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Monday, January 23, 2017

We Have The Wrong Vehicle Efficiency Incentives

Summary:  Vehicle fuel efficiency has not significantly increased since the 1980s. The current CAFE system puts the onus on automakers and therefore has been resisted (successfully) by the auto industry. A feebate program based on vehicle efficiency would nudge consumers toward efficient vehicles, creating a market demand for higher MPGe vehicles. Automakers will follow consumers and fulfill the market demand. Feebates mechanics are explained and a structure for one is purposed.

Full Story:
Soon after Donald Trump became President-elect Trump, the automakers appealed to him and his transition team to ease fuel economy requirements.
The current US regulations have a fleet average requirement of 54.5 MPG by 2025. This is known as the Corporate Average Fuel Economy (CAFE) standard. Most vehicles sold today are significantly below 54.5 MPG mark, so to meet this goal the automakers are forced to add more electric vehicles (EV) to their product offerings. These EVs would be used to offset the sales of their gas-guzzling SUVs and pickup trucks.

The automakers argue that there is no demand for electric cars. They claim this makes it impossible for them to meet the CAFE goals. Perhaps a specious claim by the automakers, but they try to sell vehicles that are profitable and in-demand. So the incentive program's goal should be to create demand for efficient vehicles.

A system that appeals to market incentives, rather than regulatory hurdles, is far more likely to be successful.

Encourage Buyers, Not Automakers

The current system puts the burden on the automakers. This guarantees that they are going to fight against it (other than the few electric-only car companies). We need a better system than CAFE. The automakers are a politically powerful group. If you try to force their hand with regulations, you get what we have today, resistance and little to no change. We need a system that creates and encourages the uptake of high MPG and electric vehicles by consumers. If a significant number of customers are demanding efficient vehicles then the automakers will be racing to win that market, rather than fighting against the government policies and delaying progress.

We need a system that encourages people to buy efficient vehicles, not one that punishes automakers for not selling them.

The automakers that don't move to meet this demand will have sales shortfalls and will either adjust course or cease to exist. Companies understand and are willing to spend money on customer acquisition costs. This is very different than spending money on compliance; different in that it will actually receive internal funding.

If there's a significant market demand for plug-in cars, automakers can spend their money designing vehicles to fill the need rather than paying lawyers to fight Washington D.C.

So how could you encourage people to demand higher MPG vehicles?

The simple answer is higher gasoline taxes/prices. This would be effective and it may have some place, but it is a regressive burden in that it punishes those who cannot afford to buy a new car and I cannot recommend it as a primary solution. I think the better answer is to modify the new vehicle purchase behaviors.

I apologize in advance, this is going to be a bit of a wonk-walk. It is hard to discuss policy details without, well, getting into policy wonk details.

Let's Try Feebates

If you want to make EVs and high mileage cars attractive, you have to make them affordable. Today, the average fuel economy for passenger vehicles on US roads is about 26 MPG. Efficiency ratings have stagnated in this zone since the 1980s and this is far below the EPA's Corporate Average Fuel Economy (CAFE) target of 54.5 MPG. A feebate system might help.

The idea of a feebate is simple. There are fees on things that you want to discourage (low MPG vehicles in this case) and rebates on things that you want to encourage. This method is a nudge on the market forces. With this method, the government is not picking technology winners and losers. Instead, it is setting goals and leaving the door open to innovation and market forces to achieve or even exceed these goals.

A feebate is a simple nudge; market forces take it from there.

Part 1 - The Fee

For this feebate thought experiment, let's say there is a tax on any passenger vehicle that's below the target (54.5 MPG). You can call it the energy security tax or gas guzzler tax.

Since most vehicles sold today (about 99%) would fall into the less than 54.5 MPG category, even a small fee would collect a large pool of money. Let's try some numbers and see how it might work out:
In this example, the amount of the tax is 0.1% (one tenth of one percent) for each 1 MPG that the vehicle is rated below the target. So an 18 MPG car would pay a 3.7% tax.

Let's look at how this example fee rate would apply to last year's top-selling US vehicles. According to Kelly Blue Book's 2016 best seller countdown, they are:

Example Fee
10 2016 Honda CRV 29          
9 2016 Nissan Altima 31 2.4%
8 2016 Toyota RAV4 26 2.9%
7 2016 Honda Accord 27 2.8%
6 2016 Toyota Corolla     31 2.4%
5 2016 Honda Civic 35 2.0%
4 2016 Toyota Camry 28 2.7%
3 2016 Ram Truck 20           3.5%
2 2016 Chevrolet Silverado    19 3.6%
1 2016 Ford F-Series 20 3.5%

The top selling cars (#10 - #4 on the list) would all have a fee of about 2.5%. The target of 54.5 MPG is an aggressive goal (as it should be). At 52 MPG, even a Toyota Prius would have a small fee of 0.3%. A target of 54.5 clearly encourages something beyond hybrid vehicles.

The top 3 selling vehicles in the US (again according to Kelly's countdown) are all trucks. As top sellers, there are more of these on the roads than any of the above cars. However, since these trucks have a lower MPG rating than the above cars, they will pay about 1% more than the cars.

According to the WSJ, automakers sold 17.5 million cars and light trucks in the U.S. in 2015. In that year Americans spent about $570 billion on these new rides. If the above fee structure were in place for these sales, then about $15 billion would have been raised.

Part 2 - The Rebate

The fees collected in this feebate program would be used as incentives (or rebates) for vehicles that get over 125% of the target, or 68 MPG. These vehicles could be battery electric, plug-in hybrid, fuel cell, compressed air, Thorium (j/k), or any new drivetrain or fuel system that could be imagined and designed to met the 125% (68 MPG) value and was safe for use on US roadways.

We need a system that sets goals and lets innovation find the path.

The amount of the rebate would be determined in such a way that it was revenue neutral with the fees collected. Today, with only one percent of new vehicle sales exceeding the 54.5MPG goal, there would be significant funds to pile on to those vehicles.

From the fees above, this program would have ~$15B to spend on incentives. Looking at 2016 sales, about 150,000 plug-in vehicles (BEV & PHEV) were sold last year. Simply applying $15B to 150,000 cars would yield $100,000 rebate incentives available for each plug-in car sold. That is a crazy amount. It would be easy to sell plug-in cars if you could give away Teslas. As fun as that would be, it's not realistic. It does, however, give you an idea of how (especially early on) this method could jumpstart the market. So how could we really use the funds?

These funds could be used to continue the $7500 federal incentive that is in place today (simply changing it from a kWh based system to an MPGe-based qualifier) or the program could be improved. If we're overhauling the system, let's improve it. Here's what I propose for the new High-Efficiency Vehicle Incentive (HEVI). (Let me know if you can come up with a better backronym)

Here's how the new incentive would work:

New Incentive: Point-of-Sale 
The incentive should be a point-of-sale incentive. The system that we have in place today requires you to file your tax return before you see the incentive dollars. This means that it does not help reduce your car payment and, depending on that time of year you buy, it might be more than a year before you see the money back in your bank account. Most people cannot have $7500 missing from their bank account for months.

New Incentive: No Income Requirement
The current federal EV incentive requires you to have a taxable income to receive the benefit. This is a problem because it excludes retirees. The workaround to the current system is to lease the vehicle (allowing the lessor to take the credit) and then the lessee buys out the lease. If the point of the program is to put efficient cars on the roadways, there is no reason to exclude retirees from the program (especially when there is a loophole). Keeping it simple and inclusive is a better method.

The other reason to not have an income restriction on HEVI is that it is funded differently than the current program. The current federal program effectively allows you to take the incentive out of your own tax payment. If you owed the taxman $17,500 then you only have to pay $10,000. This feebate program, on the other hand, collects revenue from fees. So, on the rebate-side there is no need for an income requirement, just as there is no such income requirement on the fee-side.

New Incentive: No Income Restriction
Similar to the case for including the retirees is the argument to keep high-income earners in the program. The air doesn't care about your income level. Another efficient vehicle on the road, regardless of who is behind the wheel, is a good thing.

There's no reason to exclude retirees or the well-heeled, the point is to meet the goal and they can both help us get there.

There is, however, an understandable concern that this program would be used to charge taxes to people buying Corollas, Civics, & CRVs to then use it to supplement people that are buying Teslas or plug-in Porsches. We'll limit this in the next section. 

New Incentive: Avoiding Pitfalls - Golf Carts and Supercars
There have been many incentive programs in various forms in various states and countries. There are two primary ways in which these programs can be abused: One, excessive payment for cheap vehicles making them free or nearly free and, two, excessive payment on very expensive vehicles that do little to advance the program's goals.

Let's look at each case. If the program has a fixed dollar amount incentive (such as $10,000), then a very cheap vehicle that meets the stated requirements could be nearly or completely free. Some electric golf carts have taken (excessive) advantage of state EV incentives in the past that were written with sloppy requirements that unintentionally allowed them to be included.

To curb these "Golf Cart" abuses, two things are needed:

First, the policy rules need to restrict the incentives to only roadworthy, crash tested, vehicles.

Second, the incentive would need to consider both the vehicle's cost and its contribution to the program's goals. This is handled via a restrict of the incentive to 30% of the vehicle's cost. By restricting the program to only pay for a percentage of the vehicle, this prevents excessive payment on any vehicle. Under this clause, if someone buys a $10,000 vehicle, they would only qualify for up to a $3,000 incentive. This program is not intended to 'give-away' vehicles, only to accelerate their adoption. An incentive that is too large creates a market bubble which will eventually burst and that is bad for long term growth.

That concludes closing the low-priced loophole. On the end of the spectrum is the high-priced loophole.

Just as the dollar based programs can be abused on the low-end, a purely percentage based program can be abused on the high-end. Here the abuse happens when the incentive structure pays someone buying an expensive car far more money than the car's contribution to the program's goals.

Consider two cars, both have an EPA rating of 106MPGe. One costs $1M, the other costs $35,000. These two cars contribute equally to the program's goal, so they should be awarded equally based on their contribution, rather than based upon their price tag. Let's consider the million dollar supercar (which happens to meet the program goals). If this vehicle received a full 30% incentive, this would be an incentive payment of $300,000. This is a lot of money to reduce the emissions from just one vehicle; a vehicle which is likely to spend most of its life in a display garage. Let's put a reasonable maximum dollar limit of $10,000 here to prevent this excessive payment.

New Incentive: How Much?
The above two items, when taken together, start to define how the incentive should be structured. The incentive has to have a percentage restriction to prevent the free golf cart and it must have a dollar limit to prevent the supercar overpayment case. Let's use 30% and $10,000 for these values as we did in the above examples.

Feebates can be structured with a hardline, with fees on one side and rebates on the other. Or they can be structured as three tiers. The lowest tier is the discouraged behaviors. This is where the fees are collected. Then there is an unaffected center zone (no fees or rebates). This is an area that does not significantly help nor detract from the goals. The final tier is the encouraged behavior. This is the zone that receives incentives.

I find that two-tiered systems tend to make people do just enough to avoid the fee, but not much to pursue the incentive. The three-tier system has a middle tier where no incentives are paid. This allows the incentives to be bigger and more attractive in the third tier, thereby drawing people more toward the encouraged behavior end of the spectrum.

Three tier feebate structure, via http://feebates.blogspot.com

In our example, the red zone is all vehicles below the target 54.5 MPG rating. The yellow zone is vehicles that are 100% to <125% of the target (54.5 to 68 MPG). The green zone is 125%+ of the target (69+ MPG). Further, the incentive in the green zone scales from the $5,000 at the bottom of the green zone to $10,000 at 150% of the target (82 MPG) and higher. This will be shown clearly in the vehicle chart below.

New Incentive: Not Restricted to 200,000 Vehicles
This existing federal incentive has restrictions on the number of vehicles from each manufacturer that qualify for the incentive. Just as the existing program unnecessarily excludes retirees, here it will unnecessarily exclude the automakers that are doing the most to meet the goal. Again, the air does not care if this is the first high efficient vehicle from this manufacturer or the one millionth.

Rather than restricting the incentive by automaker (as today's incentive does), the new program (HEVI) adjusts the fees, rebates, and targets annually to best meet the program's goals.

New Incentive: Program Adjusts Every Year
Each year, the program would consider the balance of the funds brought in from fees and those spent on incentives. The fees, rebates, and targets would then be adjusted to keep the program revenue neutral. To avoid market swings, none of these should be changed by more than 10% in any year.

New Incentive: Fade Out
In 2036, or whenever this program is no longer needed, it should have a slow fade out or sunset period where the fees are lowered 15% each year until they are zero. The incentives would follow the reduced funding and similarly be slowly reduced.

New Incentive: Example
Let's look at an example of HEVI applied to some upcoming high mileage vehicles.

According to www.fueleconomy.gov, here are the top rated fuel sippers of 2017:

   2017 Hyundai Ioniq Electric   136          
   2017 BMW i3 BEV (60)124
   2017 Chevrolet Bolt119
   2017 BMW i3 BEV (90)118
   2017 Fiat 500e112
   2017 Mitsubishi i-MiEV112
   2017 Nissan Leaf112
   2017 Kia Soul Electric105          
   2017 BMW i3 REX      88
   2017 Mercedes-Benz B250e  84
      * This is not considering the retail price. The incentive cannot exceed 30%.

The above list has some notable absentees such as Tesla and the Toyota Prius Prime. This may be because these vehicles are yet to be added as it is still early in the year.

What about Trucks?

The top three selling vehicles of 2016 on Kelly's list were trucks. Not surprisingly, there were no trucks on the "Top Fuel Sippers" list. This means that under this feebate, nearly all trucks would be paying a fee. Note that I said nearly. There is at least one company making trucks that would qualify for the rebate portion of this program. That company is Via Motors.

Via makes plug-in hybrid electric trucks. In practice, Via's trucks are not all that different from the Chevy Volt; they have a ~40-mile electric range, then a gas generator runs to keep the vehicle propelled. Having a built-in generator means that this truck can power work tools as well as haul them.

Another company, Cincinnati-based Workhorse Inc., has begun development of a full-size plug-in electric pickup truck for delivery in 2018. The Workhorse vehicle is also planned to be a plug-in hybrid although with 80 miles of electric range before the range extender kicks in.

Last on our plug-in truck list is Tesla. In the company’s Master Plan Part Deux the electric carmaker revealed plans to make a heavy-duty electric truck. There is no public production date yet for Tesla's truck so it is likely at least 3 years away.

If these trucks come to market, their torque and towing performance will exceed anything currently in their class. Their uptake could be accelerated by the right incentives. Perhaps the $10,000 limit could be raised to $15,000 for trucks until this important market segment has developed.

Sidebar: Aftermarket Hybrid Kits

People don't buy new cars every year. If you want the fuel economy to improve quickly, you'll need methods to update the vehicles that are already on the road. These aftermarket kits that improve the fuel economy are called "upfit" kits.

A Boston company called XL Hybrids installs hybrid kits onto existing truck and van fleet vehicles (class 2b vans up to class 6 trucks). The hybrid system improves fuel consumption by 20% and the upcoming plug-in hybrid will perform even better.

How to fund and incentivize these kits is a topic for another day.


Despite lofty goals, the average efficiency of cars and trucks on the roads today has not improved significantly since the 1980s. New technologies are emerging in plug-in hybrid and battery electric vehicles that promise to allow a leap in vehicle efficiency. As new technologies, it's not surprising that they initially have a higher price tag than the incumbents. A feebate program can both raise funds and encourage market forces to spur interest in higher efficiency products. This would allow the technologies to move through this early development stage and into mass market adoption.

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