A Green Light for Environment, or a Green Light for Protection? The EU-US Dispute Over US Corporate Average Fuel Economy Regulations

The US Corporate Average Fuel Economy (CAFE) regulation mandates, subject to a civil penalty, producers to achieve a certain fleet average fuel economy on sales of new passenger cars. Analysing the incentive effects of CAFE, we find that it affords differential tax treatment to car models with identical fuel economy, and therefore differential incentives for improvements. In fact, the incentives may be negative for producers that specialize in small or large models. This casts doubt over the environmental merits of fleet averaging. Moreover, product-mix taxes can be abused by exploiting the specialization patterns of domestic and foreign firms.