Current proposals leave a giant loophole for used vehicles, but policy innovation can help.
I love a good plan. Nothing is more satisfying than defining a goal, charting a course, and ticking off each step along the way.
So naturally I was excited last month when the California Air Resources Board released its regulatory roadmap for getting 100% of new light-duty vehicles sold in the state to be Zero Emissions Vehicles (ZEV) by 2035. The document, which boasts the alluring title, Staff Report: Initial Statement of Reasons for the Public Hearing to Consider the Proposed Advanced Clean Cars II Regulations, lays out a proposed set of regulations and an implementation timeline that will transition California to a new vehicle fleet free of fossil fuels, as called for by Governor Newsom’s 2020 executive order.
The first chance I got, I curled up with a warm cup of coffee, ready to savor the bold ideas put forth in the 230-page report. My first question was the timeline–what tools had CARB used to craft an optimal path for ZEVs between today and 2035?
Figure shows the percentage of vehicles required to be Zero Emissions Vehicles by Year. (Source: ARB’s report)
It looks like the main tool was just a ruler. The plan calls for near linear growth from today’s market, with a constant annual increase of ZEV market share of around 8%.
This is an ambitious course. The ZEV market share in 2021 in California was 12.5%, which itself was a big jump up from 7.5% in 2020. Still, this means that the market needs to double between now and 2026, and then grow steadily. The proposal marshals a number of encouraging facts – about the current and future availability of EV models, growth in the charging network, and consumer sentiment – to argue that such a course is within reach.
The proposal has a number of other interesting components, but I want to focus my attention now on one other thing the proposal includes, which is a loophole big enough to drive a car through, specifically a used car.
The used vehicle loophole, part I
The proposed regulation, and the governor’s executive order, only specify rules and targets for new vehicles. They do nothing to encourage the retirement of the ICE vehicles that exist now, nor the roughly 6 million ICE vehicles that will be sold after 2026 if the car market follows the proposed schedule.
In short, if California drivers want to drive a gas or diesel car in 2035 and well beyond, they are going to be able to do so. And, maybe that’s a good thing. When regulations are tighter than necessary or otherwise ill conceived, a loophole can actually increase welfare. Moreover, CARB’s clearly stated strategy is to use regulation to get new EVs into the market, which has impacts on the rest of the US and the world. A new vehicle regulation with a used vehicle loophole forces automakers, who inherently care about selling new cars, to accelerate their EV transitions, but simultaneously gives California consumers who still want ICE vehicles a release valve that might limit voter pushback.
But, if you really want to reduce pollution, you can’t just ignore what’s happening in the used market. While the new vehicle market share of ZEVs was 12.5% in 2021, the California Energy Commission shows that ZEVs are still less than 2% of the entire vehicle stock, and this will change slowly.
A regulation that restricts offerings in the new vehicle market will be sure to trigger what environmentalists call the Gruenspecht effect. A ZEV mandate that raises the cost of new cars and restricts the set of (ICE) vehicles on offer will drive up the value of used ICE vehicles. As those vehicles become more valuable, people will hold onto them longer, extend vehicle lifetimes and expand the used car market, thus eroding some of the apparent gains from the ZEVs taking over the new market.
Who loves the equilibrium implications of the proposed rule? This guy! (Source)
The same problem plagues any regulation of a durable good that focuses only on new products. Prior research, blogged about here, showed that the Gruenspecht effect erodes the cost effectiveness of fuel economy standards by the same amount as the rebound effect, which tends to get a lot more attention.
The used vehicle loophole, part II
The used car story doesn’t stop there. As currently constructed, California residents would be free to import ICE vehicles from out of state, even after the mandate is fully phased in. If the prior loophole was large enough to drive a car through, you can fit a truck through this one.
Why does this matter? The ZEV mandate in California creates a large, implicit subsidy to sell EVs in the state. This motivates automakers to market and discount their EVs in California relative to other states, over and above what consumers would demand. This creates an imbalance–there are “extra” used ZEV cars in California and a shortage elsewhere. This will create price differences across states, which the used car market will tend to resolve by exporting used ZEVs out of California. CARB cites evidence consistent with this in the current market: used EVs are already disproportionately exported out of state. The stronger the ZEV mandate in the future, the more powerful this force will be.
It is conceivable that the state might prohibit residents from registering a new vehicle purchased out of state (they do restrict new vehicles based on emissions rules today), but it seems less likely they want to be in the business of blocking used cars. And, market participants will be happy to move used ICE vehicles into the state if there are economic incentives to do so–there is already a robust wholesale auction market, worth $3 billion in sales per year, that dealers use to reshuffle inventories across the country.
An auction parking lot. They move a lot of cars. (Source)
The regulation will likely be a boon to that industry and to used car dealers in the state. If so, then that giant sucking sound you are going to hear will be used EVs, implicitly subsidized when new in California, fleeing to the rest of the country, with the California used market backfilled by lightly-used ICE vehicles originally sold out of state.
The economic efficiency implications of these dynamics are complicated, but what is clear is that the actual fleet of vehicles driving around California might be quite a bit different than you’d expect from just tracing out the implications of the proposed phase in.
The proposal does devote a lot of attention to the issue of the used car market, but the plan seems to be just to ensure that ZEVs are available in the used market, and then hope that consumer sentiment has shifted enough so that drivers overwhelmingly choose ZEVs over readily available ICE vehicles. As near as I can tell, the current proposal makes no attempt to contemplate the pollution or efficiency impacts of these dynamics.
Fortunately, there are policies that can be adopted subsequently if policymakers want to shrink or close this loophole in the future.
The role of complementary policies
If regulators want to close the used vehicle loophole (and, again, it may be worth leaving it open), there are straightforward ways. One option is to establish a schedule of gas tax increases, which will raise the cost of driving ICE vehicles, used and new. This would alleviate pressure by lowering demand for used ICE vehicles here. A reasonable alternative would be to schedule increases in registration fees for ICE vehicles. In either case, fee schedules can be announced ahead of time, giving consumers a chance to adjust their choices. Either would give policymakers a dial that they can move up or down as needed while the market evolves, and both are feasible and easy to administer (we already have them!).
Both options also have the substantial side benefit of raising revenue, and both have the appeal of being approximate taxes on pollution. Advocating prices for pollution is the main activity of environmental economists. When you have a hammer, everything looks like a nail. But, sometimes you really are in a room full of nails.
An immediate, and important, objection to these ideas is distributional considerations. Equity was clearly top of mind for the authors of the proposal, which includes a number of sections on environmental justice and a running commentary on distribution. In terms of the gas tax or registration fees, equity might be addressed by leveraging scrappage subsidies for ICE vehicles instead of taxes (perhaps in conjunction with a gas tax to balance revenue), or by allowing registration fees to be on a sliding scale with income.
The punchline here is that there are imminently feasible ways to make a ZEV mandate more economically efficient and environmentally impactful by evolving complementary policies to target the used vehicle market. Designing such policies to also achieve equity may take a little ingenuity, but the issue isn’t going away, so we have a few years to hash it out.
Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.
Suggested citation: Sallee, James. “A Gap in California’s Plan for the EV Future” Energy Institute Blog, UC Berkeley, May 9, 2022, https://energyathaas.wordpress.com/2022/05/09/13378/