The Mercatus Center released a paper (PDF) this month co-authored by Ted Gayer (an economist at the Brooking Institution) and W. Kip Viscusi (an economics professor at Vanderbilt), titled “Overriding Consumer Preferences with Energy Regulations” which questions the economic justification for various government schemes implemented to force energy efficiency improvements in consumer household products, automobiles, lightbulbs, etc. The abstract is below:

This paper examines the economic justification for recent U.S. energy regulations proposed or enacted by the U.S. Department of Energy, the U.S. Department of Transportation, and the U.S. Environmental Protection Agency. The case studies include mileage requirements for motor vehicles and energy-efficiency standards for clothes dryers, room air conditioners, and light bulbs. The main findings are that the standards have a negligible effect on greenhouse gases and the preponderance of the estimated benefits stems from private benefits to consumers, based on the regulators’ presumption of consumer irrationality.

The paper walks through the basic economic understanding of consumer rationality, and explains why behavioral critiques of consumer rationality fail to undermine the general conclusion that consumers are overwhelmingly rational and tend to act in their own best interest, and that “in most contexts consumers are better equipped than analysts or policymakers to make market decisions that affect themselves.”

The authors state that benefit cost analysis (BCA) conducted by government agencies in support of these policies (fuel standards, consumer appliance efficiency, etc.) make unwarranted assumptions, including the assumption that the energy efficiency of the product should trump other considerations, such as the up front cost:

As our discussion in this paper indicates, government agencies do not properly assess the benefits from energy-efficiency standards. They assume consumers and, in some cases, firms are incapable of making rational decisions and that regulatory policy should be governed by the myopic objective of energy efficiency to the exclusion of other product attributes. Energy efficiency standards provide a valuable case study of how agencies can be blinded by parochial interests to assume not only that their mandate trumps all other concerns but also that economic actors outside of the agency are completely incapable of making sound decisions. The assumption that the world outside the agency is irrational is a direct consequence of the agencies’ view that energy efficiency is always the paramount product attribute and that choices made onany other basis must be fundamentally flawed.

This paper is important because there exists a general scorn from left leaning policy groups towards anyone who dares question the wisdom of energy efficiency programs, including the recently introduced CAFE standards which will require that automobiles meet previously unheard of fuel mileage standards by 2025. Libertarians and market oriented folks are dismissed as right-wing cranks by those who are more supportive of government intervention into the economy, and yet there remains a strong and sound argument against narrowly tailored regulations designed to nudge consumers towards making different choices.

This time its former Rep. Jim Nussle (R-Iowa) writing in The Hill’s Congressional Blog:

But what people often forget is that the ethanol industry has been suggesting reform for more than a year. We recognized that the industry has changed, and that the policy must change as well.

The blender’s tax credit has been instrumental in developing the ethanol industry, but the most important challenge our nation faces today in securing our energy independence is not the continuation of this incentive, but access to a fair and open marketplace.

We have suggested a pathway that will not only create that market access but continue to provide the necessary incentives for developing the next generation of biofuels – cellulosic ethanol – to help our nation meet our stated goals of 36 billion gallons of renewable fuel by 2022.

Consumer choice at the pump is the most critical component of this plan to help us achieve this goal. Today there are about nine million Flex Fuel Vehicles in this country and the owners of these vehicles have a choice of fuel blends when they pull up to a Flex Fuel pump: E30, E50 or more. But unfortunately, there are fewer than 300 Flex Fuel pumps in the entire nation. Even as domestic automakers commit to making half their fleet Flex Fuel, the lack of pumps to serve this fleet means that most Flex Fuel Vehicles have never run on anything but gasoline.

These are the same tired lies they repeat over and over again. The ethanol industry wants as much government money as it can get its hands on, it just turns out that there aren’t many politicians willing to give them the cash in this environment. Aside from DoE regulations on higher blends of ethanol, the market is quite open for higher blends of ethanol, but no consumers want to purchase them.

And again, its quite clear that they support certain DoE regulations, such as their enforcement of the renewable fuel standard. Would they trade a hands off policy on regulating the approval of higher blends of ethanol in exchange for terminating the RFS? Absolutely not. They also support Corporate Average Fuel Economy (CAFE) standards because automakers are allowed to offset some of the mile per gallon requirements by producing flex fuel vehicles.

Little information has emerged on whether or not the industry will be able to get their ‘compromise’ stuck into the debt ceiling negotiations. Each public expenditure on ethanol creates more special interests involved with keeping the money flowing.

Today, the U.S. EPA and the National Highway Traffic Safety Administration (NHTSA) proudly unveil their new, improved, long-awaited, supah-dupah, “next generation” fuel economy sticker. All model year 2013 vehicles will have to display the redesigned stickers.

“The new labels, which are the most dramatic overhaul to fuel economy labels since the program began more than 30 years ago, will provide more comprehensive fuel efficiency information, including estimated annual fuel costs, savings, as well as information on each vehicle’s environmental impact,” EPA’s press releaseenthuses. Only in the makework world of bureaucracy central would this “overhaul” of a label be hailed as “dramatic.”

As my colleague William Yeatman joked when I told him the news: “Anyone can have a sticker, but a next generation sticker – the future is here, my friend!”

In their original August 2010 regulatory proposal, the agencies wanted the new label to include letter grades based on the car’s fuel economy and carbon dioxide (CO2) emissions. Electric vehicles and plug-in hybrids would get an A+; the biggest, heaviest, gas guzzling SUVs would get a D.

However, in December 2010, 53 House Members sent a bipartisan letter to EPA Administrator Lisa Jackson and DOT Secretary Ray LaHood protesting that letter grades would “unfairly promote certain vehicles over others.” Indeed, that was the point. Stigmatize SUVs and other politically-incorrect vehicles by giving them bad grades.

Worse, grading cars implicitly means grading the people who buy them. People who buy cars with super-low or zero emissions are caring and ahead of the curve. Those who buy gas guzzlers are yokels who voted for Bush and wear baseball caps in restaurants. The South Park spoof on the “Toyonda Pius,” Smug Alert, all-too-accurately depicts the greener-than-thou pretension of EPA and NHTSA’s proposed grading system.

Rebuked by those wielding the power of the purse, the agencies relented and the “next generation” sticker does not include letter grades. To view the current sticker, click here. To see what the scolds at EPA and NHTSA originally planned to replace it with, click here.

Clearly, these folks are into behavior modification. How potent will the redesigned label be in modifying your behavior?

Among other rationales for proposing to grade cars based on their fuel economy, the agencies claimed that adding letter grades would help consumers make smarter purchases by combating something called the “MPG Illusion.”

The MPG Illusion refers to the common mis-perception that fuel savings from mpg increases are linear. People often assume that each additional 1 mile per gallon increase in a vehicle’s fuel economy reduces fuel consumption and gasoline expenditures by the same amount. Hence, some may conclude, if they can’t afford (or simply don’t want) a Toyota Prius, Chevy Volt, or some other high-mpg vehicle, there’s no point in buying a car with only modestly better fuel economy than their current vehicle. In reality, fuel consumption avoided and dollars saved decrease as mpg increases. Which is to say, the biggest fuel savings come from modest fuel-economy improvements in the lowest mpg vehicles. Some hypothetical (indeed fanciful) examples will make this crystal clear.

Suppose that your current car gets only 1 mile per gallon, you drive 100 miles per week, and gasoline costs $3.00 per gallon. This means you consume 100 gallons and spend $300.00 per week. If you replace that car with a 2 mpg vehicle, you’ll consume 50 gallons and save $150.00 per week. At the very bottom end of the scale, even a 1 mpg increase in fuel economy yields big savings.

Suppose now that your current car gets 99 mpg, you drive 100 miles per week, and gas costs $3.00. This means you consume 1.01 gallons and spend $3.03 per week. If you replace that car with a 100 mpg vehicle, you’ll consume 1 gallon and save 3 cents per week. At the very top of the fuel economy scale, the fuel and cost savings from an extra 1 mpg are negligible.

Professors Rick Larrick and Jack Soll of Princeton University put the MPG Illusion on the map when they published an article about it in Science magazine. They explain the basic arithmetic in this Youtube video. Their illustrative case assumes a motorist who drives 100 miles per week. If the motorist has a 10 mpg vehicle and switches to a 20 mpg vehicle, he’ll cut his weekly fuel consumption from 10 gallons to 5 gallons — a savings of 5 gallons. If the motorist has a 25 mpg vehicle and switches to a 50 mpg  vehicle, he’ll cut his weekly fuel consumption from 4 gallons to 2 gallons — a savings of only 2 gallons. “The key insight,” says Larrick, “is that improving inefficient cars that have low mpgs, by even low mpg increases, saves a lot of gas.”

To counter the MPG Illusion, Larrick and Soll advise policymakers to express fuel economy in terms of the amount of fuel consumed per unit of distance traveled. Expressing fuel economy in the conventional way, as miles per gallon, leads people to “undervalue small improvements on inefficient vehicles” and “underestimate the value of removing the most fuel inefficient vehicles,” the researchers argue in Science. One could also say — they don’t — that mpg ratings lead people to overestimate the value of purchasing a hybrid.

In any event, Larrick and Soll’s paper was music to the ears of the anti-SUV crowd. Greenies would love to believe that the market for SUVs is sustained by an “illusion.” Because if that is so, then EPA and NHTSA can depress SUV sales just by making simple changes in how fuel-economy information is presented — just by redesigning the sticker!

Consistent with Larrick and Soll’s advice, the ”next generation” sticker includes an estimate of how many gallons it takes to drive 100 miles.

Years of SUV-bashing, fuel-economy proselytizing, climate-change scaremongering, and high gasoline prices have failed to kill SUV sales. Could that have something to do with the attributes of the vehicles — their size, safety, and utility? Are there no physical differences between SUVs and cars greenies insist are “smart?” Or is it simply, or mainly, a faulty optic that sustains a market for SUVs?

If the MPG Illusion has anything to do with SUV sales, then you gotta ask: Who’s responsible for foisting the illusion on the public? Answer: the very people who’ve tried to brow beat us into believing that the only vehicle attribute worth considering is its mpg — the preachers and proselytizers of fuel economy! There’s no escaping the law of unintended consequences.