Nick's Blog

The U.S. Government has allocated $4 billion to spend July 1st – November 1st on the “Cash for Clunkers” program.  The legislation is part of the stimulus package and gives car owners $3500-4500 when they trade in their old, gas-guzzling car for a new, more fuel-efficient model.  Cash for Clunkers is designed to accomplish two things:

1. Improve the average fuel economy of cars on the road, reducing our dependence on foreign oil and reducing carbon emissions.
2. Stimulate new car sales for the battered auto industry.

How do you feel about your tax dollars being used to buy your neighbor’s old SUV?  That probably depends on how important you feel the two goals listed above are.  I think both are important, and am curious to see how big an effect the program could have.  Let’s take a look on how Cash for Clunkers might do.

Improve Fuel Economy

Here’s Uncle Sam finally putting his money where his mouth is when it comes to reducing America’s dependence on foreign oil.  In fact, there’s enough money in the Cash for Clunkers program to fund 1 million trade-ins.  Customers must make a minimum 4 mpg improvement to qualify, but I think most will do better than that.

So assuming that the full million people take advantage of this, and achieve an average 8 mpg improvement, how much oil will we have saved?

EDIT 7/16 ** My initial math was way wrong, which dramatically inflated the value of Cash for Clunkers **

• 15,000 miles = average distance drove in one year
• 15,000 miles @ 18 mpg = 833 gallons per year
• 15,000 miles @ 26 mpg = 577 gallons per year
• 833 – 577 = 256 gallons saved per driver
• 256 gallons x 1 million drivers = 256,000,000 total gallons saved
• 42 gallons of gas per 1 barrel of oil
• 256,000,000 gallons / 42 gallons per barrel = 6,095,000 barrels saved

How much is 6.1 million barrels?  It sounds like a lot.

But it’s not.  The U.S. consumes nearly 25 million barrels per day.  We just spent $4 billion to reduce our annual oil consumption by 0.067%, which is less than one tenth of one percent, which sadly rounds to ZERO.  It’s going to take a lot more than that to get the job done!  But to be fair, we’ve got to start somewhere and there are plenty of “intangible” environmental and international policy benefits as well, right?

To my knowledge, this is the first time the government has ever come out and put a dollar value on reducing oil consumption.  Cash for Clunkers doesn’t have a huge impact toward that goal, but it is a laudable goal nonetheless and does give us a measuring stick to gauge future projects by.  Still, I’ve got to believe there are more cost-effective ways to do this.

Stimulate New Car Sales

If 1 million people really trade-in their old rides, Cash for Clunkers will have done a much bigger job toward accomplishing it’s second goal than it did on it’s first.  If your vehicle gets less than 18 mpg and is worth less than $4500, Cash for Clunkers isn’t a bad deal.  Let’s revisit the math from above.

• 256* gallons saved x $3 per gallon = $768 dollars saved per year
• $768 / 12 months = $64 per month

Not nearly enough to cover your new car payment, but not a bad savings either.  The first half of 2009 has been dismal for car sales, with the SAAR (seasonally adjusted annual rate of sales) hovering around 10 million units.  If the full 1 million take advantage of Cash for Clunkers, it will have effectively given the auto industry a 10% bump.

Takeaways

So in the end, Cash for Clunkers appears to have a bigger upside potential for the car business than for the environmentalists.   And the $4 billion cost?  Well it’s only $1/person/month.  So for what’s it worth, you can say you did your part to go green and save jobs.

If you’re eligible and are in the market for a new car anyway, I recommend taking Uncle Sam up on his generosity while the opportunity is there.  Although if it works, (like any good car sale) I imagine they’ll do it again soon.

EDIT 7/29 ** My original post didn’t include the potential tax revenue gains the government could see from this program. **
Corporate Income Tax

Let’s say the car companies make $1000 per car, after allocating fixed and variable expenses.  And let’s say the car dealers make $500 per car, after allocating their fixed and variable expenses.

• $1000 x 1,000,000 additional new cars sold = $1 billion in additional net income for car companies.
• $1 billion x 35% corporate income tax rate = $350 million additional federal income tax from car companies.
• $500 x 1,000,000 additional new cars sold = $500 million in additional net income for car dealers.
• $500 million x 35% corporate income tax rate = $175 million additional federal income tax from car dealers.

Payroll Taxes / Personal Income Taxes

Let’s say there’s $2000 worth of labor that goes into building each car.  And let’s say the salesperson at the dealership earns $400 for each car they sell.  What impact would Cash for Clunkers have on increasing personal payroll and income taxes for the government?

• $2000 x 1,000,000 extra cars = $2 billion in additional auto-worker income.
• $2 billion x 25% income tax bracket = $500 million in additional auto-worker income tax revenue.
• $2 billion x 16% employer payroll tax burden = $320 million in additional car company payroll taxes.
• $400 commission x 1,000,000 extra cars = $400 million in additional car salesperson income.
• $400 million x 25% income tax bracket = $100 million in additional car salesperson income tax revenue.
• $400 million x 16% employer payroll tax burden = $64 million in additional car dealer payroll taxes.

So, how much of the government’s initial $4 billion investment did they earn back?

• $350M + $175M + $500M +$320M + $100M + $64M = $1.509 billion

Taking the tax revenue into account, the cost for Cash For Clunkers goes down considerably — now down to $0.69/person/month.  These numbers are of course entirely speculative estimates, but I think they illustrate how the right incentives could be used to “move the needle” on some important issues at a relatively small cost.  In fact, I’m positive the government could make wise investments in the economy, like venture capitalists, and earn great returns.  After all, their “business” relies on the success of the country so it’s only in their best interest to spend wisely.

EDIT 8/10 **

I found this interesting article on CNN about Why Cash For Clunkers Works.

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