Demand for Free Money Surprises Government

Unless the Senate takes action in a very short time the Cash for Clunkers program will end on Tuesday. The program was supposed to run through November 1 but the fund was exhausted in less than a week. Imagine that, the government underestimated the demand for "free" money.

While responsible for an increase in new vehicle sales, it was not without unintended consequences, as The Heritage Foundation pointed out on Friday.

Does Nothing for Environment: Sens. Dianne Feinstein (D-CA) and Susan Collins (R-ME) are open to allocating more money for the program, but only if the rules are changed so that the program might actually do something for environment; because right now it is not. Edmunds.com auto analyst Jessica Caldwell explains why: “What you buy has to have an increase in fuel economy from what you traded in. But in some cases, that increase can be minimal. Owners of large pickup trucks like a Ford F150 only have to buy a replacement that increases efficiency by one mile per gallon. And they still get a $3,500 rebate. The environmental impact is negligible and the impact on national fuel demand and consumption is very small. The only real benefit in a like-for-like swap can be improved emissions standards on newer vehicles. Rather than discourage those people, they included them in this program.” Caldwell didn’t even mention the pollution costs of actually building a new car and the disposal of the old car, rather than just the pollution caused by driving the vehicle.

Hurts Working Americans: The federal government’s push to help auto makers has unintended consequences which will hut many lower-income Americans. Economist, Freakonomics author and New York Times blogger Steven Levitt writes: “People who drive clunkers are generally not in the market for new cars. Presumably their replacement car will be a used car. The increased demand for used cars will lead to higher prices for used cars.” Driving up the cost of older cars may be an intended consequence for policymakers to encourage people to buy new, but it’s a bad deal for consumers.

The lower supply of used cars is also bound to have a negative impact on the environment. People who drive true clunkers are often not able to afford new cars, even with the government rebate. As the price of used cars rises some of them will no longer be able to afford used cars of more recent vintage with better gas mileage. They will continue to drive their clunkers rather than upgrade to a higher mileage used car.

Hurts Charities: Speaking of ads, you probably have heard a ton on the radio from charities asking you to donate your old car in exchange for a tax deduction. Do a Google search of “Donating Cars for Charity,” and you will see a list of charities that cash-for-clunkers is taking money from.

In addition, they also point out that it involves the government further in the market and, on top of it all, increases the debt. As the WSJ article reveals, the program is not without its implementation problems.

But the program has frustrated some dealers, who say they have hundreds of thousands of dollars of clunker claims outstanding and that the government's cash-for-clunkers Web site won't allow them to submit applications in a timely way.

[...]

The effort has been beset by other complications. Just six days after the clunkers program launched, it became apparent to DOT officials that they didn't know how much of the $1 billion allocated to the plan had been spent.

And late Thursday, administration officials told lawmakers that the program would be suspended at midnight. The White House reversed course several hours later and insisted the program wouldn't be suspended. On Friday, the White House assured dealers and consumers the program would continue during the weekend.

There are other problems in addition to those mentioned above. It is likely that many of the vehicles that are being traded in have been paid off and the buyers are purchasing new cars on credit. This purchase is bound to saddle some of them with additional debt that they can't afford. The government may be encouraging more people to assume debt they will be unable to pay back.

If the metric for success is the number of people who participate in the program then it has succeeded beyond anyone's dreams. However, the proper measures are its impact on the economy and the environment. Therefore, it is much too early to celebrate.

UPDATE: This WSJ editorial call the program "crackpot economics".

The subsidy won’t add to net national wealth, since it merely transfers money to one taxpayer’s pocket from someone else’s, and merely pays that taxpayer to destroy a perfectly serviceable asset in return for something he might have bought anyway. By this logic, everyone should burn the sofa and dining room set and refurnish the homestead every couple of years.

It isn’t clear this will even lead to more auto production over time, since the clunker cash may simply cause buyers to move their purchases forward. GDP will get a fillip in the third and perhaps fourth quarters, which will please the Obama Administration. But the test will be if auto sales hold up next year and into the future once the clunker checks go away. The debate over the subsidy may even have prolonged this year’s auto slump as buyers delayed their purchases waiting for the free lunch.