Making Sense of 'Cash for Clunkers'

Is what's good for the car companies good for the consumer?

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With new-car sales slumping, automotive companies have been looking for ways to get consumers back into showrooms. Washington checked one item off car companies' wish list last week when it passed the Consumer Assistance to Recycle and Save Act of 2009, tucked inside a large defense bill. Car companies love the program, popularly dubbed "cash for clunkers," because it gives consumers vouchers to buy new cars. The recession has led Americans to stick with the same cars longer, as "many consumers are finding repair costs much better than replacement costs," says David Portalatin, an automotive industry analyst at the market research firm NPD Group. Now, car companies are hoping that cash for clunkers will provide more incentive for consumers to replace their cars. Kevin Saito, president of American Suzuki, praised the bill as "extraordinary," saying that it would mean an increase in dealer traffic for Suzuki. But is what's good for the car companies good for the consumer?

[Slide show: 10 Cars Detroit Should Copy.]

Here's how the program works: From July 1 through November 1, you can bring to a local dealer an old car that has been registered to you and has been insured for at least one year. You can then purchase a new vehicle and trade in your old vehicle for a $3,500 or $4,500 voucher, as long as the new vehicle gets better gas mileage. (See below to find out which vehicles qualify for what.)

But here's the catch: The car you're trading in can't be worth more than $4,500. That ceiling limits the number of people who could benefit from the program, says John Wolkonowicz, an industry analyst at economic forecasters IHS Global Insight. "If I have a car that's worth less than $3,500 or $4,500, I probably can't afford a new car anyway."

Wolkonowicz says car dealers could abuse the new program—for example, by pocketing the voucher without telling a customer that he or she is eligible. So it's important to do your research and find out exactly which vehicles qualify for the program and how much gas mileage your current vehicle gets. The Environmental Protection Agency has a list of the fuel economy of various makes and models here.

[See 10 Other Things to Know About Cash for Clunkers.]

Going green? "Cash for clunkers" was coined by economists who wanted to create incentives for drivers to shift to more energy-efficient cars. "If designed well, [a cash for clunkers program] could wean us off SUVs," says Lee Schipper, a transportation expert at the University of California-Berkeley and the Precourt Institute for Energy Efficiency at Stanford University. But he says this version of the program is far from ideal. To make a serious dent in CO2 emissions, he says, the vouchers should go only to new vehicles that get at least 28.6 miles per gallon (28.6 is the average fuel economy for SUVs required by recently enacted Department of Transportation regulations.)

But under the CARS act, the new vehicle doesn't have to be much more efficient than the clunker that's being traded. For example, a customer with a large SUV that gets only 18 miles per gallon would receive a $4,500 voucher to replace a "clunker" that got 13 miles per gallon. That's not a major difference, says Schipper, and the gap between the newer, "greener" vehicle and the clunker must be large because clunkers aren't driven as much anyway. "A clunker in its last two years [of life] might only go 3,000 miles a year. You're only eliminating 10 percent of its life [by getting rid of it]," says Schipper.

There's also the issue that building a new car is estimated to use the same amount of energy as driving the car for one year. In other words, there isn't significant "green" savings in this version of cash for clunkers—unless you buy a car that is more efficient than the average mileage standards.

Scrapping used cars. Even if you're not driving a clunker, the new program might affect prices if you're looking to buy a car. "Technically, it will make the prices of new cars lower and thus also lower the price of used cars," says Wolkonowicz. But there's a snag: The program requires that the old cars being traded in be entirely scrapped. Therefore, an unintended consequence of cash for clunkers could be a shrinking supply of used cars, as low-gas-mileage cars that would be on the used car lot are scrapped. That could mean higher prices in the used market.