Subsidy Could Harm Consumers and May Not Save Energy


President Obama has signed into a law a program to stimulate new car purchases and take old gas guzzlers off the road.  The program, referred to as Cash for Clunkers, would give new car buyers a rebate worth thousands per vehicle, when they trade in an old fuel inefficient car for a new and more fuel efficient one.  The problem, however, is that the program may not produce its desired effects and may leave consumers and the environment worse off. 


Take, for example, low-income consumers who often depend on older cars.  Because the Cash for Clunkers program reducing the supply of clunkers, the consumer price of used cars will increase, while subsidizing consumers who could better afford new cars.  In other words, the program leads to higher prices for low-income consumers and subsidies for others. 


Furthermore, subsidies are not free – the cost of the subsidy will need to be covered by taxing someone else.  But, don’t believe for a second that the cost of the subsidy will be completely offset by the benefit to car buyers. The vehicle was worth something before it was destroyed, which means that the buyer never gets the full benefit of the rebate, while the tax payers will need to cover the full cost.  


But, there are other reasons why the program may not be good policy. 


Some consumers may not drive a clunker as much as other cars.  A good number of clunkers are used by students traveling to and from school.  Other consumers may not take their clunkers on long trips, because of their unreliability.  Whether good policy or not, it depends on the costs and benefits as to whether consumers or society are better off with the cash for clunkers program.  


To illustrate the cost and benefit, assume that cars last, on average, 20 years before having to be junked.  Now say a retiree trades in his 18 year old clunker, which gets 15 miles per gallon and has valued at $3,000, for a new 19 mile per gallon car for $20,000.  Under the new program, the consumer can get an immediate rebate of $4,500 – which represents only $1,500 net benefit to the buyer ($4,500 minus $3,000), but it also represents a $4,500 cost to taxpayers.  If the retiree drives 3,000 miles per year, he will save $116 per year in gas – a clear benefit.  However, it will take 39 years of driving for there to be enough fuel savings to offset the cost of the subsidy to taxpayers – far longer than the life of the vehicle.    


The program could also be bad for the environment.  New vehicles take energy to make.  By some estimates, the energy used to produce a vehicle, along with the energy used in various stages of production (not to mention the stationary energy trapped in materials, such as plastics and later in landfills), could run $2,000 per vehicle.  Add to that the opportunity cost of taking a productive vehicle off the road two years too early, plus the costs of reducing the life of the average vehicle from 20 to 18 years, and the lost energy could be worth approximately $2,440.  To make up these energy costs, the retiree would have to drive the car for 21 years (a period longer than the clunker that was sold) to save enough energy to offset the energy wasted as a result of the program.  That is bad for the environment.


While the program may have some benefits for some, there is no evidence that it will produce more benefits than costs.  While better way would be to give consumers some sovereignty when it comes to buying and selling, how else could the government get taxpayers to buy a government-owned vehicle?