’s projected costs and benefits. But, the agency recog nizes that it is possible that, under certain circumstances, there might be some industry-wide ov er compliance. For example, oil prices much higher than projected by AEO 2012 early releas e could lead to a higher baseline due to industry-wide over compliance. But under this highe r baseline costs and benefits would both be lower and it is impossible to know whether net cons umer and societal benefits would be higher or lower. Both agencies assume no fuel economy improvement in their primary analyses, but we note that NHTSA chose to analyzed an alternative

, market-driven baseline as a sensitivity case in their RIA but the primary baseline that both agenci es are using does not assume any fuel

economy improvements absent regulation .”

## EPA Staff Draft – Deliberative Material – Do Not Ci te or Quote EPA Responses to Interagency Comments Received 8/18 /12

3 

# OMB Issue # 2- Sales/Employment Assessment

OMB Request

- Interagency commenters provided a revised sectio n for sales and employment for NHTSA. Commenters request agencies to make conf orming edits to the preamble sections on sales and jobs and EPA’s RIA section on sales and j obs. Because of multiple edits, the following includes a simplified clean version of the section for your consideration.

EPA Response :
EPA’s qualitative discussion of vehicle sales and e mployment is much different from NHTSA’s quantitative analysis. On employment, EPA quantifi es the employment associated with adding technology to vehicles, but does not quantify emplo yment associated with changes in vehicle sales; NHTSA takes the opposite approach. For thes e reasons, we do not consider it appropriate to adopt all of the interagency language provided f or NHTSA.

We have sought to identify language in the interage ncy comments that are appropriate to add to EPA’s discussion of vehicle sales. The attached do cument shows changes that EPA will make to the Preamble III.H.11.a discussion, in response to the interagency comments.

We presume that this will close out the issue of ve hicle sales and employment with respect to interagency review.EPA Staff Draft – Do Not Cite or Quote EPA Responses to Interagency Comments Received 8/18 /12

1 In response to interagency comments received on Aug ust 18, 2012, EPA will make the following edits to the EPA preamble section III.H

EPA Preamble Language:

1. What are the Estimated Cost, Economic, and Other Im pacts of the Rule?

1. U.S. Vehicle Sales Impacts and Affordability of New Vehicles

a. Vehicle Sales Impacts

Predicting the effects of this rule on vehicle sale s entails comparing two effects. On the one hand, the vehicles designed to meet the standar ds will become more expensive, which would, by itself, discourage sales. On the other h and, the vehicles will have improved fuel economy and thus lower operating costs due to signi ficant fuel savings , which could encourage sales . Which of these effects dominates for potential v ehicle buyers when they are considering a purchase will determine the effect on sales. Assess ing the net effect of these two competing effects is uncertain, as it rests on how consumers value fuel savings at the time of purchase and the extent to which manufacturers and dealers refle ct technology costs in the purchase price. The empirical literature does not provide clear evidenc e on how much of the value of fuel savings consumers consider at the time of purchase. It als o generally does not speak to the efficiency of manufacturing and dealer pricing decisions. Thus, we do not provide quantified estimates of potential sales impacts in this final rule. Howeve r, as discussed later in this section, there are several reasons why EPA believes this rulemaking wi ll lead to an increase in vehicle sales, though we do not quantify a specific impact.

An additional source of uncertainty in the analysis is understanding what would happen in the absence of this rule. Standard economic the ory would suggest that, if automakers could profitably increase sales by adding more fuel-savin g technologies to their vehicles, then manufacturers’ profit motives would lead them to vo luntarily add those technologies in the absence of this rule. As discussed in Preamble Sec tion III.D.1, we project, based on historical patterns, that auto makers would not go beyond the MY 2016 standards in the absence of this rule. Yet, if consumers consider just over three y ears’ worth of fuel savings in their vehicle purchase decisions, the payback period analysis in Section III.H.5 suggests that sales would increase in response to this rule. Are these analy ses in conflict?

Although it is possible that manufacturers could ad d at least some of the vehicle technologies in the absence of the rule (see Sectio n III.H.1.a for a discussion), there are also a number of reasons for potential increases in vehicl e sales as a result of the rule notwithstanding our assumption of a flat baseline. These explanati ons focus on conditions where the rule stimulates investments that would not happen in the rule’s absence. The explanations posed below raise possibilities that the rule, by requiri ng all automakers to meet the standards, may lead to mutually beneficial outcomes that might not happen in the absence of the rule. Deleted: would

Deleted: they would do soEPA Staff Draft – Do Not Cite or Quote EPA Responses to Interagency Comments Received 8/18 /12

2 Consumers would then have the opportunity to purcha se vehicles that would not be available in the absence of the rule; if consumers consider at l east as many years of fuel savings when buying new vehicles as the payback period for the new tech nologies, positive sales impacts could occur as a result of these final standards. The three pos sibilities we suggest for such outcomes are promotion of social learning, reduction of risk and uncertainty for manufacturers, and promotion of innovation.

i. Social Learning For many years, fuel economy standards did not chan ge (see Preamble III.D.1). 1 As discussed in Preamble III.H.1.a, consumers may not have focused on fuel economy, or may have found it difficult to do calculations involving the tradeoffs between fuel economy and increased vehicle costs, or may not have found vehicles with their preferred combination of fuel economy and other features. In recent years, though, fuel economy standards have started to increase. 2 In addition, high fuel prices have helped to focus con sumer attention toward vehicle fuel economy. Finally, the recently revised fuel economy label, w ith prominent information on fuel savings, are starting to appear on new vehicles. These factors may contribute to consumers gaining experience with the benefits that accrue to them fr om owning and operating vehicles with greater fuel efficiency. Consumer households that include v ehicles with a fairly wide range of fuel economy have an opportunity to learn about the valu e of fuel economy on their own. Consumer demand may be shifting towards such vehicles, not o nly because of higher fuel prices but also if many consumers are learning about the value of purc hases based not only on initial costs but also on the total cost of owning and operating a vehicle over its lifetime. This type of learning should continue before and during the model years affected by this rule.

Today’s rule, combined with the new and easier-to-u nderstand fuel economy labels required to be on all new vehicles in MY 2013, may increase sales by hastening this very type of consumer learning. As more consumers experience the savings in time and expense from owning more fuel efficient vehicles, demand may shift yet further in the direction of the vehicles with improved fuel economy and reduced GHG emissions man dated under the rule. This social learning can take place both within and across hous eholds, as consumers learn from one another. First and most directly, the time and fuel savings associated with operating more fuel efficient vehicles may be more salient to individuals who own them, which might cause their subsequent purchase decisions to shift closer to minimizing th e total cost of ownership over the lifetime of the vehicle. Second, this appreciation may spread across households through word of mouth, marketing and advertising, and other forms of commu nications. Third, as more motorists experience the time and fuel savings associated wit h greater fuel efficiency, the price of used cars may better reflect such efficiency, further re ducing the cost of owning more efficient vehicles for the buyers of new vehicles (since the resale price may increase). If these induced learning effects are strong, the rule could potenti ally increase total vehicle sales over time. This effect may be speeded or slowed by other factors th at enter into a consumer’s valuation of fuel efficiency in selecting vehicles.

1 Car CAFE standards did not change from MYs 1990 th rough 2010. Truck CAFE standards did not change fr om MYs 1996 through 2004, and changed only 0.5 mpg cum ulatively from MYs 1991 through 2004. See "Summary of Fuel Economy Performance," March 12, 2012, DOT/NHTS A, http://www.nhtsa.gov/fuel-economy.

2 Truck CAFE standards began to rise in MY 2005 and have risen every year since. Car CAFE standards be gan to rise in MY 2011. Ibid.EPA Staff Draft – Do Not Cite or Quote EPA Responses to Interagency Comments Received 8/18 /12

3 The possibility that the rule could (after a lag fo r consumer learning) increase sales need not rest on the assumption that automobile manufact urers are failing to pursue profitable opportunities to supply the vehicles that consumers demand. In the absence of the rule, no individual automobile manufacturer would find it pr ofitable to move toward more efficient vehicles to increase consumer learning because no i ndividual company can fully internalize the potential future boost to demand. If one company we re to make more efficient vehicles, counting on consumer learning to enhance demand in the futur e, that company would capture only a fraction of the extra sales so generated, because t he learning at issue is not specific to any one company's fleet. Many of the extra sales could accr ue to that company's competitors.

In other words, consumer learning about the benefit s of fuel efficient vehicles involves positive externalities (spillovers) from one compan y to the others. 3 These positive externalities may lead to benefits for manufacturers as a whole i f they increase the demand for vehicles. We emphasize that this discussion has been tentative a nd qualified. It is not possible to quantify these learning effects years in advance

, and these effect s may be speeded or slowed by other factors that enter into a consumer’s valuation of fuel effi ciency in selecting vehicles. To be sure, social learning of related kinds has been identified in a number of contexts. 4 We asked for comments on the discussion offered here, with particular ref erence to any relevant empirical findings. 76 FR 75150. We continue to explore this issue but di d not receive any comments on the role of social learning, except in the context (discussed i n Section III.H.1.a) of the effect of the rule on the visibility of and status associated with owning vehicles with improved fuel economy.

ii. Reduction in Risk and Uncertainty for Manufacturers As discussed in Preamble III.H.1.a, there appears t o be a great deal of uncertainty about how consumers will respond to increases in fuel eco nomy. Automakers may be cautious about adding more fuel-saving technology to vehicles if t hey are uncertain how buyers will respond. Even if they believe that buyers will respond posit ively, if a company is risk-averse, it may nevertheless hesitate to make the substantial major investments in new technologies and in research that would lead to increases in fuel econo my across its fleet. 5 If a manufacturer invests substantially in fuel efficient technologies expect ing higher consumer demand than realized, then the manufacturer has incurred the costs of investme nt but not reaped the benefits of those investments. On the other hand, if a manufacturer d oes not invest in fuel

- efficient technologies, then the manufacturers may lose some sales in the s hort run if demand for fuel economy is higher than expected, but it still retains the opti on of investing in fuel

- efficient technologies. If

3 Industrywide positive spillovers of this type are hardly unique to this situation. In many industries , companies form trade associations to promote industry-wide public goods. For example, merchants in a given locale may band together to promote tourism in that locale. Antitru st law recognizes that this type of coordination ca n increase output.
4 See Hunt Alcott, Social Norms and Energy Conservat ion, Journal of Public Economics (forthcoming 2011)

, available at http://web.mit.edu/allcott/www/Allcott %202011%20JPubEc%20- %20Social%20Norms%20and%20Energy%20Conservation.pdf (Docket EPA-HQ-OAR-0799-0825); Christophe Chamley, Rational Herds: Economic Models of Social Learning (Cambridge, 2003) (Docket EPA-HQ-OAR-0799- 1110).

5 Sunding, David, and David Zilberman, “The Agricult ural Innovation Process: Research and Technology A doption in a Changing Agricultural Sector,” Chapter 4 in Ha ndbook of Agricultural Economics , Volume 1, edited by B. Gardner and G. Rausser (Elsevier, 2001) show how de laying adoption of a new technology in order to gai n more information may be a more profitable activity than adopting a technology, even if it has positive net benefits, when a potential adopter is risk-averse. Deleted: thatEPA Staff Draft – Do Not Cite or Quote EPA Responses to Interagency Comments Received 8/18 /12

4 its investments proved unsuccessful, the company mi ght face substantial losses. Even if the probability of being unsuccessful is low, the manuf acturer may nevertheless perceive the losses in that scenario as a substantial risk. If the inv estment proved successful, the company would, of course, take market share from other companies – bu t only until the other auto companies caught up. In other words, for a risk-averse company, bei ng a first mover may appear to have a greater downside risk than upside risk, even if the investm ent, on an expected-value basis, would pay off. If all companies are risk-averse, then they m ay all seek a strategy of waiting for some other company to be the first mover. In this case, cauti on about these major investments may lead to slow adoption of new technologies, in the absence o f the rulemaking. This rulemaking, by requiring that all companies act at the same time, removes the scenario of one company bearing all the risk.

In addition, there may be risk aversion on the cons umer side. The simultaneous investment by all companies may also encourage cons umer confidence in the new technologies. If only one company adopted new technologies, early adopters might gravitate toward that company, but early adopters tend to be a relatively small portion of the public. More cautious buyers, who are likely to be more numerous, might w ait for greater information before moving away from well-known technologies. If all companie s adopt advanced technologies at the same time, though, potential buyers may perceive the new technologies as the new norm rather than as a risky innovation. They will then be more willing to move to the new technologies. As some commenters have pointed out, simultaneous action re quired by the rule may change buyers’ expectations (their reference points) for fuel econ omy, and investing in more fuel economy may seem less risky than in the absence of the rule.

The rule, then, may reduce manufacturers’ risk of m aking significant investments in fuelsaving technologies by providing a level playing fi eld for all companies. Under this outcome, it is possible for the rule to facilitate investment t hat would not happen in the absence of the rule, and vehicle sales could increase as a result of the rule.

iii. Promotion of Innovation Research among multiple parties can be a synergisti c process: ideas by one researcher may stimulate new ideas by others, and more and bet ter results occur than if the one researcher operated in isolation. One function that standards can serve is to promote research into low-CO 2 technologies that would not take place in the absen ce of the standards. Because all companies (both auto firms and auto suppliers) will have ince ntives to find better, less expensive ways of meeting the standards in this rule, the possibiliti es for synergistic interactions may increase. Thus, the rule, by focusing all companies on findin g more efficient ways of achieving the standards, may lead to better outcomes than if any one company operated on its own.

An additional aspect of the standards is the possib ility of greater standardization. As more companies adopt new technologies, the incentiv es increase for additional suppliers and more availability of after-market replacement parts ; these suppliers would be likely to find ways to increase compatibility across vehicle types. Fo r example, though electric vehicles (EVs) are not expected to be more than a few percent of the v ehicles produced in response to this rule, their adoption depends on such factors as batteries and c harging methods that are compatible across different companies. In the absence of the rule, f ewer companies would be pursuing this technology, and it would be considered a specialty product; the incentives to coordinate might beEPA Staff Draft – Do Not Cite or Quote EPA Responses to Interagency Comments Received 8/18 /12

5 low. If EVs become more common, though, compatible infrastructure and batteries may become more desirable, as potential buyers are likely to b e encouraged toward this technology if they can easily find places to charge batteries.

Thus, the rule may direct and promote innovation an d standardization that would not happen in the absence of this rule. Such changes could reduce the costs and improve the qualities of the technologies, which could result i n an increase in vehicle sales. Further, the certainty of the regulations reduces the costs of m eeting them, because there will be more economies of scale and more learning curve benefits due to greater cumulative production of fuel-efficient technologies.

In these three plausible explanations for how the r ule could increase vehicle sales, we have focused on ways that the rule could promote co ordinated actions on the part of automakers and suppliers that lead to mutual benefit, but that might not happen in the absence of the rule. These actions could lead to automakers developing technologies that they would not have developed in the absence of the rule. Consumers ma y respond positively to the vehicles resulting from this coordinated action.

Several commenters requested that we conduct a quan titative vehicle sales analysis. As discussed in the proposal, in previous rulemakings, EPA and NHTSA conducted vehicle sales analyses by comparing the up-front costs of the veh icles with the present value of five years’ worth of fuel savings; the direction of vehicle sal es would depend on whether up-front costs exceeded fuel savings (in which case sales would be expected to decline), or vice versa (in which case sales would be expected to increase). 6 Some commenters specifically requested that we us e the method found in the MYs 2012-16 rule; some spec ifically supported the five-year payback period; others argued for the importance of conduct ing the analysis without recommending methods. Ceres estimates that the rule will increa se vehicle sales by 4.7 percent; the Defour Group provided estimates that the rule will decreas e vehicle sales by 6-10 percent. The differences in the results appear to depend on the cost estimates used and on assumptions made about how vehicle buyers think about fuel savings w hen deciding on vehicle purchases. The Defour Group, for instance, uses cost estimates of about $3000 per vehicle based on summing costs (but not benefits) across multiple rules (an estimate we consider to be unfounded for reasons explained in this section below and also in TSD Chapter 3.1.2) and the assumption that consumers consider only 25 percent of fuel savings in their vehicle purchase decisions (see discussion in Section III.H.1.a). Other commenters wanted specific information on the effect of the rule on vehicle costs and whether consumers wil l be willing to buy the new vehicles, while consumer and environmental organizations indicated that consumers want more fuel-efficient vehicles, even if the up-front costs of the vehicle s increase. The costs of the rule are discussed in Preamble Section III.H.2. As discussed in Preamble Section III.H.1.a, we do not at this point have sufficient confidence in the estimates of the role of fuel economy in consumers’ vehicle purchases to come to definitive conclusions about t he impacts of the rule on vehicle sales. We do not, however, consider this uncertainty grounds for delaying the rule, as one comment

6 For instance, see U.S. Environmental Protection Ag ency (April 2010). “Final Rulemaking to Establish LightDuty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fuel Economy Standards: Regulato ry Impact Analysis.” EPA-420-R-10-009, Chapter 8.1.1, pp. 8-1 to 8-4. Deleted: Those

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6 suggested. The midterm evaluation provides an oppo rtunity to revisit the impact of the rule on vehicle sales and consumer acceptance of the new te chnologies.

This rule takes effect for MY 2017-2025. In the in tervening years, it is possible that the assumptions underlying a quantitative analysis, as well as market conditions, might change. As the United Auto Workers points out, the state of th e economy is a major, if not the primary, determinant of total vehicle sales. The impact of the rule on sales may therefore depend, among other factors, on changes in the state of the econo my. Other commenters discussed the importance of consumer confidence, fuel prices, and even of publicity over fuel prices, in consumers’ interest in additional fuel economy. Sales could be negatively affected if gasoline prices are lower than expected or technology costs are higher than expected. In these cases, it is possible that the standards could require manufactu rers to produce cars with higher levels of fuel economy than consumers would wish to buy. On the other hand, manufacturers’ marketing of increased fuel economy levels is also likely to pla y a role in consumer response to these vehicles. EPA agrees that these factors are important, but we are not sufficiently confident in quantitative estimates of the impacts of those factors to develo p numerical estimates. We instead provide this qualitative assessment to highlight the factors imp ortant for understanding the effects of this rule on vehicle sales.

As several commenters point out, t he effect of this rule on the use and scrappage of older vehicles will be related to its effects on new vehi cle prices, the fuel efficiency of new vehicle models, the fuel efficiency of used vehicles, and t he total sales of new vehicles. If the value of fuel savings resulting from improved fuel efficienc y to the typical potential buyer of a new vehicle outweighs the average increase in new model s’ prices, sales of new vehicles could rise, the used vehicle market may increase in volume as n ew vehicle buyers sell their older vehicles, and scrappage rates of used vehicles may increase s lightly. This will cause both an influx of more efficient vehicles into the used vehicle marke t and an increase in the turnover of the vehicle fleet (i.e., the retirement of used vehicles and th eir replacement by new models), thus accentuating the anticipated effect of the rule on fleet-wide fuel consumption and CO 2 emissions. However, if potential buyers value futu re fuel savings resulting from the increased fuel efficiency of new models at less than the incr ease in their average selling price, sales of new vehicles will decline, the used vehicle market may decrease in volume as people hold onto their vehicles longer, and there will be a reduction in t he rate at which used vehicles are retired from service. These effects will partly reduce the anti cipated effects of this rule on fuel use and emissions. Because we do not have good estimates of the relationships between the new and used vehicle markets, we have not attempted to estimate explicitly the effects of the rule on the used vehicle market, scrappage of older vehicles, and th e turnover of the vehicle fleet.

Consumer, environmental, and investor organizations , the United Auto Workers, as well as a citizens’ campaign suggested that the rule wil l help the domestic auto industry, including the domestic supply base, compete in the global marketp lace, through its encouragement of advanced technologies that may be useful in meeting emissions standards and consumer demands in foreign markets. We agree that this is likely, as generally the emission standards established in this rule are similar in stringency to emissions and fuel economy standards being considered by Japan, the European Union, South Kore a, Canada, China and other international markets. Global manufacturers also design vehicles using a common platform in order to reduce costs. Vehicles built on these common platforms ar e sold in many markets around the world. To Deleted: TEPA Staff Draft – Do Not Cite or Quote EPA Responses to Interagency Comments Received 8/18 /12

7 the extent the domestic OEMs and suppliers can focu s their limited research and product development efforts on the same technologies for th e U.S. market as for international markets, this should enable the companies to compete more ef fectively outside the U.S.