Regulating Untaxable Externalities: Evidence from Vehicles and Air Pollution

How should policy regulate air pollution from vehicles? Theoretically, optimal policy would apply a Pigouvian tax on emissions. In part because such a tax is technologically infeasible, most countries rely heavily on exhaust standards. These standards regulate air pollutants like nitrogen oxides and have very different properties than fuel economy regulations. This paper studies the effectiveness and efficiency of these exhaust standards and counterfactual policies. We show that the emissions rate of new U.S. vehicles has fallen by more than 99 percent since exhaust standards began in 1967, and used vehicles have had comparable declines. Several research designs show that exhaust standards have caused much of this decline. However, exhaust standards alone are not cost-effective and give limited incentive to reduce older vehicles’ emissions. To study counterfactual policies, we develop analytical and quantitative models of the new and used vehicle fleets. We find that making registration fees increase with a vehicle type’s emissions substantially reduces overall pollution. By contrast, current registration fees in most states (perversely) decrease with a vehicle’s emissions.