From: "Achanta, Chandana L." <Ch andana_L._Achanta@ omb.eop.gov> To: William Charmley/AA/USEPA/US@EPA, Robin Moran/AA/USEPA/US@EPA, <rebecca.yoon@dot.gov>, <james.tamm@dot.gov>, <Steve.Wood@dot.gov>, Maureen Delaney/DC/USEPA/US@EPA Date: 03/26/2010 03:23 PM Subjec

t: Summary of Interagency working comments on draft final rule under EO 12866



### Please find attached a summary of interagency working comments received on the draft final
rule under EO 12866 review. They are for your consideration, and subject to further policy

review.

Thanks.[attachment "Summary of Interagency working comments on draft rule under EO 12866 3.26.pdf" deleted by Tad Wysor/AA/USEPA/US]Summary of Interagency Working Comments on Draft Final Rule under EO 12866 review. These are subject to further policy review.

1 Below is a summary of interagency comments received during EO 12866 review of the draft 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.

Expanded discussion of the 41 square-foot cutpoint for passenger cars in Section II.C. of the preamble:

II.C. Development of Attribute-Based Curve Shapes

In the NPRM, NHTSA and EPA proposed to set attribute-based CAFE and CO 2 standards that are defined by a mathematical function for MYs 2012-2016 passenger cars and light trucks. EPCA, as amended by EISA, expres sly requires that CAFE standards for passenger cars and light trucks be based on one or more ve hicle attributes related to fuel economy, and be expressed in the form of a mathematical function. 1 The CAA has no such requirement, though in past rules, EPA has relied on both universal and attribute-based standards (e.g., for nonroad engines, EPA uses the attribute of horsepower). However, given the advantages of using attribute-based standards and given the goal of coordinating and harmonizing CO 2 standards promulgated under the CAA and CAFE standard s promulgated under EPCA, EPA also proposed to issue standards that are attribute-based and defined by mathematical functions. There was consensus in the public comments that EPA should develop attribute-based CO 2 standards.

Comments received in response to the agencies’ decision to base standards on vehicle footprint were largely supportive. Several commenters (BMW, NADA, NESCAUM) expressed support for attribute-based (as opposed to flat or universal) standards generally, and agreed with

EPA’s decision to harmonize with NHTSA in this respect. Many commenters (Aluminum Association, BMW, ICCT, NESCAUM, NY DEC, Schade, Toyota) also supported the agencies’ decision to continue setting CAFE standards, an d begin setting GHG standards, on the basis of vehicle footprint, although one commenter (NJ DEP) opposed the use of footprint due to concern that it encourages manufacturers to upsize vehicles and undercut the gains of the standard. Of the commenters supporting the use of footprint, several focused on the benefits of harmonization—both between EPA and NHTSA, and between the U.S. and the rest of the world. BMW commented, for example, that many other countries use weight-based standards rather than footprint-based. While BMW did not object to NHTSA’s and EPA’s use of footprint-based standards, it emphasized the impact of this non-harmonization on manufacturers who sell vehicles globally, and asked the agencies to co nsider these effects. NADA supported the use of

1 49 U.S.C. 32902(a)(3)(A).Summary of Interagency Working Comments on Draft Final Rule under EO 12866 review. These are subject to further policy review.

2 footprint, but cautioned that the agencies must be careful in setting the footprint curve for light trucks to ensure that manufacturers can continue to provide functionality like 4WD and towing/hauling capacity.

Some commenters requested that the agencies consider other or more attributes in addition to footprint, largely reiterating comments submitted to the MYs 2011-2015 CAFE NPRM. Cummins supported the agencies using a secondary attribute to account for towing and hauling capacity in large trucks, for example, while Ferrari asked the agencies to consider a multi-attribute approach incorporating curb weight, maximum engine power or torque, and/or engine displacement, as it had requested in the previous round of CAFE rulemaking. An individual, Mr. Kenneth Johnson, commented that weight-based standards would be preferable to footprint-based ones, because weight correlates be tter with fuel economy than footprint, because the use of footprint does not necessarily guarantee safety the way the agencies say it does, and because weight-based standards would be fairer to manufacturers.

In response, EPA and NHTSA continue to belie ve that the benefits of footprint-attributebased standards outweigh any potential drawbacks raised by commenters, and that harmonization between the two agencies should be the overridi ng goal on this issue. As discussed by NHTSA in the MY 2011 CAFE final rule, 2 the agencies believe that the possibility of gaming is lowest with footprint-based standards, as opposed to we ight-based or multi-attribute-based standards. Specifically, standards that incorporate weight, to rque, power, towing capab ility, and/or off-road capability in addition to footpr int would not only be significantly more complex, but by providing degrees of freedom with respect to more easily-adjusted attributes, they would make it less certain that the future fleet would actually achieve the average fuel economy and CO 2 levels projected by the agencies. The agencies recognize that based on economic and consumer demand factors that are external to this rule, th e distribution of footprints in the future may be different (either smaller or larger) than what is projected in this rule. However, the agencies continue to believe that there will not be signif icant shifts in this distribution as a direct consequence of this rule. The agencies are therefore finalizing MYs 2012-2016 CAFE and GHG standards based on footprint.”

...... [late in this same section II.C ]

2 See 74 FR 14359 (Mar. 30, 2009).Summary of Interagency Working Comments on Draft Final Rule under EO 12866 review. These are subject to further policy review.

3 Before fitting the sloped portion of the constrained linear form, NHTSA and EPA selected footprints above and below which to apply constraints (i.e., minimum and maximum values) on the function. The agencies believe that the linear form performs well in describing the observed relationship between footprint and fuel consumption or CO 2 emissions for vehicle models within the footprint ranges covering most vehicle models, but that the single (as opposed to piecewise) linear form does not perform well in describing this relationship for the smallest and largest vehicle models. For passenger cars, the agency noted that several manufacturers offer small, sporty coupes below 41 square feet, such as the BMW Z4 and Mini, Honda S2000, Mazda MX-5 Miata, Porsche Carrera and 911, and Volkswagen New Beetle. Because such vehicles represent a small portion (less than 10 percent) of the passenger car market, yet often have performance, utility, and/or structural characteristics that could make it technologically infeasible and/or economically impracticable for manufacturers focusing on such vehicles to achieve the very challenging average requirements that could apply in the absence of a constraint, EPA and NHTSA proposed to “cut off” the linear portion of the passenger car function at 41 square feet. The agencies recognize that for manufacturers who make small vehicles in this size range, this cut offe creates re is some incentive to downsize (i.e., further reduce the size and weight, and/or increase the production, of models currently smaller than 41 sq. ft.) to make it easier to m eet the target. The cut off may also create an incentive for manufacturers who do not currently offer such models to do so in the future. However, at the same time, the agencies believe that there is a limit to the market for ever

- smaller cars smaller than 41 sq ft. Most consumers likely have some minimum expectation about interior volume, among other things. The agencies thus believe that the number of consumers who will want vehicles smaller than 41sq ft. (regardless of how they are priced) to be downsized even further is extremely small, and that the incentive to downsize, if present, will be minimal. For consistency, the agency proposed to do the same ”cut off” for the light truck function at the same footprint

, although no light trucks are currently offered below 41 square feet. The agencies further noted that above 56 square feet, the only passenger car model present in the MY 2008 fleet were four luxury vehicles with extremely low sales volumes—the Bentley Arna ge and three versions of the Rolls Royce Phantom. NHTSA and EPA therefore also proposed to “cut off” the linear portion of the passenger car function at 56 square feet. Finally, the agencies noted that although public information is limited regarding the sales volumes of the many different configurations (cab designs and bed sizes) of pickup trucks, most of the largest pickups (e.g., the Ford F-150, GM Sierra/Silverado, Nissan Titan, and Toyota Tundra) appear to fall just above 66 square feet in footprint. EPA and NHTSA therefore proposed to “cut off” the linear portion of the light truck function at 66 square feet.Summary of Interagency Working Comments on Draft Final Rule under EO 12866 review. These are subject to further policy review.

4 5. Impacts on U.S. Vehicle Sales and Payback Period

a. Vehicle Sales Impacts

This analysis compares two effects. On the one hand, the vehicles will become more expensive, which would, by itself, discourage sale s. On the other hand, the vehicles will have improved fuel economy and thus lower operating costs . This rulemaking will not change the ways in which consumers value fuel economy. If some consumers make mistakes in how they trade off upfront costs and fuel sa vings over time, they will continue to make those errors. To the extent that some consumers more fully account for fuel savings in their decisions, they will

also continue to do so. , which could makes them more attractive to consumers if consumers perceive and take into account these future fuel savings. The basic question is, then, which

effect dominates? In general we would expect that the net effect would be a non-positive effect on aggregate vehicle sales. If consumers were satisfied with their purchase decisions prior to the standard, then we would expect a certain number of consumers to decide that the now higher cost of the vehicle no longer justifies purchase (while others may purchase the same vehicle or adjust their purchase in favor of other attributes). This result would apply regardless of whether consumer-side market failures currently lead to under-consumption of fuel economy.

However, if there is a market failure on the producer side that currently inhibits manufacturers from offering the level of vehicl e fuel economy that would maximize their profits, then it is possible that vehicle sales would incr ease as a result of the new standards. Potential explanations for producer market failures are discussed in sections X and Y.

The methodology EPA used for estimating the impact on vehicle sales is relatively straightforward, but makes a number of simplifying assumptions. According to the literature, the price elasticity of demand for vehicles is commonly estimated to be -1.0. 3 In other words, a one

3 Kleit A.N., 1990. “The Effect of Annual Cha nges in Automobile Fuel Economy Standards.” Journal of Regulatory Economics 2: 151-172 (Docket EPA-HQ-OAR-2009-0472-0015); McCarthy, Patrick S., 1996. “Market Price and Income Elasticities of New Ve hicle Demands.” Review of Economics and Statistics 78: 543-547 (Docket EPA-HQ-OAR-2009-0472-0016); Goldberg, Pinelopi K., 1998. “The Effects of the Corporate Average Fuel Efficiency Standards in the U.S.,” Journal of Industrial Economics 46(1): 1-33 (Docket EPA-HQOAR-2009-0472-0017).Summary of Interagency Working Comments on Draft Final Rule under EO 12866 review. These are subject to further policy review.

5 percent increase in the price of a vehicle would be expected to decrease sales by one percent, holding all other factors constant. For our estimates , EPA calculated the effect of an increase in

vehicle costs due to the GHG standards and assume s that consumers will face the full increase in costs, not an actual (estimated) change in vehicle price. (The estimated increases in vehicle cost due to the rule are discussed in Section III.H.2) This is a conservative methodology, since an increase in cost may not pass fully into an increase in market price in an oligopolistic industry

such as the automotive sector. 4 EPA also notes that we have not used these estimated sales impacts in the OMEGA Model.

Although EPA uses the one percent price elasticity of demand for vehicles as the basis for our vehicle sales impact estimates, we assumed that the consumer would take into account both the higher vehicle purchasing costs as well as some of the fuel savings benefits when deciding whether to purchase a new vehicle. Therefore, the incremental cost increase of a new vehicle would be offset by reduced fuel expenditures over a certain period of time (i.e., the “payback period”). For the purposes of this rulemaking, EPA used a five-year payback period, which is consistent with the length of a typical new light-duty vehicle loan. 5 The one commenter on this analysis stated that use of the five-year payback period was reasonable. This approach may not accurately reflect the role of fuel sa vings in consumers’ purchase decisions, as the discussion in Section III.H.1 suggests. If consum ers consider fuel savings in a different fashion than modeled here, then this approach will not accurately reflect the impact of this rule on

vehicle sales.

This increase in costs has other effects on consumers as well: if vehicle prices increase, consumers will face higher insurance costs and sa les tax, and additional finance costs if the vehicle is bought on credit. In addition, the resa le value of the vehicles will increase. EPA received no comments on these adjustments. The only change to these adjustments between the NPRM and this discussion is an updating of the inte rest rate on auto loans. EPA estimates that, with corrections for these factors, the effect on consumer expenditures of the cost of the new

4 See, for instance, Gron, Ann, and Deborah Swenson, 2000 . “Cost Pass-Through in the U.S. Automobile Market,” Review of Economics and Statistics 82: 316-324 (Docket EPA-HQ-OAR-2009-0472-0007).

5 As discussed further in Section III.H.1, there is not a consensus in the literature on how consumers consider fuel economy in their vehicle purchases. Re sults are inconsistent, possibly due to fuel economy not being a major focus of many of the studies, and possibly due to sensitivity of results to modeling and data used. A survey by Greene (2010) finds that estimates in the literature of the value that consumers place on fuel economy when buying a vehicle range from negative – consumers would pay to reduce fuel economy – to more than 1000 times the value of fuel savings.Summary of Interagency Working Comments on Draft Final Rule under EO 12866 review. These are subject to further policy review.

6 technology should be 0.914 times the cost of the technology at a 3% discount rate, and 0.876 times the cost of the technology at a 7% discount rate. The details of this calculation are in the RIA, Chapter 8.l.

Once the cost estimates are adjusted for these additional factors, the fuel cost savings associated with the rule, discus sed in Section III.H.4, are subtracted to get the net effect on consumer expenditures for a new vehicle. With the assumed elasticity of demand of -1, the percent change in this “effective price,” estimated as the adjusted increase in cost, is equal to the negative of the percent change in vehicle purchases. The net effect of this calculation is in Table

III.H.5-1 and Table III.H.5-2. The values have changed slightly from the NPRM, due to changes in fuel prices and fuel savings, technology costs, and baseline vehicle sales projections, in addition to the adjustment in financing costs.

The estimates provided in Table III.H.5-1 and Table III.H.5-2 are meant to be illustrative rather than a definitive prediction. When viewed at the industry-wide level, they give a general indication of the potential impact on vehicle sale s. As shown below, the overall impact is positive and growing over time for both cars and trucks. Because the fuel savings associated with this rule are expected to exceed the technology costs, the effective prices of vehicles (the adjusted increase in technology cost less the fuel savings over five years) to consumers will fall, and consumers will buy more new vehicles. As a result, the lower net cost of the vehicles is projected to lead to an increase in sales for both cars and trucks.

As discussed above, t his result depends on the assumption that more fuel efficient vehicles that yield net consumer benefits over five years would not otherwise be offered on the

vehicle market due to market failures on the part of vehicle manufacturers . If vehicles that achieve the fuel economy standards prescribed by today’s rulemaking would already be available, but consumers chose not to purchase them, then this rulemaking would not result in an increase in vehicle sales, because it does not alter how consumers make decisions about which vehicles to purchase. In addition, this analysis has not accounted for a number of factors that might affect consumer vehicle purchases, such as changing market conditions, changes in vehicle characteristics that might accompany improvements in fuel economy, or consumers considering a different “payback period” for their fuel economy purchases. If consumers use a shorter payback period, the sales impacts will be less po sitive, possibly negative; if consumers use a higher payback period, the impacts will be more positive. Also, this is an aggregate analysis;Summary of Interagency Working Comments on Draft Final Rule under EO 12866 review. These are subject to further policy review.

7 some individual consumers (those who drive le ss than estimated here) will face lower net benefits, while others (who drive more than estimated here) will have even greater savings. These complications add considerable uncertainty to our vehicle sales impact analysis.

Table III.H.5-1 Vehicle Sales Impacts Using a 3% Discount Rate

Change in Car

Sales % Change Change in

Truck Sales % Change

2012 67,500 0.7 62,100 1.1

2013 76,000 0.8 190,200 3.2

2014 114,000 1.1 254,900 4.3

2015 222,200 2.1 352,800 6.1

2016 360,500 3.3 488,000 8.6

Table III.H.5-1 shows the impacts on new vehicle sales using a 3% discount rate. The fuel savings over five years are always higher than the technology costs. Although both cars and trucks show very small effects initially, over ti me vehicle sales become increasingly positive, as increased fuel prices make improved fuel economy more desirable. The increases in sales for trucks are larger than the increases for trucks (except in 2012) in both absolute numbers and
percentage terms.

Table III.H.5-2 New Vehicle Sales Impacts Using a 7% Discount Rate

Change in Car

Sales % Change Change in

Truck Sales % Change

2012 62,800 0.7 58,300 1

2013 70,500 0.7 92,300 1.5 Comment [A1]: New language suggested by NHTSA/EPA in response to comments document.Summary of Interagency Working Comments on Draft Final Rule under EO 12866 review. These are subject to further policy review.

8 2014 106,100 1 127,700 2.1

2015 208,400 2 194,200 3.3

2016 339,400 3.1 280,000 4.9

Table III.H.5-2 shows the impacts on new vehicle sales using a 7% interest rate. While a 7% interest rate shows slightly lower impacts than using a 3% discount rate, the results are qualitatively similar to those using a 3% discount rate. Sales increase for every year. For both cars and trucks, sales become increasingly positive over time, as higher fuel prices make improved fuel economy more valuable. The car market grows more than the truck market in absolute numbers, but less on a percentage basis.

The effect of this rule on the use and scrappa ge of older vehicles will be related to its effects on new vehicle prices, the fuel efficiency of new vehicle models, and the total sales of new vehicles. If the value of fuel savings resulti ng from improved fuel efficiency to the typical potential buyer of a new vehicle outweighs the average increase in new models’ prices, sales of new vehicles will rise, while scrappage rates of used vehicles will increase slightly. This will cause the “turnover” of the vehicle fleet (i.e., the retirement of used vehicles and their replacement by new models) to accelerate slightly, thus accentuating the anticipated effect of the rule on fleet-wide fuel consumption and CO 2 emissions. However, if potential buyers value future fuel savings resulting from the increased fu el efficiency of new models at less than the increase in their average selling price, sales of new vehicles will decline, as will the rate at which

used vehicles are retired from service. This effect will slow the replacement of used vehicles by new models, and thus partly offset the anticipated effects of this rule on fuel use and emissions.

Because the agencies are uncertain about how the value of projected fuel savings from this rule to potential buyers will compare to thei r estimates of increases in new vehicle prices, we have not attempted to estimate explicitly the effect s of the rule on scrappage of older vehicles

and the turnover of the vehicle fleet.

A detailed discussion of the vehicle sales impacts methodology is provided in the Chapter

8 of EPA’s RIA.Summary of Interagency Working Comments on Draft Final Rule under EO 12866 review. These are subject to further policy review.

9