To fine or not to fine? Implementing standards

On May 7, China’s Ministry of Industry and Information Technology (MIIT) released its proposed Enforcement Rule for New Passenger Car Corporate-Average Fuel Consumption Standard for public comment.

As we note in our policy update here, the Enforcement Rule incorporates elements from regulations in other major auto markets, tailored to fit the Chinese context. What most distinguishes the Chinese implementation proposal from other rules is its lack of fiscal penalties for not complying with the standards.

The goal of a fiscal penalty in any vehicle regulation is to significantly increase the cost of noncompliance, so that manufacturers are motivated to improve vehicle technologies and achieve their targets. This goal determines the main principle of setting the penalty amount: the marginal penalty must exceed the marginal cost of achieving the standard targets. An ideal penalty rate (i.e., payment to offset excessive emissions) should be above any manufacturer’s marginal cost of achieving their targets. For instance, the EU imposed a penalty of €95 per vehicle on every gram of CO2 emitted per kilometer by which a manufacturer exceeds the target value it’s assigned under the EU’s vehicle efficiency regulation. According to analysis on behalf of the European Commission [.pdf, see pp. 220–221], the maximum marginal cost of reducing CO2 emissions is around €91 per g per kilometer on average. So a €95 penalty per gram of excess CO2 on each noncompliant vehicle sold still seems reasonable, although it should in fact be higher to ensure that there is enough of an incentive for all manufacturers to reach their equivalent target.

An advantage of the system of fiscal penalties is that manufacturers are able to continue to sell a diversity of models in the market, and have a clear signal to adopt technologies with marginal cost lower than the penalty rate to achieve their targets. In some cases, the manufacturer may decide to take the penalty in order to continue to sell certain inefficient (luxury or performance oriented) vehicles.

The US has a dual penalty structure to deal with noncompliant manufacturers. The Environment Protection Agency (EPA) provides “conditional” type-approval certification to new vehicles. The condition assumes that the manufacturers will meet their corporate-average GHG emissions standards by the end of the year. If a manufacturer fails to meet its corporate-average GHG emissions standard after applying all the flexibilities and credits, EPA may void the certification of relatively high-emission models until the recalculated corporate-average GHG level meets the standard. The sales of all voided models are considered to be in violation of the condition in the type-approval certification, and manufacturers are penalized for illegally selling uncertified models. The penalty for each vehicle sold with voided certification is up to $37,500 These enforcement measures are consistent with EPA’s regulation of criteria pollutants, and derived from the Clean Air Act.

In China, MIIT proposes to void certification for models that do not meet its specific weight-based fuel consumption target, meaning that those models simply cannot be sold at all. If the proposal can be implemented thoroughly, MIIT can effectively ensure the enforcement of the Phase 3 standard.