The Obama administration’s cash-for-clunkers program of paying up to $4,500 for owners of fuel-thirsty vehicles to trade them in on more fuel-efficient vehicles may not be a clunker itself, but it is no creampuff.
The program is pretty simple. The government will make sliding-scale payments of up to $4,500 to owners who trade in vehicles that get poor gas mileage for ones that get substantially better gas mileage. The trade-ins must be scrapped. To avert the most obvious way to game the system, the buyer must have owned the trade-in for at least a year.
There are multiple stated objectives to the program. Replacing high fuel-consumption vehicles with others that use less fuel should reduce pollution, energy consumption and oil imports. Increased vehicle purchases will aid profits and employment in the struggling auto industry, with spillover benefits for the general economy. Sales taxes on increased vehicle sales will help financially strapped states.
Economics is all about how humans respond to incentives. The observation that if you subsidize some activity, people will do it more has been demonstrated again and again. So yes, paying cash for clunkers should increase the trading in of such vehicles. The question is how much the increase will be and the size of the actual effects on the environment, the auto industry and oil consumption.
But the more important question is whether paying a $4,500 trade-in subsidy is a cost-effective way to achieve whatever beneficial objectives the program may have. Or are there cheaper and more efficient alternatives?
The answer depends in part on the net change in the number of vehicles sold. Consider two alternatives at opposite ends of the spectrum. First, consider someone with an old pickup worth only $200 who was already in the market for a small car. The new subsidy program reinforces a decision already made. There is no net change in the number of vehicles sold or gas consumed or pollutants emitted. The buyer gets a windfall payment of $4,500. The only effect on the economy as a whole is up to $4,500 of consumer spending. This is reduced by the amount the recipient uses the money to pay down debt rather than increasing spending.
The polar opposite would be someone with an SUV with a value of $4,000. Without the new program, she would not buy a new vehicle for a couple of years. The extra $500 over the trade-in value she would get for retiring her clunker could be just enough to tip the scales and send her to the dealership. There is an increase in vehicles sold, at least this year rather than in 2011, with some positive effects for auto companies and workers and some reduction in fuel use and emissions. But a vehicle that could provide a beneficial service to society gets scrapped prematurely.
Most people who take advantage of the program will fall somewhere in between. Buyers will capture some of the benefit as a one-time windfall. Since owners of old vehicles are likely to have lower income than investment bankers, this is one program that may benefit the lower-income half of society more than the better-off.
The environmental benefits may not be great, especially relative to the cost. Considering only CO2 and not other pollutants like nitrous oxides, the required reduction in miles driven by prematurely junking gas guzzlers is large. High-end estimates for the environmental damage of one ton of CO2 are $80. The value of cap-and-trade permits in Europe shows that alternate reductions in emissions can be made for less than $40.
A gallon of gas causes the emission of about 20 lbs of CO2. A vehicle that gets 10 fewer miles per gallon would have to be driven 1,000 miles to emit an extra ton compared to a more efficient vehicle. If all of the $4,500 were attributed to reducing this pollutant, the reduction in miles per vehicle junked would have to exceed 50,000. Few of the vehicles scrapped under the program are likely to have that great a remaining life.
Some economist could, and probably will, develop some model to estimate the net change. The results would depend in part on ways people may find to game the system. Without the one-year-ownership provision, anyone looking for a new car would rationally first buy any $200 SUV capable of crawling to a dealership under its own power.
There still may be opportunities on the buying end. If you want a new small car and your uncle has an old 3/4-ton pickup, he could buy a car for you, get the $4,500 payment and sell you the car for a reduced price. But the sales tax due on transfers of used cars in most states would eat up most of the benefit. A private lease might be an option.
Hard-core Keynesians would see general stimulative benefits. Keynes argued that in some circumstances, it would be beneficial for government to put money in old bottles and bury them in abandoned mines. Otherwise unemployed people would dig up the bottles, and the resulting increase in consumer spending would be worth the cost. Cash-for-clunkers is better than that. But not necessarily a lot.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.