Living Economics

Cash for Clunkers - Cash Rebates vs Fuel Tax
Cash rebates are an inefficient means to reduce carbon emissions.

In 2009, the U.S. Congress appropriated $1 billion to offer cash rebates of up to $4500 each to encourage owners to trade in their “gas guzzlers” for new more fuel-efficient vehicles. These cash rebates were intended to stimulate the depressed auto industry and the general economy as well as to reduce carbon emissions.

The program was widely popular and soon oversubscribed. A second appropriation of $2 billion was soon approved to keep the program going.

Germany actually started a popular cash-for-clunkers program earlier than the U.S. as part of its economic stimulus package. And much earlier in 1998, Ford already offered $1000 cash for clunkers to buyers of new Ford cars in smoggy south California.

Since owners have little incentive to turn in their vehicles if their trade-in values exceed the cash rebates, there is a trade-off between higher reduction of carbon emissions and higher sale of new vehicles. Specifically, higher cash rebates may attract owners of later-vintage vehicles which may not be serious gas guzzlers. Low cash rebates will attract owners of older-vintage vehicles which are serious gas guzzlers. But owners of older-vintage cars which are serious air polluters may not be able to afford to buy new more fuel-efficient cars.

If the objective of cash for clunkers is solely to reduce carbon emissions, it can be achieved either by cash rebates or by taxing vehicle fuels. Cash subsidy makes more fuel-efficient vehicles cheaper to buy. Higher fuel tax makes more fuel-efficient vehicles cheaper to run. The net result is to increase the demand (i.e., shifting the demand curve to the right) for more fuel-efficient vehicles.

But a fuel tax is by far more efficient in reducing carbon emissions because there are no abrupt discontinuities in incentives. For example, in the U.S. cash rebates program, a vehicle with a combined mpg of 18 is eligible for rebates but one with 18.2 is not. But the owner of a vehicle with a combined mpg of 18.2 mpg might want to buy a new vehicle with a combined mpg much higher than the minimum fuel efficiency required under the cash rebates program.

And by destroying the “clunkers”, the program raises the prices of used vehicles which might be more fuel efficient than the much older gas guzzlers. The owners of these real gas guzzlers would be condemned to continue to drive them instead of trading up to the more fuel-efficient traded-in clunkers if they are not destroyed.

But a tax is politically less popular than a cash rebate even though cash rebates generate a budget deficit while a tax generates a budget surplus if the measures are not otherwise neutralized. And the tax revenues can be used for projects with much higher marginal social benefits.

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