Financial support for the transition needs clear and carefully chosen definitions of what qualifies for that support. Getting it wrong leads to unintended consequences, some which may not reduce emissions, explains James Sallee at the Energy Institute at Haas. Ever wondered why SUVs and big cars proliferated after the 1970s in the U.S. (and are on roads all over the world now)? The 1970s oil crisis triggered new rules that penalised fuel consumption in cars more than trucks. It made sense because trucks (mainly pickups) were only 15% of the national fleet, used only by farmers and select business owners, and by being bigger couldn’t match the fuel economy of cars. So manufacturers gamed the system and invented big passenger cars that qualified as trucks. By the 1990s nationwide fuel consumption wasn’t declining as planned but flatlining because the shift towards less efficient trucks cancelled out gains made by innovations in both car and truck fuel economy. And by 2021, the truck (real and fake) had risen to a staggering 63% of the personal vehicle market in the U.S. That’s what happens when suppliers manipulate product characteristics rather than chase the environmental target. Sallee warns today’s Inflation Reduction Act policy-makers not to make the same mistake with the raft of financial incentives now rolling out on “clean energy” jobs, “domestic” content requirements for batteries, qualifying an “area” as an “energy community”, and more.

In February the US Treasury announced that the Tesla Model Y would be eligible for a $7,500 electric vehicle tax credit, this after having previously ruled it ineligible. (Tesla promptly increased prices in response, in order to claim some of the credit for itself.)

This is but one example of the vast number of rulings necessary to determine eligibility for the legion of subsidies unleashed by the Inflation Reduction Act. Most of these decisions now reside with the Treasury Department, which must quickly decide things like what makes hydrogen green, how to decide if a power plant component is “primarily” made of iron or steel, and how to measure whether an “energy community” will receive a specified percentage of the benefits of a project. Eligibility for electric vehicle tax credits continues to change.

Definitions can radically affect the direction of change

In the case of the Tesla Model Y, the issue at stake was whether the Model Y was a car or a light truck, which have different eligibility price caps. The regulatory distinction between cars and trucks is not new. It has a winding history that connects Ayatollah Khomeini to Elon Musk by way of the Chrysler minivan and the PT Cruiser, and it has been a spark for major industry trends with global consequences for the environment and safety. A quick tour of this history serves as a useful reminder that seemingly obvious, and innocent, regulatory distinctions can have large and lasting unexpected effects.

If it looks like a car and acts like a car… it might still be a truck

The legal distinction between light-duty trucks and cars stretches back to the oil crises of the 1970s (hence the reference to the Iranian Revolution). To cut oil consumption, the US introduced a Gas Guzzler Tax and Corporate Average Fuel Economy (CAFE) standards. The Gas Guzzler Tax, which levied an excise tax up to $7,700 on vehicles with low fuel economy, applied only to cars, not trucks. CAFE standards were separate for cars and trucks, with trucks required to meet much lower fuel efficiency targets.

At the time, trucks accounted for around 15% of the personal vehicle market, and almost all trucks were pickups. Setting a lower fuel-economy bar for trucks appealed to common sense because trucks are bigger and have to haul cargo. But it created an incentive for automakers to find a way to design and market vehicles that were legally trucks, but could serve the consumer needs of people who usually bought a car, rather than a pickup.

A wave of innovation followed. In the 1980’s, the minivan, pioneered by Chrysler, qualified as a light truck but competed with large sedans and family station wagons, which were cars. During the low gas price era of the 1990’s, fuel-economy standards were restrictive, and the industry wrestled itself free by refashioning and rebranding SUVs (trucks) that could replace larger luxury sedans. Pickups were stretched out and fancied up so that they comfortably sat five (sometimes six!) and functioned as family vehicles. More recently, cars have increasingly morphed into cross-overs, most of which are legally trucks, even when they just look like a car wearing platform shoes.

In 2021, the regulatory truck had risen to a staggering 63% of the personal vehicle market in the US. In the twentieth century, America fell in love with the car. By the early twenty-first century, America’s eye had wandered. It had fallen in love with the truck.

Who cares about the distinction between cars and trucks?

The story of the ever evolving truck has real consequences. We cannot say for sure how much policy incentives drove the rise of the light-duty truck, but economic reasoning and received wisdom in the industry suggests it was an important factor.

Shifting drivers towards trucks and away from cars has environmental and safety consequences. The shift means that CAFE and other policies have less impact than expected—during the 1990s and early 2000s, both car and truck fuel economy rose, but fleetwide fuel consumption flatlined because the compositional shift towards less efficient trucks cancelled out those gains.

Trucks tend to be heavier, and this makes them more dangerous. Even at the same weight, trucks tend to be higher which makes them more dangerous for pedestrians and cyclists.

What’s more, the rise of the truck is becoming the latest American cultural export. Having designed and marketed SUVs to the American consumer for the last several decades, global automakers are increasingly pushing related models into global markets, where the SUV share is steadily rising.

Special regulatory treatment of light trucks is what economists call attribute-based regulation, which is generally inefficient when it enables actors to comply by manipulating product characteristics (qualifying for the truck category) rather than the environmental target (improving fuel consumption). We would likely be better off not making a distinction between cars and trucks—it erodes environmental regulations, gives automakers a reason to tweak cars for compliance benefits, and has the unintended consequence of making automobiles less safe.

Back in 1975, the users most closely associated with trucks were two of the sacred cows of the American political psyche, the farmer and the small business owner. Today, that link is weaker, but by now the light truck constituency is deep and wide, suggesting little appetite for a reversal of the fifty-year trend.

What lessons does this hold for today’s energy regulator?

The history of the light truck reminds us that apparently simple concepts and choices today can lead in unexpected directions tomorrow by creating incentives for what I like to call creative compliance. Recent reports suggest that the EPA is poised to dramatically tighten CAFE, which will create more pressure on automakers to comply in creative ways.

As (the other) Jim pointed out last week, if you want to reward market actors for doing “good stuff,” you have to “define what the ‘good stuff’ is.” This is often harder than it seems, and it frequently opens the door to unintended consequences.

…in particular for the Inflation Reduction Act

In the wake of the Inflation Reduction Act, a lot of “good stuff” needs defining. Prevailing wage requirements, which determine eligibility for some bonuses, apply to “labourers and mechanics,” but not other classes of workers. Developers might be able to relax restrictions by employing more “apprentices,” who can be paid less, or shifting tasks between categories. Domestic content requirements for batteries hinge on whether “critical minerals” (the definition of which can change) come from the US or a country with a “free trade agreement” (which itself turns out not to have a statutory definition). Qualifying an “area” as an “energy community” can create bonus credits, but this requires Treasury to figure out consistent ways to define the fraction of “direct employment” or tax revenue, both of which fluctuate, that are “related to [emphasis added] extraction, processing, transport, or storage of coal, oil, or natural gas.”

The subsidies contained in the IRA are massive. We may not be able to say for sure whether creative compliance with the associated regulatory distinctions will create important distortions or lead to trends as grand as the rise of the truck, but we can be certain that market actors will look for every opportunity to qualify for maximal benefits, even if it leads them in unexpected directions.

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James Sallee is Associate Professor, Department of Agricultural and Resource Economics, University of California, Berkeley, and a Research Associate of the Energy Institute at Haas

This article is published with permission.

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