ECONOMIC AND BUDGET ISSUE BRIEF

Fuel Economy Standards Versus a Gasoline Tax

Proponents of increasing corporate average fuel economy 

(CAFE) standards for passenger vehicles see the policy as 

a relatively low cost and proven way to decrease the 

United States’ dependence on oil and emissions of carbon 

dioxide (the predominant greenhouse gas). Opponents 

argue that CAFE standards are a costly and cumbersome 

way to reduce gasoline consumption, that they interfere 

with the market and unduly burden U.S. business, and 

(because they may encourage more driving and alter vehicle design) that they may compromise the safety of motorists. 

CAFE standards are currently 27.5 miles per gallon 

(mpg) for cars and 20.7 mpg for light trucks. The standard for cars has not changed since 1990, and the truck 

standard has been fixed since 1996 but is scheduled to increase to 22.2 mpg by 2007. The average fuel economy of 

each manufacturer’s fleets of cars and light trucks must 

meet those standards, or the firm will be subject to a fine. 

All major automakers currently meet or exceed the standards.

This issue brief focuses on the economic costs of CAFE 

standards and compares them with the costs of a gasoline 

tax that would reduce gasoline consumption by the same 

amount. The Congressional Budget Office (CBO) estimates that a 10 percent reduction in gasoline consumption could be achieved at a lower cost by an increase in 

the gasoline tax than by an increase in CAFE standards. 

Furthermore, an increase in the gasoline tax would reduce 

driving, leading to less traffic congestion and fewer accidents. This analysis stops short of estimating the value of 

less congestion and fewer accidents and, therefore, does 

not draw any conclusions about whether an increase in 

the gasoline tax would be warranted. However, CBO 

does find that, given current estimates of the value of decreasing dependence on oil and reducing carbon emissions, increasing CAFE standards would not pass a

benefit-cost test. 

What Would It Cost to Raise CAFE

Standards? 

Raising CAFE standards would impose costs on both the 

producers and buyers of passenger vehicles. To comply, 

producers would need to incorporate technologies to 

boost the fuel economy of their vehicles, which would increase their cost of production. Consumers would face 

higher prices for new cars and trucks.1

 But consumers 

would also see lower operating costs for new vehicles because they would use less gasoline, offsetting some of the 

sting of the higher purchase prices.

CBO estimates that raising CAFE standards by 3.8 mpg 

(to 31.3 mpg for cars and 24.5 mpg for trucks)—enough 

to reduce the amount of gasoline consumed by new vehicles by 10 percent—would cost the U.S. economy a total 

of $3.6 billion per year.2

That figure translates to about $230 per new vehicle. 

Consumers would most likely bear about two-thirds of 

the costs. Although the average price of a new passenger 

vehicle would go up by nearly $900, fuel savings would 

lower the additional costs to consumers to roughly $150 

per vehicle, on average. Automakers’ lost profits would 

constitute the remaining $80. Although a 3.8 mpg increase in CAFE standards would reduce gasoline use by 

new vehicles by 10 percent, it would take 15 years for total gasoline consumption (by both new and older cars 

and light trucks) to fall by 10 percent—only after all vehicles currently on the road were retired.

CBO A series of issue summaries from

the Congressional Budget Office

MARCH 9, 2004

1. Alternatively, producers could comply by raising the prices of their 

gas-guzzling vehicles and lowering the prices of their most fuelefficient cars to encourage consumers to buy more of the latter, in 

which case consumers would still see higher vehicle prices on average. Or producers could offer new vehicles that provided better 

fuel economy in place of other attributes that consumers might 

prefer, such as additional horsepower or more interior space, in 

which case prices might not increase.

2. That figure incorporates the value of gasoline savings; it also 

reflects the reduced profits, and reduced value, that producers and 

consumers would receive as a result of lower sales of new vehicles.
2 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

An important assumption underlying those cost estimates 

is that, without regulation, automakers would not use 

technological advances to improve gasoline mileage. That 

assumption stems from the observation that, in response 

to consumers’ preferences over the past 15 years, automakers have increased vehicles’ size, weight, and horsepower, while holding gasoline mileage ratings steady. 

Hence, regulatory intervention would be required to raise 

average mileage ratings, and any increase in the standards 

would impose costs on vehicle producers and consumers. 

An Increase in CAFE Standards Could 

Be Designed to Cost Less

An increase in CAFE standards could be achieved at a 

lower cost if manufacturers were given more flexibility in 

how to comply than they have under current policy. A 

2002 study by the National Research Council proposed a 

system of trading under which producers with high costs 

of improving their fleets’ fuel economy could meet the 

standards by purchasing “fuel economy credits” from producers that generated credits by exceeding the standards.3

Producers that were able to increase their fleets’ fuel economy at relatively low costs would have an incentive to 

generate credits because they could sell them at a profit to 

firms that had higher compliance costs.

Fuel economy credit trading could cut the cost of a 3.8 

mpg increase in the CAFE standards by 16 percent, down 

to $3.0 billion per year, CBO estimates. It would probably yield larger benefits for producers than for consumers; 

on average, costs for the former would fall by about $35 

per vehicle (from $80 to $45), and costs for the latter 

would drop by only about $10 per vehicle (from $150 to 

$140). Average vehicle prices would increase by roughly 

$860, instead of the $900 that would occur from increasing CAFE standards but not incorporating credit trading. 

Under a system with trading, producers that purchased 

credits (primarily domestic firms) would have lower compliance costs than they would have had without the trading, and producers that sold credits (primarily foreign 

firms) would have higher profits.

A Gasoline Tax Increase Could Cost 

Less Than an Increase in CAFE

Standards

A gasoline tax is a good policy to compare with CAFE 

standards because it is the most direct way to reduce gasoline consumption. By raising the price of gasoline to consumers, a tax raises the cost of driving and encourages 

consumers to buy more-fuel-efficient vehicles. 

The federal gasoline tax, which dates from 1932 and is 

used to support mass transit and highways, is currently 

18.4 cents per gallon. The average tax on gasoline, including federal, state, and local taxes, is 41 cents per

gallon. 

By CBO’s estimate, increasing the federal tax on gasoline 

by 46 cents per gallon would achieve a 10 percent reduction in gasoline consumption in the long run (once all existing vehicles were retired) at lower economic costs overall than either of the CAFE policies considered. The 

gasoline tax increase would cost the U.S. economy $2.9 

billion annually, 19 percent less than the increase in 

CAFE standards without trading and 3 percent less than 

the increase in the standards with trading. That $2.9 billion incorporates costs for the inconvenience and expenditures that consumers might incur to reduce their gasoline consumption (including, for example, car-pooling or 

taking public transportation) as well as a reduction in gasoline producers’ profits as a result of reduced sales. It does 

not include the tax payments because they would be 

transfers—from people who paid the tax to people who 

benefited from the increase in revenue (for example, 

through increased public expenditures or reductions in 

other tax payments)—and, as such, would not be costs to 

society as a whole. (See Table 1.)

The advantage of the gasoline tax over CAFE standards 

would be most apparent in the initial 14 years—that is, 

before all of the existing vehicles were retired. Although 

both approaches would produce fuel savings gradually as 

old passenger vehicles were replaced by more-fuel-efficient ones, the gas tax would provide greater immediate 

savings by also encouraging vehicle owners (of both new 

and older vehicles) to drive less. In contrast, higher CAFE 

standards would give new-vehicle owners an incentive to 

drive more—because higher fuel economy would decrease their gasoline cost per mile—and would not alter 

the driving incentives for owners of existing vehicles

at all. 

3. See National Research Council, Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards (Washington, D.C.: 

National Academy of Sciences, 2002).
ECONOMIC AND BUDGET ISSUE BRIEF

FUEL ECONOMY STANDARDS VERSUS A GASOLINE TAX 3

Table 1.

Total Long-Run Annual Costs to Achieve a 10 Percent Reduction in Gasoline

Consumption Under Alternative Policies

(Billions of dollars)

Source: Congressional Budget Office.

Note: CAFE = corporate average fuel economy; mpg = miles per gallon.

a. For producers, costs are measured as reductions in total profits, whereas for consumers, they include both higher prices and the reduction in welfare for consumers who chose not to buy a new vehicle because of the higher prices.

Figure 1.

The Effects of CAFE Standards with 

Trading Versus a Gasoline Tax Over the 

First 14 Years

(Billions)

Source: Congressional Budget Office.

Notes: CAFE = corporate average fuel economy.

The figure depicts effects over the first 14 years (after which 

all current vehicles are assumed to be retired) from policy 

changes that would bring about a 10 percent reduction in 

gasoline consumption in the 15th year.

Over the initial 14 years, a 46-cent-per-gallon increase in 

the tax on gasoline would save 91 billion gallons of gasoline, or 27 billion gallons (42 percent) more than a 3.8 

mpg increase in CAFE standards would, even though 

both policies would cut gasoline consumption by the 

same amount once all existing vehicles were replaced (see 

Figure 1). Further, the tax increase would cost 27 percent 

less over those initial 14 years than higher CAFE standards would, even if firms were allowed to trade fuel 

economy credits.4

Would Increases in CAFE Standards or 

the Gasoline Tax Produce Benefits That 

Outweighed Their Costs?

Increasing CAFE standards or the gasoline tax would impose costs on both producers and consumers of vehicles 

and gasoline—direct costs that are estimated by CBO’s 

modeling. Would those costs be justified by the accompanying benefits? Unless current estimates of the benefits of 

reducing gasoline consumption are significantly understated, increasing CAFE standards would not pass a

CAFE Standards

Without Trading With Trading Gasoline Tax

Policy 31.3 mpg for cars

24.5 mpg for light trucks

46-cent-per-gallon

increase

Total Costs to the Economya 3.6 3.0 2.9

Producers’ costs 1.2 0.8 0.5

Consumers’ costs 2.4 2.2 2.4

Under a Higher

Gasoline Tax

Under Higher CAFE

Standards with Trading

0

10

20

30

40

50

60

70

80

90

100

Gallons Costs

Saved

Gallons Costs

Saved

90.5

63.6

$21.0

$28.9

4. Those calculations incorporate discounting, acknowledging that 

current cost reductions and savings of gasoline are worth more 

than those in later years.
4 CONGRESSIONAL BUDGET OFFICE

ECONOMIC AND BUDGET ISSUE BRIEF

benefit-cost test.5 Already, the existing tax on gasoline 

provides consumers with a more than adequate incentive 

to take those benefits into account when choosing how 

fuel efficient a vehicle to purchase. Increasing CAFE standards would force manufacturers to increase fuel efficiency at a cost that exceeded the benefits. In contrast, increasing the gasoline tax might pass a benefit-cost test if 

the test included benefits in addition to those associated 

with reducing gasoline consumption (for instance, the 

benefits arising from reduced traffic congestion or fewer 

accidents). Estimating the value of those additional benefits is beyond the scope of this analysis, however. 

The primary benefit from reducing gasoline consumption would be the decrease in the external costs (that is, 

costs not borne by producers or consumers) that such 

consumption creates. The United States’ dependence on 

oil brings the risk of economic losses resulting from 

higher oil prices when the world oil supply is disrupted; 

thus, gasoline consumption entails an energy security 

cost. In addition, carbon dioxide emissions are thought to 

contribute to climate change, and while the extent of and 

potential damage from climate change are still quite uncertain, it could ultimately cause extensive physical and 

economic harm in some regions.6

 In its 2002 report, the 

National Research Council suggests that a reasonable, albeit uncertain, estimate of those external costs stemming 

from oil dependence and carbon emissions is 26 cents per 

gallon.7

The question of whether higher CAFE standards would 

be justified must be considered in relation to the effects of 

the current gasoline tax. That tax, regardless of the motivation for its existence, curbs gasoline consumption. The 

existing tax on gasoline—at 41 cents per gallon, on average—gives consumers an additional incentive to buy fuelefficient vehicles and to reduce driving up to a cost of 41 

cents for each gallon of gasoline saved.8 The tax thus induces consumers to buy more-fuel-efficient vehicles than 

they otherwise would (provided that a higher purchase 

price—or a decrease in other amenities, such as horsepower—is outweighed by the value of the tax savings 

from consuming less gasoline).

If the National Research Council’s estimate of 26 cents 

for external costs is roughly correct, then the existing 41-

cent tax on gasoline already provides consumers with an 

incentive to reduce gasoline consumption up to a cost 

that exceeds the benefits of those reductions by 15 cents 

per gallon saved. In that case, raising the CAFE standards 

to achieve additional reductions would impose unwarranted costs on automakers and buyers of new vehicles 

and would reduce social welfare.9

Because both a gasoline tax and CAFE standards reduce 

gasoline consumption by increasing vehicles’ fuel efficiency, the estimated costs of each policy have to take into 

account the effects of the other. Not doing so could result 

in underestimating policy costs. For example, some analysts have proposed that higher CAFE standards could be 

justified if the gasoline tax was first increased, but that approach fails to account for the cumulative costs of the

5. This discussion assumes that consumers receive adequate information about the fuel savings offered by different vehicles and that 

they correctly value those savings. If that were not the case, then 

the advantages of an increase in CAFE standards could be greater 

than assumed here.

6. Although improving fuel efficiency would lessen carbon dioxide 

emissions, it would not necessarily reduce other pollutants emitted by passenger vehicles—such as carbon monoxide, nitrogen 

oxides, and hydrocarbons—because the Environmental Protection 

Agency’s maximum emission rates for those pollutants are defined 

in terms of grams per mile rather than per gallon. Thus, levels of 

those pollutants are, in principle, independent of gasoline mileage. 

In practice, though, vehicles that get better mileage may pollute 

less than the agency’s standards allow. Reducing gasoline consumption could also reduce releases of hydrocarbons and toxic 

chemicals that occur within the gasoline supply chain (from 

exploration and recovery through retail sales). However, because 

those releases are now tightly regulated, the environmental costs 

that they impose are small. 

7. See National Research Council, Effectiveness and Impact of CAFE 

Standards, pp. 85-88. That estimate of external costs per gallon of 

gasoline consumed includes 12 cents attributable to oil dependence, 12 cents for carbon emissions, and 2 cents for releases of 

hydrocarbons and toxic chemicals in the gasoline supply chain, 

including oil exploration and recovery, oil refining, and distribution (by tanker, pipeline, and tanker truck and through retail 

sales). 

8. Producers of gasoline might bear part of the tax. In that case, the 

price of gasoline would increase by less than the amount of the 

tax. In either case, however, the incremental cost of the tax (borne 

by producers and consumers) would be 41 cents.

9. An increase in CAFE standards would not impose costs if firms’ 

average fuel economy was above the new standards because of, say, 

a shift in consumers’ preferences toward more-fuel-efficient vehicles. However, in that case, the standards would also not produce 

gasoline savings.
ECONOMIC AND BUDGET ISSUE BRIEF

FUEL ECONOMY STANDARDS VERSUS A GASOLINE TAX 5

two policies.10 That is, raising CAFE standards would 

seem to cost less because the higher tax would cause consumers to want greater fuel economy, with or without the 

increase in the standards. Such a policy would shift the 

cost of increasing fuel economy from CAFE standards to 

the gasoline tax but would not then justify higher CAFE 

standards.

Even though the National Research Council’s estimate of 

the external costs associated with consuming gasoline is 

uncertain (indeed, the council itself considers the figure 

of 26 cents to be tentative) higher CAFE standards would 

have the potential to improve social welfare only if those 

external costs were significantly higher than that—that is, 

if they exceeded the average tax of 41 cents.

In addition, higher CAFE standards could further reduce 

social welfare by worsening traffic congestion and increasing the number of traffic accidents. Those undesirable 

outcomes could occur because such standards would 

lower the per-mile cost of driving, providing new-vehicle 

owners with an incentive to drive more. Although the increase in driving associated with higher CAFE standards 

could be relatively small, some studies suggest that the resulting costs of the increased congestion and greater number of traffic accidents might nevertheless be large. (Critics of CAFE standards have also argued that design 

changes made to vehicles so that they comply have increased the severity of injuries in accidents, but that contention remains controversial.)

Although the existing tax on gasoline exceeds the National Research Council’s estimate of the external costs associated with consuming gasoline, the current tax is not 

necessarily too high. The gasoline tax serves purposes 

other than encouraging gasoline buyers to take the external costs of gasoline consumption into account—it also 

discourages driving. Setting the “optimal” tax on gasoline 

would require estimating all of the external costs associated with driving—including those resulting from traffic 

congestion and accidents as well as from oil dependence 

and carbon emissions. Such an assessment could conclude that increasing the tax on gasoline would improve 

social welfare if those costs, on average, exceeded the existing tax. 

10. See David Gerard and Lester B. Lave, The Economics of CAFE 

Reconsidered: A Response to CAFE Critics and A Case for Fuel Economy Standards (Washington, D.C.: AEI-Brookings Joint Center 

for Regulatory Studies, September 2003). 

This brief, prepared by Terry Dinan and David 

Austin, is based on The Economic Costs of Fuel Economy Standards Versus a Gasoline Tax (December 

2003). A related CBO publication is Reducing Gasoline Consumption: Three Policy Options (November 

2002). Those studies are available at the agency’s 

Web site (www.cbo.gov).