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ESSAYS ON ISSUES
	

	 THE FEDERAL RESERVE BANK	
OF CHICAGO

2016
	 NUMBER 357

Chicag­ Fed Letter
o
The VW scandal and evolving emissions regulations
by Thomas H. Klier, senior economist and research advisor, and Joshua Linn, senior fellow, Resources for the Future

In September 2015, Volkswagen (VW) admitted to having programmed nearly 11 million
of its diesel vehicles to cheat on tailpipe emissions tests. 1 To put VW’s emissions rigging
into a broader context, the authors review the different approaches that the U.S. and
Europe have historically taken in regulating automotive emissions and fuel economy.
Moreover, they discuss the scandal’s implications for regulatory changes in both regions.2

Automobiles are subject to emissions and

fuel economy regulations in most regions
of the world. Underlying the VW scandal
are trade-offs between controlling a vehicle’s emissions and improving its performance (i.e., its acceleration, power,
etc.). VW, like most other
1. U.S. fuel economy standards
European automakers,
pursued diesel technolmpg
ogy—which, compared
70
with gasoline technology,
54.5 mpg
60
provides greater fuel
fleet-wide
x
average
economy, resulting in
50
in 2025
lower greenhouse gas
40
(GHG) emissions, such
30
as carbon dioxide (CO2).
20
Yet, relative to gasoline
10
engines, diesel engines
tend to emit more nitro0
1975 ’80 ’85 ’90 ’95 2000 ’05 ’10 ’15 ’20 ’25
gen oxide (NOx ) and
model year
particulate matter,3 which
Passenger cars
Light trucks
contribute to the forN otes: The figure displays the evolution of corporate average fuel economy (CAFE)
mation of smog. VW purstandards—measured in miles per gallon (mpg)—for new passenger cars and light trucks
sued a “clean diesel”
in the U.S. See the text for further details.
Source: Adapted from https://www.whitehouse.gov/blog/2012/08/30/what-new-fuelstrategy rather aggressiveeconomy-standards-mean-you.
ly; but when some of its
diesel engines could not
meet the stringent tailpipe emissions
standards in the U.S. and Europe without sacrificing on-road performance, the
company installed “defeat devices,” which
allowed its vehicles to circumvent lab tests.
In this Chicago Fed Letter, we discuss the
different approaches that the U.S. and

Europe have historically taken in regulating the emissions and fuel economy
of light-duty vehicles (i.e., cars and light
trucks)4 and some implications of the
VW scandal for the regulation of the
auto industry in both regions.
The history of U.S. regulations

Vehicles emit pollutants as byproducts
of fuel combustion in their engines.
According to the U.S. Environmental
Protection Agency (EPA), light-duty
vehicles accounted for one-third of carbon monoxide emissions, about one-fifth
of nitrogen oxide emissions, and about
one-quarter of carbon dioxide emissions
in the U.S. in 2011.5 Some of these tailpipe emissions are key ingredients in the
formation of smog, which can be harmful
to human health and the environment.
The hazards of smog were first recognized by state and federal officials in
the U.S. during the 1950s and 1960s.6
Rapid motorization in the U.S. led to smog
becoming a major public health issue
back then. On account of the unique
weather conditions in the Los Angeles
Basin, Southern California experienced
some of the worst smog in the nation.
The subsequent scientific and regulatory discussions were concentrated in
that state. California passed the Motor
Vehicle Pollution Control Act in 1959,
but it was several years before the issue

2. European fuel economy standards
CO2 emissions in g/km
180
160

x
2020: 147 g/km
–18% (2012–20)

140
120

2020: 95 g/km
(one year phase-in)
–28% (2012–21)

100

x

again starting in
2007—to 35.5 mpg
for cars and light
trucks combined, to
be achieved by 2016.10
In 2011, an even higher target of 54.5 mpg
was set for light-duty
vehicles, to be met by
2025.11 (See figure 1
on front page.)

The particular rules
for meeting fuel
economy standards
Passenger cars
Light trucks
changed during the
Notes: The figure displays the evolution of carbon dioxide (CO ) emissions standards in
grams per kilometer (g/km) for new passenger cars and light trucks in the European Union.
second CAFE regime
The CO emissions rate is a measure of fuel economy. See the text for further details.
Source: Adapted from http://www.theicct.org/sites/default/files/publications/ICCTupdate_
(beginning in 2007).
EU-95gram_jan2014.pdf.
Originally, as established in the first CAFE
of vehicle emissions was taken up at the regime (beginning in 1975), manufacturfederal level. In 1965, Congress passed
ers needed to show compliance by meetamendments to the Clean Air Act of
ing separate requirements for cars and
1963 and adopted the 1966 California
light trucks. The compliance mechanism
vehicle emissions standards as the 1968 has since been refined: Manufacturers
federal standards. In 1970, additional
now face standards that for both cars and
Clean Air Act amendments were passed light trucks are based on the footprint
and the EPA was established.7 In subse- (roughly the rectangle defined by the
quent negotiations, automakers, regufour wheels) of the vehicle. Consequently,
lators, and legislators agreed to phase
automakers that sell more large vehicles
out lead as a gasoline additive. This was
than small ones are subject to lower avera crucial step in making catalytic techage fuel economy requirements for their
nology (which converts harmful pollut- light-duty fleets. Because of this relationants in tailpipe gas into less hazardous
ship between the vehicle’s footprint and
substances) commercially viable. The
fuel economy, the recent decline in gasfirst catalytic converter, which reduced
oline prices (which caused sales to shift
hydrocarbon and carbon monoxide
toward large vehicles) has reduced the
emissions from vehicles, was introduced overall level of fuel economy required by
in 1975 models. By 1980, automakers
the CAFE standards, albeit only slightly.12
developed an even better catalytic converter, which also reduced nitrogen oxide The history of European regulations
emissions. Tailpipe emissions requireIn Europe, the regulatory goals for
ments have evolved much further since
emissions control and fuel economy were
the early 1980s: Today a rather complex addressed in reverse order: Controlling
set of federal and state regulations for
fuel consumption (measured in gallons
a number of air pollutants is in place.8
per mile)—a concept that is largely interchangeable with fuel economy (measured
Vehicle fuel economy became an imin miles per gallon)—came first.13 Nuportant policy issue in the U.S. during
merous European countries responded
the 1970s, when oil prices spiked multo the oil shocks of the 1970s by sub9
tiple times. Legislators enacted national
stantially raising fuel taxes to lower fuel
corporate average fuel economy (CAFE)
consumption.14 Moreover, many of them
standards in 1975. Automakers needed
decided to tax diesel at a lower rate than
to roughly double the average fuel econogasoline.15 As a result, diesel’s share
my of their new light-duty fleets by 1985—
among new passenger cars in Western
to 27.5 miles per gallon (mpg) for cars
Europe rose substantially, from around
and to 19.5 mpg for light trucks. Fuel
15% in 1990 to 51.6% in 2015.16
economy standards were tightened
80
2005

’10

’15

’20

2

2

In 1998 the European Commission
reached an agreement with vehicle
manufacturers to reduce the emissions
rate of CO2 (a measure of fuel efficiency)
by 25% by 2008—to 140 grams per
kilometer (g/km), which is equivalent
to achieving a fuel economy of about
40 mpg.17 Implemented in 2009, a mandatory requirement—backed by fines
for noncompliance—set a new level of
130 g/km for CO2 emissions, to be met
by 2015. Even tighter regulations, including specific standards for light-duty trucks,
were put in place in 2014: For passenger
cars, the CO2 emissions target was set to
95 g/km (equivalent to 57.9 mpg), to
be achieved by 2021; and for light-duty
trucks, the CO2 emissions target was set
to 147 g/km (equivalent to 43.3 mpg),
to be reached by 2020.18 (See figure 2.)
Notably, whereas the U.S. fuel economy
standards are based on a vehicle’s footprint, European standards are based
on a vehicle’s weight.19 Therefore, heavier
vehicles are subject to a lower fuel economy requirement (higher CO2 allowance)
in Europe.
Compared with the U.S., Europe came
late to regulating vehicle emissions of
pollutants. It started with the Euro 1
requirements that set the NOx emissions
limit to 780 milligrams per kilometer
(mg/km) in 1992.20 Catalytic converters
were required in new cars in Europe at
the beginning of the 1990s, and the sale
of leaded fuel was largely prohibited
across the region by 2000.21 The U.S. was
ahead of Europe by a decade on both
counts: Catalytic converters were ubiquitous in new cars by the early 1980s, and
leaded gas was phased out almost entirely
by 1990.22 Currently, the Euro 6 emissions
rules are being implemented. These rules
require NOx emissions to be cut from 1992
levels by 90% starting in September 2015.23
However, those emissions standards are
still less stringent than the ones currently
in place in the U.S.24
The role of compliance tests

Auto manufacturers play a key role in
testing and reporting emissions of their
vehicles. For each model year, new vehicles are tested in a laboratory, where
they are subjected to standardized testing
protocols. These tests are required for

vehicles to be certified for sale in a market.
The outcomes of those tests do not necessarily reflect real-life driving conditions.25
For example, the EPA adjusts fuel economy ratings of vehicles communicated
to U.S. consumers from the lab results
in order to better reflect actual driving
conditions. Typically, the test results are
reduced by about one-fifth, meaning
that the EPA estimates that the testing
overstates fuel economy by around 20%.26
In addition, the EPA conducts in-use
(on-road) testing of vehicles—both at low
mileage (at least 10,000 miles) and at
high mileage (more than 50,000 miles).27
Europe’s regulators pursue a similar
testing approach, but European tests
tend to be less restrictive and have not
included an on-road component.28
In Europe, there is evidence that the gap
between the reported lab test results and
real-world emissions has been growing.
For example, a recent study reports a remarkable increase in the divergence between official lab-based and real-world
CO2 emissions values in Europe from
about 8% in 2001 to 40% in 2014; it attributes the growing gap to manufacturers’
exploitation of tolerances and flexibilities
in the testing procedure.29 Another study,
also based on on-road testing, finds the
average level of NOx emissions from
vehicles in Europe to be seven times
the certified Euro 6 emissions limit.30
In the U.S., in several instances manufacturers have been penalized for reporting incorrect data: For instance, Hyundai
and Kia were fined for overstating the
mpg claims on the majority of their 2012
and 2013 models in the U.S., and Ford
had to restate the mpg claim of one of
its hybrid vehicles in 2013.31
The VW scandal dwarfs these previous
cases—both in terms of potential fines
and lost sales for the offending company.
In the 12 months prior to September 2015,
diesel vehicles represented slightly more
than 13% of VW’s U.S. sales.32 The company has since been prohibited from
selling any diesel light-duty vehicles in
the U.S.33
Longer-term implications

Besides reducing VW’s profits and affecting its reputation, the scandal will likely

have broader implications for the regulation of vehicle emissions and fuel
economy. Following VW’s admission of
circumventing emissions requirements,
officials in the U.S. and Europe have
discussed test improvements to address
the gap between lab-based test values
and real-world observations. Thus far,
the discussions among lawmakers and
regulators have focused on the emissions
of pollutants, but the divergence between
fuel economy testing and real-world performance raises similar concerns. Some
have suggested giving more weight to
in-use testing—i.e., measuring emissions
and fuel economy of vehicles while on
the road, possibly over their lifetimes
and not just at the point of certification.
Thus far, U.S. and European regulators
have responded quite differently to the
VW case, partly because of Europe’s
relatively greater reliance on diesel
technology. In the U.S., the EPA has
changed its emissions certification
procedure, adding several tests and
more time to the process.34 In contrast,
European officials weakened the testing
framework in response to widespread
noncompliance with emissions standards
in order to provide more time for the
auto industry to adjust before the Euro 6
standards are fully applied. Manufacturers will be allowed to exceed the
NOx emissions standard under real-world
driving conditions by 110% between
September 2017 and the start of 2020
and by 50% afterward.35
The choices that policymakers, regulators, and automakers make to address
their respective goals for vehicle emissions
and fuel economy will depend on both
local conditions and public sensitivities.
For example, recent occurrences of smog
in London and Paris may have begun
shifting public sentiment and policy in
Europe away from favoring diesel vehicles.36 In the U.S., prior to the VW scandal, diesel fuel vehicles accounted for a
small but growing share of the overall
market. Whether the scandal or morereliable testing affects the long-term
prospects of diesel vehicles in either
Europe or the U.S. is an open question.
If their share were to fall, the auto industry’s reliance on other technologies, such
as hybrid and plug-in electric powertrains,

would likely rise in order to meet the
increasingly stringent emissions and
fuel economy standards in the U.S.
and Europe.
	 See Jack Ewing, 2016, “VW scandal clouds
prospects for other diesel makers at Geneva
motor show,” New York Times, March 3,
http://www.nytimes.com/2016/03/04/
automobiles/wheels/vw-scandal-cloudsprospects-for-other-diesel-makers-atgeneva-motor-show.html. See also
http://www.theicct.org/news/epasnotice-violation-clean-air-act-volkswagenpress-statement.

1

	 A Resources for the Future policy brief
(No. 16-03) based on this Chicago Fed Letter will
be available at http://www.rff.org/research.

2

	 For an explanation of particulate matter,
see https://www3.epa.gov/pm/.

3

	 We exclude from our discussion mediumand heavy-duty trucks, as well as off-road
vehicles, because they are subject to different
sets of regulations in both regions.

4

	See https://www.epa.gov/air-emissionsinventories/2011-national-emissionsinventory-nei-data.

5

	 Tom McCarthy, 2007, Auto Mania: Cars,
Consumers, and the Environment, New Haven,
CT: Yale University Press. The rest of this
paragraph draws heavily on this source.

6

	 The Clean Air Act amendments of 1970
required substantial reductions—90%
within less than ten years—in the emissions
of hydrocarbons, carbon monoxide, and

7

Charles L. Evans, President; Daniel G. Sullivan,
Executive Vice President and Director of Research;
David Marshall, Senior Vice President and Associate
Director of Research; Spencer Krane, Senior Vice
President and Senior Research Advisor; Daniel Aaronson,
Vice President, microeconomic policy research; Jonas D. M.
Fisher, Vice President, macroeconomic policy research;
Robert Cox, Vice President, markets team; Anna L.
Paulson, Vice President, finance team; William A. Testa,
Vice President, regional programs, and Economics Editor;
Helen Koshy and Han Y. Choi, Editors; Julia Baker,
Production Editor; Sheila A. Mangler, Editorial Assistant.
Chicago Fed Letter is published by the Economic
Research Department of the Federal Reserve Bank
of Chicago. The views expressed are the authors’
and do not necessarily reflect the views of the
Federal Reserve Bank of Chicago or the Federal
Reserve System.
© 2016 Federal Reserve Bank of Chicago
Chicago Fed Letter articles may be reproduced in
whole or in part, provided the articles are not
reproduced or distributed for commercial gain
and provided the source is appropriately credited.
Prior written permission must be obtained for
any other reproduction, distribution, republication, or creation of derivative works of Chicago Fed
Letter articles. To request permission, please contact
Helen Koshy, senior editor, at 312-322-5830 or
email Helen.Koshy@chi.frb.org. Chicago Fed Letter
and other Bank publications are available at
https://www.chicagofed.org.
ISSN 0895-0164

nitrogen oxide by new motor vehicles
(McCarthy, 2007, p. 182).
	 For light-duty vehicles, the federal “Tier 3”
standards were adopted in 2014 and will
be phased in over the period 2017–25 (see
https://www3.epa.gov/otaq/documents/
tier3/420f14009.pdf). Those standards
represent about an 80% reduction from
today’s fleet average in tailpipe emissions.
They also require lowering the sulfur
content of gasoline.

8

	See http://www.federalreservehistory.org/
Events/DetailView/36 and
http://www.federalreservehistory.org/
Events/DetailView/40.

9

10

The 2007 CAFE regulations also introduced
controls on vehicle GHG emissions, and
added the EPA as a regulator (the U.S.
Department of Transportation alone administered the previous CAFE standards);
see Thomas Klier and Joshua Linn, 2011,
“Corporate average fuel economy standards
and the market for new vehicles,” Annual
Review of Resource Economics, Vol. 3, October,
pp. 445–462. Initially, the 2007 regulations
required compliance of at least 35 mpg for
light-duty fleets by 2020, but in 2009 the
compliance date was moved up to 2016; see
http://www.eesi.org/papers/view/fact-sheetvehicle-efficiency-and-emissions-standards.

	Compliance with the 54.5 mpg target for
light-duty vehicles will be based on the EPA’s
lab tests. Notably, manufacturers can receive
“emissions credits” from the EPA by introducing electric or plug-in hybrid technologies and off-cycle technologies (such as
automated engine start–stop systems, which
reduce engine idling time). Additional
credits can be earned for improving air
conditioning efficiency, which reduces
GHG emissions. These credits can be used
to offset low-mileage vehicles, thereby
keeping an automaker’s fleet-wide fuel
economy average in compliance with the
target. See https://www3.epa.gov/otaq/
climate/documents/420f12051.pdf.

11

	Benjamin Leard, Joshua Linn, and Virginia
McConnell, 2016, “Fuel prices, new vehicle
fuel economy, and implications for attributebased standards,” Resources for the Future,
discussion paper, No. 16-04, February,
http://www.rff.org/files/document/file/
RFF-DP-16-04.pdf.

12

	Note that unlike fuel economy, fuel consumption is a linear metric (e.g., reducing
consumption from, say, eight to seven gallons
per 100 miles saves the same amount of
fuel as reducing it from three to two gallons
per 100 miles).

13

	See, e.g., Eugenio J. Miravete, María J. Moral,
and Jeff Thurk, 2015, “Innovation, emissions
policy, and competitive advantage in the
diffusion of European diesel automobiles,”
University of Notre Dame, working paper,
August 13, https://www3.nd.edu/~jthurk/
Papers/MMT.pdf. There is agreement in
the economics literature that compared with
enacting stricter fuel economy standards,
levying higher fuel taxes is more cost effective
in reducing fuel consumption.

14

	Thomas Klier and Joshua Linn, 2013, “Fuel
prices and new vehicle fuel economy—
Comparing the United States and Western
Europe,” Journal of Environmental Economics
and Management, Vol. 66, No. 2, pp. 280–300;
and Miravete, Moral, and Thurk (2015).

15

	See Ewing (2016). In the U.S., diesel’s
share of light-duty vehicle sales was zero
between 1990 and 2003. In 2015 it stood
at just under 3% (authors’ calculations
based on data from WardsAuto InfoBank,
database by subscription).

16

	Klier and Linn (2013).

17

	http://www.theicct.org/sites/default/
files/info-tools/pvstds/EU_PVstds-facts_
dec2014.pdf.

18

	http://www.theicct.org/sites/default/files/
publications/ICCTupdate_EU-95gram_
jan2014.pdf.

19

	http://www.spiked-online.com/newsite/
article/vw-a-panto-of-green-politics/17488#.
VwQ163IUXcs.

20

21

http://ec.europa.eu/finland/news/
press/101/pdf/catalytic_converters_
reduce_traffic_emissions_en.pdf
(accessed on April 15, 2016).

	Timothy F. Bresnahan and Dennis A. Yao,
1985, “The nonpecuniary costs of automobile emissions standards,” RAND Journal
of Economics, Vol. 16, No. 4, Winter, pp. 437–
455; and Richard G. Newell and Kristian
Rogers, 2003, “The U.S. experience with the
phasedown of lead in gasoline,” Resources
for the Future, discussion paper, June,
http://web.mit.edu/ckolstad/www/
Newell.pdf.

22

	Authors’ calculations based on data from
http://www.spiked-online.com/newsite/
article/vw-a-panto-of-green-politics/
17488#.VwQ163IUXcs.

23

	http://www.theicct.org/sites/default/
files/ICCT_comparison%20Euro%20
v%20US.pdf.

24

	However, in-use (on-road) testing seems
impractical for a large number of vehicles
and is likely not as precise as lab testing.
See Danny Hakim and Jad Mouawad, 2015,
“Galvanized by VW scandal, E.P.A. expands
on-road emissions testing,” New York Times,
November 8, http://www.nytimes.com/
2015/11/09/business/energy-environment/
epa-expands-on-road-emissions-testing-toall-diesel-models.html.

25

	https://www3.epa.gov/otaq/cert/mpg/
fetrends/1975-2015/420s15001.pdf.

26

	http://www.theicct.org/sites/default/
files/publications/ICCT_InUse_working_
paper_2012_Eng.pdf.

27

	Ewing (2016); and Hakim and Mouawad
(2015).

28

	http://www.theicct.org/sites/default/files/
Fact%20sheet_FromLabToRoad_2015.pdf.

29

	http://www.theicct.org/sites/default/
files/publications/ICCT_PEMS-study_
diesel-cars_20141013.pdf.

30

	See https://www.epa.gov/enforcement/
hyundai-and-kia-clean-air-act-settlement
and https://www3.epa.gov/otaq/
documents/fueleconomy/420f13044.pdf.

31

	Authors’ calculations based on data from
WardsAuto InfoBank.

32

	Ryan Beene, 2015, “VW’s diesel sales frozen
until compliance is proven, EPA official
says,” Automotive News, September 21,
http://www.autonews.com/article/20150921/
OEM11/150929980/vws-diesel-sales-frozenuntil-compliance-is-proven-epa-official-says.

33

	Ryan Beene, 2016, “After VW cheated, tests
got tougher,” Automotive News, March 7,
http://www.autonews.com/
article/20160307/OEM11/303079956/
after-vw-cheated-tests-got-tougher.

34

	Hakim and Mouawad (2015); and Financial
Times Limited, 2015, “Europe has ducked
its obligations on diesel cars,” Financial Times,
November 1, available by subscription at
http://www.ft.com/cms/s/0/afc4d66a7efd-11e5-98fb-5a6d4728f74e.html.

35

	Mathieu Rosemain, 2015, “Paris smog
obscuring Eiffel Tower threatens diesel-car
dominance,” Bloomberg, June 19,
http://www.bloomberg.com/news/
articles/2015-06-19/paris-smog-obscuringeiffel-tower-threatens-diesel-car-dominance.

36