Cash for Clunkers: Good Politics Trumps Good Policy – Again

Posted by & filed under CGR Staff, Rochester Business Journal.

Kent GardnerI sent my Nissan Quest to the crusher for a lousy $4,500.  Yes, I could see into the engine compartment without opening the hood—but it ran like a top! Now the feds will have their way with my car. Some minion will replace its engine oil with sodium silicate and fire up the unsuspecting engine—until it seizes up, never to run again. It’s the automotive equivalent of “hung from the neck until dead.” What have I done?

As cars fly out of the showroom and the dealerships are clogged with eager buyers, many of us are questioning this bit of Washington wisdom.

The environmental benefits of the plan will be modest, at best. With $2 billion added to the kitty last week, the total number of trades would be 750,000 if the rebates were evenly split between $3,500 and $4,500. That’s three tenths of one percent of the 240-250 million cars and trucks registered in the United States[1]. Surely there are better ways to reduce our consumption of gasoline. Might the $3 billion have achieved more for the environment if spent on improving Amtrak or subsidizing public transit? The real “green” in this program is the fig leaf covering yet-more money propping up the auto industry. Oh, and the three billion greenbacks we’ve borrowed for the purpose.

What worries me most is the precedent for Congress. I agree that some amount of fiscal “pump priming” was needed. In the past, however, the bulk of fiscal stimulus has been nonspecific and broad based, e.g. we cut tax rates and withholding, we issue tax rebates, or we extend unemployment benefits. In this crisis, Congress has also used fiscal stimulus as an excuse to spend vast sums on very specific objectives.

In place of “cash for clunkers,” we might have granted tax rebates totaling $3 billion to, perhaps, the 111 million taxpayers with adjusted gross income under $75,000. (They’d spend it, don’t you think?) Instead, we’re dangling a very substantial incentive in front of the small fraction of taxpayers who both own an eligible “clunker” and can afford to buy a new car (and many who can’t, I suspect). This is “déjà vu all over again:” Congress fell prey to the same temptation with the earlier stimulus bill.  It was a Christmas tree of pet programs and projects.

But will it work? Yes, the “cash for clunkers” rebates will be stimulative. This summer. Long term, who knows?

We are certainly borrowing some car sales from 2010. Any policy that puts more buying power in the hands of consumers may simply shift the timing of consumer spending. And consumer durable purchases, like cars, are notoriously volatile anyway, as we can often delay buying a new refrigerator or vehicle. I doubt that car manufacturers are increasing production in response to the rebate. As the rebate has been squeezed into a brief period of time, the new sales have had to come largely from inventory. Manufacturers will be wary of increasing production now if the new cars will only arrive after the rebate has ended. Auto dealers might speculate that sales through the end of the year—particularly of fuel-efficient cars like the econobox I’m now driving—will be slow, as most of the ready buyers bought with the rebate.

In hindsight, the rebate is too large. It cut the price of my new car by 40% over the price I negotiated with the dealer (after a manufacturer rebate). That’s a discount you don’t get every day, which is why I was eager to get in line. The speed at which the cash is disappearing suggests that we could have stimulated the same volume of sales over a longer period of time with a much smaller rebate. Remember that the original plan only allocated $1 billion to the program, not $3 billion, and that it was expected to last through November. The fact that dealerships are even busier now than in July suggests that the entire sum will soon be exhausted.

The popularity of the program has also shifted more of the benefit to the manufacturers (foreign and domestic) and to dealers. As an example, the $1,500 manufacturer rebate I secured in mid July disappeared when the strength of demand became clear. With a smaller rebate, total participation would have been less, the average trade would have been “clunkier” (as only cars worth the rebate or less should be traded), and the impact on manufacturers would have been stretched out over time. Had the rebate been only $3,000, for example, my Quest would still be sitting in my driveway, eagerly waiting for a trip to Wegmans or Home Depot.  At $4,500, the trade was too good to pass up.

I question, too, the wisdom of sending perfectly serviceable vehicles to the crusher.  They represent a share of our national treasure. My van would easily have provided another 30-40,000 miles of service to someone. One salesman told me of a customer trading an immaculate 1999 Mercedes with fewer than 100,000 miles on the odometer. The labor and materials used to build these cars will be wasted. Isn’t this another version of the “bridge to nowhere?”

Alas, the popular appeal of “cash for clunkers” proved irresistible to our elected officials. Seeking a “jiffy lube” for our clunky economy, Congress has put us further in debt (both as a nation and individually), a burden that will hinder future prosperity.

Kent Gardner, Ph.D. President & Chief Economist
Published in the Rochester (NY) Business Journal August 14, 2009