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Executive Summary In the wake of the 1973 oil crisis, the U.S. Congress passed the Energy Policy and Conservation Act of 1975, with the goal of reducing the country's dependence on foreign oil. Among other things, the act established the Corporate Average Fuel Economy (CAFE) program, which required automobile manufacturers to increase the sales-weighted av- erage fuel economy of the passenger car and light-duty truck fleets sold in the United States. Today, the light-duty truck fleet includes minivans, pickups, and sport utility vehicles. Congress itself set the standards for passenger cars, which rose from 18 miles per gallon (mpg) in automobile model year (MY) 1978 to 27.5 mpg in MY 1985. As authorized by the act, the Department of Transportation (DOT) set stan- dards for light trucks for model years 1979 through 2002. The standards are currently 27.5 mpg for passenger cars and 20.7 mpg for light trucks. Provisions in DOT's annual ap- propriations bills since fiscal year 1996 have prohibited the agency from changing or even studying CAFE standards. In legislation for fiscal year 2001, Congress requested that the National Academy of Sciences, in consultation with the Department of Transportation, conduct a study to evaluate the effectiveness and impacts of CAFE standards.) In par- ticular, it asked that the study examine the following, among other factors: 1. The statutory criteria (economic practicability, tech- nological feasibility, need for the United States to con- serve energy, the classification definitions used to dis- tinguish passenger cars from light trucks, and the effect of other regulations); 2. The impact of CAFE standards on motor vehicle safety; 3. Disparate impacts on the U.S. automotive sector; iConference Report on H.R. 4475, Department of Transportation arid Related Agencies Appropriations Act, 2001. Report 106-940, as published in the Congressional Record, October 5, 2000, pp. H8892-H9004. 1 4. The effect on U.S. employment in the automotive sector; 5. The effect on the automotive consumer; and 6. The effect of requiring separate CAFE calculations for domestic and nondomestic fleets. In response to this request, the National Research Coun- cil (NRC) established the Committee on the Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards. In consultation with DOT, the NRC developed a statement of work for the committee. The committee's work was to emphasize recent experience with CAFE standards, the impact of possible changes, and the stringency and/or structure of the CAFE program in future years. The commit- tee held its first meeting in early February 2001. In effect, since the congressional appropriations language asked for the report by July 1, 2001, the committee had less than 5 months (from February to late June) to complete its analysis and prepare a report for the National Research Council's ex- ternal report review process. In its findings and recommen- dations, the committee has noted where analysis is limited and further study is needed. Following the release of the Republication copy of this report in July 2001, the committee reviewed its technical and economic analyses. Several changes were made to the results, as reported in a letter report released in January 2002, which is reprinted in Appendix F below. These changes have been incorporated in this report also. The CAFE program has been controversial since its in- ception. Sharp disagreements exist regarding the effects of the program on the fuel economy of the U.S. vehicle fleet, the current mix of vehicles in that fleet, the overall safety of passenger vehicles, the health of the domestic automobile industry, employment in that industry, and the well-being of consumers. It is this set of concerns that the committee was asked to address. These concerns are also very much dependent on one an- other. For example, if fuel economy standards were raised,

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2 EFFECTIVENESS AND IMPACT OF CORPORATE AVERAGE FUEL ECONOMY (CAFE) STANDARDS the manner in which automotive manufacturers respond would affect the purchase price, attributes, and performance of their vehicles. For this reason, the mix of vehicles that a given manufacturer sells could change, perhaps resulting in a greater proportion of smaller and lighter vehicles; this, in turn, could have safety implications, depending on the even- tual mix of vehicles that ended up on the road. If consumers are not satisfied with the more fuel-efficient vehicles, that in turn could affect vehicle sales, profits, and employment in the industry. Future effects would also depend greatly on the real price of gasoline; if it is low, consumers would have little interest in fuel-efficient vehicles. High fuel prices would have just the opposite effect. In addition, depending on the level at which fuel economy targets are set and the time the companies have to implement changes, differential impacts across manufacturers would probably occur depend- ing on the types of vehicles they sell and their competitive position in the marketplace. Thus, understanding the impact of potential changes to CAFE standards is, indeed, a difficult and complex task. In addition to the requirement that companies meet sepa- rate fleet averages for the automobiles and light-duty trucks they sell, there are other provisions of the CAFE program that affect manufacturers' decisions. For example, a manu- facturer must meet the automobile CAFE standard separately for both its import and its domestic fleet (the two-fleet rule), where a domestic vehicle is defined as one for which at least 75 percent of its parts are manufactured in the United States. Also, CAFE credits can be earned by manufacturers that pro- duce flexible-fuel vehicles, which can run interchangeably on gasoline or an alternative fuel, such as ethanol. Why care about fuel economy at all? It is tempting to say that improvements in vehicle fuel economy will save money for the vehicle owner in reduced expenditures for gasoline. The extent of the annual saving will depend on the level of improvement in the fuel economy (in miles per gallon of gasoline), the price of gasoline, and the miles traveled per year, as well as on the higher cost of the vehicle attributable to the fuel economy improvement. While a strong argument can be made that such savings or costs are economically relevant, that is not by itself a strong basis for public policy intervention. Consumers have a wide variety of opportuni- ties to exercise their preference for a fuel-efficient vehicle if that is an important attribute to them. Thus, according to this logic, there is no good reason for the government to inter- vene in the market and require new light-duty vehicles to achieve higher miles per gallon or to take other policy mea- sures designed to improve the fuel economy of the fleet. There are, however, other reasons for the nation to con- sider policy interventions of some sort to increase fuel economy. The most important of these, the committee be- lieves, is concern about the accumulation in the atmosphere of so-called greenhouse gases, principally carbon dioxide. Continued increases in carbon dioxide emissions are likely to further global warming. Concerns like those about climate change are not normally reflected in the market for new ve- hicles. Few consumers take into account the environmental costs that the use of their vehicle may occasion; in the par- lance of economics, this is a classic negative externality. A second concern is that petroleum imports have been steadily rising because of the nation's increasing demand for gasoline without a corresponding increase in domestic sup- ply. The demand for gasoline has been exacerbated by the increasing sales of light trucks, which have lower fuel economy than automobiles. The high cost of oil imports poses two risks: downward pressure on the strength of the dollar (which drives up the costs of goods that Americans import) and an increase in U.S. vulnerability to macroeco- nomic shocks that cost the economy considerable real out- put. Some experts argue that these vulnerabilities are an- other form of externality that vehicle purchasers do not factor into their decisions but that can represent a true and signifi- cant cost to society. Other experts take a more skeptical view, arguing instead that the macroeconomic difficulties of the 1970s (high unemployment coupled with very high inflation and interest rates) were due more to unenlightened monetary policy than to the inherent difficulties associated with high oil prices. Most would agree that reducing our nation's oil cat - import bill would have favorable effects on the terms of trade, and that this is a valid consideration in deliberations about fuel economy. The committee believes it is critically important to be clear about the reasons for considering improved fuel economy. Moreover, and to the extent possible, it is useful to try to think about how much it is worth to society in dollar terms to reduce emissions of greenhouse gases (by 1 ton, say) and reduce dependence on imported oil (say, by 1 bar- rel). If it is possible to assign dollar values to these favorable effects (no mean feat, the committee acknowledges), it be- comes possible to make at least crude comparisons between the beneficial effects of measures to improve fuel economy on the one hand, and the costs (both out-of-pocket and more subtle) on the other. In conducting its study, the committee first assessed the impact of the current CAFE system on reductions in fuel consumption, on emissions of greenhouse gases, on safety, and on impacts on the industry (see Chapters 1 and 2~. To assess the potential impacts of modified standards, the com- mittee examined opportunities offered by the application of existing (production-intent) or emerging technologies, estimated the costs of such improvements, and examined the lead times that would typically be required to introduce such vehicle changes (see Chapter 3~. The committee re- viewed many sources of information on technologies and the costs of improvements in fuel economy; these sources included presentations at its meetings and available reports. It also used consultants under its direction to facilitate its work under the tight time constraints of the study. Some of the consultants'work provided analyses and information that helped the committee better understand the nature of

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EXECUTIVE SUMMARY previous fuel economy analyses. In the end, however, the committee conducted its own analyses, informed by the work of the consultants, the technical literature, and pre- sentations at its meetings, as well as the expertise and judg- ment of its members, to arrive at its own range of estimates of fuel economy improvements and associated costs. Based on these analyses, the implications of modified CAFE stan- dards are presented in Chapter 4, along with an analysis of what the committee calls cost-efficient fuel economy lev- els. The committee also examined the stringency and struc- ture of the current CAFE system, and it assessed possible modifications to it, as well as alternative approaches to achieving higher fuel economy for passenger vehicles, which resulted in suggestions for improved policy instru- ments (see Chapter 5~. FINDINGS Finding 1. The CAFE program has clearly contributed to increased fuel economy of the nation's light-duty vehicle fleet during the past 22 years. During the 1970s, high fuel prices and a desire on the part of automakers to reduce costs by reducing the weight of vehicles contributed to improved fuel economy. CAFE standards reinforced that effect. More- over, the CAFE program has been particularly effective in keeping fuel economy above the levels to which it might have fallen when real gasoline prices began their long de- cline in the early 1 980s. Improved fuel economy has reduced dependence on imported oil, improved the nation's terms of trade, and reduced emissions of carbon dioxide, a principal greenhouse gas, relative to what they otherwise would have been. If fuel economy had not improved, gasoline consump- tion (and crude oil imports) would be about 2.8 million bar- rels per day greater than it is, or about 14 percent of today's consumption. Finding 2. Past improvements in the overall fuel economy of the nation's light-duty vehicle fleet have entailed very real, albeit indirect, costs. In particular, all but two members of the committee concluded that the downweighting and downsizing that occurred in the late 1970s and early 1980s, some of which was due to CAFE standards, probably re- sulted in an additional 1,300 to 2,600 traffic fatalities in 1993.2 In addition, the diversion of carmakers' efforts to improve fuel economy deprived new-car buyers of some amenities they clearly value, such as faster acceleration, greater carrying or towing capacity, and reliability. 2A dissent by committee members David Greene and Maryann Keller on the impact of downweighting and downsizing is contained in Appendix A. They believe that the level of uncertainty is much higher than stated and that the change in the fatality rate due to efforts to improve fuel economy may have been zero. Their dissent is limited to the safety issue alone. 3 Finding 3. Certain aspects of the CAFE program have not functioned as intended: The distinction between a car for personal use and a truck for work use/cargo transport has broken down, initially with minivans and more recently with sport utility vehicles (SUVs) and cross-over vehicles. The car/truck distinction has been stretched well beyond the original purpose. The committee could find no evidence that the two- fleet rule distinguishing between domestic and foreign content has had any perceptible effect on total employ- ment in the U.S. automotive industry. The provision creating extra credits for multifuel ve- hicles has had, if any, a negative effect on fuel econ- omy, petroleum consumption, greenhouse gas emis- sions, and cost. These vehicles seldom use any fuel other than gasoline yet enable automakers to increase their production of less fuel efficient vehicles. Finding 4. In the period since 1975, manufacturers have made considerable improvements in the basic efficiency of engines, drive trains, and vehicle aerodynamics. These im- provements could have been used to improve fuel economy and/or performance. Looking at the entire light-duty fleet, both cars and trucks, between 1975 and 1984, the technol- ogy improvements were concentrated on fuel economy: It improved by 62 percent without any loss of performance as measured by 0-60 mph acceleration times. By 1985, light- duty vehicles had improved enough to meet CAFE standards. Thereafter, technology improvements were concentrated principally on performance and other vehicle attributes (in- cluding improved occupant protection). Fuel economy re- mained essentially unchanged while vehicles became 20 per- cent heavier and 0-60 mph acceleration times became, on average, 25 percent faster. Finding 5. Technologies exist that, if applied to passenger cars and light-duty trucks, would significantly reduce fuel consumption within 15 years. Auto manufacturers are al- ready offering or introducing many of these technologies in other markets (Europe and Japan, for example), where much higher fuel prices ($4 to $5/gal) have justified their develop- ment. However, economic, regulatory, safety, and consumer- preference-related issues will influence the extent to which these technologies are applied in the United States. Several new technologies such as advanced lean exhaust gas aftertreatment systems for high-speed diesels and direct- injection gasoline engines, which are currently under devel- opment, are expected to offer even greater potential for re- ductions in fuel consumption. However, their development cycles as well as future regulatory requirements will influ- ence if and when these technologies penetrate deeply into the U.S. market. The committee conducted a detailed assessment of the

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4 EFFECTIVENESS AND IMPACT OF CORPORATE AVERAGE FUEL ECONOMY (CAFE) STANDARDS technological potential for improving the fuel efficiency of 10 different classes of vehicles, ranging from subcompact and compact cars to SUVs, pickups, and minivans. In addi- tion, it estimated the range in incremental costs to the con- sumer that would be attributable to the application of these engine, transmission, and vehicle-related technologies. Chapter 3 presents the results of these analyses as curves that represent the incremental benefit in fuel consumption versus the incremental cost increase over a defined baseline vehicle technology. Projections of both incremental costs and fuel consumption benefits are very uncertain, and the actual results obtained in practice may be significantly higher or lower than shown here. Three potential development paths are chosen as examples of possible product improvement approaches, which illustrate the trade-offs auto manu- facturers may consider in future efforts to improve fuel effi- ciency. Assessment of currently offered product technologies suggests that light-duty trucks, including SUVs, pickups, and minivans, offer the greatest potential to reduce fuel consump- tion on a total-gallons-saved basis. Finding 6. In an attempt to evaluate the economic trade-offs associated with the introduction of existing and emerging technologies to improve fuel economy, the committee con- ducted what it called cost-efficient analysis. That is, the com- mittee identified packages of existing and emerging tech- nologies that could be introduced over the next 10 to 15 years that would improve fuel economy up to the point where fur- ther increases in fuel economy would not be reimbursed by fuel savings. The size, weight, and performance characteris- tics of the vehicles were held constant. The technologies, fuel consumption estimates, and cost projections described in Chapter 3 were used as inputs to this cost-efficient analysis. These cost-efficient calculations depend critically on the assumptions one makes about a variety of parameters. For the purpose of calculation, the committee assumed as fol- lows: (1) gasoline is priced at $1.50/gal, (2) a car is driven 15,600 miles in its first year, after which miles driven de- clines at 4.5 percent annually, (3) on-the-road fuel econ- omy is 15 percent less than the Environmental Protection Agency's test rating, and (4) the added weight of equipment required for future safety and emission regulations will ex- act a 3.5 percent fuel economy penalty. One other assumption is required to ascertain cost-effi- cient technology packages the horizon over which fuel economy gains ought to be counted. Under one view, car purchasers consider fuel economy over the entire life of a new vehicle; even if they intend to sell it after 5 years, say, they care about fuel economy because it will affect the price they will receive for their used car. Alternatively, consumers may take a shorter-term perspective, not looking beyond, say, 3 years. This latter view, of course, will affect the iden- tification of cost-efficient packages because there will be many fewer years of fuel economy savings to offset the ini- tial purchase price. The full results of this analysis are presented in Chap- ter 4. To provide one illustration, however, consider a mid- size SUV. The current sales-weighted fleet fuel economy average for this class of vehicle is 21 mpg. If consumers consider only a 3-year payback period, fuel economy of 22.7 mpg would represent the cost-efficient level. If, on the other hand, consumers take the full 14-year average life of a ve- hicle as their horizon, the cost-efficient level increases to 28 mpg (with fuel savings discounted at 12 percent). The longer the consumer's planning horizon, in other words, the greater are the fuel economy savings against which to balance the higher initial costs of fuel-saving technologies. The committee cannot emphasize strongly enough that the cost-efficient fuel economy levels identified in Tables 4-2 and 4-3 in Chapter 4 are not recommended fuel economy goals. Rather, they are reflections of technological possibili- ties, economic realities, and assumptions about parameter values and consumer behavior. Given the choice, consumers might well spend their money on other vehicle amenities, such as greater acceleration or towing capacity, rather than on the fuel economy cost-efficient technology packages. Finding 7. There is a marked inconsistency between press- ing automotive manufacturers for improved fuel economy from new vehicles on the one hand and insisting on low real gasoline prices on the other. Higher real prices for gasoline- for instance, through increased gasoline taxes would cre- ate both a demand for fuel-efficient new vehicles and an incentive for owners of existing vehicles to drive them less. Finding 8. The committee identified externalities of about $0.30/gal of gasoline associated with the combined impacts of fuel consumption on greenhouse gas emissions and on world oil market conditions. These externalities are not nec- essarily taken into account when consumers purchase new vehicles. Other analysts might produce lower or higher esti- mates of externalities. Finding 9. There are significant uncertainties surrounding the societal costs and benefits of raising fuel economy stan- dards for the light-duty fleet. These uncertainties include the cost of implementing existing technologies or developing new ones; the future price of gasoline; the nature of con- sumer preferences for vehicle type, performance, and other features; and the potential safety consequences of altered standards. The higher the target for average fuel economy, the greater the uncertainty about the cost of reaching that target. Finding 10. Raising CAFE standards would reduce future fuel consumption below what it otherwise would be; how- ever, other policies could accomplish the same end at lower cost, provide more flexibility to manufacturers, or address

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EXECUTIVE SUMMARY inequities arising from the present system. Possible alter- natives that appear to the committee to be superior to the current CAFE structure include tradable credits for fuel economy improvements, feebates,3 higher fuel taxes, stan- dards based on vehicle attributes (for example, vehicle weight, size, or payload), or some combination of these. Finding 11. Changing the current CAFE system to one featuring tradable fuel economy credits and a cap on the price of these credits appears to be particularly attractive. It would provide incentives for all manufacturers, including those that exceed the fuel economy targets, to continually increase fuel economy, while allowing manufacturers flex- ibility to meet consumer preferences. Such a system would also limit costs imposed on manufacturers and consumers if standards turn out to be more difficult to meet than ex- pected. It would also reveal information about the costs of fuel economy improvements and thus promote better- informed policy decisions. Finding 12. The CAFE program might be improved signifi- cantly by converting it to a system in which fuel economy targets depend on vehicle attributes. One such system would make the fuel economy target dependent on vehicle weight, with lower fuel consumption targets set for lighter vehicles and higher targets for heavier vehicles, up to some maxi- mum weight, above which the target would be weight-inde- pendent. Such a system would create incentives to reduce the variance in vehicle weights between large and small ve- hicles, thus providing for overall vehicle safety. It has the potential to increase fuel economy with fewer negative ef- fects on both safety and consumer choice. Above the maxi- mum weight, vehicles would need additional advanced fuel economy technology to meet the targets. The committee be- lieves that although such a change is promising, it requires more investigation than was possible in this study. Finding 13. If an increase in fuel economy is effected by a system that encourages either downweighting or the produc- tion and sale of more small cars, some additional traffic fa- talities would be expected. However, the actual effects would be uncertain, and any adverse safety impact could be mini- mized, or even reversed, if weight and size reductions were limited to heavier vehicles (particularly those over 4,000 lb). Larger vehicles would then be less damaging (aggressive) in crashes with all other vehicles and thus pose less risk to other drivers on the road. Finding 14. Advanced technologies including direct- injection, lean-burn gasoline engines; direct-injection com- 3Feebates are taxes on vehicles achieving less than the average fuel economy coupled with rebates to vehicles achieving better than average fuel economy. pression-ignition (diesel) engines; and hybrid electric ve- hicles have the potential to improve vehicle fuel economy by 20 to 40 percent or more, although at a significantly higher cost. However, lean-burn gasoline engines and die- sel engines, the latter of which are already producing large fuel economy gains in Europe, face significant technical challenges to meet the Tier 2 emission standards estab- lished by the Environmental Protection Agency under the 1990 amendments to the Clean Air Act and California's low-emission-vehicle (LEV II) standards. The major prob- lems are the Tier 2 emissions standards for nitrogen oxides and particulates and the requirement that emission control systems be certified for a 120,000-mile lifetime. If direct- injection gasoline and diesel engines are to be used exten- sively to improve light-duty vehicle fuel economy, signifi- cant technical developments concerning emissions control will have to occur or some adjustments to the Tier 2 emis- sions standards will have to be made. Hybrid electric ve- hicles face significant cost hurdles, and fuel-cell vehicles face significant technological, economic, and fueling in- frastructure barriers. Finding 15. Technology changes require very long lead times to be introduced into the manufacturers' product lines. Any policy that is implemented too aggressively (that is, in too short a period of time) has the potential to adversely affect manufacturers, their suppliers, their employees, and consumers. Little can be done to improve the fuel economy of the new vehicle fleet for several years because production plans already are in place. The widespread penetration of even existing technologies will probably require 4 to 8 years. For emerging technologies that require additional research and development, this time lag can be considerably longer. In addition, considerably more time is required to replace the existing vehicle fleet (on the order of 200 million ve- hicles) with new, more efficient vehicles. Thus, while there would be incremental gains each year as improved vehicles enter the fleet, major changes in the transportation sector's fuel consumption will require decades. RECOMMENDATIONS Recommendation 1. Because of concerns about greenhouse gas emissions and the level of oil imports, it is appropriate for the federal government to ensure fuel economy levels beyond those expected to result from market forces alone. Selection of fuel economy targets will require uncertain and difficult trade-offs among environmental benefits, vehicle safety, cost, oil import dependence, and consumer prefer- ences. The committee believes that these trade-offs right- fully reside with elected officials. Recommendation 2. The CAFE system, or any alternative regulatory system, should include broad trading of fuel

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6 EFFECTIVENESS AND IMPACT OF CORPORATE AVERAGE FUEL ECONOMY (CAFE) STANDARDS economy credits. The committee believes a trading system would be less costly than the current CAFE system; provide more flexibility and options to the automotive companies; give better information on the cost of fuel economy changes to the private sector, public interest groups, and regulators; and provide incentives to all manufacturers to improve fuel economy. Importantly, trading of fuel economy credits would allow for more ambitious fuel economy goals than exist under the current CAFE system, while simultaneously reducing the economic cost of the program. Recommendation 3. Consideration should be given to de- signing and evaluating an approach with fuel economy targets that are dependent on vehicle attributes, such as ve- hicle weight, that inherently influence fuel use. Any such system should be designed to have minimal adverse safety consequences. Recommendation 4. Under any system of fuel economy targets, the two-fleet rule for domestic and foreign content should be eliminated. Recommendation 5. CAFE credits for dual-fuel vehicles should be eliminated, with a long enough lead time to limit adverse financial impacts on the automotive industry. Recommendation 6. To promote the development of longer-range, breakthrough technologies, the government should continue to fund, in cooperation with the automotive industry, precompetitive research aimed at technologies to improve vehicle fuel economy, safety, and emissions. It is only through such breakthrough technologies that dramatic increases in fuel economy will become possible. Recommendation 7. Because of its importance to the fuel economy debate, the relationship between fuel economy and safety should be clarified. The committee urges the National Highway Traffic Safety Administration to undertake addi- tional research on this subject, including (but not limited to) a replication, using current field data, of its 1997 analysis of the relationship between vehicle size and fatality risk.