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

To: <rebecca.yoon@dot.gov>, William Charmley/AA/USEPA/US@EPA, <james.tamm@dot.gov>, Robin Moran/AA/USEPA/US@EPA

Date: 03/31/2010 09:34 AM Subjec

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



### Please find attached a summary of interagency working comments on the draft rule under EO

12866 review. They are for your consideation and subject to further policy review. [attachment
"Summary of Interagency Working Comments on draft rule under EO 12866.pdf" deleted by Tad Wysor/AA/USEPA/US]Summary of Interagency Working Comments on Draft rule under EO 12866 review. 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.

Please find suggested edits below.

DOT Preamble Discussion:

6. Potential Unquantified Consumer Welfare Impacts of The Final Standards

The underlying goal of the CAFE and GHG standards is to increase social welfare, in the broadest sense, and as shown in earlier sections, NHTSA projects that the MY 2012-2016 CAFE standards will yield large net social benefits. In its net benefits analysis, NHTSA made every attempt to include all of the costs and benefi ts that could be identified and quantified.

It is important to highlight several featur es of the rulemaking analysis that NHTSA believes gives high confidence to its conclusion that there are large net social benefits from these standards. First, the agencies adopted footprint-based standards in large part so that the full range of vehicle choices in the marketplace could be maintained. Second, the agencies performed a rigorous technological feasibility, co st, and leadtime analysis that showed that the

standards could be met while mainta ining current levels of other vehicle attributes such as safety, utility, and performance. Third, widespread au tomaker support for the st andards, in conjunction with the future product plans that have been provided by automakers to the agencies and recent industry announcements on new product offerings, provides further indication that the standards can be met while retaining the full spectrum of vehicle choices.

Notwithstanding these points, and its high degree of confidence that the benefits amply justify the costs, NHTSA recognizes the possibi lity of consumer welfare impacts that are not accounted for in its analysis of benefits and costs from higher CAFE standards. The agencies received public comments expressing diverging views on this issue. The majority of commenters suggested that potential losses in we lfare from requiring higher fuel economy were unlikely to be a significant concern, because of the many imperfections in the market for fuel economy. In contrast, other comments suggeste d that potential unidentified and unquantified consumer welfare losses could be large. Acknowledging the comments, the FRIA provides a sensitivity analysis showing how various levels of unidentified consumer welfare losses would affect the projected net social benefits from the CAFE standards established by this final rule.

There are two viewpoints for evaluating the costs and benefits of the proposed increase in CAFE standards: the private perspective of vehicle buyers themselves on the higher fuel economy levels that the proposed rule would require, and the economy-wide or “social” perspective on the costs and benefits of requiring higher fuel economy. It is important, in short, to distinguish between costs and benefits that are “private” and costs and benefits that are “social.” The agency’s analysis of benefits and costs from requiring higher fuel efficiency,Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

2 presented above, includes several categories of benef its (“social benefits”) that are not limited to automobile purchasers and that extend throughout the U.S. economy, such as reductions in the energy security costs associated with U.S. petroleum imports and in the economic damages expected to result from climate change. In contra st, other categories of benefits – principally the economic value of future fuel savings proj ected to result from higher fuel economy – will be experienced exclusively by the initial purchasers and subseq uent owners of vehicle models whose fuel economy manufacturers elect to improve as part of their strategies for complying with higher CAFE standards (“private benefits”).

Although the economy-wide or “social” benefits from requiring higher fuel economy represent an important share of the total economic benefits from raising CAFE standards,

NHTSA estimates that benefits to vehicle buyers themselves will significantly exceed the costs of complying with the stricter fuel economy standards this rule establishes, as shown above. Since the agency also assumes that the costs of ne w technologies manufacturers will employ to improve fuel economy will ultimately be shifted to vehicle buyers in the form of higher purchase prices, NHTSA concludes that the benefits to vehicle buyers from requiring higher fuel efficiency will far outweigh the costs they will be required to pay to obtain it. However, this raises the question of why current purchasing patterns do not already result in higher average fuel economy, and why stricter fuel efficiency standards should be necessary to achieve that goal.

As an illustration, Table IV.G.6-1 reports the agency’s estimates of the average lifetime values of fuel savings for MY 2012-2016 passenger cars and light trucks calculated using future retail fuel prices, which are those likely to be used by vehicle buyers to project the value of fuel savings they expect from higher fuel economy. The table compares NHTSA’s estimates of the average lifetime value of fuel savings for cars and light trucks to the price increases it projects to result as manufacturers attempt to recover th eir costs for complying with increased CAFE standards for those model years by increasing vehicle sales prices. As the table shows, theagency’s estimates of the present value of lifetime fuel savings (discounted using the OMBrecommended 3% rate) substantially outweigh proj ected vehicle price increases for both cars and light trucks in every model year, even under the assumption that all of manufacturers’ technology outlays are passed on to buyers in the form of higher selling prices for new cars and light trucks. By model year 2016, NHTSA proj ects that average lifetime fuel savings will exceed the average price increase by more than $2,000 for cars, and by more than $2,700 for light trucks.

Table IV.G.6-1 Value of Lifetime Fuel Savings vs. Vehicle Price Increases

Fleet Measure Model year

2012 2013 2014 2015 2016 Passenger

Cars Value of Fuel Savings $759 $1,349 $1,914 $2,480 $2,932 Average Price Increase $505 $573 $690 $799 $907Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

3 Difference $255 $897 $1,264 $1,680 $2,025

Light

Trucks Value of Fuel Savings $828 $1,634 $2,277 $2,887 $3,700 Average Price Increase $322 $416 $621 $752 $961 Difference $506 $1,218 $1,656 $2,135 $2,739

The comparisons above immediately raise the question of why current vehicle purchasing patterns do not already result in average fuel economy levels approaching those that this rule would require, and why stricter CAFE standard s should be necessary to increase the fuel economy of new cars and light trucks. They also raise the question of why manufacturers do not elect to provide higher fuel economy even in the absence of increases in CAFE standards, since the comparisons in Table IV.G.6-1 suggest that doing so would increase the value of many new vehicle models by far more than it would raise th e cost of producing them (and thus raise their purchase prices), thus presumably increasing sa les of new vehicles. More specifically, why would potential buyers of new vehicles hesitate to make investments in higher fuel economy that would produce the substantial economic returns illustrated by the comparisons presented in Table IV.G.6-1? And why would manufacturers vol untarily forego opportunities to increase the attractiveness, value, and comp etitive positioning of their car and light truck models by improving their fuel economy?

The majority of comments received on this topic answered these questions by pointing out many reasons why the market for vehicle fuel economy does not appear to work perfectly, and accordingly, that properly designed CAFE standards would be expected to increase consumer welfare. Some of these imperfections might stem from standard market failures (such as an absence of adequate information on the part of consumers); some of them might involve findings in behavioral economics (including, for example, a lack of sufficient consumer attention to long-term savings, or a lack of salience, to consumers at the time of purchase, of relevant benefits, including fuel and time savings). Both th eoretical and empirical research suggests that many consumers do not make energy-efficient investments even when those investments would pay off in the relatively short-term. 1 This research is in line with related findings that consumers may underweight benefits and cost s that are less salient or that will be realized only in the

future. 2

Existing work provides support for the agency’s conclusion that the benefits buyers will receive from requiring manufacturers to increase fuel economy far outweigh the costs they will pay to acquire those benefits, by identifying aspects of normal behavior that may explain buyers’ current reluctance to purchase vehicles whose higher fuel economy appears to offer an attractive

1 Jaffe, A. B., and Stavins, R. N. (1994). The Energy Paradox and the Diffusion of Conservation Technology. Resource and Energy Economics, 16(2); see Hunt Alcott a nd Nathan Wozny, Gasoline Prices, Fuel Economy, and the Energy Paradox (2010, available at http://web.mit.edu/allcott/www/Allcott%20and%20Wozny%202010%20- %20Gasoline%20Prices,%20Fuel%20Economy,%20and%20the%20Energy%20Paradox.pdf

2 Hossain, Janjim, and John Morgan (2009). “. . . Plus Shipping and Handling: Revenue (Non)Equivalence in Field Experiments on eBay,” Advances in Economic Analysis and Policy vol. 6; Barber, Brad, Terrence Odean, and Lu Zheng (2005). “Out of Sight, Out of Mind: The Effectsof Expenses on Mutual Fund Flows,” Journal of Business vol. 78, no. 6, pp. 2095-2020.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

4 economic return. For example, consumers’ underst andable aversion to the prospect of losses (“loss aversion”) may produce an exaggerated sense of uncertainty about the value of future fuel savings, making consumers reluctant to purchase a more fuel-efficient vehicle seem unattractive, even when doing so is likely to be a sound economic decision. Compare the finding in Greene et al. (2009) to the effect that the expected net present value of increasing the fuel economy of a passenger car from 28 to 35 miles per gallon falls from $405 when calculated using standard net present value calculations, to nearly zero when un certainty regarding future cost savings is taken

into account. 3

The well-known finding that as gas prices rise, consumers show more willingness to pay

for fuel-efficient vehicles is not inconsistent w ith the possibility that many consumers undervalue gasoline costs and fuel economy at the time of purchase. In ordinary circumstances, such costs may be a relatively “shrouded” attribute in consumers’ decisions, in part because the savings are cumulative and extend over a significant period of time. This claim fits well with recent findings to the effect that many consumers are willing to pay less than $1 upfront to obtain a $1 benefit reduction in discounted gasoline costs. 4

Some research suggests that the consumers’ apparent unwillingness to purchase more fuel efficient vehicles stems from their inability to value future fuel savings correctly. For example, Larrick and Soll (2008) find evidence that consumers do not understand how to translate changes in fuel economy, which is denominated in miles per gallon, into resulting changes in fuel consumption, measured in gallons per time period. 5 Sanstad and Howarth (1994) argue that consumers resort to imprecise but conve nient rules of thumb to compare vehicles that offer different fuel economy ratings, and that this behavior can cause many buyers to underestimate the value of fuel savings, particularly from significant increases in fuel economy. 6

If the behavior identified in these studies is wi despread, then the agency’s estimates -- suggesting that the benefits to vehicle owners from requiring higher fuel economy significantly exceed s the costs of providing it -- are indeed likely to be correct.

Another possible reconciliation of the agency’s claim that the average vehicle buyer will experience large fuel savings from the higher CAFE standards this rule establishes with the fact

that the average fuel economy of vehicles currently purchased falls well short of the new standards is that the values of future savings from higher fuel economy vary widely across consumers. As an illustration, one recent review of consumers’ willingness to pay for improved fuel economy found estimates that varied from less than 1% to almost ten times the present value of the resulting fuel savings when those are di scounted at 7% over the vehicle’s expected

3 Greene, D., J. German, and M. Delucchi (2009). “Fue l Economy: The Case for Market Failure” in Reducing Climate Impacts in the Transportation Sector

, Sperling, D., and J. Cannon, eds. Springer Science. Surprisingly, the authors find that uncertainty regarding the future price of gasoline appears to be less important than uncertainty surrounding the expected lifetimes of new vehicles. (Docket NHTSA-2009-0059-0154)

4 See Alcott and Wozny.

5 Larrick, R. P., and J.B. Soll (2008). “The MPG illusion

. ” Science 320: 1593-1594.

6 Sanstad, A., and R. Howarth (1994). “’Normal’ Markets, Market Imperfections, and Energy Efficiency.” Energy Policy 22(10): 811-818.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

5 lifetime. 7 The wide variation in these estima tes undoubtedly reflects methodological and measurement differences among the studies surveyed. However, it may also reveal that the expected savings from purchasing a vehicle w ith higher fuel economy vary widely among individuals, because they travel different amounts, have different driving styles, or simply have varying expectations about future fuel prices.

These differences reflect the possibility that many buyers with high valuations of increased fuel economy already purchase vehicle models that offer it, while those with lower values of fuel economy emphasize other vehicle attributes in their purchasing decisions. A related possibility is that beca use the effects of differing fuel economy levels are relatively modest when compared to those provided by othe r, more prominent features of new vehicles – passenger and cargo-carrying capacity, performance, safety, etc. – it is simply not in many shoppers’ interest to spend the time and effort necessary to determine the economic value of higher fuel economy, attempt to isolate the comp onent of a new vehicle’s selling price that is related to its fuel economy, and compare these two. (This possibility is consistent with the view that fuel economy is a relatively “shrouded” attribute.) In either case, the agency’s estimates of

the average value of fuel savings that will result from requiring cars and light trucks to achieve higher fuel economy may be correct, but those savings may not be large enough to lead a sufficient number of buyers to push for vehicles with higher fuel economy to increase average fuel economy from its current levels.

Defects in the market for cars and light trucks could also lead manufacturers to undersupply fuel economy, even in cases where many buyers were willing to pay the increased prices necessary to provide it. To be sure, the relevant market, taken as a whole, has a great deal of competition. But even in those circumstances, there may not such competition with respect to all vehicle attributes. Incomplete or “asymmet ric” access to information on vehicle attributes such as fuel economy – whereby manufacturers of new vehicles or sellers of used cars and light trucks have more complete knowledge of the value of purchasing higher fuel economy than do potential buyers – may also prevents sellers of new or used vehicles from capturing its full value. In this situation, the level of fuel efficiency provided in the markets for new or used vehicles might remain persistently lower than that demandedby potential buyers (at least if they are wellinformed).

It is also possible that deliberate decisi ons by manufacturers of cars and light trucks, rather than constraints on the combinations of fuel economy, carrying capacity, and performance that manufacturers can offer using current technologies, limit the range of fuel economy available to buyers within individual vehicle ma rket segments, such as full-size automobiles, small SUVs, or minivans. As an illustration, once a potential buyer has decided to purchase a

7 Greene, David L., “How Consumers Value Fuel Economy: A Literature Review,” Draft report to U.S. Environmental Protection Agency, Oak Ridge National La boratory, December 29, 2009; see Table 10, p. 37.

See also David Greene and Jin-Tan Liu (1988). “Automot ive Fuel Economy Improvements and Consumers’ Surplus.” Transportation Research Part A 22A(3): 203-218 (Docket EPA-HQ-OAR-2009-0472-0045). The study actually calculated the willingness to pay for reduced vehicl e operating costs, of which vehicle fuel economy is a major component.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

6 minivan, the range of fuel economy among current models extends only from 18 to 24 mpg. 8
Manufacturers might make such decisions if they underestimate the premiums that shoppers in certain market segments are willing to pay for more fuel-efficient versions of the vehicle models thy currently offer to prospective buyers within those segments. If this occurs, manufacturers may fail to supply levels of fuel efficiency as high as those buyers are willing to pay for, and the average fuel efficiency of their entire new vehicle fleets could remain below the levels that potential buyers demand and are willing to pay for. (Of course this possibility is most realistic if it is also assumed that buyers are imperfectly informed or if fuel economy savings are not sufficiently salient.)

However, other commenters suggested that, if one assumes a perfectly functioning market, there must be unidentified consumer welf are losses that could offset the private fuel savings that consumers are currently foregoing.

One explanation for this apparent paradox is that NHTSA’s estimates of benefits and costs from requiring manufacturers to improve the fuel efficiency of their vehicle models do not match potential vehicle buyers’ assessment of the likely benefits and costs from requiring higher fuel efficiency. This could occur because the agency’s underlying assumptions about some of the factors that affect the value of fuel savings differ from those made by potential buyers, because NHTSA has used different estimates for some components of the benefits from saving fuel than do buyers, or because the agency has failed to account for some potential costs of achieving higher fuel economy.

For example, buyers may not value increased fuel economy as highly as the agencies’ calculations suggest, because they have shorter time horizons than the full vehicle lifetimes assumed by NHTSA and EPA, or because, when buying vehicles, they discount future fuel future savings using higher rates than those prescribed by OMB for evaluating federal regulations. Potential buyers may also anticipate lower fuel prices in the future than those forecast by the Energy Information Administrati on, or may expect larger differences between

vehicles’ rated and actual on-road mpg MPG levels than the agencies estimate.

To illustrate the first of these possibilities, Table IV.G.6-2 shows th e effect of differing assumptions about vehicle buyers’ time horizons fo r assessing the value of future fuel savings. Specifically, the table compares the average value of fuel savings from purchasing a MY 2016 car or light truck when fuel savings are evaluate d over different time horizons to the estimated increase in its price. This table shows that as reported previously in Table IV.G.6-2, when fuel savings are evaluated over the entire expected lifetime of a MY 2016 car (approximately 14 years) or light truck (about 16 years), thei r discounted present value (using the OMBrecommended 3% discount rate) lifetime fuel savings exceeds the estimated average price increase by more than $2,000 for cars and by more than $2,700 for light trucks.

8 This is the range of combined city and highway fuel ec onomy levels from lowest (Toyota Siena 4WD) to highest (Mazda 5) available for model year 2010; http://www.f ueleconomy.gov/feg/bestworstEPAtrucks.htm (last accessed February 15, 2010).Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

7 If buyers are instead assumed to consider fuel savings over a 10-year time horizon, however, the present value of fuel savings excee ds the projected price increase for a MY 2016 car by about $1,300, and by somewhat more than $1,500 for a MY 2016 light truck. Finally, Table VI.G.6-2 shows that under the assumption th at buyers consider fuel savings only over the length of time for which they typically finance new car purchases (slightly more than 5 years during 2009), the value of fuel savings exceeds the estimated increase in the price of a MY 2016 car by only about $350, and the corresponding difference is reduced to slightly more than $500 for a MY 2016 light truck.

Table IV.G.6-2 Value of Fuel Savings vs. Vehicle Price Increases with Alternative Assumptions about Vehicle Buyer Time Horizons

Vehicle Measure Value over Alternative Time Horizons Expected

Lifetime 9 10 Years Average Loan

Term 10

MY 2016 Passenger

Car Fuel Savings $2,932 $2,180 $1,254

Price Increase $907 $907 $907

Difference $2,025 $1,273 $347

MY 2016 Light Truck Fuel Savings $3,700 $2,508 $1,484
Price Increase $961 $961 $961

Difference $2,739 $1,547 $523

Potential vehicle buyers may also discount fu ture fuel future savings using higher rates than those typically used to evaluate federal regulations. OMB guidance prescribes that future benefits and costs of regulations that mainly aff ect private consumption d ecisions, as will be the case if manufacturers’ costs for complying with higher fuel economy standards are passed on to vehicle buyers, should be discounted using a consumption rate of time preference. 11 OMBestimates that savers currently discount future consumption at an average real or inflationadjusted rate of about 3 percent when they face little risk about its likely level, which makes it a reasonable estimate of the consumption rate of time preference. However, vehicle buyers may view the value of future fuel savings that results from purchasing a vehicle with higher fuel economy as risky or uncertain, or they may instead discount future consumption at ratesreflecting their costs for financing the higher capital outlays required to purchase more fuelefficient models. In either case, they may discount future fuel savings at rates well above the 3% assumed in NHTSA’s evaluation in their purchase decisions.

9 Expected lifetimes are approximately 14 years for cars and 16 years for light trucks.

10 Average term on new vehicle loans made by auto finance companies during 2009 was 62 months; see Board of Governors of the Federal Reserve System, Federal Re serve Statistical Release G.19, Consumer Credit. Available at http://www.federalreserve.gov/releases/g19/ Current (last accessed March 1, 2010).

11 Office of Management and Budget, Circular A-4, “Regulatory Analysis,” September 17, 2003, 33. Available at http://www.whitehouse.gov/omb/assets/regulatory_ma tters_pdf/a-4.pdf (last accessed March 1, 2010).Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

8 Table IV.G.6-3 shows the effect of higher di scount rates on vehicle buyers’ evaluation of the fuel savings projected to result from the CAFE standards established by this rule, again using MY 2016 passenger cars and light trucks as an example. As Table IV.G.6-1 showed previously, average future fuel savings discounted at the OMB 3% consumer rate exceed the agency’s estimated price increases by more than $2,000 for MY 2016 passenger cars and by more than $2,700 for MY 2016 light trucks. If vehicle buyers instead discount future fuel savings at the average new-car loan rate during 2009 (6.7%), however, these differences decline to slightly more than $1,400 for cars and $1,900 for light trucks, as Table IV.G.6-3 illustrates.

This is a potentially plausible alternative assumption, because buyers are likely to finance the increases in purchase prices resulting from co mpliance with higher CAFE standards as part of the process financing the vehicle purchase itself. Finally, as the table also shows, discounting future fuel savings using a consumer credit card rate (which averaged 13.4% during 2009) reduces these differences to less than $800 for a MY 2016 passenger car and less than $1,100 for the typical MY 2016 light truck. Note, however, that even at these higher discount rates, the table shows that the private net benefits from purchasing a vehicle with the average level of fuel economy this rule requires remain large.

Table IV.G.6-3 Value of Fuel Savings vs. Vehicle Price Increases with Alternative Assumptions about Consumer Discount Rates

Vehicle Measure Value over Alternative Time Horizons

OMB

Consumer Rate (3%) New Car

Loan Rate

(6.7%) 12 OMB

Investment Rate (7%) Consumer

Credit Card

Rate (13.4%) 13

MY 2016 Passenger

Car Fuel Savings $2,932 $2,336 $2,300 $1,669

Price Increase $907 $907 $907 $907

Difference $2,025 $1,429 $1,393 $762

MY 2016 Light Truck Fuel Savings $3,700 $2,884 $2,836 $2,030
Price Increase $961 $961 $961 $961

Difference $2,739 $1,923 $1,875 $1,069

Combinations of a shorter time horizon and a hi gher discount rate could further reduce or

even eliminate the difference between the value of fuel savings and the agency’s estimates of

12 Average rate on 48-month new vehicle loans made by commercial banks during 2009 was 6.72%; see Board of Governors of the Federal Reserve System, Federal Re serve Statistical Release G.19, Consumer Credit. Available at http://www.federalreserve.gov/releases/g19/ Current (last accessed March 1, 2010).

13 Average rate on consumer credit card accounts at commercial banks during 2009 was 13.4%; see Board of Governors of the Federal Reserve System, Federal Re serve Statistical Release G.19, Consumer Credit. Available at http://www.federalreserve.gov/releases/g19/ Current (last accessed March 1, 2010).Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

9 increases in vehicle prices. One plausible comb ination would be for buyers to discount fuel savings over the term of a new car loan, using the interest rate on that loan as a discount rate. Doing so would reduce the amount by which future fuel savings exceed the estimated increase in the prices of MY 2016 vehicles to about $340 fo r passenger cars and $570 for light trucks. Some evidence also suggests directly that vehicle buye rs may employ combinations of higher discount rates and shorter time horizons for their purchase decisions; for example, consumers surveyed by Kubik (2006) reported that fuel savings would ha ve to be adequate to pay back the additional purchase price of a more fuel-efficient vehicle in less than 3 years to persuade a typical buyer to purchase it. 14 As these comparisons and evidence illustrate, reasonable alternative assumptions about how consumers might evaluate the major benefit from requiring higher fuel economy can significantly affect the benefits they expect to receive when they decide to purchase a new

vehicle.

Imaginable combinations of shorter time horizons, higher discount rates, and lower expectations about future fuel prices or annual vehicle use and fuel savings could make potential buyers hesitant or even unwilling to purchase ve hicles offering the increased fuel economy levels this rule will require manufacturers to produce. At the same time, they might cause vehicle buyers’ collective assessment of the aggregate be nefits and costs of this rule to differ from

NHTSA’s estimates. If consumers’ views about criti cal variables such as future fuel prices or the appropriate discount rate differ sufficiently from the assumptions used by the agency, some or perhaps many potential vehicle buyers might conclude that the value of fuel savings and other benefits they will experience from higher fuel economy are not sufficient to justify the increase in purchase prices they expect to pay. This would explain why their current choices among available models do not result in average fuel economy levels approaching those this rule would require.

Another possibility is that achieving the fu el economy improvements required by stricter fuel economy standards might mean that manufactur ers will forego planned future improvements in performance, carrying capacity, safety, or other features of their vehicle models that represent important sources of utility to vehicle owners. Although the specific economic values that vehicle buyers attach to individual vehicle at tributes such as fuel economy, performance, passenger- and cargo-carrying capacity, and other sour ces of vehicles’ utility are difficult to infer from their purchasing decisions and vehicle prices , changes in vehicle attributes can significantly affect the overall utility that vehicles offer to potential buyers. Foregoing future improvements in these or other highly-valued attributes could be viewed by potential buyers as an additional cost of improving fuel economy.

As indicated in its previous discussion of technology costs, NHTSA has approached this potential problem by developing cost estimates for fuel economy-improving technologies that include allowances for any additional manufacturing costs that would be necessary to maintain the reference fleet (or baseline) levels of performance, comfort, capacity, or safety of light-duty vehicle models to which those technologies are applied. In doing so, the agency followed the

14 Kubik, M. (2006). Consumer Views on Transportation and Energy. Second Edition. Technical Report: National Renewable Energy Laboratory. Available at Docket No. NHTSA-2009-0059-0038.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

10 precedent established by the 2002 NAS Report on improving fuel economy, which estimated “constant performance and utility” costs for t echnologies that manufacturers could employ to increase the fuel efficiency of cars or light truc ks. Although NHTSA has revised its estimates of manufacturers’ costs for some technologies signifi cantly for use in this rulemaking, these revised estimates are still intended to represent costs that would allow manufacturers to maintain the performance, safety, carrying cap acity, and utility of vehicle models while improving their fuel economy. The adoption of the footprint-based standards also addresses this concern.

Finally, vehicle buyers may simply prefer the choices of vehicle models they now have available to the combinations of price, fuel economy, and other attributes that manufacturers are likely to offer when required to achieve higher ove rall fuel economy. If this is the case, their choices among models – and even some buyers’ decisions about whether to purchase a new vehicle – will respond accordingly, and their res ponses to these new choices will reduce their overall welfare. Some may buy models with combinations of price, fuel efficiency, and other attributes that they consider less desirable than those they would otherwise have purchased, while others may simply postpone buying a new vehicle. The use of the footprint-based standards, the level of stringency, and the lead time this rule allows manufacturers are all

intended to ensure that this does not occur. Although the potential losses in buyers’ welfare associated with these responses cannot be large enough to offset the estimated value of fuel savings reported in the agencies’ analyses, they might reduce the benefits from requiring manufacturers to achieve higher fuel efficiency, particularly in combination with the other possibilities outlined previously.

As the foregoing discussion suggests, the agency does not have a complete answer to the question of why the apparently large differences between its estimates of benefits from requiring higher fuel economy and the costs of supplying it do not result in higher average fuel economy for new cars and light trucks in the absence of this rule. One explanation is that NHTSA’s estimates are reasonable, and that for the reasons outlined above, the market for fuel economy is not operating efficiently. NHTSA believes that th e existing literature gives support for the view that because of various market failures (including behavioral factors, such as emphasis on the short-term and a lack of salience), there are likely to be substantial private gains, on net, from the rule, but it will continue to investigate new empirical literature as it become available.

NHTSA acknowledges the possibility that it has incorrectly characterized the impact of

the CAFE standards this rule establishes on cons umers. To recognize this possibility, this section presents an alternative accounting of the benefits and costs of CAFE standards for MYs 2012-2016 passenger cars and light trucks and di scusses its implications. Table IV.G.6-4 displays the economic impacts of the rule as viewed from the perspective of potential buyers, and

also reconciles the estimated net benefits of the ru le as they are likely to be viewed by vehicle buyers with its net benefits to the economy as a whole.

As the table shows, the total benefits to vehicl e buyers (line 4) consist of the value of fuel savings at retail fuel prices (line 1), the eco nomic value of vehicle occupants’ savings in refueling time (line 2), and the economic benefits from added rebound-effect driving (line 3). As the zero entries in line 5 of the table suggest, the agency’s estimate of the retail value of fuelSummary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

11 savings reported in line 1 is assumed to be correct, and no losses in consumer welfare from changes in vehicle attributes (other than those from increases in vehicle prices) are assumed to

occur. Thus there is no reduction in the total private benefits to vehicle owners, so that net private benefits to vehicle buyers (line 6) are equal to total private benefits (reported previously in line 4).

As Table IV.G.6-4 also shows, the decline in fuel tax revenues (line 7) that results from reduced fuel purchases is in effect a social cost th at offsets part of the benefits of fuel savings to vehicle buyers (line 1). 15 Thus the sum of lines 1 and 7 is the savings in fuel production costs that was reported previously as the value of fuel savings at pre-tax prices in the agency’s usual accounting of benefits and costs. Lines 8 and 9 of Table IV.G.6-4 report the value of reductions in air pollution and climate-related externalit ies resulting from lower emissions during fuel production and consumption, while line 10 reports the savings in energy security externalities to the U.S. economy from reduced consumption and imports of crude petroleum and refined fuel. Line 12 reports the costs of increased congestion delays, accidents, and noise that result from additional driving due to the fuel economy rebound ef fect; net social benefits (line 13) is thus the sum of the change in fuel tax revenues, the reduction in environmental and energy security externalities, and increased costs from added driving.

Line 14 of Table IV.G.6-4 shows manufacturers’ technology outlays for meeting higher CAFE standards for passenger cars and light tr ucks, which represent th e principal cost of requiring higher fuel economy. The net total be nefits (line 15 of the table) resulting from the rule consist of the sum of private (line 6) and external (line 13) benefits, minus technology costs (line 14); as expected, the figures reported in lin e 15 of the table are identical to those reported previously in the agency’s customary format.

Table IV.G.6-4 highlights several important features of this rule’s economic impacts. First, comparing the rule’s net private (line 6) and external (line 13) benefits makes it clear that s substantial majority of the benefits from requiring higher fuel economy are experienced by vehicle buyers, with only a small share distributed throughout the remainder of the U.S. economy. In turn, the vast majority of private bene fits stem from fuel savings. External benefits

are small because the value of reductions in envi ronmental and energy security externalities is almost exactly offset by the decline in fuel ta x revenues and the increased costs associated with added vehicle use via the rebound effect of high er fuel economy. As a consequence, the net economic benefits of the rule mirror closely its benefits to private vehicle buyers and the technology costs for achieving higher fuel economy, again highlighting the importance of accounting for any other effects of the rule on the economic welfare of vehicle buyers.

15 Strictly speaking, fuel taxes represent a transfer of res ources from consumers of fuel to government agencies and not a use of economic resources. Reducing the volume of fuel purchases simply reduces the value of this transfer, and thus cannot produce a real economic cost or benefit. Representing the change in fuel tax revenues in effect as an economy-wide cost is necessary to of fset the portion of fuel savings included in line 1 that represents savings in fuel tax payments by consumers. This prevents the savi ngs in tax revenues from being counted as a benefit from the economy-wide perspective.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

12 Table IV.G.6-4 Private, Social, and Total Benefits a nd Costs of MY 2012-16 CAFE Standards: Passenger Cars plus Light Trucks

Entry Model Year Total,

2012-

2016 2012 2013 2014 2015 2016

1. Value of Fuel Savings (at Retail Fuel Prices) $10.5 $22.9 $32.9 $42.5 $52.7 $161.6 2. Savings in Refueling Time $0.7 $1.4 $1.9 $2.5 $3.0 $9.4 3. Consumer Surplus from Added Driving $0.7 $1.5 $2.2 $2.8 $3.4 $10.5 4. Total Private Benefits (=1+2+3) $11.9 $25.8 $37.0 $47.8 $59.0 $181.5
5. Reduction in Private Benefits $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 6. Net Private Benefits (=1+2) $11.9 $25.8 $37.0 $47.8 $59.0 $181.5

7. Change in Fuel Tax Revenues -$1.3 -$2.7 -$3.8 -$4.8 -$5.9 -$18.5 8. Reduced Health Damages from Criteria Emissions $0.5 $0.9 $1.3 $1.6 $2.0 $6.4 9. Reduced Climate Damages from CO2 Emissions $0.9 $2.0 $2.9 $3.8 $4.8 $14.5 10. Reduced Energy Security Externalities $0.5 $1.2 $1.6 $2.1 $2.5 $8.0 11. Reduction in Externalities (=8+9+10) $1.9 $4.1 $5.9 $7.6 $9.3 $28.8 12. Increased Costs of Congestion, etc. -$0.7 -$1.3 -$1.9 -$2.4 -$3.0 -$9.4 13. Net Social Benefits (=7+11+12) $0.0 $0.1 $0.1 $0.3 $0.5 $1.0

14. Technology Costs $5.9 $7.9 $10.5 $12.5 $14.9 $51.7

15. Net Social Benefits (=6+12-14) $6.0 $17.9 $26.6 $35.5 $44.6 $130.7

As discussed in detail previously, NHTSA be lieves that the aggregate benefits from this rule amply justify its aggregate costs, but it remains possible that the agency has overestimated the value of fuel savings to buyers and subsequent owners of the cars and light trucks to which higher CAFE standards will apply. It is also possible that the agency has failed to identify and value reductions in consumer welfare that could result from buyers’ responses to changes in

vehicle attributes that manufact urers make as part of their efforts to achieve higher fuel economy. To acknowledge these possibilities, NHTSA examines their potential impact on the rule’s benefits and costs, showing the rule’s economic impacts for MY 2012-16 passenger cars and light trucks under varying theoretical assumptions about the agency’s potential overestimation of private benefits from higher fuel economy and the value of potential changes

in other vehicle attributes. See Chapter VIII of the FRIA.

DOT RIA discussion:

H

. Potential Impacts of the Final Standards on Consumer Welfare

There are two reasonable viewpoints for evaluating the costs and benefits of the increase in CAFE standards: the private perspective of vehicle buyers themselves on the higher fuel economy levels the final rule would require, and the economy-wide or “social” perspective onSummary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

13 the costs and benefits of requiring higher fuel economy. The agency’s analysis of benefits from requiring higher fuel efficiency, presented previo usly in this Chapter, includes some categories that extend throughout the U.S. economy, such as reductions in the energy security costs associated with U.S. petroleum imports and in the economic damages expected to result from climate change. In contrast, other categories of benefits – principally the economic value of future fuel savings projected to result from higher fuel economy , and including savings in refueling time – will be experienced exclusively by the initial purchasers and subsequent owners of vehicle models whose fuel economy manufacturers elect to improve as part of their strategies for complying with higher CAFE standards. In sh ort, it is important to distinguish between the “private” and “social” benefits and costs.

Although the economy-wide or “social” benefits from requiring higher fuel economy represent an important share of the total economic benefits from raising CAFE standards, NHTSA

estimates that benefits to vehicle buyers themselves will significantly exceed the costs of complying with the stricter fuel economy standards this rule establishes, as Chapter X [need number] shows. Since the agency also assumes that the costs of new technologies manufacturers will employ to improve fuel economy will ultimately be shifted to vehicle buyers in the form of higher purchase prices, NHTSA concludes that the benefits to vehicle buyers from requiring higher fuel efficiency will far outweigh the cost s they will be required to pay to obtain it. However, this raises the question of why current purchasing patterns do not result in higher average fuel economy, and why stricter fuel efficiency standards should be necessary to achieve that goal.

As an illustration, Table VIII-14 reports the agency’s estimates of the average lifetime values of fuel savings for MY 2012-2016 passenger cars and light trucks calculated using future retail fuel prices, which are those likely to be used by vehicle buyers to project the value of fuel savings they expect from higher fuel economy. The table compares NHTSA’s estimates of the average lifetime value of fuel savings for cars and light truc ks to the price increases it projects to result as manufacturers attempt to recover their costs for complying with increased CAFE standards for those model years by increasing vehicle sales prices . As the table shows, the agency’s estimates of the present value of lifetime fuel savings (discounted using the OMB-prescribed 3% rate) outweigh projected vehicle price increases for both cars and light trucks in every model year, even under the assumption that all of manufacturers’ technology outlays are passed on to buyers in the form of higher selling prices for new cars and light trucks. By model year 2016, NHTSA projects that average lifetime fuel savings will exceed the average price increase by more than $2,000 for cars, and by more than $2,700 for light trucks.

Table VIII-14 Value of Lifetime Fuel Savings vs. Av erage Technology Cost Increase/VehicleSummary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

14 2012 2013 2014 2015 2016 Value of Fuel Savings $759 $1,469 $1,954 $2,480 $2,932 Average Price Increase $505 $573 $690 $799 $907 Difference $255 $897 $1,264 $1,680 $2,025

Value of Fuel Savings $828 $1,634 $2,277 $2,887 $3,700
Average Price Increase $322 $416 $621 $752 $961 Difference $506 $1,218 $1,656 $2,135 $2,739 Model Year Measure Fleet

Light Trucks

Passsenger

Cars

Assuming these comparisons are accurate, they raise the question of why current vehicle purchasing patterns do not result in average fuel economy levels approaching those that this rule would require, and why stricter CAFE standard s should be necessary to increase the fuel economy of new cars and light trucks. They also raise the question of why manufacturers do not elect to provide higher fuel economy even in the absence of increases in CAFE standards, since the comparisons in Table VIII-14 suggest that doing so would reduce the effective price of purchasing many new vehicle models, and thus to increase sales of new vehicles. More specifically, why would potential buyers of new vehi cles hesitate to make investments in higher fuel economy that would produce the substantial economic returns illustrated by the comparisons presented in Table VIII-14? And why would manufacturers voluntarily forego opportunities to increase the attractiveness, value, and competitiv e positioning of their car and light truck models by improving their fuel economy?

One explanation for this apparent paradox involves imperfections in the relevant market. Some of these imperfections might stem from standard market failures (such as an absence of adequate information); some of them involve behavioral findings (including, for example, a lack of sufficient attention to long-term savings, or a lack of salience, at the time of purchase, of relevant benefits, including fuel and time savings). A subs et of the theoretical and empirical research suggests that many consumers do not make energy-efficient investments even when those investments would pay off in the relatively short-term, 16 in line with related findings that consumers may underweight benefits and costs that are less salient or that will be realized only in

the future. 17

Another explanation is that NHTSA’s estima tes of benefits and costs from requiring manufacturers to improve the fuel efficiency of their vehicle models do not match potential vehicle buyers’ ex ante assessment of the likely benefits and costs from requiring higher fuel efficiency. This could occur because the agency’s underlying assumptions about some of the

16 Jaffe, A. B., and Stavins, R. N. (1994). The Energy Paradox and the Diffusion of Conservation Technology. Resource and Energy Economics, 16(2); see Hunt Alcott a nd Nathan Wozny, Gasoline Prices, Fuel Economy, and the Energy Paradox (2010, available at http://web.mit.edu/allcott/www/Allcott%20and%20Wozny%202010%20- %20Gasoline%20Prices,%20Fuel%20Economy,%20and%20the%20Energy%20Paradox.pdf

17 Hossain, Janjim, and John Morgan (2009). “. . . Plus Shipping and Handling: Revenue (Non)Equivalence in Field Experiments on eBay,” Advances in Economic Analysis and Policy vol. 6; Barber, Brad, Terrence Odean, and Lu Zheng (2005). “Out of Sight, Out of Mind: The Effectsof Expenses on Mutual Fund Flows,” Journal of Business vol. 78, no. 6, pp. 2095-2020.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

15 factors that affect the value of fuel savings differ from those made by potential buyers at the time of purchase , because NHTSA has incorrectly estimated some components of the benefits from saving fuel, or because the agency has failed to account for some potential costs of achieving higher fuel economy.

For example, buyers may not value increased fuel economy as highly as the agencies’ calculations suggest, because they have shorter time horizons than the full vehicle lifetimes assumed by NHTSA and EPA, or because they discount future fuel future savings using higher rates than those prescribed by OMB for evaluating federal regulations. Potential buyers may also anticipate lower fuel prices in the future than those forecast by the Energy Information Administration, or may expect larger differen ces between vehicles’ rated and actual on-road MPG levels than the agencies estimate.

To illustrate the first of these possibilities , Table VIII-15 shows the effect of differing assumptions about vehicle buyers’ time horizons fo r assessing the value of future fuel savings. Specifically, the table compares the average value of fuel savings from purchasing a MY 2016 car or light truck when fuel savings are evaluate d over different time horizons to the estimated increase in its price. This table shows that as reported previously in Table VIII-15, when fuel savings are evaluated over the entire expected lifetime of a MY 2016 car (approximately 14 years) or light truck (about 16 years), their disc ounted present value (using the OMB-prescribed 3% discount rate) lifetime fuel savings exceeds the estimated average price increase by more than $2,000 for cars and by more than $2,700 for light trucks.

If buyers are instead assumed to evaluate fuel savings over a 10-year time horizon, however, the present value of fuel savings exceeds the projected price increase for a MY 2016 car by about $1,300, and by somewhat more than $1,500 for a MY 2016 light truck. Finally, Table VIII-15 shows that under the assumption that buyers value fuel savings only over the length of time for which they typically finance new car purchases (slightly more than 5 years during 2009), the value of fuel savings exceeds the estimated increase in the price of a MY 2016 car by only about $350, and the corresponding difference is reduced to slightly more than $500 for a MY 2016 light truck.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

16 Table VIII-15 Value of Fuel Savings vs. Vehicle Price Increases with Alternative Assumptions about Vehicle Buyer Time Horizons

Expected
Lifetime (1) 10 Years Average Loan
Term (2) Fuel Savings $2,932 $2,180 $1,254
Price Increase $907 $907 $907

Difference $2,025 $1,273 $347

Fuel Savings $3,700 $2,508 $1,484
Price Increase $961 $961 $961

Difference $2,739 $1,547 $523

(1) Expected lifetimes are approximately 14 years for cars and 16 years for light trucks.

(2) Average term on new-vehicle loans made by auto finance companies during 2009 was 62 months; see Board of Governors of the Federal Reserve System, Federal Reserve
Statistical Release G. 19, Consumer Credit, http://www.federalreserve.gov/releases/g19/Current/ last accessed March 1, 2010.

MY 2016
Passenger

Car

MY 2016
Light Truck Value over Alternative Time Horizons

Measure Vehicle

Potential vehicle buyers may also discount future fuel future savings using higher rates than those typically used to evaluate federal regulations. (For some consumers, these high discount rates might reflect rational behavior; for others, they might reflect an excessive focus on the short-term and a neglect of the future.) OMB guidance prescribes that future benefits and costs of regulations that mainly af fect private consumption decisions, as will be the case if manufacturers’ costs for complying with higher fu el economy standards are passed on to vehicle buyers, should be discounted using a consumption rate of time preference. 18 OMB estimates that savers currently discount future consumption at an average real or inflation-adjusted rate of about 3 percent when they face little risk about its likely level, which makes it a reasonable estimate of the consumption rate of time preference. However, vehicle buyers may view the value of future fuel savings that results from purchasing a vehicle with higher fuel economy as risky or uncertain, or they may instead discount future consumption at rates reflecting their costs for financing the higher capital outlays required to purchase more fuel-efficient models. In either case, they may discount future fuel savings at rates well above the 3% assumed in NHTSA’s

evaluation.

Table VIII-16 shows the effect of higher discount rates on vehicle buyers’ evaluation of the fuel savings projected to result from the CAFE standa rds established by this rule, again using MY 2016 passenger cars and light trucks as an ex ample. As Table VIII-14 showed previously,

18 Office of Management and Budget, Circular A-4, “Regulatory Analysis,” September 17, 2003, 33. Available at http://www.whitehouse.gov/omb/assets/regulatory_matters_pdf/a-4.pdf (last accessed March 1, 2009).Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

17 average future fuel savings discounted at the OMB 3% consumer rate exceed the agency’s estimated price increases by more than $2,000 for MY 2016 passenger cars and by more than $2,700 for MY 2016 light trucks. If vehicle buyers instead discount future fuel savings at the average new-car loan rate during 2009 (6.7%), however, these differences decline to slightly more than $1,400 for cars and $1,900 for light trucks, as Table VIII-16 illustrates. This is a particularly plausible alternative assumption, because buyers are likely to finance the increases in purchase prices resulting from compliance with higher CAFE standards as part of the process financing the vehicle purchase itself. Finally, as the table also shows, discounting future fuel savings using a consumer credit card rate (w hich averaged 13.4% during 2009) reduces these differences to less than $800 for a MY 2016 passenger car and less than $1,100 for the typical MY 2016 light truck. Thus even at relatively high discount rates, the higher fuel economy levels required by this final rule would generate significant net benefits to vehicle buyers.

Table VIII-16 Value of Fuel Savings vs. Vehicle Price Increases with Alternative Assumptions about Consumer Discount Rates

OMB

Consumer
Rate (3%) New Car

Loan Rate
(6.7%; 1) OMB

Investment
Rate (7%) Consumer

Credit Card

Rate
(13.4%; 2) Fuel Savings $2,932 $2,336 $2,300 $1,669

Price Increase $907 $907 $907 $907

Difference $2,025 $1,429 $1,393 $762

Fuel Savings $3,700 $2,884 $2,836 $2,030
Price Increase $961 $961 $961 $961

Difference $2,739 $1,923 $1,875 $1,069

(1) Average rate on 48-month new-vehicle loans made by commercial banks during 2009 was 6.72%; see Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release G. 19, Consumer Credit, http://www.federalreserve.gov/releases/g19/Current/ last accessed March 1, 2010.

(2) Average rate on consumer credit card accounts at commercial banks during 2009 was13.4%; see
Board of Governors of the Federal Reserve System, Federal Reserve Statistical Release G. 19, Consumer Credit, http://www.federalreserve.gov/releases/g19/Current/ last accessed March 1, 2010. Value at Alternative Discount Rates

Measure Vehicle

MY 2016

Passenger

Car

MY 2016
Light Truck

Combinations of a shorter time horizon and a higher discount rate could further reduce or even eliminate the difference between the value of fuel savings and the agency’s estimates of increases in vehicle prices. One plausible comb ination would be for buyers to discount fuel savings over the term of a new car loan, using the interest rate on that loan as a discount rate. Doing so would reduce the amount by which future fuel savings exceed the estimated increase inSummary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

18 the prices of MY 2016 vehicles to about $340 fo r passenger cars and $570 for light trucks. Some evidence suggests directly that vehicle buyers may employ combinations of higher discount rates and shorter time horizons than the agency assumes; for example, consumers surveyed by Kubik (2006) reported that fuel savings would have to be adequate to pay back the additional purchase price of a more fuel-efficient vehicle in less than 3 years to persuade a typical buyer to purchase

it. 19 As these comparisons and evidence illustrate , reasonable alternative assumptions about how consumers might evaluate the major benefit from requiring higher fuel economy can significantly reduce its magnitude from the agency’s estimate.

Imaginable combinations of shorter time horizons , higher discount rates, and lower expectations about future fuel prices or annual vehicle use and fuel savings could make potential buyers hesitant or even unwilling to purchase vehicles offering the fuel economy levels this rule will require. At the same time, they would also cau se vehicle buyers’ collective assessment of how the benefits from requiring higher fuel economy comp are to the costs they will be required to pay for it to differ significantly from NHTSA’s assessment of the aggr 4 egate benefits and costs of

this rule. If consumers’ views about critical variables such as future fuel prices or the appropriate discount rate differ sufficiently from the assumptions used by the agency, potential vehicle buyers might conclude that the value of fuel savings and other benefits they will experience from higher fuel economy are not sufficie nt to justify the increase in purchase prices they expect to pay. This would not only explain why their current choices among available models do not result in average fuel economy levels approaching those this rule would require,

but

, under what we believe to be unlikely assumptions, might also raise questions about

N HTSA ’ s conclusion that the total

– that is, private plus economy

- wide

– economic benefits from raising CAFE standards exceed the costs of complying with high er fuel economy requirements.

Another possibility is that achieving the fuel economy improvements required by stricter fuel economy standards might require manufacturers to forego planned future improvements in performance, carrying capacity, safety, or other features of their vehicle models that represent important sources of utility to vehicle owners. In extreme cases, manufacturers might even find it necessary to change the levels of these attributes that some currently available models offer. Although the specific economic values that vehicle buyers attach to individual vehicle attributes such as fuel economy, performance, passenger- and cargo-carrying capacity, and other sources of vehicles’ utility are difficult to infer from thei r purchasing decisions and vehicle prices, changes in vehicle attributes can significantly affect the overall utility that vehicles offer to potential buyers. Compromises in these or other highly-valued attributes would be viewed by potential buyers as an additional cost of improving fuel economy that the agency has failed to acknowledge or include in its estimates of the cost s of complying with stricter CAFE standards.

As indicated in its previous discussion of technology costs, NHTSA has approached this potential problem by developing cost estimates for fuel economy-improving technologies that include allowances for any additional manufacturing costs that would be necessary to maintain

19 Kubik, M. (2006). Consumer Views on Transportation a nd Energy. Second Edition. Technical Report: National Renewable Energy Laboratory. Docket NHTSA-2009-0050-0038.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

19 the reference fleet (or baseline) levels of performance, comfort, capacity, or safety of light-duty vehicle models to which those technologies are applied. In doing so, the agency followed the precedent established by the 2002 NAS Report on improving fuel economy, which estimated “constant performance and utility” costs for t echnologies that manufacturers could employ to increase the fuel efficiency of cars or light truc ks. Although NHTSA has revised its estimates of manufacturers’ costs for some technologies signifi cantly for use in this rulemaking, these revised estimates are still intended to represent costs that would allow manufacturers to maintain the performance, carrying capacity, and utility of vehicle models while improving their fuel

economy.

The agency readily acknowledges the difficulty of estimating technology costs that include adequate provision for the accompanying changes in vehicle design that are necessary to maintain performance, capacity, and utility. Wh ile NHTSA believe that its cost estimates for fuel economy-improving technologies are sufficient to prevent significant compromises in other

attributes of the vehicle models to which manufactu rers apply them, it is possible that these costs do not include adequate allowance for the necessary investments by manufacturers to maintain

baseline levels of these critical vehicle attributes. If this is the case, the true economic costs of achieving higher fuel economy would include the opportunity costs to vehicle owners of any sacrifices in vehicles’ performance, carrying capacity, and utility that accompanied increases in their fuel economy. In that event, the agencies’ estimated technology costs would underestimate the true economic costs of complying with st ricter fuel economy emission standards.

Finally, it is possible that vehicle buyers may simply prefer the choices of vehicle models they now have available to the combinations of pr ice, fuel economy, and other attributes that manufacturers are likely to offer when required to achieve higher overall fuel economy. If this is the case, their choices among models – and ev en some buyers’ decisions about whether to purchase a new vehicle – will respond accordingly, and their responses to these new choices will reduce their overall welfare. Some may buy models with combinations of price, fuel efficiency, and other attributes that they consider less de sirable than those they would otherwise have purchased, while others may simply postpone buying a new vehicle. It is also possible that manufacturers may discontinue some currently popular vehicle models or styles as part of their efforts to comply with requirements for higher fuel efficiency. Although the losses in buyers’ welfare associated with these responses cannot be large enough to offset the estimated value of fuel savings reported in the agencies’ analyses, they could significantly reduce the benefits from requiring manufacturers to achieve higher fuel e fficiency, particularly in combination with the other possibilities outlined previously. (Recall, however, that, NHTSA has attempted to respond to the potential problem by developing cost esti mates that include allowances for any additional manufacturing expenses that would be necessary to maintain the reference fleet levels of performance, comfort, capacity, or safety of light-duty vehicle models to which those technologies are applied.)

An entirely different explanation for buyers’ reluctance to invest in higher fuel economy despite the large economic return it appears to promise is that the agency’s assertion that the benefits buyers will experience from higher fuel economy fa r outweigh the costs they will pay to acquire it is indeed correct, yet certain plausible – if short-sighted – aspects of normal behaviorSummary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

20 nevertheless make buyers reluctant to purchase vehicles whose higher fuel economy offers an attractive return. For example, consumers’ understandable aversion to the prospect of losses (the behavioral phenomenon of “loss aversion”) from making investments that do not produce their expected returns may exaggerate their uncertainty about the value of future fuel savings sufficiently to make purchasing a more fuel-effici ent vehicle seem unattractive even when doing

so is likely to be a sound economic decision. Compare the finding in Greene et al. (2009), to the effect that the expected net present value of increasing the fuel economy of a passenger car from 28 to 35 miles per gallon falls from $405 when calculated using standard net present value calculations, to nearly zero when uncertainty regarding future cost savings is taken into

account. 20

Another possible reconciliation of the agency’s claim that the average vehicle buyer will experience large fuel savings from the higher CAFE standards this rule establishes with the fact

that the average fuel economy of vehicles currently purchased falls well short of the new standards is that the values consumers place on the future savings they expect to obtain from higher fuel economy vary widely. As an illu stration, one recent review of consumers’ willingness to pay for improved fuel economy found estimates that varied from less than 1% to almost ten times the present value of the resultin g fuel savings when those are discounted at 7% over the vehicle’s expected lifetime. 21 Although the wide variation in these estimates partly undoubtedly reflects methodological and measurem ent differences among the studies surveyed, it probably also reflects the fact that the expect ed savings from purchasing a vehicle with higher fuel economy vary widely among individuals, because they travel different amounts, have different driving styles, or have different expectations about future fuel prices.

This is likely to be reflected in the fact that many buyers with high valuations of increased fuel

economy already purchase vehicle models that offer it, while those with lower values of fuel economy emphasize other vehicle attributes in th eir purchasing decisions. A related possibility is that because the effects of differing fuel economy levels are relatively modest when comparedto those provided by other, more prominent features of new vehicles – passenger and cargocarrying capacity, performance, safety, etc. – it is simply not in many shoppers’ interest to spend the time and effort necessary to determine the economic value of higher fuel economy, attempt to isolate the component of a new vehicle’s selling price that is related to its fuel economy, and compare these two. (This may be so even though more fuel-efficient choices might ultimately be in consumers’ economic self-interest.) In either case, although the agency’s estimates of the

average value of fuel savings that will result from requiring cars and light trucks to achieve higher fuel economy may be correct, they are not likely to be large enough to lead a sufficient

20 Greene, D., J. German, and M. Delucchi (2009). “Fuel Economy: The Case for Market Failure” in Reducing Climate Impacts in the Transportation Sector

, Sperling, D., and J. Cannon, eds. Springer Science. Surprisingly, the authors find that uncertainty regarding the future price of gasoline appears to be less important than uncertainty surrounding the expected lifetimes of new vehicles.

21 Greene, David L., “How Consumers Value Fuel Eco nomy: A Literature Review,” Draft report to U.S. Environmental Protection Agency, Oak Ridge National La boratory, December 29, 2009; see Table 10, p. 37. (Docket NHTSA-2009-0059-0155) and Jin-Tan Liu ( 1988). “Automotive Fuel Economy Improvements and Consumers’ Surplus.” Transportation Research Part A 22A(3): 203-218 (Docket EPA-HQ-OAR-2009-0472-0045). The study actually calculated the willingness to pay for reduced vehicle operating costs, of which vehicle fuel economy is a major component.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

21 number of buyers to purchase vehicles with higher fuel economy to increase average fuel economy from its current levels.

Defects in the market for cars and light trucks could also lead manufacturers to undersupply fuel economy, even in cases where many (informed) buyers would be willing to pay the increased prices necessary to provide it. Most obviou sly, an absence of vigorous competition among producers of cars and light trucks may lead manufacturers to undersupply attributes that contribute to the overall quality of new vehicles, including fuel economy, because such “imperfect” competition reduces prod ucers’ profit incentive to supp ly the level of fuel economy that buyers are willing to pay for. Incomplete or “asymmetric” access to information on vehicle attributes such as fuel economy – whereby manuf acturers of new vehicles or sellers of used cars and light trucks have more complete knowledge of vehicles’ actual fuel economy levels, or of the value of purchasing higher fuel economy, than do potential buyers – may also prevents sellers of new or used vehicles from capturing its full value. In this situation, the level of fuel efficiency provided in the markets for new or used vehicles might remain persistently lower than that demanded by potential buyers.

It is also possible that deliberate decisions by ma nufacturers of cars and light trucks, rather than constraints on the combinations of fuel economy, carrying capacity, and performance that manufacturers can offer using current technologies, limit the range of fuel economy available to buyers within individual vehicle market segments, such as full-size automobiles, small SUVs, or minivans. As an illustration, once a potential buyer has decided to purchase a minivan, the range of fuel economy among current models extends only from 18 to 24 MPG. 22 Manufacturers might make such decisions if they underestimat e the premiums that shoppers in certain market segments are willing to pay for mo re fuel-efficient versions of the vehicle models thy currently offer to prospective buyers within those segmen ts. If this occurs, ma nufacturers may fail to supply levels of fuel efficiency as high as t hose buyers are willing to pay for, and the average fuel efficiency of their entire new vehicle fleet s could remain below the levels that potential buyers demand and are willing to pay for.

Finally, some research suggests that the consumers’ apparent unwillingness to purchase more fuel efficient vehicles stems from their inability to value future fuel savings correctly. For example, Larrick and Soll (2008) find evidence that consumers do not understand how to translate changes in fuel economy, which is denominated in miles per gallon, into resulting changes in fuel consumption, measured in gallons per time period. 23 Sanstad and Howarth (1994) argue that consumers appear optimize behavior without full information by resorting to imprecise but convenient rules of thumb, which can cause many buyers to underestimate the value of fuel savings, particularly from significant increases in fuel economy. 24 If the behavior

22 This is the range of combined city and highway fuel economy levels from lowest (Toyota Siena 4WD) to highest (Mazda 5) available for model year 2010; http://www.f ueleconomy.gov/feg/bestworstEPAtrucks.htm (last accessed February 15, 2010).

23 Larrick, R. P., and J.B. Soll (2008). “The MPG illusion

. ” Science 320: 1593-1594. Docket EPA-HQ-OAR-2009-

0472-0043.

24 Sanstad, A., and R. Howarth (1994). “’Normal’ Markets, Market Imperfections, and Energy Efficiency.” Energy Policy 22(10): 811-818. Docket EPA-HQ-OAR-2009-0472-11289.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

22 identified in these studies is indeed widespread, then the agency’s calculations suggesting that the benefits to vehicle owners from requiring hi gher fuel economy significantly exceeds the costs of providing it may indeed be correct, yet the re sulting difference is still insufficient to motivate buyers to purchase a mix of car or light truck vehicle models whose average fuel economy approaches those required by this rule.

The agency has been unable to reach a conclusive answer to the question of why the apparently large differences between its estimates of benefits from requiring higher fuel economy and the costs of supplying it do not result in higher average fuel economy for new cars and light trucks. One explanation is that NHTSA’s estimates are reasonable, and the market for fuel economy is simply not operating efficiently. For reasons stated above, NHTSA believes that a number of imperfections in the relevant market (including the lack of salience of fuel economy benefits and an emphasis on the short-term) likely play a key role, thus justifying th e conclusion that the private benefits are substantial. However, the ag ency acknowledges that this situation may also

reflect the fact that some combination of overe stimating the value of fuel savings and omitting potential reductions in the welfare of vehicle buyers means that it has not fully characterized the impact of the CAFE standards this rule establis hes on consumers. To recognize this possibility, and as part of a sensitivity analysis, this section presents an alternative accounting of the benefits and costs of CAFE standards for MY 2012-2016 passenger cars and light trucks and discusses its implications.

Table VIII-17 displays the economic impacts of the rule from the perspective of potential buyers,

and also reconciles the estimated net benefits of the rule as they are likely to be viewed by vehicle buyers with its net benefits to the economy as a whole. As the table shows, the total benefits to vehicle buyers (line 4) consist of the value of fuel savings at retail fuel prices (line 1), the economic value of vehicle occupants’ savings in refueling time (line 2), and the economic benefits from added rebound-effect driving (line 3). As the zero entries in line 5 of the table suggest, the agency’s estimate of the retail value of fuel savings reported in line 1 is assumed to be correct, and no losses in consumer welfare from changes in vehicle attributes (other than those from increases in vehicle prices) are assumed to occur. Thus there is no reduction in the total private benefits to vehicle owners, so that net private benefits to vehicle buyers (line 6) are equal to total private benefits (re ported previously in line 4).

As Table VIII-17 also shows, the decline in fuel tax revenues (line 7) that results from reduced fuel purchases is in effect an external cost fr om the viewpoint of vehicle buyers, which offsets part of the benefits of fuel savings when those are viewed from the economy-wide or “social” perspective. 25 Thus the sum of lines 1 and 7 is the savings in fuel production costs that was reported previously as the value of fuel savings at pre-tax prices in the agency’s usual accounting of benefits and costs (see Chapter X). Lines 8 and 9 of Table VIII-17 report the value of

25 Strictly speaking, fuel taxes represent a transfer of res ources from consumers of fuel to government agencies and not a use of economic resources. Reducing the volume of fuel purchases simply reduces the value of this transfer, and thus cannot produce a real economic cost or benefit. Re presenting the change in fuel tax revenues in effect as an economy-wide cost is necessary to of fset the portion of fuel savings included in line 1 that represents savings in fuel tax payments by consumers. This prevents the savi ngs in tax revenues from being counted as a benefit from the economy-wide perspective.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

23 reductions in air pollution and climate-related externalities resulting from lower emissions during fuel production and consumption, while line 10 reports the savings in energy security externalities to the U.S. economy from reduced consumption and imports of crude petroleum and refined fuel. Line 12 reports the costs of increas ed congestion delays, accidents, and noise that result from additional driving due to the fuel economy rebound effect; net social benefits (line 13) is thus the sum of the change in fuel tax revenues, the reduction in environmental and energy security externalities, and increased costs from added driving.

Line 14 of Table VIII-17 shows manufacturers’ technology outlays for meeting higher CAFE standards for passenger cars and light trucks, which represent the principal cost of requiring higher fuel economy. The net total benefits (line 15 of the table) resulting from the rule consist of the sum of private (line 6) and social (line 13 ) benefits, minus technology costs (line 14); as expected, the figures reported in line 15 of the table are identical to those reported previously in the agency’s customary format (see Chapter X).

Table VIII-17 highlights several important featur es of this rule’s economic impacts. First, comparing the rule’s net private (line 6) and external (line 13) benefits makes it clear that a substantial majority of the benefits from requiring higher fuel economy are experienced by vehicle buyers, with only a small share distributed throughout the remainder of the U.S. economy. In turn, the vast majority of private benefits stem from fuel savings, which highlights the importance of the many assumptions the agency uses to estimate and value future fuel savings resulting from higher fuel economy, as well as of the assumption that the rule has no adverse impacts on vehicle buyers. The aggregate external benefits are small because the

substantial value of reductions in environmental and energy security externalities is almost exactly offset by the decline in fuel tax revenues and the increased costs associated with added vehicle use via the rebound effect of higher fuel economy.

As a consequence, the net economic benefits of the rule mirror closely its benefits to private vehicle buyers and the technology costs for ach ieving higher fuel economy, again highlighting the importance of correctly valuing fuel saving s from the perspective of those who experience them and accounting for any other effects of the rule on the economic welfare of vehicle buyers.

Table VIII-17 Private, Social, and Total Benefits a nd Costs of MY 2012-16 CAFE Standards: Passenger Cars plus Light TrucksSummary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

24 2012 2013 2014 2015 2016

1 Value of Fuel Savings (at Retail Fuel Prices) $10.5 $22.9 $32.9 $42.5 $52.7 $161.6
2 Savings in Refueling Time $0.7 $1.4 $1.9 $2.5 $3.0 $9.4 3 Consumer Surplus from Added Driving $0.7 $1.5 $2.2 $2.8 $3.4 $10.5 4 Total Private Benefits (=1+2+3) $11.9 $25.8 $37.0 $47.8 $59.0 $181.5

5 Reduction in Private Benefits $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 6 Net Private Benefits (=1+2) $11.9 $25.8 $37.0 $47.8 $59.0 $181.5

7 Change in Fuel Tax Revenues -$1.3 -$2.7 -$3.8 -$4.8 -$5.9 -$18.5
8 Reduced Health Damages from Criteria Emissions $0.5 $0.9 $1.3 $1.6 $2.0 $6.4 9 Reduced Climate Damages from CO2 Emissions $0.9 $2.0 $2.9 $3.8 $4.8 $14.5 10 Reduced Energy Security Externalities $0.5 $1.2 $1.6 $2.1 $2.5 $8.0
11 Reduction in Externalities (=8+9+10) $1.9 $4.1 $5.9 $7.6 $9.3 $28.8 12 Increased Costs of Congestion, etc. -$0.7 -$1.3 -$1.9 -$2.4 -$3.0 -$9.4 13 Net Social Benefits (=7+11+12) $0.0 $0.1 $0.1 $0.3 $0.5 $1.0

14 Technology Costs $5.9 $7.9 $10.5 $12.5 $14.9 $51.7

15 Net Total Benefits (=6+12-14) $6.0 $17.9 $26.6 $35.5 $44.6 $130.7 Entry Model Year Total, 2012

- 2016

As discussed in detail previously, it is possible that NHTSA has overestimated the value of fuel savings to buyers and subsequent owners of the cars and light trucks to which higher CAFE standards will apply. It is also possible that the agency has failed to identify and value

reductions in consumer welfare that could result from buyers’ responses to higher vehicle prices or changes in vehicle attributes that manufacturers make as part of their efforts to achieve higher fuel economy. To acknowledge these possibilitie s and examine their potential impact on the rule’s benefits and costs, and in order to prov ide a sensitivity analysis, Table IV.G.6-5 shows the rule’s cumulative economic impacts for MY 2012-16 passenger cars and light trucks under varying assumptions about the agency’s potential overestimation of fuel savings and the value of potential changes in vehicle attributes such as performance, carrying capacity, or safety.

Table VIII-18 accounts for both potential overestimation of the value of fuel savings to vehicle buyers and the possible omission of welfare losses from changes in other vehicle attributes in the entry labeled “Reduction in Private Benefits” (line 5). Although the examples reported previously in Tables VIII-15 and VIII-16 illustrate d sources of possible overestimation of fuel savings using specific alternatives to the agency’s assumptions, NHTSA has been unable to determine exactly how buyers’ time horizons or discount rates might differ from those assumed in its analysis. Nor has NHTSA analyzed how vehicle buyers’ expectations about future fuel prices or differences between fuel economy ratings and actual on-road fuel economy might differ from those it employs to estimate the value of fuel savings. Finally, NHTSA has not attempted to project changes in vehicle attributes other than fuel economy, or to estimate the economic value of resulting losses in vehicle utility.

Instead Table VIII-18 illustrates the effect of these possibiliti es using different assumptions about the fraction of total private benefits to vehicle buyers that might be offset by some combination of these factors. It is important to see that these assumptions are used merely for the sake of analysis and illustration; there is no cl aim here that they have an empirical basis, orSummary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

25 that they are founded in any existing estimates, theoretical or empirical, of actual offsets. 26 As Table VIII-18 shows, if there is no offset to priv ate benefits, the rule’s total and net private and social benefits are exactly as shown in the last column of Table IV.G.6-4 above. If, however, these factors combine to offset as much as 25% of the agency’s estimate of total private benefits (line 5), the rule’s net private (line 6) and ne t total (line 15) benefits remain substantially positive. If the private savings turn out to be 25% less than projected, the benefits of the rule continue to justify the costs by a large measure. If the offset is assumed to be as much as 50%, the net total benefits (line 15) would significan tly decline, but would remain positive, and the benefits would continue to justif y the costs by a large measure.

26 While some empirical evidence suggests that consumer s are largely making rational decisions, other evidence suggests this is not the case. Since ther e is not agreement in the literature on this point, it is not possible to estimate the potential degree of consumer loss in welfare.Summary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

26 Table VIII-18 Effect of Overestimation of Fuel Savings or Omission of Welfare Losses on Net Private and

Total Benefits of MY 2012-2016 CAFE Standards

Entry Fraction of Private Benefits Offset by Overestimation of Fuel Savings or Omission of

Welfare Losses to Vehicle Buyers

None 25% 50%
1 Value of Fuel Savings (at Retail Fuel Prices) $161.6 $161.6 $161.6 2 Savings in Refueling Time $9.4 $9.4 $9.4 3 Consumer Surplus from Added Driving $10.5 $10.5 $10.5
4 Total Private Benefits (=1+2+3) $181.5 $181.5 $181.5
5 Reduction in Private Benefits $0.0 -$45.4 -$90.7
6 Net Private Benefits (=1+2) $181.5 $136.1 $90.7

7 Change in Fuel Tax Revenues -$18.5 -$18.5 -$18.5 8 Reduced Health Damages from Criteria Emissions $6.4 $6.4 $6.4 9 Reduced Climate Damages from CO2 Emissions $14.5 $14.5 $14.5

1 0 Reduced Energy Security Externalities $8.0 $8.0 $8.0

1 1 Reduction in Externalities (=8+9+10) $28.8 $28.8 $28.8

1 2 Increased Costs of Congestion, etc. -$9.4 -$9.4 -$9.4

1 3 Net Social Benefits (=7+11+12) $1.0 $1.0 $1.0

1 4 Technology Costs $51.7 $51.7 $51.7

1 5 Net Total Benefits (=6+12-14) $130.7 $85.3 $40.0

It is important to reemphasize that NHTSA view s the alternative estimates of this rule’s economic impacts presented in Table VIII-18 as illustrative only. The agency has attempted to develop the most accurate estimates of the value of fuel savings that are possible. The design of the CAFE standards (e.g., the footprint curves), the stringency of the standards, and the lead time provided to manufacturers for complying with the new standards have all been tailored to ensure

that desirable vehicle attributes other than fuel economy will not be compromised. NHTSA hasSummary of Interagency Working Comments on Draft rule under EO 12866 review. Subject to further policy review.

27 also attempted to ensure that its estimates of technology costs include adequate provisions to prevent the degradation of performance, safety, or other valuable attributes as consequences of manufacturers’ efforts to comply with higher CAFE standards.

A major lesson is that the benefits of the rule justify the costs even on the assumption that the private savings are significantly offset (an assumption that the agency believes to be highly unlikely). Nevertheless, the agency believes that it is important to acknowledge a degree of uncertainty in its estimates of how buyers are lik ely to value fuel savings, as well as in its conclusion that no losses in the performance, utility, or safety of cars and light trucks subject to this rule will occur. NHTSA is committed to developing improved methods for estimating the value of improvements in fuel economy, as well as the magnitude and economic consequences of accompanying changes in other vehicle attributes, as part of its future CAFE rulemaking

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