9
POLICIES FOR IMPROVING FUEL ECONOMY

Previous chapters have evaluated the opportunities for and constraints on the improvement of the fuel economy of automobiles and light trucks. This chapter confronts a different subject—the policies to require or induce lower fuel consumption. The existing corporate average fuel economy (CAFE) system is one such approach. The committee's investigations have revealed, however, that the existing system deserves careful reconsideration. Accordingly, this chapter discusses the CAFE system and some of its principal alternatives.

COMMENTS ON THE EXISTING CAFE SYSTEM

Congress has set in place a particular approach—the CAFE system—for improving the fuel economy of automobiles and light trucks (15 U.S.C. §§ 2001 et seq. (1988)). The statute set a fleet fuel economy standard for automobiles of 27.5 miles per gallon (mpg) for model year (MY) 1985 and thereafter, unless the limit was relaxed by the Secretary of Transportation (15 U.S.C. §§ 2002(a)(1), (4) (1988)).1 Compliance is measured as the harmonic average of the fuel economy, as measured on a designated test cycle, of the automobiles produced by a manufacturer (15 U.S.C. § 2003 (1988)).2

1  

The standards for MY 1986-1988 were adjusted to 26 mpg, and for MY 1989 to 26.5 mpg. The standards for 1990 and thereafter have remained at the statutory target of 27.5 mpg (49 C.F.R. § 531.5 (1990)).

The legislation did not specify a particular standard for light trucks, but rather allowed the standard for light trucks to be determined by the Secretary of Transportation. 15 U.S.C. § 2002(b) (1988). The standards have varied over time; the standard for light trucks in 1991 was 20.2 mpg. 49 C.F.R. § 533.5 (1990).

2  

The harmonic average is the reciprocal of the average of the gallons per mile used by each car in the fleet. For example, a company that sells a vehicle with a fuel economy rating of 20 mpg and a vehicle with a fuel economy rating of 40 mpg would achieve a CAFE rating of 26.7 mpg. The use of the harmonic average is appropriate because it provides a measure of the fuel consumption of the fleet. That is, in the above example, if the two cars were each driven 10,000 miles, they would jointly consume 750 gallons of gasoline, thereby achieving an aggregate fuel economy of 26.7 mpg.



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Automotive Fuel Economy: How Far Should We Go? 9 POLICIES FOR IMPROVING FUEL ECONOMY Previous chapters have evaluated the opportunities for and constraints on the improvement of the fuel economy of automobiles and light trucks. This chapter confronts a different subject—the policies to require or induce lower fuel consumption. The existing corporate average fuel economy (CAFE) system is one such approach. The committee's investigations have revealed, however, that the existing system deserves careful reconsideration. Accordingly, this chapter discusses the CAFE system and some of its principal alternatives. COMMENTS ON THE EXISTING CAFE SYSTEM Congress has set in place a particular approach—the CAFE system—for improving the fuel economy of automobiles and light trucks (15 U.S.C. §§ 2001 et seq. (1988)). The statute set a fleet fuel economy standard for automobiles of 27.5 miles per gallon (mpg) for model year (MY) 1985 and thereafter, unless the limit was relaxed by the Secretary of Transportation (15 U.S.C. §§ 2002(a)(1), (4) (1988)).1 Compliance is measured as the harmonic average of the fuel economy, as measured on a designated test cycle, of the automobiles produced by a manufacturer (15 U.S.C. § 2003 (1988)).2 1   The standards for MY 1986-1988 were adjusted to 26 mpg, and for MY 1989 to 26.5 mpg. The standards for 1990 and thereafter have remained at the statutory target of 27.5 mpg (49 C.F.R. § 531.5 (1990)). The legislation did not specify a particular standard for light trucks, but rather allowed the standard for light trucks to be determined by the Secretary of Transportation. 15 U.S.C. § 2002(b) (1988). The standards have varied over time; the standard for light trucks in 1991 was 20.2 mpg. 49 C.F.R. § 533.5 (1990). 2   The harmonic average is the reciprocal of the average of the gallons per mile used by each car in the fleet. For example, a company that sells a vehicle with a fuel economy rating of 20 mpg and a vehicle with a fuel economy rating of 40 mpg would achieve a CAFE rating of 26.7 mpg. The use of the harmonic average is appropriate because it provides a measure of the fuel consumption of the fleet. That is, in the above example, if the two cars were each driven 10,000 miles, they would jointly consume 750 gallons of gasoline, thereby achieving an aggregate fuel economy of 26.7 mpg.

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Automotive Fuel Economy: How Far Should We Go? A manufacturer may have both a domestic and an import fleet and must separately comply with the limit for each. The regulatory approach for improving fuel economy departs from the approach applied to automobile safety and environmental pollution. In these other areas, Congress has required that every vehicle satisfy certain minimal standards. The CAFE system, in contrast, allows vehicles with low fuel economy to be sold, so long as they are counterbalanced by the sale of vehicles with high fuel economy.3 The system thus maintains a measure of flexibility for both manufacturers and consumers, which presumably reflects Congress's conclusion that, for example, the opportunity to purchase large cars should be preserved despite their low fuel economy. The net effect is that the CAFE system, while encouraging vehicle weight reduction and other changes, allows some diversity in the fleet. As discussed earlier, the introduction of CAFE standards coincided with significant advances in automotive fuel economy. There is some disagreement among analysts as to the impact of CAFE standards in bringing about the change. Some of the increased fuel economy may be attributed, for example, to the impact of rising fuel prices in the late 1970s and early 1980s (see, e.g., Leone and Parkinson, 1990). Nonetheless, there is no doubt that the CAFE standards have, at the least, reinforced market pressures in bringing about an upgrading of the fuel efficiency of the vehicle fleet. The committee finds, however, that the CAFE system has both weaknesses and strengths. Some of the weaknesses are outlined below: Dissonance Between CAFE Requirements and Market Signals. The CAFE approach places the manufacturer in an awkward position in the marketplace. The system constrains consumer choice—at least in the aggregate—to vehicles with characteristics that differ from those that otherwise would be offered. In effect, the manufacturers are required to sell vehicles with higher fuel economy regardless of consumer interest in purchasing such vehicles.4 A rational consumer—other things being equal—should always prefer a fuel-efficient vehicle over a fuel inefficient vehicle. But, in fact, an increase in fuel economy can impose costs: the financial costs of the technology to achieve fuel economy and the costs reflected in reduced vehicle size, decreased performance, or other undesired attributes.5 To the extent that improved fuel economy is achieved at the expense of other characteristics of the vehicle that the   3   Because of the effect of harmonic averaging, the CAFE system can present the manufacturers with a more substantial challenge than might be immediately apparent. For example, to achieve a CAFE level of 30 mpg, a manufacturer would have to sell two 40-mpg vehicles for each 20-mpg vehicle that is sold. 4   Surveys indicate that the typical consumer now values fuel economy far less than a variety of other vehicle attributes (presentation by Ford Motor Company to the committee's Impacts Subgroup, September 16, 1991; Consumer Attitude Research, 1991). 5   As discussed in Chapter 6, reduced fuel consumption enables the consumer to recover some of the costs through lower operating costs. Moreover, some of the technologies that improve fuel economy provide other benefits to consumers. Nonetheless, the CAFE system is intended to require manufacturers to produce vehicles that depart from those that consumers might otherwise select.

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Automotive Fuel Economy: How Far Should We Go? consumer values more,6 the manufacturer is being required to try to sell a product that does not reflect consumer demand. The consequence is an undesirable diminution in consumer satisfaction and, presumably, a reduction in overall automotive sales.7 In short, over the past several years, there has been a growing dissonance between CAFE standards and market signals as the real price of gasoline has fallen. Competitive Effects. The existing CAFE standards can have perverse competitive effects. The standards have their most severe impact on the full-line manufacturers—the manufacturers that include large cars among their offerings. Because large cars in general have lower fuel economy than small cars, full-line manufacturers must invest resources to increase their sales of small cars and/or must invest in technology to increase the fuel economy of their large cars. Manufacturers of small cars, on the other hand, can more readily meet the standards and, indeed, may have fleets sufficiently above the CAFE standards as to enable them to expand initially into the large-car market without applying the expensive technology required of the full-line manufacturer. The system, thus, does not present equivalent technical or financial challenges to the manufacturers: Full-line manufacturers must strain to comply, whereas small-car manufacturers can comply with comparative ease. As it happens, this characteristic of the CAFE system has operated to the benefit of the Japanese manufacturers, and at the expense of the domestic (and some European) manufacturers. The CAFE system, thus, enhanced the competitive position of those foreign manufacturers that now pose the greatest threat to the domestic industry. Attenuated Impact on Fuel Consumption. Although the CAFE system encourages a fleet with higher fuel economy, it does not provide incentives for the use of a vehicle in a way that conserves fuel. In fact, to the extent that vehicles become more efficient and fuel prices remain unchanged, the consumer has incentives to respond to the lower per-mile fuel costs that efficient vehicles provide by driving more. Indeed, exactly such a trade-off has taken place: The improved fuel economy of automobiles has saved fuel, but some of the gains in fuel economy have been spent in the form of increased travel (cf. Chapter 6). To the extent that vehicle miles traveled (VMT) increase as a result of improved fuel economy, the goal of reduced overall fuel consumption is compromised.   6   Some technologies that increase fuel economy can be attractive to consumers. For example, aerodynamic styling, four-valve-per-cylinder engines, and electronically controlled transmissions may enhance both fuel economy and consumer interest. To the extent that fuel economy requirements impose constraints on the manufacturers, however, the net effect is a reduction in the manufacturer's ability to optimize vehicles in a way that maximizes consumer satisfaction. 7   The CAFE system initially imposed constraints on the automotive manufacturers at a time in the late 1970s and early 1980s in which the American public was experiencing a rapid increase in gasoline prices. It may plausibly be argued that the CAFE system, by requiring the manufacturers to produce more fuel-efficient vehicles, in fact prepared the manufacturers to meet the consumer demand that arose for those vehicles as a result of the increased fuel prices. The late 1980s, however, saw a reduction in gasoline prices in real terms. As a result, the achievement of high fuel economy is now of lesser importance to the public than other vehicle characteristics.

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Automotive Fuel Economy: How Far Should We Go? Slow Impact on Fuel Economy of Fleet. The CAFE standards affect only a portion of the fleet—the new vehicles sold in the years to which the standards apply. Even aggressive CAFE requirements, thus, have a slow impact on overall fuel consumption because of the slow turnover of the vehicle fleet. Moreover, if the standards became so stringent that the cost of automobiles increases significantly or their characteristics (e.g., size, performance) became less desirable, consumers might tend to continue to operate older cars. Because the older vehicles in the fleet are in general the least fuel efficient and the most undesirable in terms of environmental pollution, incentives that inhibit vehicle turnover could delay the achievement of the objectives of the regulatory system.8 Gaming. The CAFE regulatory approach—perhaps like any complex regulatory system—also invites "gaming" to exploit the system.9 For example, because the fuel economy of automobiles is determined on a specified test cycle, manufacturers seeking to enhance their CAFE performance understandably adjust their cars—the shift points on automatic transmissions, for example—to optimize fuel economy on the test cycle. To the extent that the test cycle departs from actual driving conditions, however, cars tuned for fuel economy on the test cycle may not optimize fuel economy in real-world driving. Similarly, the CAFE system distinguishes between domestic and foreign automobile fleets, which can lead to distortions in the locations at which vehicles or parts are produced in ways that are not justified by market conditions. 10 Mix Shifting. In order to ensure compliance with an aggregate fleet-average standard, manufacturers may find it necessary to induce consumers to shift to smaller cars. As discussed in Chapter 3, such a trend may have safety consequences.   8   As noted in Chapter 4, the production of a new vehicle involves the investment of energy resources that are equivalent to about two to three years of fuel use. Thus, the turnover of the automobile fleet has an energy cost, although much of the energy is not provided through petroleum. Evaluation of the impacts of fleet turnover should include consideration of the energy and environmental costs of production, as well as the energy and environmental savings that a more modern fleet would provide. 9   This is not to suggest that actions by the manufacturers to use the regulatory system to best advantage are improper. Indeed, such behavior is consistent with the law and should be expected. In fact, it is the committee's view that the manufacturers are not alone in their gaming of the system. For example, it appears that at least part of the public's growing interest in light trucks and vans is a result of the more lenient CAFE and other requirements that apply to such vehicles. In effect, the public has exploited the system so as to avoid the effects of CAFE regulations. 10   An automobile is deemed to be a foreign automobile unless 75 percent of its value added is of domestic origin (15 U.S.C. § 2003(b)(2)(E) (1988)). By adjusting the production location or the source of parts, a manufacturer has the capacity to allocate an automobile to either its domestic or its foreign fleet. Although the manufacturer must meet the CAFE requirements for each fleet, the distinction between foreign and domestic fleets does not limit or reduce the aggregate fuel economy of the manufacturer's total new car fleet. But, the distinction does have an impact on the location of production activities. For example, some manufacturers may choose to produce large cars abroad or to purchase parts for such cars abroad so as to "use" the CAFE opportunities for large-car sales that their foreign small-car production provides. Ford has turned to foreign sources of parts for its Crown Victoria for exactly this reason.

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Automotive Fuel Economy: How Far Should We Go? Costs and Benefits. Fuel economy standards should be set at the point at which the marginal costs of the requirements balance the (overall) marginal benefits. Some evaluations have asserted that the costs of the CAFE standards far exceed their benefits (see, e.g., Charles River Associates, 1991; Leone and Parkinson, 1990; Shin, 1990). Others have found that the CAFE system is cost-effective (see Greene and Duleep, 1991). It seems, however, the CAFE approach, which involves the establishment of a fleet target by a political process many years in advance, will achieve a balance of costs and benefits only with difficulty.   Wholly apart from the cost-benefit balance, the costs of the system are largely concealed. The costs of the technologies to improve fuel economy are embedded in the prices of new cars. In addition, the system affects the pricing structure for cars: Full-line manufacturers may discount small cars and exact a premium for large cars so as to ensure a fleet mix that achieves compliance with the CAFE standard. The true costs are not easily tallied—a deficiency in any regulatory system. Although the undesirable attributes of the CAFE system are significant, the approach has the following positive features: Technology Forcing. By imposing a mandatory fuel economy requirement for the fleet, the CAFE system forces manufacturers to introduce fuel-conserving technology. Although compliance with CAFE could be achieved by shifting the fleet mix to smaller cars, any such efforts would confront consumer resistance (at least at current fuel prices). Hence, there are strong incentives for the manufacturers to provide both fuel economy and vehicle characteristics that consumers favor. This direct technology-forcing aspect of CAFE is difficult to obtain through alternative approaches, particularly since the rational consumer may be relatively indifferent to significant variations in vehicle fuel economy (see Chapters 6 and 8). Reduced Vulnerability to Increased Oil Prices. The CAFE system does serve, in time, to bring about a more fuel-efficient fleet, an important and desirable goal. In effect, while oil is plentiful, it allows—perhaps, through lower per-mile operating costs, even encourages—the use of petroleum. A more efficient fleet also provides greater mobility when oil becomes scarce. Because it is impossible to turn over the fleet quickly, the establishment of a fuel-efficient fleet reduces (but does not eliminate) the vulnerability of the United States to the effects of an interruption in oil supplies. Market Pressures. The CAFE system reduces the capacity of foreign oil suppliers to raise prices. It also reduces current and potential demand for petroleum without decreasing the use of automobiles and light trucks. In effect, it diminishes the leverage that foreign petroleum cartels might otherwise be able to exploit.   Although the CAFE system has some favorable dimensions, the CAFE approach to achieving automotive fuel economy has defects that are sufficiently grievous to warrant careful reconsideration of the approach. Policymakers should explore other options or, if the continuation of the basic approach is deemed necessary, consider

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Automotive Fuel Economy: How Far Should We Go? modifying the system to diminish its undesirable effects. The remainder of this chapter explores some of the alternatives that the committee believes warrant further scrutiny. MARKET APPROACHES TO REDUCED FUEL CONSUMPTION Various market incentives could be introduced to encourage consumer behavior that reduces fuel consumption. Two such approaches are discussed below: a policy of increasing the price of automotive fuel, and a system of fees and rebates to encourage the acquisition of fuel-efficient vehicles.11 Both approaches have the advantage of using the market to achieve fuel economy by aligning consumer behavior with societal goals. Increases in Fuel Price One alternative—or supplement—to the existing CAFE system is a federal policy to increase the price of automotive fuel.12 Federal efforts to enhance the fuel economy of vehicles reflect the conclusion that market forces are inadequate to ensure a usage of fuel that is consistent with societal objectives. Efforts to bring the price of fuel more in line with its "true" societal costs would allow market pressures to provide appropriate incentives to consumers. Any strategy for increasing automotive fuel prices raises important issues of public and political acceptability. If an increase in fuel price were viewed as a tax, significant political costs would likely attend its enactment. Indeed, a gasoline tax can be regressive in that it has a differentially greater impact on people with lower income. It is the committee's view that, properly considered, efforts to increase fuel prices should not be characterized as a tax. A gasoline price increase should be set so as to reflect the true cost of gasoline usage. Thus, a price increase is a price correction, not a tax purely for the purposes of raising revenue. Moreover, there are opportunities to collect fees at the gas pump relating to automotive usage that would otherwise be collected through other means. Such an approach would mean there could be no net 11   Numerous other strategies could be considered. For example, incentives might be provided to encourage the drivers of older cars to purchase newer vehicles. Because older cars have poorer fuel economy than new cars, such a strategy raises the fuel economy of the fleet. Moreover, because older cars in general pollute the environment more than new cars, such a system would also have environmental benefits. However, despite recycling and especially extensive use of ferrous scrap, there are energy and environmental consequences from early retirement of vehicles, including more waste materials requiring proper disposal. 12   The increase in price could be aimed at gasoline, at petroleum-based automotive fuels (gasoline and diesel), at petroleum, or even at carbon usage. A focus on automotive fuel would help reduce fuel consumption in the automotive sector, but it would not directly affect other parts of the economy. In contrast, a petroleum tax or a carbon tax would have widespread direct impacts throughout the economy and would achieve somewhat different objectives. A carbon tax, for example, presumably would reflect emphasis on responding to concerns about global warming. Given the scope of this report, the committee has focused on the implications of a strategy of increasing the price of petroleum-based automotive fuels. This does not imply that the committee rejects a more comprehensive strategy.

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Automotive Fuel Economy: How Far Should We Go? increase in payments by the average driver, but collection of such funds at the gas pump would provide incentives for improved fuel consumption. For example, there is widespread discussion of the nation's decaying transportation infrastructure—roads, bridges, and the like—and of the need for substantial investment in its restoration and improvement (National Research Council, 1987; U.S. Department of Transportation, 1991b). Funds collected at the gas pump for this purpose would pass the costs of this investment on to those who directly benefit from it.13 Indeed, there may be opportunities for investments of this kind that can reap improvements in fuel consumption and in safety that may exceed those attainable at equivalent cost through improved automotive technology. Such opportunities might include improved traffic management—improved road design, synchronized traffic lights, alternative-routing systems, and the like—and, in some circumstances, mass transportation systems. Such investments are important because a car in a gridlock is wasting fuel, no matter how impressive its CAFE rating. The trend toward increased numbers of vehicles on a road system that is not designed to accommodate them obviously compromises the achievement of efficient gasoline usage. There are also possible opportunities to collect other types of fees at the fuel pump in a way that would not impose any net cost on the average consumer. For example, at least some portion of automotive insurance costs is properly related to the number of miles traveled and the location of that driving.14 The recovery of a portion of the costs of insurance at the gasoline pump might allow an equitable recovery of insurance costs. Because insurance costs are a significant fraction of the operating costs of a vehicle, collecting a portion of them at the gas pump might also provide an important incentive for more efficient use of fuel with no net out-of-pocket impact on the average consumer. In sum, the committee does not believe that political concerns about increased taxes should foreclose consideration of a strategy of increasing fuel prices. Indeed, efforts to increase the price of fuel would help to achieve the following important objectives: Encouragement of Fuel Conservation. Even if the CAFE system was not eliminated, an increase in fuel price would encourage conservation. The consumer would have incentives to acquire a fuel-efficient vehicle that is consistent with his or her needs and to use that vehicle in a way that conserves fuel. The existing CAFE system, in contrast, provides incentives to use improved automotive fuel efficiency at least in part in increased vehicle usage. Impact on Entire Fleet. An increase in fuel price would also provide incentives to improve the fuel economy of the entire vehicle fleet. Unlike the existing   13   To the extent that any revenues collected at the pump are allocated to the improvement of the transportation system, the force of the claim that such increases in price have an undesirable regressive impact is reduced. 14   Other types of fees—such as registration fees—might also be collected at the gas pump.

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Automotive Fuel Economy: How Far Should We Go? CAFE system, an increase in fuel price would affect all drivers (and the miles they choose to drive), not just the purchasers of new vehicles. And, to the extent that existing automobiles are not fuel efficient, an increase in fuel price would encourage turnover in the fleet. Market Reinforcement of Societal Goals. An increase in fuel price would encourage the consumer, within certain limits, to trade off vehicle attributes in a way that is consistent with societal objectives.15 Unlike the existing CAFE system, the market would cause the consumer to weigh fuel economy more heavily among the attributes of the car (e.g., performance, size, weight) that are to be considered. Also, unlike the existing CAFE system, the market would provide incentives that reinforce societally desirable consumer decision making. The dissonance between the regulatory system and the market would be reduced. Competitive Effects. A policy of improving fuel economy by increasing fuel price would constrain full-line manufacturers (the domestic producers) in their ability to compete in various size classes only to the extent that they were unable to produce vehicles with the fuel economy of foreign manufacturers. (Increasing fuel prices would also cause mix shifts to small cars, thereby giving advantages to the strong producers in those segments.) There is no indication that the domestic manufacturers are unable to compete in this area. 16 Market Efficiency. Reliance on the price of fuel to encourage fuel economy in lieu of CAFE requirements would not affect the location of production operations. And, unlike the existing CAFE system, there would be less incentive to seek to ''game" the regulatory system to exploit its defects. Perhaps even more important, if fuel prices were set at levels that fully reflected the externalities, the market in theory would serve to balance costs and benefits so as to ensure a cost-effective policy toward fuel efficiency.   Although reliance on increased fuel price in lieu of a CAFE system offers many advantages, the following drawbacks to the approach must also be considered: Economic Disruption. The size of the fuel price increase that would be necessary to achieve fuel savings equivalent to those demanded by aggressive CAFE standards might be quite substantial. The committee has had neither the time nor the capacity to evaluate fully the price increase for fuel that would induce reduced fuel consumption that is equivalent to that associated with aggressive CAFE standards. It may well be the case that the necessary increases in fuel price are so great as to make   15   The environmental and safety attributes of automobiles are established as rigid requirements that all vehicles must satisfy. There would remain an important governmental role to ensure that these mandatory requirements reflect an appropriate balancing of societal objectives. 16   In discussions with the committee, certain of the domestic manufacturers asserted that, when the size class of their vehicles is considered, they achieve a fuel economy that meets or exceeds that of their foreign competitors (see Chapter 5). Indeed, heightened consumer sensitivity to fuel economy might increase interest in 4-cylinder engines, a type of engine for which the domestic manufacturers currently have excess capacity.

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Automotive Fuel Economy: How Far Should We Go? sole reliance on a pricing strategy politically unacceptable because of the ripple effects on the economy of the adjustment to higher prices.17 Moreover, such an increase in prices could upset reliance on low fuel costs, such as by those who live distant from their workplace. Societal Disruption. As discussed above, a reduction in vehicle miles traveled—one of the effects of fuel price increases—would reduce fuel consumption and diminish the environmental threat presented by automobiles. The achievement of those benefits would have its associated costs, however. American society is based on the mobility that low-cost fuel allows. If increasing fuel prices constrained travel significantly, there would be disruptive effects. Such a modification of American ways may be overdue, but one should not underestimate the implications to society of any reduction in mobility that might attend substantially increased fuel prices.18 Diminished Pressure for Technological Change. Sole reliance on increased fuel prices to reduce fuel consumption would diminish the technology-forcing element of the existing CAFE system. Although the increased price of gasoline would create market pressures for the development of technology to improve fuel economy, the rational consumer would demand only those technologies that would pay for themselves through fuel savings. Moreover, only a few of the available technologies that might be demanded by an aggressive CAFE standard may be cost-effective unless very substantial increases in fuel price occurred.19 The CAFE system, in contrast, encourages technological advances that do not pay for themselves in terms of fuel savings, even at elevated fuel prices.20 Although a rational consumer might not choose   17   A report prepared for the Motor Vehicle Manufacturers Association by Charles River Associates (1991) asserts that a gasoline tax of 27.5 cents per gallon that is phased in at an annual rate of 5.5 cents per gallon from 1992 to 1996 and held constant thereafter would yield, at less expense, cumulative gasoline savings until 2002 exceeding those from a CAFE standard that dictates 40-mpg fleet averages by the year 2001. These excess savings accrue over the short term because the gasoline tax immediately affects all vehicles, including the new car fleet. However, because the impacts of the CAFE system are delayed by reason of the diluted impacts of new car fuel efficiency on fleet-wide fuel efficiency, the long-term effects of a 40-mpg CAFE standard would be much more substantial than the 27.5 cents per gallon fuel tax. Other analyses suggest that much greater price increases (perhaps in excess of $1 per gallon) would be required to achieve the impact of such CAFE requirements (U.S. Department of Transportation, 1991a). 18   Increased fuel prices might encourage drivers to reduce miles traveled in ways that do not require a significant modification of life-style. For example, shoppers might plan their trips more carefully and workers might join carpools or use public transportation. The unavoidable impacts of increased fuel costs might fall most heavily on the rural poor. 19   Although other countries have fuel prices substantially higher than of those in the United States, this fact has not induced the introduction of new technologies offering radically enhanced fuel economy. Fuel consumption in those countries is lower on a per-vehicle basis because of the types of automobiles that are purchased—typically smaller cars with manual transmissions and without air conditioning—and because people drive less. 20   Moreover, a CAFE approach can spur the introduction of even cost-justified technology at a faster pace than the market. In order to ensure the reliability of new technology and to prevent the premature obsolescence of current production facilities, a manufacturer typically introduces a new technology in only a small portion of its fleet. The experience that is gained can reduce the risk associated with the widespread introduction of the

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Automotive Fuel Economy: How Far Should We Go?   such a vehicle in the market,21 the CAFE approach creates an inventory of fuel-efficient automobiles, which provides some protective capacity in the event of a petroleum interruption. Mix Shifting. Significantly increased fuel prices would induce a reduction in miles traveled and mix shifting by consumers to smaller cars. Thus, although the safety impacts of future downsizing may be uncertain, any safety effects brought about by aggressive CAFE requirements might also be associated with a strategy of sharply increased fuel prices. The safety impacts would be reduced, however, because the impacts of mix shifting would be counteracted to some extent by reduced miles traveled and by the trading-in of older, less safe cars for new cars with improved safety. Impacts on Manufacturers. An increase in the price of fuel, if not collected in some revenue-neutral way, would increase the cost of owning and operating a vehicle. If the price increase was significant, aggregate demand for new vehicles would be reduced, which would have adverse impacts on the auto industry and its employees. Moreover, as noted above, increased fuel prices could induce mix shifting by consumers, which would have a differential effect on the various manufacturers. Nonetheless, in their presentations to the committee, the automobile manufacturers have uniformly identified a strategy of increasing fuel prices as a desirable alternative to the CAFE system.   The committee recognizes that balancing the costs and benefits of a strategy of using fuel prices to improve fuel economy in lieu of CAFE-style regulations involves a significant measure of judgment on which reasonable people may well differ. The committee nonetheless believes that, at the least, a strategy of complementing fuel efficiency regulations with modest fuel price increases may be appropriate so as to minimize at least some of the disadvantages associated with CAFE standards. For example, even limited price increases for fuel would reduce the gulf between market signals and the regulatory requirements. Although conscious of the delicate state of the economy, the committee believes that market circumstances warrant consideration of a policy of increasing fuel prices. As shown earlier (refer to Figure 1-4), the price of gasoline is now lower in real terms than at any time in the recent past. In such circumstances, an increase in the price of gasoline would, in part, restore price levels. Indeed, because of the low real price of gasoline, the CAFE system is increasingly inconsistent with market pressures, which exacerbates the various problems described above.     technology. An aggressive CAFE system could force the manufacturers to accept increased risk and cost in introducing technology. 21   Indeed, as shown in Chapter 6, a rational consumer might be relatively indifferent to fuel economy ratings over a considerable range.

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Automotive Fuel Economy: How Far Should We Go? The United States stands alone among the industrial nations in its policy toward gasoline prices. As shown in Figure 9-1, the price of gasoline in other countries is significantly higher than in the United States. (The increments above U.S. prices are largely the result of taxes, not of higher costs of production.) Other nations have been able to absorb increased fuel prices without significant adverse impacts, and the committee believes that the United States might also accommodate an increase in price. Although the United States may be unique in the degree to which its citizenry relies on the automobile for personal transportation, this fact should not inhibit a pricing strategy for fuel that reflects a larger share of its true costs.22 On balance, the benefits of a policy of increasing fuel prices seem to outweigh the disadvantages. Whether sole reliance should be placed on increased fuel prices as a means to improve fuel economy presents issues that require further scrutiny. Serious consideration should be given to such matters. FIGURE 9-1 Gasoline prices for selected countries, 1979 and 1989. SOURCE: Oak Ridge National Laboratory (1991). 22   An increase in gasoline prices may also commend itself as a national policy for other reasons. The recent Persian Gulf war has reemphasized the vulnerability of the world's petroleum supply. An increase in fuel prices would not only reinforce desirable consumer behavior, but could supplement the nation's Strategic Petroleum Reserve in that it would provide a buffer to the shock to the economy that could arise from a severe supply disruption. A supply disruption could threaten a sharp run-up in gasoline prices and, in such circumstances, the government could reduce the surcharge on gasoline so as to reduce the resulting economic impacts.

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Automotive Fuel Economy: How Far Should We Go? ceiling established by feebates would be a reasonable and practical constraint on investments in technologies that are not economically justified. IMPROVING THE CAFE SYSTEM Even if it is concluded that market-based alternatives to CAFE regulations are infeasible, consideration should be given to modifying of various aspects of the CAFE system. Timing Because of the nature of the automotive development process, extensive lead time is required to prepare for the introduction of a new automobile. At the time this report was written, the engineering design for cars for MY 1996 was largely fixed. There is no reasonable way to impose significantly enhanced fuel economy requirements on vehicles that are three to four years away from sale without imposing very substantial costs—either very expensive retrofits or price increases to force a mix change. In light of this fact, there is little opportunity by MY 1996 to achieve fuel economy gains that are substantially in excess of those that are already in the product plans of the manufacturers. Any modifications of the CAFE system must recognize this fact. As the time horizon moves to the more distant future, there is an opportunity to establish more significant fuel economy requirements. By establishing firm requirements with an adequate lead time, the regulatory system provides the manufacturers with the opportunity to plan for change in an economically efficient way. For example, the need to achieve certain levels of fuel economy could be accommodated by introducing a new engine that incorporates certain technology at the time that an older engine would have been replaced in any event. The difficulty with establishing requirements in the very distant future, however, is uncertainty: It is difficult to establish standards that will challenge the manufacturers, but that are also practically achievable. Establishing such standards requires significant elements of judgment, and the stakes are very substantial if the judgment is erroneous. Any modification of the CAFE standards should be guided by these realities. Limits for vehicles to be produced in five years (1996) should be substantially similar to the fuel economy already planned by the manufacturers. Standards for vehicles to be produced in 10 years (2001) might be fixed so as to establish a firm planning target for the manufacturers. Standards for cars to be produced in 15 years (2006) might also be established so as to guide advanced product planning and cause the manufacturers to conduct the necessary advanced engineering and research. But, there must be some measure of flexibility in such a distant target to accommodate uncertainty. The 15-year target could then be reconsidered after 5 years and a firm requirement established for vehicles that are then to be produced in 10 years. Such a rolling system of standards satisfies the need for certainty, but also recognizes the need for flexibility to accommodate the uncertainty in distant estimates.

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Automotive Fuel Economy: How Far Should We Go? Alternatives to Uniform Fleet Targets Under the existing CAFE system each manufacturer is required to achieve a specified fleet fuel economy. As discussed above, the approach imposes greater burdens on manufacturers that produce predominantly large cars than on those that produce small cars. This aspect of the CAFE system has disadvantaged U.S. and some European manufacturers in comparison with Japanese manufacturers. Legislation under consideration in Congress (S. 279) would address this problem by requiring certain mandatory percentage gains in CAFE performance ratings by each manufacturer over the level that was attained in a specified base year. This approach would establish different requirements for different manufacturers and would have the perverse effect of requiring those manufacturers with the best fleet fuel economy in the base year to comply with CAFE requirements in the outlying years that are more stringent than those for manufacturers who had not achieved similar accomplishments. The regulatory system would thus penalize those manufacturers who have exceeded the minimal requirements and thereby discourage any fuel economy accomplishments above the baseline in the future. Moreover, the approach is unfair because the currently available technology for improving fuel economy might already have been incorporated in the base year by the manufacturer who is confronted with the largest future-year fuel economy requirements. In addition, the selection of the base year could create arbitrary advantages or disadvantages for the manufacturers based on the happenstance of the product mix or technology that was applied by the manufacturers in that year. The percentage approach would also have important differential effects among the manufacturers. As discussed above, the existing CAFE system has operated to the disadvantage of the full-line manufacturers (the domestic industry) and to the advantage of the producers of small cars (particularly the Japanese). The percentage approach would reverse this effect. Because the small-car manufacturers—who would have high base-year CAFE accomplishments—would be required to achieve higher absolute CAFE requirements under the percentage approach than full-line manufacturers, the small-car manufacturers would have a particular challenge in changing their product mix to include a higher percentage of large cars. As discussed in Chapter 5, the Japanese manufacturers in recent years have sought an increasing share of the large- and luxury-car market. The percentage approach would protect domestic manufacturers from this competition.24 A variety of other alternatives to the current CAFE scheme are worthy of consideration. A revised system might establish fuel economy requirements that are tailored to an attribute of the car, such as usable passenger volume (or passenger-carrying capability) or perhaps size class. For example, cars with larger volume might be required to meet lower fuel economy standards than smaller cars, in recognition that 24   Some Japanese auto manufacturers have claimed that the percentage approach is protectionist and constitutes an illegal trade barrier (comments of American Suzuki Motor Corporation on S.1224, U.S. Congress, 1989).

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Automotive Fuel Economy: How Far Should We Go? the achievement of equivalent fuel economy is more difficult in the larger car. The standards would have to be set, however, so as to challenge the manufacturers to improve the fuel economy of all their vehicles.25 This approach has an advantage over the existing system in that it could be applied so as to ensure that each manufacturer is confronted with a roughly equal challenge regardless of the differences in the sizes of cars that the manufacturer produces. If an attribute or class standard is not imposed on cars and trucks, then a relatively lower CAFE standard may have to be formulated in order to minimize the adverse consequences for full-line domestic manufacturers. Unlike the current CAFE system or the percentage approach, a revised system based on a vehicle attribute does not ensure that a given overall fleet fuel efficiency will in fact be achieved. Manufacturers would be under less pressure to adopt a pricing structure that ensures the sale of sufficient small cars so as to achieve compliance with the fleet standard.26 The attribute-based system thus would not provide any incentive for the manufacturers to encourage mix shifting to small, fuel efficient vehicles. Such a change may be a necessary cost, however, of a system that does not disadvantage the full-line manufacturers and that creates challenges for the enhancement of fuel economy by all manufacturers, regardless of the type of cars they produce. The selection of the attribute (or attributes) that would provide the basis for the revised system admittedly has an element of arbitrariness. For passenger cars, interior volume (or passenger-carrying capacity) appears to be a sensible criterion because it is obviously related to consumer vehicle use. Some people, however, may buy large cars despite an absence of real need for their carrying capacity, and the system provides no incentives for such a consumer to make another choice. Moreover, attributes other than volume could be suggested. For example, performance is an attribute demanded by consumers and its satisfaction, like an increase in volume, tends to undermine fuel economy. Some might suggest that the fuel economy standard could be adjusted to allow higher performing cars to benefit from more lenient standards than lower performing cars. Performance has a very different character than interior volume, however, because its social utility, once certain levels have been achieved, is more debatable. Nonetheless, the selection of the attribute (or attributes) on which to base the system would raise questions of judgment. Another difficulty with an attribute-based approach is that it might be susceptible to gaming. For example, a volume-based standard might provide incentives for a manufacturer to increase the volume of vehicles regardless of whether the increased volume enhances utility for drivers. 27 Similarly, a standard based on size class would 25   This approach might be combined with a corporate-averaging scheme so as not to require the wholesale modification of every model in a given year (Office of Technology Assessment, 1991). 26   Under the existing system, small cars may be more attractively priced than larger cars so as to ensure that the fleet CAFE standard is achieved. This may have desirable social consequences in that it makes vehicles more available for less wealthy purchasers than would otherwise be the case. 27   Chrysler Corporation presentation to the committee's Subgroup on Standards and Regulations, November 4, 1991, Washington, D.C.

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Automotive Fuel Economy: How Far Should We Go? provide an incentive for the manufacturer of a vehicle near the boundary of a class to add additional volume to gain the benefit of the lower fuel economy requirement of the larger size class. The opportunities for gaming and the means, if any, for reducing undesirable side-effects warrant careful scrutiny. The committee has not had an opportunity to pursue such issues in depth, but it believes they require careful examination. Light Trucks As discussed above, light trucks have grown to nearly 30 percent of the total fleet. Currently, these vehicles must comply with significantly more lenient CAFE requirements than automobiles,28 with the consequence that the aggregate fuel economy of the vehicle fleet is compromised by the growth in the light-truck segment. Although trucks and vans used for load-carrying or towing functions should have lower fuel economy than cars due to engineering constraints, the evidence suggests that most consumers of certain popular categories of light trucks use these capabilities only occasionally.29 Moreover, the manufacturers have not been required to achieve fuel economy improvements for light trucks that are commensurate with those required of automobiles. The percentage improvement in the fuel economy of light trucks since 1973 has been about three-fifths of that attained by automobiles (see Chapter 1). The regulatory system should better serve to integrate and conform the requirements for light trucks with those for automobiles. The precise means for achieving such conformance requires further examination. One approach is to include certain categories of "trucks"—small vans, light pickups, and sport utilities—in the automobile CAFE category in recognition of the fact that these vehicles are largely used in the same way as automobiles.30 (Some corresponding adjustment of the aggregate automobile CAFE standard would have to be made to reflect the legitimate constraints on the revised fleet.) But, such an approach would have an important differential effect among the various manufacturers because of their different shares of the light-truck market. Chrysler, for example, is a significant producer of vans and could be seriously affected by such a change. Domestic Content The existing CAFE system requires that each manufacturer separately satisfy the CAFE requirements for its domestic and its foreign fleet. The distinction was introduced so as to ensure that manufacturers currently producing large cars in the United States would have an incentive to produce small cars here as well. Although 28   Whereas automobiles must achieve a fuel economy rating of 27.5 mpg in 1991, light trucks need only achieve 20.2 mpg. 49 C.F.R. §§ 531.5, 533.3 (1990). 29   Presentation to the committee at the July 8–12, 1991, workshop in Irvine, Calif., by the Bureau of the Census entitled "Census of Transportation: The Truck Inventory and Use Survey." 30   Similar approaches could be designed for various alternative CAFE systems. See, e.g., Office of Technology Assessment (1991:104).

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Automotive Fuel Economy: How Far Should We Go? the approach may serve that end, it also provides incentives to produce large cars abroad (or to keep domestic content below the 75 percent limit) so as to avoid wasting any CAFE benefits that are gained from the production of small cars abroad. Indeed, it appears that there is a substantial measure of arbitrariness in the way the system is applied because of the complications associated with evaluating foreign and domestic content. (Business Week, 1991; Fortune, 1991; Wall Street Journal, 1991). It is the committee's view that the domestic-content provision has no obvious or necessary connection to the achievement of fuel economy. Moreover, it is not clear that the restriction achieves any net gain in the domestic manufacture of cars or the preservation of American jobs. Although it may encourage the production of small cars in the United States, it also encourages the production of large cars abroad. The limitation should be evaluated to assess whether the restraint it places on the market achieves any net benefits. Consideration should be given to the elimination of this provision. CAFE Credits The fleet fuel economy achieved by a manufacturer is not completely within the manufacturer's control: It is governed by the mix of vehicles that consumers decide to purchase.31 In light of this fact, it is important that the system provide sufficient flexibility so as to allow the manufacturers to avoid a penalty for shortfalls that are not persistent from year to year. The existing CAFE system provides a measure of flexibility by allowing the carry-forward and carry-back of "credits" for fleet fuel economy that exceeds the CAFE requirements. In this way, manufacturers can avoid the penalty that would otherwise accrue for a temporary shortfall in any given year, at least to the extent that it is "covered" by credits in other nearby years. But, perhaps greater flexibility should be allowed. The committee believes that there may be some merit in allowing the manufacturers to trade CAFE credits. That is, a manufacturer that exceeds CAFE requirements might be allowed to sell credits to manufacturers that fall below the standards. In effect, such trading is currently going on through the sale by some manufacturers under their own marque of vehicles produced by other manufacturers. (This practice is termed rebadging.) Although direct trading of credits may have differential impacts on foreign and domestic manufacturers, it should be considered because it enhances economic efficiency. Unlawful Conduct The existing law provides a penalty of $5 per car for each 0.1 mpg by which a manufacturer falls short of its fleet CAFE requirements (15 U.S.C. § 2008(b)(1) (1988)). Because a shortfall on CAFE compliance constitutes unlawful conduct (15 U.S.C. § 2007 (1988)), however, the violation of the CAFE limit is not a socially 31   Within certain limits the manufacturers can use price as a means to channel consumer decisions. Nonetheless, the mix of cars that are sold is not a variable that is entirely subject to a manufacturer's control.

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Automotive Fuel Economy: How Far Should We Go? or legally neutral act. As a result, the domestic manufacturers have stated that any plan to depart from the CAFE approach presents the threat of legal exposure in addition to the penalties. (The foreign manufacturers do not have the same inhibitions; some foreign manufacturers appear to view the payment of the penalty as a cost of doing business.) The system might be modified so as to remove the characterization of a CAFE violation as unlawful conduct, thereby allowing the manufacturers to trade-off the costs of compliance with the penalty.32 Such a modification would put an effective cap on the cost of compliance with the CAFE requirements—thereby enabling some balancing of costs and benefits, a real advantage. Such a modification of the system, although subtle, would effectively introduce some of the elements of the feebate system within the existing regulatory structure. OTHER POLICIES FOR REDUCING FUEL CONSUMPTION As noted above, the chief purpose of the legislation establishing fuel economy standards was to reduce the consumption of petroleum by cars and light trucks. If this objective is to be served, it is important to recognize that a variety of approaches in addition to those discussed above can have an important impact on petroleum use. An appropriate strategy for reducing petroleum consumption is to consider a variety of tools to address the problem and to select those that can achieve the objective at the lowest cost. An appropriate strategy need not rely on one approach—for example, reliance on CAFE standards—to achieve the policy objective. Although the committee did not examine other approaches in detail, a number are mentioned below because they touch in important ways on fuel economy: Infrastructure Improvements. Real-world fuel economy is directly governed by the capacity of the road system to enable drivers to travel quickly, efficiently, and safely. As noted above, the nation suffers from a decaying transportation infrastructure. Improvement of roads, bridges, highways, and the like would not only improve safety, but also offer fuel economy benefits by improving traffic flow and reducing delays (National Research Council, 1987). Intelligent Vehicle-Highway Systems. Information and computer technology can be harnessed to improve traffic flow. There are numerous opportunities to do so through providing alternate route and road information, synchronized traffic lights, and the like (National Research Council, 1991). Public Transportation Systems. Public transportation systems can provide the means for the movement of large numbers of people at very low consumption of fuel per passenger mile. Indeed, electrically powered public transit may not be dependent on petroleum at all, although it still may contribute indirectly to greenhouse gas emissions because of the use of fossil fuels in the generation of electricity. In   32   The modification might be accompanied by an adjustment of the fee. The fee should be set at a level that approximates the social costs of noncompliance.

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Automotive Fuel Economy: How Far Should We Go? appropriate circumstances, improved public transit can be a means for reducing demand for petroleum and for limiting the traffic load on congested streets. Highway Speeds. As discussed above, the aerodynamic drag on a vehicle is proportional to the square of the velocity of the vehicle. As a result, a vehicle traveling at 55 mph can operate significantly more efficiently than one traveling at 65 mph (or higher). The reduction of speed limits, although politically unpopular, is a rational strategy for reducing petroleum consumption and enhancing safety (National Research Council, 1984). Car Pooling. A significant portion of fuel consumption is related to commuting to and from work. Tax or other policies could be adjusted so as to encourage car pooling and thereby reduce the number of vehicles involved in commuting.   Although this study has focused on the means for enhancing the fuel economy of cars and light trucks, the objective of reducing the consumption of petroleum can be achieved by a wider set of policy tools than has been examined. All such policies should be weighed and applied as appropriate. SUMMARY The means by which improved fuel economy is attained have important implications for consumers, manufacturers, and automotive workers. This review leads to the following observations: The exiting CAFE system has defects that warrant careful examination. Chief among the defects is the fact that the CAFE system, over recent years, has been increasingly at odds with market signals, which mutes and diminishes the system's effectiveness and increases its costs. Moreover, the CAFE system has operated to disadvantage the domestic manufacturers in competition with certain foreign manufacturers (principally Japanese). A policy of increasing fuel prices warrants consideration either as an alternative to fuel economy regulation or as a complement to it. Increasing fuel prices would internalize the costs associated with fuel consumption and would thereby provide appropriate market signals to channel consumer behavior in a direction consistent with societal objectives. A system of fees and rebates that are related to the fuel economy of vehicles might also be considered. Such ''feebates" would encourage the acquisition of fuel-efficient vehicles. In determining whether the CAFE system should be retained, Congress should consider several modifications, including the following:  

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Automotive Fuel Economy: How Far Should We Go? Establish a rolling set of requirements that reflect the need to provide the manufacturers with adequate lead time to comply with CAFE requirements, but that allow for modification of requirements that are distant in time. Alter the system so as to present equivalent technical challenges to manufacturers, regardless of the type of vehicles they produce. Standards based on a relevant vehicle attribute, such as interior volume, should be examined. Bring the fuel economy standards for light trucks into conformance with those for automobiles. Study the elimination of the distinction between domestic and foreign fleets for CAFE purposes. Enhance the flexibility of the CAFE system by allowing the trading of CAFE credits. Modify the law so as to remove the characterization of noncompliance with a CAFE limit as unlawful conduct and increase the penalty to a level that approximates the social cost of noncompliance. This change would increase the flexibility to respond to the law in an economically efficient way. The percentage-improvement approach to CAFE regulation—an approach proposed in legislation pending in Congress—has the perverse effect of requiring those manufacturers with the best fleet fuel economy in a base year to comply with CAFE requirements in the outlying years that are more stringent than those applied to manufacturers with lesser accomplishments. The selection of the base year would create arbitrary advantages and disadvantages, depending on the happenstance of the product mix or technology that was applied by the manufacturers in the base year. The system is unfair because the manufacturers confronting the most stringent requirements may already have incorporated in the base year many of the available technologies for improving fuel economy. Moreover, the system would limit efforts by the Japanese manufacturers to increase their market share of larger cars and thereby reduce competition in that segment. The objective of reducing petroleum consumption can be achieved by a variety of means. In addition to the CAFE system (and its variants) and increased fuel prices, the available policy instruments include improvements in the transportation infrastructure, intelligent vehicle-highway systems, improved public transit, reduced speed limits, and incentives for car pooling. All such policy instruments should be considered in developing an appropriate federal strategy for reducing petroleum consumption.  

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