Sallee, James and Slemrod, Joel “Car Notches: Strategic Automaker Responses to Fuel Economy Policy”(December 2010) (Revised version published in Journal of Public Economics, 96(11-12), December 2012), WP-212: Full Paper
Notches — where small changes in behavior lead to large changes in a tax or subsidy — figure prominently in many policies, but have been rarely examined by economists. In this paper, we analyze a class of notches associated with policies aimed at improving vehicle fuel economy. We provide several pieces of evidence showing that automakers respond to notches in fuel economy policy by precisely manipulating fuel economy ratings so as to just qualify for more favorable treatment. We then describe the welfare consequences of this behavior and derive a welfare summary statistic applicable to many contexts.