Over recent decades, GATT panels have been requested to adjudicate a handful of disputes between the EU and the US over environmental measures with an alleged discriminatory impact on imports. In particular, the Corporate Average Fuel Economy (CAFE) regulation, an oil conservation measure employed by the US, produced an EU challenge. In Discussion Paper No. 1373, Research Fellow Joseph Francois and Research Affiliate Håkan Nordström explore the extent to which the CAFE regulation affords differential tax treatment to car models with identical fuel economies and, therefore, differential incentives for improvements.

They show that the fleet averaging provision translates into a schedule of internal taxes and subsidies within each fleet that depends on the miles per gallon of each individual model in relation to the fleet average fuel economy. Competing models with the same fuel economy are taxed at different rates if they belong to fleets with different average fuel economies. This implies that incentives to improve fuel economy differ among producers and may even be negative for manufacturers specializing in fuel-efficient cars. It is also demonstrated that the fleet separation provision serves as an implicit tax on certain categories of imports, while providing implicit subsidies to other categories of imports. This analysis shows that environmental averaging which sends mixed signals to producers is in any case inferior to simply taxing individual products according to their own environmental merits, and can be interpreted as a subtle protectionist instrument.

A Green Light for Environment, or a Green Light for Protection? The EU-US Dispute over US Corporate Average Fuel Economy Regulations
Joseph F Francois and Håkan Nordström