1 UNITED ST AT ES ENVIRONMENT AL PROTECTION AGENCY

ANN ARBOR, MI 48105

May 20, 2011 OFFICE OF AIR AND RADIATION MEMORANDUM SUBJECT: Economy

- Wide Impacts of Heav y- Dut y Truck Greenhouse Gas Emissions

and Fuel Efficiency Standards FROM: Shary

n Lie and Michael Shelby , Office of Transportation and Air Quality TO: Docket EPA

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E PA has undertaken an analy sis of the econom y- wide impacts of the heavy

- duty (HD) vehicle fuel efficiency and GHG standards. The results were not a factor regarding the appropriateness of the GHG or fuel efficiency standards. It is important to note that the results of this modeling exercise are dependent on the assumptions associated with how producers will make fuel e fficienc y improvements and how consumers will respond to increases in higher vehicle costs and improved vehicle fuel efficiency as a result of the program . It is anticipated that the HD vehicle standards will have impacts on the U.S. econom y that extend beyond the transportation sector. The price of HD vehicles would increase with this program ; at the same time, the program would also lower the demand for transportation fuels, resulting in a lower overall world oil price. This combination of effects

— price increases for HD vehicles and lower fuel demand and world oil prices

— would impact all sectors of the econom y that use HD vehicles and petroleum

- based energy as intermediate inputs to produce final goods. Households would also be impacted indirectl y as consumers of final goods. Furthermore, as discussed in the RIA Chapter 9 , HD VMT is largely driven by

changes in economic activity . To the extent that we have accounted for the increase in truck use due to the rebound effect in our anal ys is, it seems appropriate to also take into account the change in economic activity associated with increased truck travel as a result of the program . It is important to note, however, that these potential impacts do not represent additional benefits or costs from the regulation. Instead, they represent the effects on the U.S. economy

as its direct benefits and costs are transmitted through changes in pric es and quantities sold in the affected markets, including those for vehicles and their components, fuel, and the various resources used to supply them. T he predicted impacts of the regulation s on economic activity depend on what we assume with regard to f uel2

savings. In particular, it depends on the extent to which market failures affecting demand for vehicle fuel economy are present, and when they are not, the extent to which they are offset b y costs not captured in EPA and NHTSA’s anal ys is. Such costs include changes in economic welfare due to the purchase of more fuel econom y than businesses would otherwise elect to purchase absent the regulation s . As discussed in Section VIII.A., cost and fuel saving calculations presented in the RIA are predicated on the argument that there are inefficiencies in the market for fuel

- saving technology in the trucking industry

. To estimate the impacts of this program on U.S. GDP and personal consumption, EPA has used an economy

- wide, computable general equilibrium (CGE) model. Over the past twenty

years, the use of peer

- reviewed CGE models to assess the econom y- wide impacts of large

- scale environmental policies has become a common practice. The features of CGE models make them particularly well

- suited to such anal yses 1 which, in turn, have led to strong endorsements for their use by EPA ’ s Science Advisory Board. 2 The econom y- wide model used in this analy sis is the Intertemporal General Equilibrium Model (IGEM). 3 IGEM is a model of the U.S. economy with an emphasis on the econom y’s energy and environmental aspects. IGEM is a dynamic model which depicts growth of the economy

due to capital accumulation, technical change and population change. The model utilizes a unified accounting framework consistent with the National In come and Product Accounts and the Industry Classification Sy stem. It is a detailed multi

- sector model covering thirty

- five industries, consisting of five energy and thirty non - energy

sectors. The model ensures market balances (suppl y equals demand) i n value and quantity

terms, including limits placed on private investment dictated by domestic and foreign saving behavior and b y the fiscal policies of federal, state and local governments. Capital accumulation in the model arises from the saving and i nvestment behavior of households and businesses , and provides an essential input to production and consumption. Households in the model make perfect

- foresight choices regarding present and future consumption (i.e., saving) , and make choices regarding the allocation of their members’ time between labor and leisure. The model covers all aspects of long

- run growth including the supply of capital, labor, imported and intermediate inputs to production; the rates and directions of exogenous and endogenous techn ical change for each producing sector; and the degrees of substitutability among inputs and commodities in production and final demand (consumption, investment, governments and foreign trade). The substitution possibilities for both producers and consumer s in IGEM are driven by model parameters that are based on observed market behavior revealed over the past forty to fifty years.

1 See Weyant, J.P., 2000. An Introduction to the economics of climate change policy. Pew Center on Global Climate Change Report (Docket ID: EPA

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- 0023 ) 2 See EPA’s Guidelines for Preparing Economic Analyses, 2010 and 2000 , available at http://yosemite .epa.gov/ee/epa/eed.nsf/pages/Guidelines.html (Docket ID: EPA

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- 0022 ) 3 The model is developed and run by Dale W. Jorgenson Associates for EPA. More information on the assumptions included in IGEM, such as the equations used, the elasticities employed, and the market clearing mechanisms assumed can be found on the model homepage: http://www.igem.insightworks.com/3

In order to model these rules , the CGE model uses outputs of the transportation sector models as inputs to determine the eco nom y - wide impacts of this program . Specificall y, the model uses information from other sources on incremental costs of vehicle technologies, reduction s in fuel consumption, and impacts on the world oil price. The incremental cost of vehicle technologies is used to generate a percentage change in vehicle cost that is applied to the IGEM motor vehicles sector. However, since the cost and fuel savings vary

significantly

across truck classes, we have used a weighted average cost and fuel saving s for all truc k classes in this analy sis. In addition, since heav y- duty trucks make up less than 5 percent of the motor vehicles manufacturing sector , the cost increases represented here only apply to that portion of the IGEM sector. The data on reduction s in fuel con sumption are used as inputs to I GEM in order to reduce the amount of refined petroleum sector output required b y the transportation sector and other sectors in the model. Finally , the estimates of reductions in the world oil price are directly used to red uce the oil price in the model. The changes in world oil price are estimated using the Energy

Security Oil Premium Model maintained by Oak Ridge National Laboratory , which is discussed in more detail in Section VIII. I

. (1) Impacts on U.S. GDP In order to use IGEM to estimate the real U.S. GDP impacts of th ese rules , w e anal yz ed the impact of changes in the costs of heavy

- duty trucks, changes in fuel consumption from the shift to a lower GHG

- emitting vehicle stock, and the impacts of changes in the demand for m otor fuels on fuel prices. (s ee the Preamble Section VIII.B for additional information on the change in vehicle technology costs, Section VIII.E for details on changes in fuel demand, and Section VIII. I for a discussion of the effect of reduced U.S. fuel c onsumption on the world price of petroleum). It is important to note that the econom y- wide analy sis does not include a representation of a number of external benefits summarized in the previous section (e.g. , reducing greenhouse gas and non

- GHG emissions) , and thus differs in important respects from the anal ys is of costs and benefits reported in the previous section

. Table 1 and Figure 1 show the Reference Case GDP and GDP with this rule from 2015 through 2050. Table 1 : Annual GDP Impacts Associated with this Program (Billions of 2008 dollars) Y ear R eference C ase

GDP GDP with Program % C hange from R eference C ase 201 5 $16,637.5 $16,637.2

- 0.002% 2020 $19,281.9 $19,281.1

- 0.004% 2 030 $24,913.9 $24,913.1

- 0.003% 2040 $31,324.0 $31,324.9 0.003% 2050 $38,758.4 $38,757.6

- 0.002%4 $0 $5, 000 $10, 000 $15, 000 $20, 000 $25, 000 $30, 000 $35, 000 $40, 000 $45, 000

2015 2020 2030 2040 2050$2009 Billion Re fe rence Case HD Re gu la ti ons

Figure 1 Annual GDP Impacts The combined direct market forces of this HD program have a negligible effect on the overall economy , its sectors and its industries. Though small in absolute magnitude, there are, however, very

recognizable relative consequences arising from these forces in general equilibrium. The direct market forces divide on the cost side in the form of higher vehicle prices and on the benefit side in the form of fuel savings and lower world oil prices. These combine to yield lower prices economy

- wide for generally every thing except motor vehicles . With lower prices and national income virtually unchanged, each dollar of household spending buys more consumer goods and services, each dollar of household and business saving finances more investment and capital accumulation , and each dollar of tax receipts supports more real purchases b y Federal, state , and lo cal governments. On the demand side, these serve to increase real GDP, but their effects are offset b y reductions in net U.S. exports. In addition, the price benefits of the HD program increase over time. In turn, the decisions needed by forward

- looking households to increase future consumption contribute, along with the noted export reductions, to small losses in real GDP. On the supply side, the increased availability of capital following greater investment and improved productivity permit and are acc ompanied b y an almost undetectable reduction in labor supply (or, equivalentl y, increase in leisure demand) leaving national income very slightly lower. Whether viewed from the demand or supply sides, the changes in the overall economy as measured b y real GDP are virtually zero. 4 This simulation adopts the common practice in CGE modeling of assuming government deficits and current accounts are held constant (i.e., no changes from

4 Note that GDP changes should not be confused with a measure of welfare since i t focuses only on changes in what is produced by the economy, not what is consumed , and it does not include effects on externalities

.5

reference case levels). Thus any changes in private investment arise solel y from changes in household saving and business profitability

. 5 For governments, with nominal purchases more or less the same, lower prices economy

- wide mean higher levels of real government purchases. 6 The assumption that current accounts are held constant has additional consequences. Under the HD program, the U.S. economy becomes less intensive in petroleum use. The fuel savings lead to lower overall petroleum demand, and lower world oil prices further reduce petroleum import bills. This puts upward pressure on the dollar as fewer dollars seek foreign currency . A stronger dollar also is necessary to ensure current account balances are held constant in the face of relatively lower U.S. prices. The stronger dollar discourages real exports from the U.S. while encouraging real imports to the U.S. The decline in net exports arising from the stronger dollar works to partially offset the positive effects of consumption, investment and government purchases on real GDP. For additional information on GDP impac ts, refer to the model outputs included in the docket. 7 (2) Impacts on U.S. Consumption In addition to showing the impacts of the HD program on U.S. GDP, EPA also shows the impacts on real U.S. personal consumption expenditures. Table 2 and Figure 2 show the Reference Case consumption and consumption with th ese rules from 2015 through 2050.

Table 2 : Consumption Impacts of the Program (Billions of 2008 dollars) Y ear R eference C ase

C o nsumption C onsumption with

Program % C hange from R eference C ase 201 5 $10,373.4 $10,373.6 0.002% 2020 $11,732.5 $11,733.3 0.007% 2030 $15,126.2 $15,128.9 0.018% 2040 $19,109.0 $19,113.8 0.025% 2050 $23,573.0 $23,579.1 0.026%

5 In other words, there can be neither “crowding out” nor “crowding in” by reason of policy driven changes in the “twin” deficits. 6 To preserve government deficit neutrality, any changes in nominal tax receipts are assumed to be matched by changes in nominal spending. 7 See, “ IGEM 2011.05.20 FRM Economy

- wide Impacts”, Document ID EPA

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.6 $0 $5, 000 $10, 000 $15, 000 $20, 000 $25, 000

2015 2020 2030 2040 2050$2009 Billion Re fe rence Case HD Re gu la ti ons

Figure 2 Annual Consumption Impacts
Under the HD program, s ince the prices of all commodities except for vehicles are decreasing, households can purchase more goods and services . As a result, real household consumption increases . In addition, househ olds also can consume more leisure as more investment leads to a larger capital stock. 8 The consumption impacts on a per household basis are presented in Table 3 and Figure 3

. Consumption increases slightly as a result of this program . 9

Table 3 : Consumption Impacts of This Program per Household (200 8 dollars) Y ear R eference C ase

C onsumption C onsumption with Program C hange from R eference C ase 201 5 $81,331 $81,333 $2 2020 $87, 202 $87,208 $6 2030 $102,039 $102,058 $18 2040 $117,422 $117,451 $29 2050 $133,188 $133,223 $35

8 Note that th is measure of consumption focuses only on goods and services sold in the market and therefore excludes effects on leisure. 9 Note that this measure of consumption focuses only on goods and services sold in the market and therefore excludes effects on lei sure.7 Figure 3 Annual Consumption per Household