Evaluating New Policy Instruments of the Corporate Average Fuel Economy Standards: Footprint, Credit Transferring, and Credit Trading

The reformed U.S. Corporate Average Fuel Economy (CAFE) standards have not only tightened the efficiency levels to be achieved by automakers, but also made substantial changes to the regulatory design and structure by introducing three new policy instruments (footprint-based targeting, intra-firm transferring of fuel economy credits across vehicle categories, and inter-firm trading of credits). While there are a number of economics studies on tightening CAFE standards, little attention has been paid to the design aspects. This paper uses policy simulation to evaluate the new policy instruments. First, I model and estimate vehicle purchase and utilization decisions by American households. Based on estimation results, I simulate the effects of four counterfactual CAFE policies with or without the three instruments. Simulation results suggest (1) footprint-based targeting has little impact at the aggregate market level, while at the individual automaker level it favors firms selling relatively large vehicles; (2) allowing intra-firm credit transferring (but not inter-firm credit trading) cuts aggregate gasoline consumption by 0.1%–0.3%; and that (3) inter-firm credit trading significantly lowers the aggregate compliance costs (by $110–$140 million), and thus achieves the highest social welfare among the simulated policies.