Car Junkyard

Both the Senate and the House of Representatives are seeking to pass “Cash for Clunkers” legislation that would have three primary objectives: increase car sales, improve the environment, and stimulate the economy. The bill would provide consumers with a voucher (up to $4,500) to purchase a new vehicle to completely scrap the old one. The Associated Press gives a good summary of the House and Senate versions.

Although the bill passed today in the House, cash for clunkers is full of problems and unintended consequences:

1.) Economist, Freakonomics author and New York Times blogger Steven Levitt writes, “People who drive clunkers are generally not in the market for new cars. Presumably their replacement car will be a used car. The increased demand for used cars will lead to higher prices for used cars, which will push some buyers towards a new car, but the likely impact on new cars would be small.”

2.) This program would distort the used car market in a couple of ways. If the idea is to get older cars off the road, the supply of used cars will be reduced at a time when demand has been increasing. This will raise the sticker prices of used cars for people who can barely afford them in the first place. Because the program would scrap a relatively small percentage of used cars and parts, the effect may be marginal, but it’s still a market-distorting policy.

3.) Thanks to one of our commenters, Karen, for this unintended consequence: “This bill would put every charity car donation program in the nation out of business since the amount of the voucher would be much greater than the tax deduction.” Simply do a Google search of “Donating Cars for Charity” to see how many organizations this would affect.

4.) The environmental benefits are questionable. Maybe a few more miles-per-gallon improvement will emit less carbon dioxide per mile, but increased fuel efficiency often leads to more driving because people know they’re getting more miles to the gallon. Furthermore, the excitement of buying and driving a new car entices people to drive more. New cars are “[…] typically driven between 15,000 and 18,000 miles a year in its first three years of ownership, while a car owned for 10 years is driven between 5,000 and 6,000 miles a year and a 15-year-old car is driven only 2,000 miles on average.” There are also the pollution costs of actually building a car and the disposal of a car to be considered, rather than just the pollution caused by driving the vehicle.

5.) Proponents of the bill point to Germany’s boost in car sales as a reason to enact the program in the United States, but Germany’s incentive structure for buying new cars is much different ours. Gas prices in Germany are $5.50 per gallon, forcing people to switch to smaller cars. Their government also put in place other tax breaks and incentives on top of their cash for clunkers provision. And it may not have as big an impact on stimulating Germany’s economy as previously thought; the program instead simply shifted spending: “Retailers, for instance, say the bonus is shifting spending patterns rather than creating demand. Higher February car sales coincided with falling turnover at consumer electronics stores. Stefan Genth, managing director of the HDE retailers’ federation, slammed the bonus last week, saying it was ‘sucking out spending’ from the retail sector.”

6.) Clearly this won’t be a costless program – it’s estimated to be $4 billion in taxpayer money from the $787 billion stimulus bill. Chump change, right? But if the program in Germany does provide any forecast, it will cost more. In Germany’s case, the program has become three times more expensive than what they initially budgeted.

This is a good example of economic Frederic Bastiat’s broken window fallacy, except that instead of breaking windows to “stimulate the economy”, we’re destroying perfectly good cars. Meanwhile, we’re asking consumers to purchase cars they might not be able to afford and incur more debt. Sounds strangely reminiscent of the home mortgage crisis, don’t you think?