Cash for Clunkers

My first series of articles delved into aspects of speculative bubbles, the government's contribution to our economic challenges and their own ability to deal with said challenges, and the all too insidious nature of inflation. Laying that foundation we move into a topic of recent consumer interest.


The term “Cash for Clunkers” refers to a government program under the acronym CARS (Car Allowance Rebate System). Under the program, recently extended by Congress, consumers receive $3,500 - $4,500 towards the purchase of a more fuel-efficient vehicle. Details are available at http://www.cars.gov .


The program accomplishes two things. First, it provides a boost to reeling automakers beset by sharply declining sales. Secondly, by exchanging vehicles of less fuel efficiency for those with more fuel efficiency, the average MPG of the US fleet improves, thus driving down our reliance on imported oil. On balance, it appears a laudable goal. Let us examine the efficacy of this government program.


Does this program make economic sense? Discard political loyalties for a moment. Think about this in terms of economics. In 2003 Congress passed legislation offering up to a $100,000 tax credit for business owners purchasing vehicles weighing 6,000 lbs or more. The $100,000 represented an increase from $75,000 the prior year. Curiously, there were many SUVs fitting that description. What happened to large SUV sales during this period? According to the watchdog group Taxpayers for Common Sense, 100,000 people claimed the credit in 2002 (out of 3.6 million large SUVs sold). During this same period, a $2,000 deduction for hybrid vehicles was set to expire.


There are two operative points to consider with the program encouraging gas-guzzlers. Taxpayers not desiring large SUVs subsidized those qualifying for the program. What led Congress and the Administration to consider this is worthy program? Was the market for large SUVs in a state of decline (3.6 million sold in 2002)? Keep in mind this does not consider other SUVs of smaller dimensions who were already selling quite well. Next, was the oil importation equation from 2003 significantly different than it is now? We were quite reliant on oil imports in 2003. Our geopolitical interests in oil-bearing regions certainly confirm this.


Now we have a sea change at hand. We reward former purchasers of gas-guzzlers in their acquisition of a more fuel-efficient vehicle. The new program is multiples larger than the original. A taxpayer originally purchasing what the government considers a fuel-efficient vehicle loses again since they never purchased the gas-guzzler in the first place. The point is not to castigate purchasers of gas-guzzlers. Is the attempt by government to stimulate demand in this instance economically worthy? The site http://www.CNN.com suggests this program will stimulate demand, increase production from the automakers and have a ripple effect on the economy.


If government stimulation of demand by spending or tax subsidies such as this is the magic potion to remediate our economic ills we can envision two scenarios. The government could commission defense contractors to build warships and tanks. Our military could then unleash a massive wave of target practice, without humans occupying the ships and tanks, and spend quite a bit of money. The economic stimulation occurs and there are ripples throughout the economy.


In another case, a group of vandals is unleashed in a suburban neighborhood to break as many windows as possible. A sympathetic member of Congress proposes legislation, with Presidential support, to provide a tax credit for people replacing those windows with more energy-efficient ones. Window makers and installers rejoice since their industries were struggling with the recent collapse of new home building.


Two problems exist in the aforementioned examples. A) Our present government has no money for either program, which means further borrowing. B) The spending for military target practice or windows replaces other spending in the market. In both of these cases, a wealth transfer from taxpayers not directly involved with military production or window production occurs. We also did not create any wealth but we certainly created debt.


The current Cash for Clunkers program is a wealth transfer from taxpayers not purchasing cars to those who actually may have purchased cars regardless of the tax incentive. More likely, the Cash for Clunkers program accelerated some number of future car purchases. Another unintended effect is the removal of a supply of used cars from the market since the Clunkers program requires dealers to scrap the vehicle or disable its engine. Americans dependent on the used vehicle market will see the supply of available cars diminish.


Government is seldom an agent of positive economic change. We have literally come full-circle with this program. The initial incentive to purchase a fuel-inefficient vehicle is replaced a by program to purchase a fuel-efficient vehicle. Compounding this “solution” is the destruction of real value of many previously owned cars now rendered useless. Kafka would be proud!


Jim Mosquera publishes The Sentinel newsletter (http://www.TheSentinel.biz).