Image Credit: Potomac Gas & Fuel Co. , None. [Between 1918 and 1921] [Photograph] Retrieved from the Library of Congress
Most motor vehicles emit pollution, including greenhouse gases, and use gasoline that increases national dependence on foreign oil. On standard economic grounds, the result is a market failure in the form of excessive pollution, for which some kind of cap-and-trade system or corrective tax is the best response, designed to ensure that drivers internalize the social cost of their activity. The choice between cap-and-trade programs and carbon taxes raises a host of important questions. But the fundamental point is that economic incentives of some kind, and not mandates, are the appropriate instrument. Simply put, incentives are far more efficient; for any given reduction in pollution levels, they impose a lower cost.
For obvious reasons, a great deal of recent analysis has been focused on greenhouse gas emissions and how best to reduce them. In principle, regulators have a host of options. They could create subsidies—say, for electric cars. They could nudge consumers—say, by providing information about greenhouse gas emissions on fuel economy labels. They could impose regulatory mandates—say, with fuel economy and energy efficiency standards. Careful analysis suggests that carbon taxes can produce reductions in greenhouse gas emissions at a small fraction of the cost of fuel economy mandates (Karplus et al. 2013; Knittel 2019). On one account, “a fuel economy standard is shown to be at least six to fourteen times less cost effective than a price instrument (fuel tax) when targeting an identical reduction in cumulative gasoline use” (Karplus et al. 2013, 322).
These are points about how best to reduce externalities. But behaviorally informed regulators focus on consumer welfare, not just on externalities. They are concerned about a different kind of market failure, one that is distinctly behavioral. Regulators speculate that at time of purchase, many consumers, focused on the short term, might not give sufficient attention to the full costs of driving a car. Even if they try, they might not have a sufficient understanding of those costs, because it is not simple to translate differences in MPG into economic and environmental consequences (Larrick and Soll 2008). An obvious response, preserving freedom of choice, would be disclosure, in the form of a fuel economy label that might correct that kind of behavioral market failure and, in a sense, offer people a vision of Laterland.
Such a label might, for example, draw the attention of consumers to the long-term costs or savings associated with motor vehicles. Indeed, the existing label in the United States does exactly that; it specifies annual fuel costs and also five-year costs (or savings) compared to the average vehicle (see figure 1).
In principle, such a label, if designed to counteract present bias, should solve the problem. In short: labels should be used to promote consumer welfare by increasing the likelihood that consumers will make optimal choices, while corrective taxes should be used to respond to externalities. A label protects consumers from their own mistakes, in terms of their self-interest; corrective taxes protect those who are injured by pollution.
Figure 1. Fuel economy label, United States Environmental Protection Agency
But the existence of present bias makes it reasonable to wonder whether such a label would be sufficient. It might not be easy to get people to attend to Laterland. This is an empirical question, not resolvable in the abstract. Perhaps some or many consumers would pay too little attention to the label and hence would not purchase cars that could save them a significant amount of money. If consumers are frequently inattentive to the costs of operating a vehicle at the time of purchase, and if they tend not to make fully informed decisions in spite of adequate labeling (perhaps because of present bias), then it is possible to justify fuel economy standards with a level of stringency that would be difficult to defend on standard economic grounds.
In support of that argument, it would be useful to focus directly on two kinds of consumer savings from fuel economy standards, involving internalities rather than externalities: money and time. In fact, the vast majority of quantified benefits from recent fuel economy standards have been said to come not from environmental improvements, but from money saved at the pump; turned into monetary equivalents, the time savings are also significant. Under the Obama administration’s fuel economy standards, the Department of Transportation found consumer savings of about $529 billion, time savings of $15 billion, energy security benefits of $25 billion, carbon dioxide emissions reduction benefits of $49 billion, other air pollution benefits of about $14 billion, and just under $1 billion of savings from reduced fatalities as a result of cleaner air (NHTSA 2012, 49–50). The total projected benefits were $633 billion over 15 years, of which a remarkable 84 percent comes from savings at the pump, and no less than 86 percent from those savings along with time savings (because drivers do not have to go to the gas station as often) (Bento et al. 2020).
In its own rulemaking, the Trump administration rethought those numbers by referring to recent work (e.g., Allcott and Knittel 2019; Busse, Knittel, and Zettelmeyer 2013; Sallee, West, and Fan 2016) that questions whether consumers really are insufficiently attentive to economic savings. But in the end, the Trump administration projected consumer savings to be in the same general vicinity (Bento et al. 2020). (In fact, they turned out to be higher.) The Biden administration produced numbers that were broadly similar to those of previous administrations—in the sense that, once again, the strong majority of monetized benefits come from consumer savings (EPA 2021, 74500).
The problem is that, on standard economic grounds, it is not at all clear that consumer benefits in the form of money and time savings should count in this analysis, because they are purely private savings and do not involve externalities (Gayer and Viscusi 2013). In deciding which cars to buy, consumers are certainly capable of considering private savings from fuel-efficient cars; if they choose not to buy such cars, it might be because they do not value fuel efficiency as much as other vehicle attributes, such as safety, aesthetics, and performance. Where is the market failure? If the problem is a lack of information, the standard economic prescription is the same as the behaviorally informed one: fix the label and provide that information so that consumers can easily understand it. More simply, make Laterland fully present.
We have seen, however, that even with the best fuel economy label in the world, consumers may turn out to be insufficiently attentive to the benefits of improved fuel economy at time of purchase, not because they have made a rational judgment that other factors outweigh these benefits, but simply because consumers focus on other, more current variables, such as performance, size, and cost. So the problem may not be one of information but of present bias and insufficient attention. The behavioral hunch is that automobile purchasers do not give adequate consideration to economic savings. Apart from economic savings, there is the question of time: How many consumers think about time savings when they are deciding whether to buy a fuel-efficient vehicle?
Cass R. Sunstein teaches at Harvard Law School and is author of Decisions about Decisions.