Journal Pre-Proof: Journal of Environmental Economics and Management

Journal Pre-proof
When tax incentives drive illicit behavior: The manipulation of fuel economy in the
automobile industry
Shinsuke Tanaka
PII: S0095-0696(20)30090-5
DOI: https://doi.org/10.1016/j.jeem.2020.102367
Reference: YJEEM 102367
To appear in: Journal of Environmental Economics and Management
Received Date: 8 October 2019

Revised Date: 31 July 2020
Accepted Date: 6 August 2020
Please cite this article as: Tanaka, S., When tax incentives drive illicit behavior: The manipulation of fuel
economy in the automobile industry, Journal of Environmental Economics and Management (2020), doi:
https://doi.org/10.1016/j.jeem.2020.102367.
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When Tax Incentives Drive Illicit Behavior: The Manipulation of
Fuel Economy in the Automobile Industry∗
Shinsuke Tanaka†
Abstract
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This study examines and identifies the underlying incentives for falsifying fuel econ-
omy on the part of the automobile industry. Using novel microdata on on-road
fuel consumption in Japan, we find a discontinuous increase in the fuel economy
r
gap—the disparity between official test results and real-world fuel economy—of 6
-p
percent at the tax-incentive eligibility thresholds. Further evidence suggests that
much of the observed gap remains unexplained by driver or vehicle characteristics,
e
and that no gap is observed at similar levels of fuel economy when they are not
Pr
tied to the large tax-incentive eligibility. Our findings suggest that feebates, large
incentive schemes based on fuel economy levels, may in turn incentivize automakers
to “cook the books” on fuel economy figures.
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Keywords: fuel economy gap, feebate policy, manipulation, automobile industry

JEL Codes: H23, Q58, L62, L51
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∗
A previous version of this paper has been circulated as “Minding the Gap: Tax Incentives and Incentives
for Manipulating Fuel Economy in the Automobile Industry.” I thank Ujjayant Chakravorty, Saori Chiba,
Federico Esposito, Raymond Fisman, Kelly Sims Gallagher, Cristian Huse, Takanori Ida, Emiko Inoue,
Tetsuya Kaji, Keisuke Kawata, Koichiro Ito, Ayako Kondo, Kelsey Jack, Daiji Kawaguchi, Tatsuya
Kikutani, Michael Klein, Christopher R. Knittel, Hisaki Kono, Jing Li, Shanjun Li, Joshua Linn, Gilbert
Metcalf, Toru Morotomi, Tatsushi Oka, Hitoshi Shigeoka, Shomon R. Shamsuddin, Robert Stavins,
Adam Storeygard, Yoshito Takasaki, Kensuke Teshima, Takayuki Tsuruga, Naoki Wakamori, Martin
Weitzman, Ken Yamada, Jeffrey Zabel, Da Zhang, two anonymous referees, and seminar participants
at AEA-ASSA, AERE Summer Conference, Harvard University Kennedy School of Government, NARE
Annual Meeting, NBER SI, National Institute for Environmental Studies in Japan, University of Tokyo,
Kyoto University, the Japan’s Ministry of Land, Infrastructure, Transport and Tourism, and the Japan’s
Ministry of Environment for the helpful comments. We also appreciate the IID, Inc. Group for sharing
the data on real-world fuel economy. Financial support from the Hitachi Center for Technology and
International Affairs is gratefully acknowledged. This research was assisted by a grant from the Abe
Fellowship Program administered by the Social Science Research Council in cooperation with funds
provided by the Japan Foundation Center for Global Partnership. The views expressed here are those of
the author and do not reflect those of the data provider or the funding agencies. This paper was written
in part while the author was visiting the Center for Energy and Environmental Policy Research at MIT.
I am grateful to the center for its hospitality. I do not, nor do any close relatives, have any paid or unpaid
positions as officer, director, or board member of relevant non-profit and for-profit organizations. The
usual disclaimer applies.
†
The Fletcher School, Tufts University. 160 Packard Ave. Medford, MA 02155. Email: Shin-
suke.Tanaka@tufts.edu
When Tax Incentives Drive Illicit Behavior: The Manipulation of
Fuel Economy in the Automobile Industry
f
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Abstract
r
This study examines and identifies the underlying incentives for falsifying fuel econ-
-p
omy on the part of the automobile industry. Using novel microdata on on-road
fuel consumption in Japan, we find a discontinuous increase in the fuel economy
e
gap—the disparity between official test results and real-world fuel economy—of 6
percent at the tax-incentive eligibility thresholds. Further evidence suggests that
Pr
much of the observed gap remains unexplained by driver or vehicle characteristics,

and that no gap is observed at similar levels of fuel economy when they are not
tied to the large tax-incentive eligibility. Our findings suggest that feebates, large
l
na
incentive schemes based on fuel economy levels, may in turn incentivize automakers
to “cook the books” on fuel economy figures.
ur
Keywords: fuel economy gap, feebate policy, manipulation, automobile industry

Jo
JEL Codes: H23, Q58, L62, L51

I. Introduction
The illicit manipulation of fuel economy and related emission data on the part of the
automobile industry has recently garnered substantial public attention.1 While individual
cases vary in nature and magnitude, investigations of their underlying causes and impacts
have been impeded by the absence of tools which would enable researchers to collect and
monitor systematic quantitative data regarding distorted fuel economy figures, as well as
the absence of credible research designs to establish causality.
In this study, we overcome these two obstacles by utilizing novel microdata on on-
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road fuel consumption in a quasi-experimental research design that offers causal inference.
In particular, we focus on cases from 2016 in which automakers in Japan have falsified
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fuel economy figures in order to shed light on two phenomena: (1) the incentives that
induced automakers to manipulate data regarding fuel economy, and (2) the extent to
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which the resulting data have distorted compliance with current environmental policies.
To address these questions, we consider the feebate policy in Japan since 2009. With
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the aim of promoting fuel-efficient vehicles, the policy provided massive tax incentives to
vehicle purchasers based on fuel economy. These tax incentives have boosted demand for
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eligible vehicles and therefore induced the automakers to inflate the fuel economy of their
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vehicles to meet the eligibility thresholds. We examine whether and to what extent these
tax incentives give rise to a so-called “fuel economy gap,” which is the disparity between
test results and what is actually achieved on the road.
Our study finds both that there is a large fuel economy gap and that this gap ex-
hibits significant increases at the eligibility thresholds. On average, while real-world fuel
economy is about 21.6 percent lower than the officially reported test data for ineligi-
ble vehicles below the eligibility thresholds, the fuel economy gap for eligible vehicles
exhibits a discontinuous increase of 6.0 percent at the eligibility cutoffs. Perhaps most
interestingly from an economics perspective, the point estimates illustrate a suggestive
1
In the U.S., Hyundai-Kia, Ford, BMW Mini, and Mercedes have been forced to lower fuel-efficiency
ratings and pay penalties. More recently, Volkswagen was discovered to be equipping so-called “cycle-
beating” software in their diesel vehicles, which enables vehicles to produce reduced emissions during
tests while those same vehicles on the road emit up to 40 times more emissions than allowed under
federal standards. In Japan, Mitsubishi admitted to manipulating fuel economy data in April 2016.
1
pattern of larger discontinuities in fuel economy gaps at eligibility thresholds associated
with greater marginal tax incentives, while the differences in individual point estimates
are not statistically different from each other, suggesting that the automakers rationalize
their manipulation efforts on the basis of expected returns on sales at the margin. While
we find great heterogeneity in the fuel economy gap across automakers, the extent esti-
mated for Mitsubishi is commensurate with what was revealed by the company executives
during a press conference in April 2016. Our findings offer among the first evidence that
feebates, the large incentive schemes with nonlinear schedules based on fuel economy
figures, create incentives on the part of the automobile industry to “cook the books” on
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fuel economy figures by exploiting existing legal laxity and potentially illegally falsifying
data.
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Our results are pertinent to contentious debates among economists and policymak-
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ers over the efficacy of a variety of policy schemes aimed at improving automobile fuel
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economy and curbing greenhouse gas emissions.2 Policy schemes based on fuel economy
figures, e.g. fuel economy standards, taxes, subsidies, or scrappage programs, are very
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popular around the world.3 Existing studies show that these policies have effectively in-
creased the demand for and market share of fuel-economical vehicles and have contributed
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to improvements in official fuel economy.4

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However, such policy schemes are also likely to induce behavioral distortions as eco-
nomic agents form incentives to game the system. Recent studies have documented evi-
dence that vehicles were redesigned to comply with the fuel economy standards (Knittel
2011, Klier and Linn 2012; Sallee and Slemrod 2012; Ito and Sallee 2018; Bento et al.
2017; and Whitefoot et al. 2017). These responses reflect strategic and legitimate behav-
2
For instance, see Anderson and Sallee (2016) for an extensive review of policy designs and their
effects on fuel consumption and greenhouse gas emissions.
3
Fuel economy standards or equivalent emission standards are adopted by countries collectively
producing 80 percent of world vehicles, e.g., the U.S., EU, Japan, Brazil, Canada, China, India, Mexico,
and South Korea. Further, a variety of federal, state, and local tax incentives and subsidies are provided
in the U.S. for the purchase and sale of hybrid-electric or fuel-efficient vehicles, e.g., the 2009 Cars
Allowance Rebate System, also known as Cash for Clunkers, program, while on the other hand, the Gas
Guzzler Tax is imposed on fuel-inefficient vehicles that do not meet the fuel economy standards.
4
See Goldberg (1998), Greene (1990), Clerides and Zachariadis (2008), Bento et al. (2009), Chandra
et al. (2010), Beresteanu and Li (2011), Gallagher and Muehlegger (2011), Lucas and Kilian (2011), Mian
and Sufi (2012), Li et al. (2014), Hoekstra et al. (2017), and Konishi and Zhao (2017).
2
iors that do not necessarily give rise to a discontinuous fuel economy gap at eligibility
thresholds.
This study makes a unique contribution by focusing on a fuel economy gap at the eli-
gibility threshold that arises only from distinct mechanisms of a potentially illicit nature,
namely cheating fuel economy figures on the producer’s side, a topic that has garnered
increasing policy interest in recent years.5 A series of recent scandals exposing automak-
ers’ manipulation of fuel economy and emission data have revealed that various loopholes
in vehicle testing procedures have allowed manufacturers to game opportunities for opti-
mizing the results, as discussed in more detail in Section IV.D.
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Our analysis provides two methodological advantages and an excellent case to study
the extent of the distorted fuel economy figures and the underlying incentives for their
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manipulation. First, we observe a large set of high-frequency on-the-road fuel consump-
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tion microdata obtained directly from regular drivers through a unique mobile phone
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application at every refueling level. The data set also identifies configurations of vehicles
at the exact level at which a unique value of official fuel economy is designated, allowing
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us to compute the fuel economy gap with a rare level of precision. Since the pioneering
work by Schipper and Tax (1994), some quantitative evidence used anecdotally has doc-
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umented the existence and even growth of gaps between fuel consumption in real-world
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driving and officially reported performance.6 However, the gap can naturally arise and
grow over time due to differences between testing cycles and individual driving conditions,
and therefore the mechanism to explain the gap remains little understood (Anderson and
Sallee 2016). Our investigation into the magnitude and cause of the fuel economy gap
based on a more systematic quantitative analysis is therefore important, relatively new,
and unique.
Second, our research design, which compares eligible and ineligible vehicles locally
5
In a different context, Oliva (2015) presents compelling evidence of corrupted emission regulations
by testing center technicians in Mexico.
6
For example, the International Council on Clean Transportation (2015b) reports that the gap in fuel
consumption between in-use vehicles and official figures widened from 8 percent in 2001 to 38 percent in
2014 across six countries in the EU (Germany, UK, Netherlands, Spain, Sweden, and Switzerland). In
the U.S., the fuel economy rates reported to the Environmental Protection Agency turned out to be 25
percent lower than the official measures (Greene et al. 2015). Reynaert and Sallee (2018) also presents
increased gaps from around 12 percent in 1998 to 55 percent in 2014 in the Netherlands.
3
in the neighborhood of the eligibility thresholds that were exogenously established and
varied over time, allows us to discard a number of channels that would otherwise ex-
plain a fuel economy gap. In particular, our identification assumption is that no other
factors—other than the large tax incentives and factors that can be controlled for by a
flexible underlying function of the running variable—explain an increased fuel economy
gap at the thresholds. We present a variety of placebo evidence that supports the iden-
tification assumption, which suggests the absence of a discontinuity in the fuel economy
gap (1) at the tax-incentive eligibility thresholds before 2009, when the sizes of the tax
incentives were small, and (2) at the levels of fuel economy since 2009, which defined
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large tax-incentive eligibility in one period for vehicles produced in another period, dur-
ing which these levels were not tied to the tax-incentive eligibility. These findings are
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difficult to reconcile with an alternative explanation unrelated to the regulation. Further,
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we show that a number of driver characteristics do not differ across the thresholds in a
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systematic way that could possibly account for the observed fuel economy gap, whereas
some vehicle characteristics are shown to explain some of the observed gap, highlighting
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mechanisms through which fuel economy can be inflated. Nevertheless, much remains
unexplained, leaving the potential for illicit manipulation.
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Our study is closely related to, yet differs from, contemporary work by Reynaert and
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Sallee (2018) in four important dimensions. First, our analysis associates the fuel economy
gap with a feebate policy, which differs from the fuel economy standards examined in Rey-
naert and Sallee (2018). While economic analyses typically conclude that market-based
approaches are much more efficient than traditional fuel economy standards at influenc-
ing consumer behavior and achieving pollution reductions, feebate policies are relatively
new and are considered among the most promising policy schemes because unlike taxes,
they provide a visible price signal at the time of purchase, while the largest impact is ex-
pected from manufacturer innovation in the long-run (the International Council on Clean
Transportation 2010a, International Energy Agency 2012, and APEC Energy Working
Group 2018). Our finding that feebate systems, especially those with nonlinear payoff
schedules, are substantially less effective in reducing fuel consumption has important
4
policy implications for the increasing number of countries that are implementing similar
programs.7
Second, our empirical strategy is established on the discontinuous nature of eligibility
thresholds over the official fuel economy figure, while Reynaert and Sallee (2018) rely
on temporal changes. Importantly, the fuel economy gap is observed to mechanically
widen as levels of fuel economy increase, rendering the identification of its cause based
on temporal changes difficult.
Third, our data measure actual fuel economy for regular drivers driving their own
vehicles for daily purposes, while the measure employed by Reynaert and Sallee (2018) is
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based on fuel consumption paid by employers for their corporate vehicles also provided by
employers. Lastly, we analyze potential mechanisms for automakers to game the system,
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which the earlier study did not.
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The rest of the paper is structured as follows: Section II describes the feebate policy in
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Japan and introduces our unique data. Section III explains the econometric framework.
Section IV discusses the results, an extensive set of robustness checks, mechanisms, and
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heterogeneity in the treatment effect. Section V tests the validity of the identification
assumption. Section VII concludes.
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II. Institutional Background and Data
A. The Feebate Policies in Japan8
Japanese consumers incur a substantially greater burden of taxes assessed upon purchase
of a new vehicle than those in other countries. For example, besides a consumption tax, the
acquisition tax (jidosha shutoku zei ) is levied upon acquisition of a vehicle. In addition,
while the tonnage tax (jidosha juryo zei ) is levied for each year of a vehicle’s ownership,
it is paid forward for all years up to the next mandatory inspection (shaken). Because
7
While a feebate program is defined as a policy by which fees are levied for the purchase of less
efficient vehicles and rebates (or discounts) are provided for the purchase of more efficient vehicles, many
countries have implemented various forms of feebate-like programs, including Austria, Denmark, France,
Japan, the Netherlands, Norway, Ontario (Canada).
8
Further details of the policy schemes are described in Appendix ??.
5
inspections are mandated three years after the purchase of a new car and every two
years afterwards, vehicle purchasers must pay the tonnage tax for three years, signifying
one additional year of tax payment relative to every subsequent mandatory inspection.
Further, an annual automobile tax (i.e., ownership tax) (jidosha zei), assessed on the
basis of the vehicle’s engine displacement (i.e., engine capacity), for a regular vehicle
alone is 21 percent higher than in the UK and nearly 25 times higher than in the U.S.
(Japan Automobile Manufacturers Association, Inc 2015).9
The Japanese government has historically instituted incentive programs on these taxes
since 200110 for the purchase of high-fuel efficient vehicles with the dual goals of easing
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these tax burdens and of promoting the wider use of low-carbon, environmentally-friendly
vehicles in order to curb global warming. Most remarkably, what is known as the Eco-
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Car Tax Incentives (ETI) (eco-car genzei ) started in 2009, which included substantially
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greater tax incentives on the acquisition tax than before and newly introduced tax cuts
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on the tonnage tax for the purchase of a new eligible vehicle. The policy continues up
to the present, with incentives and eligibility criteria having been revised twice, in 2012
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and 2015. Eligibility is determined by the vehicle’s year of manufacture and official fuel
economy in accord with and often larger than the fuel economy standards. For instance,
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for vehicles manufactured in 2009, the tax incentives applied to vehicles that exceeded by
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15 percent or more the 2010 fuel economy standards, and greater incentives applied to
vehicles that met even higher eligibility thresholds. Appendix ?? presents the historical
changes in eligibility thresholds in fuel economy.
The magnitude of tax incentives under the ETI were massive both absolutely and
relatively to the previous tax incentives. For example, consider the initial amount of
tax payments when a consumer acquires an average new passenger vehicle priced at
U3,000,000 (approximately $28,700), weighing 1.5 tons, and with a displacement size of
2 liters.11 Figure 1 Panel A illustrates the costs of the acquisition and tonnage taxes,
with and without tax incentives, over time (represented by dashed and solid lines, re-
9
The total automobile-related taxes paid during the lifetime of an average vehicle in Japan are nearly
5 times those in the U.S.
10
Throughout the paper, all years refer to fiscal years, which begin in April in Japan.
11
These are median characteristics of vehicles in our sample produced in 2009–2014.
6
spectively). In 2009, the total amount of these two taxes without a tax reduction was
U191,700 (approximately $1,80012 ). In contrast, the corresponding figure with tax incen-
tives was U71,200 (approximately $680), which represents reduced payments of U120,500
($1,150), or 63 percent, per eligible vehicle. These numbers are substantially larger than
the corresponding figures in 2008, when the average amount of the tax reduction was
U10,500 ($100) or only 5.5 percent. During our study period of 2001–2014, the average
size of tax incentives until 2008 for these attributes of a vehicle was only U13,000 ($120)
or 9.6 percent for the acquisition tax and none for the tonnage tax, while since 2009 it has
increased to U89,500 ($860) or 71.7 percent for the acquisition tax and U30,950 ($300)
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or 73.7 percent for the tonnage tax.
Panel B documents analogous sharp, discontinuous reductions in average initial pay-
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ments of acquisition and tonnage taxes for vehicles in our sample at the ETI eligibility
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thresholds in 2009–2014. What is more, substantial “Eco-Car Subsidies” (eco-car hojokin)
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were also provided during two limited periods (shaded areas in Figure 1) to consumers
purchasing an ETI-eligible new vehicle.13
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[Figure 1 About Here]

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These tax incentives provided clear motivation for consumers to purchase eligible
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vehicles, and thus for automakers to make their vehicles eligible. Figure 2 illustrates the
sales share of vehicles eligible to the ETI over time. At the beginning of the policy, only
slightly over 40 percent of sales were eligible for the ETI (while only 35.8 percent of
sales would have been eligible for tax incentives in 2008 had the ETI been in effect),
which skyrocketed within a year up to more than 70 percent by the end of 2009. The
share plummeted when the standards were tightened in 2012, which is not explained by
demand response because the tax incentives increased in the second phase, indicating that
12
The average exchange rate is U104.51/US$ over our study period of 2001–2014; yet note that
yen appreciated by more than 36 percent during the period. Using the average exchange rate in 2009,
U93.57/US$, this value is equivalent to more than $2,000.
13
The first period of the subsidy spanned between April 10, 2009 and September 7, 2010, during
which the amounts of the subsidies were respectively U100,000 (U250,000) or $960 ($2,400) for passenger
vehicles on purchases of an ETI-eligible vehicle without (or with) scrapping a used car that had been on
the road over 13 years. The subsidies were re-introduced between December 20, 2011 and September 21,
2012, during which time the amount of the subsidies was U100,000 ($960) for the purchase of ETI-eligible
passenger vehicles.
7
the figure not only illustrates demand by consumers for tax-incentive-eligible vehicles but
also the available supply of eligible vehicles by automakers. The fact that the supply of
eligible vehicles increased immediately in the short period following the announcements
of initially challenging eligibility standards underscores the automakers’ high motivation
to meet the eligibility requirements.
B. Data
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The primary data for our analysis are obtained from IID, Inc. Group, a company that
collects on-road fuel consumption data for vehicles in Japan through a unique mobile
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phone application. The application can be downloaded and registered free of charge. The
application enables users to monitor their real-world fuel economy every time they refuel
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by reporting the odometer value and the amount of gasoline required to fill the vehicle
tank completely (users are advised to fill the tank completely at every refueling).14 Users
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benefit from knowing their car’s fuel economy levels, as compared with those achieved by
other drivers driving the identically configured vehicles, as a guide for improving their
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driving habits and simultaneously reducing gasoline costs.

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We made a special agreement with the company to obtain case-level observations

of actual fuel economy for every refueling from 2005 through 2014. In our data, we
can identify individual drivers and vehicles by their identification numbers, allowing us
to distinguish vehicles even when a single driver drives multiple vehicles. Further, the
data allow for matching identically configured vehicles across users with a high degree
of detail, including model, manufacturing year and month, displacement size (i.e., engine
size), weight, engine type, wheel drive type, body type, and transmission type—i.e., the
configuration level at which the government designates a unique value of fuel economy.15
14
Users can take and upload photos of fuel-purchase receipts to record the information in order to
minimize typing errors. Further, users must choose yes or no in response to the question of whether there
is any refuel not recorded since the last time, which helps avoid counting distance travelled for more
than a single refueling cycle. See Appendix Figure ?? for the sample screenshots of the application and
additional key features.
15
For example, the 2000 Toyota Rav4 (model type code or katashiki ACA20W) can be equipped with
either manual or automatic transmission, and fuel economy figures differ between the two.
8
We limited the observations to domestic manufacturers and gasoline-powered vehicles.16
In total, we have nearly 3 million observations for approximately 44,000 drivers with
about 1,600 configurations of vehicles produced after 2001. We aggregate the observations
at the driver-vehicle level to obtain the average (both in mean and median) and the
standard deviation of actual fuel economy, reducing the sample size to approximately
52,000 observations.
As our data rely on driver-submitted information, the sample is likely to include
individuals who are more strongly motivated to save fuel costs, improve fuel economy,
and lower fuel consumption than is the general population. Such selection can bias our
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estimates of actual fuel economy on the road in either direction. On the one hand, drivers
in our sample drive in a more fuel-conserving manner than others, which would push the
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fuel economy gap to a lower-bound estimate. On the other hand, individuals who were
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previously concerned about higher fuel costs and lower fuel economy than other drivers
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may engage with the application, in which case the general fuel economy gap achieved
on the road will be lower than what is suggested by our sample. In either case, such
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selection in the sample does not invalidate our analysis below, as the bias, regardless of
the direction, should be consistent across thresholds locally determined by official fuel
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economy.17
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Summary Statistics. Table 1 presents the summary statistics of key variables in our
sample of gasoline-powered passenger vehicles and minicars manufactured by domestic au-
tomakers in 2001–2014.18 Panel A focuses on drivers’ characteristics at the driver-vehicle
16
These vehicles comprise a large majority of the original datasets. The sample excludes other types
of vehicles including next-generation cars (i.e., electric, fuel cell, natural gas, plug-in hybrid, hybrid, and
clean diesel vehicles). In addition, among the users, our sample is limited to frequent but not too frequent
submitters (those who record at least 12 times and at most 52 times a year) in an effort to minimize
errors from infrequent reports and eliminate extremely heavy vehicle users. This sample selection was
made at the initial stage of obtaining the data from the company. Note that some users in our analysis
sample may have submitted fewer than 12 times, because they report more during periods not covered
in our study.
17
This is also supported by the finding that there is no meaningful difference in drivers’ characteristics
at the eligibility thresholds to explain the observed fuel economy gap (Section IV.A and IV.D).
18
The Japanese automobile industry is typically divided into two broad categories of vehicles. The first
classification of vehicles is passenger cars, a category which includes light vehicles whose displacement is
2000 cubic centimeters (cc) for gasoline-powered vehicles and regular vehicles but excludes motorcycles,
buses, and trucks. The corresponding categories in the U.S. include cars and light trucks i.e., cross-over
vehicles, sport-utility vehicles, pickup trucks, and minivans. The other classification is minicars (called
“kei-cars”), tiny vehicles whose displacement is 660cc or lower, which constitute a unique and sizable
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level.19 It shows that average real-world fuel economy on the road is 11.79 kilometers-
per-liter (km/L) using mean values. The standard deviation of real-world fuel economy
at the driver-vehicle level is small relative to the mean value, suggesting not only that
fuel economy varies little at the driver-vehicle level but that the values of real-world fuel
economy in our data are precisely and accurately computed. About 89 percent of our
drivers are male, with an average age of 36.8 years, reporting 54.2 times on average.20
Panel B focuses on vehicle characteristics officially reported by the automakers at the
vehicle configuration level.21 The data show that average official fuel economy is 16.5
km/L. This suggests that the average fuel economy realized on the road in Panel A is
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approximately 30 percent lower than officially reported. Among the vehicles in the data,
62 percent are passenger vehicles, and the remaining 38 percent are minicars.
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III. Econometric Framework
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We are interested in testing whether the feebate policy functions as the underlying incen-
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tive for manipulating fuel economy figures on the part of the automakers. Using mathe-
matics, the treatment effect is defined as:
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τ = E[Yv (1) − Yv (0)], (1)
where Yv (Tv ) denotes the potential outcomes for vehicle v, and the treatment, Tv , is equal
to one during the ETI period and zero otherwise. In words, the treatment effect estimates
differences between observed fuel economy gaps during the ETI period and what it would
market in Japan, where roads are in general narrow, and which incur lower taxes than full-sized vehicles,
as described below. There is no equivalently-sized vehicle in the U.S.
19
We keep this at the driver-vehicle level rather than the driver level to be consistent and comparable
to the main analysis based on the same level of observations. See Appendix ?? for the analogous summary
statistics at the driver level. These two are quantitatively similar because most drivers (71.5 percent)
drive a single vehicle, and most of the remainder (21.1 percent) drive two vehicles.
20
Note that we observe a birth year, subtract it from the year for which we have of records in order
to compute ages, and then compute an average age for a driver over the period of observations. Because
there is no way to ensure the accuracy of our information, we eliminate ages below 18 (the legal age to
qualify for driving a vehicle) and above 65.
21
See Appendix ?? for the analogous summary statistics at the driver-vehicle level, essentially pro-
viding weighted mean values of individual vehicle characteristics by the number of drivers.
10
have been had the ETI not been implemented.22
The identification challenge here is clear: there are no vehicles during the ETI for
whom we observe the fuel economy gap in the absence of the ETI. A simple comparison
between eligible and ineligible vehicles during the ETI to estimate Equation 1 would be
severely biased by selection mechanism. For instance, it is known that the fuel economy
gap grows relative to the official fuel economy because technical issues make it more
difficult to achieve the official fuel economy levels as the levels of official fuel economy
increase.23 Using our data, we find that the fuel economy gap tends to monotonically
widen as the levels of official fuel economy increase, with the coefficient of 0.012 and
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the standard error of 0.0007 (statistically significant at the 1 percent level, N = 50,347)
(See Appendix Figure ??). Further, drivers who buy highly fuel-efficient vehicles and low
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efficiency vehicles would be systematically different, which could bias the results in either
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direction.
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Instead, the ideal experiment to test this hypothesis would randomly vary the eligi-
bility thresholds in fuel economy across automakers. For any given level of fuel economy,
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a simple comparison of the fuel economy gaps between automakers that are eligible and
ineligible for the tax incentives would estimate the causal effect of the tax incentives on
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the fuel economy gap. In practice, however, such experiments are both practically and
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politically unfeasible.
Fortunately, the structures of the feebate policy design and data permit us to estimate
a close approximation to such experiment, using a strategy essentially drawing on the
spirit of the regression discontinuity design (RDD) that estimates the treatment effect
locally around the ETI eligibility thresholds:
τ = E[Yv (1) − Yv (0)|Dv = D∗ ], (2)

22
One may think that the treatment effect should be conditional on being eligible for the ETI, but as
we will show later, the ETI may or may not affect the fuel economy gap for ineligible vehicles as well,
for which reason we keep it as unconditional in Equation 1.
23
Also, it is known that fuel consumption in the real world that is not accounted in the laboratory
test, e.g., electronic devices, air-conditioning, and road congestion, consumes about the same amount
of fuel regardless of the levels of fuel economy, and thereby representing a greater share of actual fuel
consumption for vehicles with higher fuel economy.
11
where Dv denotes the official fuel economy level, and D∗ refers to the ETI eligibility
thresholds. The basic idea of the estimation framework is to examine whether the outcome
exhibits a discontinuous change at the levels of fuel economy that meet the eligibility
criteria for the tax incentives. In particular, we follow the conventional RDD methodology
and estimate the following model:
Yiv = α + β × 1(Dv ≥ D∗ ) + f (Dv ) + εiv , (3)
where Yiv is an outcome variable, such as the log deviation of official fuel economy from
f
actual fuel economy on roads, ln( Of f icialf ueleconomy
), for driver i and vehicle v, 1(·) is an
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Actualf ueleconomy
indicator variable that equals one if official fuel economy (D) is greater than or equal
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to the eligibility threshold in the fuel economy for the tax incentives (D∗ ), and ε is an
idiosyncratic error.24
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The parameter of interest, β, directly tests whether there is manipulation in the
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running variable. If there is no manipulation in the fuel economy at the tax incentive
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eligibility thresholds, we expect β to be zero, whereas the running variable captures some
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inherent relationship between the official and actual fuel economy. In contrast, if there is
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manipulation, β will be positive as manipulation will be manifested as an increased gap at

the thresholds because the dependent variable is smooth and continuous in the official fuel
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economy (represented in the numerator), because it is just a log of the running variable
itself, and thus any discontinuity in the dependent variable must come from deviations
in actual fuel economy (represented in the denominator).
The identification assumption requires that any aforementioned relationship between
the fuel economy gap and official fuel economy is captured by the flexible function of
the running variable, f (Dv ). To address this issue, we follow Imbens and Lemieux (2008)
in estimating the model locally around the thresholds using a uniform kernel density
function and specify f (Dv ) as a linear function while allowing the slopes to differ on both
24
We use kilometers-per-liter as a measure of fuel economy instead of liters-per-kilometer because the
running variable is determined by kilometers-per-liter. It is worth noting that the use of kilometers-per-
liter involves nonlinear fuel consumption, whereas liters-per-kilometer does not. We also find consistent
results with using liters-per-kilometer. Kilometers-per-liter is still relevant for our research purpose to
estimate the deviation of actual fuel economy from official fuel economy.
12
sides of the cutoff. In particular, we use:
f (Dv ) = γ1 × (Dv − D∗ ) + γ2 × (Dv − D∗ ) × 1(Dv ≥ D∗ ). (4)
The size of the bandwidth invokes the classic tradeoff between efficiency and bias. In
our context, due largely to the short individual tax policy phases (e.g., three years) and the
limited number of vehicle configurations in our sample, we use a bandwidth of 8 km/L in
the main analyses to preserve sufficient statistical power, while confirming the robustness
of the findings to much smaller bandwidths.25 The standard errors are clustered at the
f
configuration level, allowing for unobservable arbitrary correlations among identically
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configured vehicles across drivers.
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The causal inference under our model is warranted if the conditional expectation,
-p
E[εiv |Dv ], is locally smooth as official fuel economy (D) crosses the eligibility thresh-
e
old (D∗ ). That is, no factor affecting a fuel economy gap other than the tax incentives
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exhibits a discontinuity at the eligibility thresholds. In our research context, this as-
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sumption almost inevitably holds, as individual thresholds are exogenously determined

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by the government without reference to (or even observation of) a fuel economy gap in
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the real world. Nonetheless, it is important to rule out any possibility that the eligibility
thresholds themselves are associated with an increasing fuel economy gap even without
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tax incentives. We provide evidence, based on a set of placebo tests, that supports this
identification assumption in Section IV.V.
In contrast, many factors that are associated with a fuel economy gap may be en-
dogenously determined by the tax incentives and thus systematically differ as official fuel
economy crosses the eligibility thresholds. For example, consumers who purchase eligible
vehicles may be different from consumers who purchase ineligible vehicles, and eligible
vehicles have different attributes than ineligible vehicles. Both of these factors exert some
25
Our selection of the bandwidth is slightly larger than, but still close to, the optimum bandwidth
selected based on the cross-validation method proposed by Ludwig and Miller (2007), 5.7, to enable use of
a consistent bandwidth across all the analyses involving, in some cases, smaller samples. In Appendix ??,
we provide additional robustness checks for much smaller and larger bandwidths and those selected by
the cross-validation method as well as those selected by methods proposed by Imbens and Kalyanaraman
(2012) and Calonico et al. (2014). The findings are quantitatively similar across alternative selections of
bandwidths. If anything, we find a larger gap when bandwidths are set very small.
13
influence over distinct trends in a fuel economy gap surrounding the thresholds. These
factors shed light on important mechanisms to explain the gap found in our main results
and are examined in Section IV.D.
Importantly, our approach differs from the conventional RDD model in that a typi-
cal RDD requires the assumption that there is no manipulation in the running variable,
whereas outcome variables are by themselves distinct from the running variable. Our
design, in contrast, aims at detecting the manipulation in the running variable by con-
structing the outcome variable as a function of the running variable itself; thereby, for all
intents and purposes, it does not hinge on the typical RDD assumption. Instead, in our
f
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context where the running variable may be manipulated, the identification assumption
for estimated β, to be interpreted as the size of the fuel economy gap induced by the tax
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incentives, requires that:
e -p
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lim E[Yv (1)|Dv = d] = lim∗ E[Yv (0)|Dv = d]. (5)

d↑D∗ d↓D
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In other words, ineligible vehicles just below the eligibility thresholds during the ETI
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period (left-hand side) approximate the counterfactual fuel economy gap among eligible
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vehicles slightly above the eligibility thresholds in the absence of the ETI (right-hand
side). This is illustrated in Appendix Figure ?? Panel B. This occurs when fuel economy
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is manipulated for some vehicles (possibly because their fuel economy can be manipulated
easily, or because only certain automakers manipulate their own vehicles) but not for other
vehicles that are otherwise similar in both official and actual fuel economy (and thus the
fuel economy gap).
However, the equality in Equation 5 should not be taken for granted. Accordingly, we
consider cases when it does not hold. First, consider the case:
lim E[Yv (1)|Dv = d] > lim∗ E[Yv (0)|Dv = d], (6)

d↑D∗ d↓D
where the observed fuel economy gap for ineligible vehicles during the ETI period over-
states the size of fuel economy gap for eligible vehicles without the ETI (see Appendix
14
Figure ?? Panel C). In this case, the estimated β based on Equation 3 understates the
true treatment effect. This occurs when automakers attempt to inflate the fuel economy
figures of all vehicles, or at least vehicles near the eligibility thresholds, in order to meet
the eligibility thresholds, yet some are successful, while others are not.
In contrast, the opposite case arises when:
lim E[Yv (1)|Dv = d] < lim∗ E[Yv (0)|Dv = d], (7)

d↑D∗ d↓D
where the observed fuel gap for ineligible vehicles during the ETI period understates the
f
size of the fuel economy gap for eligible vehicles without the ETI, thereby overstating the
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estimated effect. Two conditions give rise to such case. First, assuming that magnitudes of
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the fuel economy gap are similar in the counterfactual scenario, resources for manipulation
-p
are diverted from ineligible to eligible vehicles, reducing the size of fuel economy gap
e
for ineligible vehicles and increasing the size of fuel economy for eligible vehicles (See
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Appendix Figure ?? Panel D). Although this may sound plausible, two issues make it
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less likely. First, this requires an additional assumption that there is manipulation in the
na
first place even without the ETI because otherwise there would be no potential for the
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fuel economy gap to fall. However, there is no evidence to support this claim. Rather,
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we show later that many automakers do not manipulate fuel economy even at the ETI
eligibility thresholds, suggesting that observed fuel economy gaps should resemble what
they would have been even without the ETI. Second, if such resource allocation occurs
at the first threshold, we would also expect to see that at the second (and possibly third)
thresholds as well. In this case, we would expect to observe bunching at the eligibility
threshold, after which fuel economy gaps would fall until the next eligibility threshold, as
illustrated in Appendix Figure ?? Panel E. In contrast, as we will show later, we observe
no such bunching but instead observe continuously positive trends after the first eligibility
threshold.
The second case in which Equation 7 holds is that, assuming the counterfactual fuel
economy gaps for observed fuel economy gaps just above the threshold would be inher-
ently larger than those for observed fuel economy gaps just below the threshold, relative
15
difficulties in crossing the eligibility threshold would be different (see Appendix Figure ??
Panel F). Note that there need not be manipulation below the threshold in this case, and
the fuel economy gap without the ETI would be similar to that under the ETI. However,
we would still expect to observe bunching at the threshold, which, as stated above, is not
supported by the data.
In sum, we clarify in this section the identification assumptions behind our economet-
ric framework and carefully examine the cases where it does or does not hold. Two of our
observations (shown later)—that many automakers do not manipulate fuel economy at
the eligibility thresholds and that the overall positive trend in fuel economy gap continues
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even beyond the eligibility thresholds—provide support that the observations just below
the threshold serve as valid counterfactuals. Although we need to be cautious about the
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estimates in cases where other assumptions hold, our conclusion that the observed discon-
e
tinuity in the fuel economy gap at the eligibility threshold arises only from manipulation
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remains unaltered.
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IV. Empirical Results

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We begin with the baseline analysis using the pooled sample across the two ETI periods.
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We then repeat the analysis for every policy period and at every threshold to explore
variation in the treatment effects. Next, we adopt various alternative specifications to
attest the robustness of the findings. We then explore potential mechanisms that explain
the fuel economy gap at the eligibility thresholds. Lastly, we examine heterogeneity in
the extent of the gap across various dimensions.
A. Pooled Results
We begin by estimating the average effect of the ETI on the fuel economy gap by pooling
the two policy periods. In particular, we examine the discontinuity at the first threshold,
at which vehicles become eligible for the tax incentives.
Figure 3 illustrates the relationship between the fuel economy gap and the deviation
16
in official fuel economy from the eligibility thresholds. Vehicles with positive values on
the x-axis are eligible for the tax incentives, while vehicles with negative values are not.
Panel A, which focuses on the period of the ETI in 2009–2014, demonstrates that the fuel
economy below the thresholds slightly increases over official fuel economy figures among
ineligible vehicles, indicating that official fuel economy is about 20 percent higher than
actual values. However, there is a sharp and large increase at the threshold, underscoring
the fact that the fuel economy gap marks a discontinuous increase at the tax incentives
eligibility threshold.
f
[Figure 3 Here]
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One may wonder why the fuel economy gap does not fall beyond the first eligibility
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threshold if automakers have no more incentives to further inflate official fuel economy.
There are at least two reasons we observe the continued growth of the fuel economy gap
e
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beyond the first eligibility threshold, rather than simply bunching at the threshold, after
which the gap falls. First, as already mentioned above, the fuel economy gap tends to
l
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monotonically widen as the levels of official fuel economy increase. This is illustrated
by Appendix Figure ?? and Figure 3 Panel B, which we will discuss later. Thus, we
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can interpret the discontinuity at the threshold observed in Panel A as a shift up in

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the level of the positively sloped line that would otherwise have been continuous in the
absence of tax incentives. Second, there are additional eligibility thresholds beyond the
first threshold, which may also drive further gaps. Note that although the slope of the
relationship between the two variables appears to be different across the thresholds, this
may not be indicative of varying elasticity because the slope far beyond the first threshold
may be driven by other discontinuities at the higher thresholds. Indeed, the regression-
adjusted estimates below show that the slopes are not statistically significantly different
from each other locally around the thresholds.
Table 2 Columns (1)–(3) present the regression-adjusted estimates of the graphical
discontinuities presented above, focusing on the period of the ETI between 2009 and
2014.26 Column (1) does not include any driver or vehicle controls. We find that, at
26
In Appendix Table ??, we provide the estimates of all other variables included in the regressions.
17
the thresholds, the fuel economy gap is amplified by about 6.0 percent, and the point
estimate is statistically significant at the 1 percent level. While conventional wisdom
favors estimates with controls, the point estimate in Column (1) represents our preferred
estimate, because as we explain in more detail below, the driver and vehicle characteristics
are endogenous to the treatment itself, the so-called “bad controls” (Angrist and Pischke
2009), and thus should not be included in the regressions. In other words, the estimate
without these controls represents the pure extent of the fuel economy gap at the first
eligibility threshold.
f
[Table 2 About Here]
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Nevertheless, we present the point estimates with these controls to provide an in-
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sight into mechanisms that explain the identified gap. Any substantial reductions in the
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point estimates with controls illuminate a potential causal pathway through which the
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incentives resulted in an enlarged fuel economy gap. Column (2) presents the estimate
with the drivers’ characteristics.27 The point estimate is slightly lower by 0.3 percentage
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points but remains statistically significant at the 5 percent level. Column (3) additionally
includes the vehicles’ official characteristics28 , which reduces the magnitude of the point
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estimate further by 0.6 percentage points, yet again remains statistically significant at
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the 5 percent level.

These findings carry the important implication that the observed gap in the fuel
economy at the first eligibility thresholds cannot be fully explained by differences in
drivers’ characteristics (in the sense that individuals driving eligible vehicles are likely to
have a greater fuel economy gap) or those in vehicles’ characteristics (as evidence of a
weak regulatory system that allows automakers to game the system by redesigning the
prototype in an entirely legal manner). In other words, we are left with the implication
that other mechanisms, including illegal ones such as the outright fabrication of data,
may be responsible for the observed fuel economy gap.
27
These characteristics include gender, age, standard deviation of actual fuel economy, number of
reports, average odometer, and average fuel prices paid.
28
These characteristics include vehicle weight, displacement (i.e., engine capacity), registration year
and month, seating capacity, gasoline type, and transmission type.
18
B. Results at Individual Thresholds in Each Policy Period
From an economics perspective, an important question related to the automakers’ cheat-

ing on fuel economy data is whether their manipulation efforts and costs are justified
by their potential benefits. To answer this question, we now extend the analysis above
to investigate the effect at the individual thresholds in each ETI policy period. Table 2
Column (4) focuses on the first three years during which the ETI policy was in effect, be-
tween 2009 and 2011. The first threshold refers to 15 percent above the 2010 fuel economy
standards, and the second to 25 percent above the 2010 efficiency standards.29 Vehicles
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above the first threshold and below the second threshold receive 50 percent tax reductions
on both the automobile acquisition tax and the tonnage tax. For an average passenger car
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in our sample, this amounts to lower initial tax payments for owners of U93,000 ($890).
The corresponding figures for vehicles performing above the second threshold are larger:
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75 percent reductions from both the acquisition and tonnage taxes, which amounts to
reductions of U140,000 ($1,300) on initial tax payments for an average passenger car, or
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U47,000 ($450) additional reductions on top of meeting the first thresholds. The point
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estimates suggest that the fuel economy gap diverges by 5.4 percent at the first threshold
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and 3.8 percent at the second threshold.

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Column (5) replicates the analysis for the second period of the ETI between 2012
and 2014. There were three thresholds during this period: the first, meeting the 2015
fuel economy standards; the second, 10 percent above those standards; and the third, 20
percent above the 2015 standards. In total, marginal tax reductions at each threshold are
U90,700 ($870), U27,100 ($260), and U34,600 ($330), respectively. The estimates suggest
that the fuel economy gap increases by 6.9 percent at the first threshold, 4.1 percent at
the second, and 6.2 percent at the third.
While these point estimates across individual thresholds do not differ significantly from
each other, there is variation in the extent of increases in the fuel economy gap across
thresholds. Considering their sizes in relation to the marginal sizes of the tax incentives,
29
Note that the third threshold, which involves exemption from both acquisition and tonnage taxes,
is applicable to only next-generation vehicles, which are not part of our dataset.
19
we consistently find greater increases in the fuel economy gap for the larger marginal
tax incentives.30 Notably, the findings show the largest increases in the fuel economy gap
at the first eligibility thresholds that correspond to the largest amounts of the marginal
tax incentives. Further, while increases in the fuel economy gap are slightly lower at the
second threshold relative to the first in both policy periods, the point estimate becomes
larger at the third threshold relative to the second in the second policy period, as the
size of the marginal tax incentives increases at the third threshold relative to the second,
underscoring that the changes in the size of the discontinuities are not simply monotonic.
Overall, while individual coefficients are not statistically significantly different from each
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other, these findings suggest that automakers are likely to fully rationalize their efforts
to manipulate the fuel economy figure at the margin based on the size of tax incentives
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closely associated with the size of the sales effect.31
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C. Alternative Specifications
Table 3 presents the robustness of the main findings to various alternative specifications.
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We find that the estimated discontinuity in the fuel economy gap at the eligibility thresh-
olds is robust to:
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Alternative measure of real-world fuel economy. The main analysis uses the mean
values of actual fuel economy at the driver-vehicle level to compute the fuel economy
gap, whereas here we use the median values instead to provide a guard against outliers
at the refueling case level. The point estimate is identical.
Bandwidth selections. When a smaller bandwidth of 6 km/L and a larger bandwidth
of 10 km/L are applied, the point estimates remain unchanged and statistically significant
at the 5 percent and 1 percent level, respectively. In Appendix ??, we experiment with
30
Appendix Table ?? summarizes these comparison
31
Focusing on manipulation on the part of manufacturers, this analysis does not control for drivers’
characteristics either because the presence of bad controls does not necessarily allow the interpretation of
the estimates conditional on drivers’ characteristics as the effects not explained by drivers’ characteristics
(Angrist and Pischke 2009). Nonetheless, the results are similar with drivers’ controls (Appendix Table
??).
20
much smaller bandwidth selections with the minimum value of 1 km/L, including optimal
bandwidths provided by various methods, confirming that the results are unchanged. If
anything, we find greater fuel economy gaps when the bandwidths are very small.
Flexible underlying functions. We incorporate a higher order, in particular the quartic,
in trends to model a more flexible relationship between the fuel economy gap and devi-
ation of fuel economy from the cut-offs. The point estimate becomes larger and remains
statistically significant at the 5 percent level, while it remains in the same range of the
magnitudes.32
Weighting the regressions. We employ weighted least squares by assigning a greater
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weight to observations from drivers who submitted a larger number of reports, as the
mean actual fuel economy figures can be more precisely estimated for drivers with more
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observations. The point estimate is similar and remains statistically significant at the 5
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percent level.
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Two-way clustering the standard errors. Because the same drivers may drive multi-
ple vehicles, we adjust our standard errors for two-way clustering across both vehicle
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configurations and drivers. The standard error is unchanged.

Alternative level of observations. We repeat the analysis using individual case-level
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(at every refueling) observations. In this case, because individual drivers submitted a
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number of reports, the standard errors are two-way clustered at the driver and vehicle
configuration level. The estimate is very close to the main result.
Deviation in percentage. We use percentage deviation in official fuel economy from the
eligibility threshold instead of level deviation as the running variable. The bandwidth is
set to select a sample similar to that in the main analysis. This does not influence the
point estimate.
Kernel function. We use a triangular instead of uniform kernel function to attribute a
greater weight to observations closer to the thresholds. Reassuringly, the point estimate
remains similar.
Overall, we find our main results robust to various alternative specifications, confirm-
32
We also explored various other orders of polynomials, and they all provide similar ranges of the
magnitudes.
21
ing that the estimated discontinuity in the fuel economy gap at the eligibility thresholds
is not driven by inappropriate alternative assumptions.
D. Exploring Mechanisms
The findings in Table 2 in the main text highlight that the fuel economy gap remains
large even after controlling for various drivers’ and vehicles’ characteristics, suggesting
that these controls do not fully explain the observed gap. Nevertheless, in this subsection,
we attempt to shed light on mechanisms that potentially explain the fuel economy gap
even to a small degree. In particular, we investigate whether factors that are endoge-
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nously determined by, or could themselves be outcomes of, the tax incentives, and are
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associated with the fuel economy gap, sort around the eligibility thresholds, at a magni-
-p
tude that accounts for the growing fuel economy gap. In our setting, both the attitudes
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and behaviors of consumers who purchase vehicles that are either eligible or in-eligible
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for the tax incentives, as well as the configurations of eligible or ineligible vehicles, may
exert influence over the increasing fuel economy gap at the thresholds. We quantitatively
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test these possibilities by replicating the analysis using each characteristic as a dependent
variable. We focus this analysis on the same period of the ETI in 2009–2014. Table 4 pro-
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vides the variables’ mean values in Column (1) and the discontinuity measure at the first
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eligibility threshold in Column (2). In Column (3), we provide the marginal effect of the
respective variable on the fuel economy gap, when the marginal effects are estimated in a
single regression with all these characteristics controlled for, to provide a ceteris paribus
interpretation.33
First, we explore heterogeneity in drivers’ characteristics at the eligibility cutoffs.

Table 4 Panel A explores six characteristics of drivers we observe in our dataset. With
regard to the demographics, it shows that drivers of tax-incentive-eligible vehicles are less
likely to be male. However, an association between gender and the fuel economy gap is not
33
We replace missing values with zeros and include dummy variables to indicate missing values to
preserve the sample size.
22
clear or precise. The magnitude of the point estimate is economically small, suggesting
that an increased share of women driving ETI eligible vehicles can explain only about a
0.06 percent increase in the fuel economy gap.34 We also find that younger drivers’ actual
fuel economy on the road is closer to the officially reported one so the fuel economy gap
is lower for these drivers; since as a group they are slightly more likely to buy eligible
vehicles, the fuel economy gap is likely to shrink, if anything, for eligible vehicles, which
is the opposite of what is suggested in the main analysis.
Regarding driving behavior, we find that the standard deviation of actual fuel economy
at the driver-vehicle level, a measure of driving habits, is an important determinant of a
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fuel economy gap (e.g., the greater the standard deviation is, the worse the driver behavior
is, and the larger the fuel economy gap becomes), yet it only exhibits an economically
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small and statistically insignificant discontinuity at the thresholds.35
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We also examine whether there is a systematic difference in the number of reports
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submitted by drivers, a proxy for vehicle usage and potentially reflective of driving loca-
tions (e.g., urban vs. rural or highway vs. city). It shows that drivers of eligible vehicles
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submit a lower number of reports by about 20 percent, yet the association with the fuel
gap is small and negligible.
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Further, while odometer readings are a measure of overall vehicle distance travelled
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and are an important determinant of a fuel economy gap, it does not exhibit a disconti-
nuity at the threshold or explain the observed fuel economy gap.
Finally, we consider average fuel prices paid by drivers to infer income or expenditure
behaviors. Those who purchase vehicles eligible for the tax incentives are likely to have
greater incentives to reduce their upfront tax payments and gasoline costs than those who
purchase ineligible vehicles. However, if this were the case, we should not find a widening
gap at the thresholds. For example, drivers who are more financially constrained should
drive more economically; therefore, the fuel economy gap should shrink for drivers of the
tax-eligible vehicles.36 We find that the gap at the eligibility threshold is negligible in
34
This is obtained by multiplying the estimates in Columns (2) and (3).
35
We would expect more aggressive drivers to cluster on the left-side of the thresholds, in which case
the fuel economy gap is likely to be bigger below the threshold than above.
36
Alternatively, it may be possible that drivers of eligible vehicles may drive in a more fuel-consuming
23
magnitude and statistically insignificant. Thus, we can rule out drivers’ income level or
socioeconomic status as a determining factor in the widening fuel economy gap.
In sum, it is unlikely that drivers sort around the thresholds in a way that contributes
to the increasing fuel economy gap. If anything, it is more plausible that the estimate in
the main analysis is a conservative one; the fuel economy gap would likely be larger if
individual characteristics were homogenous across the cutoffs.
We now turn to the differences in vehicle configurations at the thresholds that are likely
to explain the fuel economy gap. It is likely and institutionally feasible that automakers
redesign their vehicles in an endogenous manner to make them eligible for tax incentives,
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which may also be associated with the increasing fuel economy gap at the thresholds.
Although redesigning vehicles at the fundamental level may take years, several loopholes
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exist in the system which allow automakers to configure or alter their vehicles to perform
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better only during tests and thereby inflate official fuel economy.
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Table 4 Panel B explores seven of the detailed official vehicle attributes as reported by
the automakers in their catalogues at the configuration level, which are linked to a unique
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value of official fuel economy. We find that eligible vehicles weigh less than ineligible
vehicles.37 The estimated relationship in Column (3) indicates that lower-weight vehicles
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are associated with an increased fuel economy gap. This is the likely outcome of weight
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being deliberately minimized as a means to achieve higher fuel economy in tests, while
real vehicles on roads tend to be heavier (since standard vehicles come equipped with
various devices), which contributes to a growing fuel economy gap. Though the point
estimate is not statistically significant,38 its magnitude is economically substantial, and
the difference in weight can explain an increasing fuel economy gap at the thresholds by
about 1.0 percent on average. We also find that engine displacement (i.e., size) is lower for
eligible vehicles.39 The point estimate is statistically significant at the 10 percent level and
manner if they feel wealthy after saving some money with the ETI.
37
Again, these are official values of weight, not the actual weights of individual vehicles. There is
practically no means whereby to observe actual vehicle weight that is influenced by numerous factors.
38
The point estimate becomes statistically significant at the 10 percent level with a slightly larger
bandwidth. See Appendix ??.
39
The finding is consistent even among passenger vehicles alone; therefore the difference cannot be
attributed to the large share of minicars among ETI eligible vehicles.
24
explains an approximate 1.9 percent increase in the fuel economy gap at the thresholds.
Indeed, smaller displacement is known to be advantageous during a laboratory test, which
involves long idling times. None of the other characteristics is found to be statistically or
economically significant enough to make a meaningful contribution to the fuel economy
gap.
Overall, the findings shed light on two of the vehicle attributes—vehicle weight and
size of displacement—as potential mechanisms through which automakers could qualify
their vehicles for the tax incentives even when their actual fuel economy does not meet
the eligibility standards. It is important to note that in order to prove that these dis-
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continuities in vehicle characteristics reflect automakers’ manipulation of fuel economy
figures rather than their legitimate efforts to improve fuel economy, further evidence is re-
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quired that actual vehicles on the road have distinct characteristics (e.g., heavier weight).
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Nonetheless a large portion of the fuel economy gap remains unexplained, suggesting that
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loopholes other than those investigated above must be involved, whether legally in the
current system (e.g., testing repeatedly under favorable conditions until desired values
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are achieved) or illegally through outright fabrication of data.

While such allegations may sound far-fetched, a series of recent scandals exposing
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automakers’ manipulation of fuel economy and emission data have revealed that various
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loopholes in vehicle testing procedures have allowed manufacturers to game opportuni-

ties for optimizing the results. For example, manufacturers prime these vehicles to show
enhanced fuel economy by, for instance, fully recharging their batteries before testing,
equipping them with low-friction tires and stop-start systems, minimizing vehicle weight,
and shutting off energy-consuming auxiliary devices such as air-conditioning (Interna-
tional Council on Clean Transportation 2015b). Further, the tests are mainly conducted
in a laboratory and the cars are never re-tested under real-world conditions. On top of
all this, there is evidence showing that automakers pay testing authorities to produce op-
timum results. While the above practices are not prohibited by regulations, they create
a laboratory testing environment conducive to fuel economy inflation, which leads to un-
realistic and unrepresentative expectations and standards, resulting in the fuel economy
25
gap.
Meanwhile, independent tests based on the official drive cycle, using regular vehicles
without these manipulations, show 23 percent higher CO2 emissions and fuel consumption
than the values reported by automakers (Dings 2013). In the U.S., Hyundai and Kia were
found to conduct improper testing procedures to obtain 1–2 miles per gallon (MPG) (up
to 6 MPG highway for Kia) higher fuel economy for more than a third of vehicles sold in
2012–2013. Ford, BMW Mini, and Mercedes have also been forced to lower fuel-efficiency
ratings and pay penalties. More recently, Volkswagen was discovered to be equipping so-
called “cycle-beating” software in their diesel vehicles, which enables vehicles to produce
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reduced emissions during tests while those same vehicles on the road emit up to 40 times
more emissions than allowed under federal standards.
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In Japan, automakers can select a testing agency, often their own subsidiary, for
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road load tests. During a road load test, vehicles are driven on a testing road, and the
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air and rolling resistance of the vehicles are recorded. These estimates are crucial for
setting the resistance of the rolling road that mimics actual driving conditions during
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the subsequent laboratory test conducted by the regulatory agency, during which fuel
economy and emissions data are collected.
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In the case of Mitsubishi, the company executives admitted to deliberately falsifying

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driving resistance data by using improper coasting tests not compliant with mandates,
conducting road load tests in Thailand (on the assumption that better, i.e., warmer,
metrological conditions would improve engine lubrication), and choosing favorable values
rather than the mean values they were mandated to report. In some cases, the company
did not carry out the road tests at all but reported the numbers entirely based on desktop
calculations or outright fabrication, all of which contributed to inflating fuel economy
by 5–10 percent, and up to 15 percent. Suzuki later also admitted to relying on desktop
calculations instead of actual road load tests to determine fuel economy, though corporate
executives denied their intention to inflate fuel economy but claimed that their testing
roads were located on a coastal hill that made measures erratic. These cases of fraud that
have come to the public’s attention provide strong qualitative confirmation of the claim
26
that the discontinuities we find in the vehicles’ characteristics at the eligibility thresholds
reflect manufacturers’ intentions to manipulate fuel economy.
E. Heterogeneity in the Treatment Effects
We now explore heterogeneity in the treatment effects at the first eligibility threshold
using the pooled sample of 2009–2014 across automakers. We present these estimates
and others in additional dimensions in Appendix ??.40 Overall, our findings highlight a
great deal of heterogeneity in the fuel economy gap manipulated at the ETI eligibility
thresholds. While individual names of automakers are anonymized to avoid identification,
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we do identify Mitsubishi as it has already admitted to having cheated in reporting fuel
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economy data. Table 5 shows that the fuel economy gap increases by 7.7 percent for
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Mitsubishi’s eligible vehicles, a magnitude in the range of what the company executives
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recently admitted to in falsifying their fuel economy data (5–10 percent). We find sub-
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stantial variation in the fuel economy gap for other automakers. Company A shows an
approximately 10 percent larger gap, which is statistically significant. Companies B and
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C have a similar range of gap, although their individual point estimates are not statis-
tically significant. In contrast, two companies show even negative estimates, indicating
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a relatively lower fuel economy gap, at the threshold.41 We also want to highlight that
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although we still avoid identification of Nissan in our results, we find no gap for Nissan,
which blew the whistle on the Mitsubishi scandal after conducting fuel economy tests and
found inconsistencies for vehicles made by Mitsubishi for Nissan.42 This implies that the
fuel economy gap does not exhibit a discontinuity at the eligibility threshold for “clean”
automakers even when it is tied to the incentives. This finding bolsters our confidence
that the elevated fuel economy gap at the eligibility thresholds is due to manipulation.
40
We omit one automaker whose observations are not sufficient in the standard bandwidth; their
results are presented in Appendix ??.
41
Note that the negative coefficient found for Company F appears to be an artifact of imposing
linearity in the underlying relationship—the point estimate becomes positive when applying a relatively
flexible local polynomial function.
42
In the end, Mitsubishi was absorbed into the Nissan-Renault Alliance in October 2016. Note that
Nissan was also recently found guilty of some misconduct in their fuel economy tests but denied that
these instances inflated fuel economy.
27
V. Validity of the Identification Assumption
One of the key identification assumptions of the empirical strategy spelled out in Section
III requires that all factors that affect the fuel economy gap, except for vehicle’s eligibility
for the tax incentives, are continuous at the thresholds, on the condition that a flexible
function of the running variable, f (·), captures an underlying relationship between official
fuel economy and the fuel economy gap.
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One may be concerned that the density of the running variable may not be smooth
at the threshold. This is a typical concern for the conventional RDD approach, as it
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indicates that individuals exert some control over the treatment status, which is likely
to confound other behavioral responses that may explain observed outcomes. However, a
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discontinuity in the distribution, if any, does not pose an issue in our context because it
is a discontinuity in sales at the threshold that gives rise to incentives to manipulate fuel
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economy. In other words, to the extent that vehicle compositions in our data mimic sales
distribution, there ought to be a discontinuity at the eligibility threshold.43 We follow
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Lee and Lemieux (2010) and show a histogram of the running variables over bins with a
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bandwidth of 0.5 km/L.44 Appendix Figure ?? shows that there is a substantially lower
number of driver-vehicle observations in the bins just below the eligibility threshold, while
a large fraction of observations come from vehicles 1 or 2 km/L above the threshold. A
formal test of a discontinuity in the density also indicates that there is a discontinuity.
Thus, insofar as our data can explain the effect of the ETI on vehicle sales, the finding is
consistent with greater incentives on the part of automakers to manipulate the treatment
status to maximize their sales.
A true threat to the identification, on the other hand, is that the eligibility thresh-
olds for the ETI are associated with an increased fuel economy gap without reference to
43
Alternatively, for a given smooth distribution of demand, an increased supply of vehicles that barely
meet the eligibility criteria also creates a discontinuity in the distribution. In either case, these discon-
tinuities in demand or supply cannot directly explain increased the fuel economy gap at the thresholds,
especially after we control for drivers’ and vehicles’ characteristics.
44
Lee and Lemieux (2010) recommends against plotting a smooth function for this exercise.
28
the capacity of automakers to manipulate fuel economy. For example, whether due to an
alternative policy or a technical reason, there may be a potential confounding determi-
nant of a fuel economy gap that exhibits a discontinuity at the levels of fuel economy
commensurate with the eligibility thresholds. In this subsection, we present three dimen-
sions of evidence, both qualitative and quantitative, to attest that there is no scope for
such a confounding factor to play a role: institutional design, quasi-placebo evidence, and
placebo evidence.
First, in our context, the institutional design most likely satisfies the conditional ex-
pectation assumption. To understand that the cut-offs for the ETI eligibility are exoge-
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nously, and, for all intents and purposes, randomly (at least to automakers) determined,
it is important to understand how these cut-offs were established. The fuel economy stan-
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dards, the primary determining factor for eligibility, are formulated by the “top-runner”
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criteria, whereby the target value for a given vehicle weight category is set at the level
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of fuel economy achieved by the leading vehicles to date for that category. These stan-
dards are announced a number of years in advance of the target year.45 Most automakers
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successfully advanced fuel economy technologies and complied with the standards well in
advance of the target year.46 These standards were tightened over time—the 2020 target
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for passenger vehicles is nearly 23 percent higher on average in every weight category
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compared to the 2015 target.47 Further, on top of the exogenous variation in the fuel
economy standards across weight categories and over time, the target values used for the
ETI differ from and are often larger than those used for the standards. For example, the
lowest values to be eligible for the first phase of the ETI in 2009–2011 are 20 percent above
the 2010 fuel economy standards. Moreover, the 2015 standards that were formulated in
2007 were not used for the ETI eligibility purpose until 2012. This suggests that, while
45
For example, the 2010 standards were announced in March 1999, and the 2015 standards were
formulated in July 2007.
46
For example, the share of vehicle shipments that met the 2010 fuel economy standards in 1999,
when the standards were set, was slightly below 20 percent, increased to 80 percent in 2003 and reached
90 percent in 2007 (Ministry of the Environment 2010).
47
Since the 2010 fuel economy standards are based on different weight categories than the 2015 or
2020 standards, it is not feasible to calculate an average increase in standards for every weight category;
however, the average of fuel economy across all weight categories increased by 14.3 percent from the 2010
to 2015 standards.
29
the values used to determine the tax incentive eligibility are based on the fuel economy
standards, the two are inherently incongruent. Such institutional background leaves no
scope for the cut-off values for the ETI eligibility to be confounded by other exogenous
factors of a fuel economy gap, unless they are endogenous factors, such as other vehicle
characteristics, that could themselves be outcomes.
Second, even when the institutional evidence above suggests that the levels of fuel
economy used to determine eligibility are formulated exogenously by the government,
it may still be possible that those values coincide with unobserved potentials for an in-
creased fuel economy gap other than the eligibility to the ETI. We test this hypothesis
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by exploring potential discontinuities at the tax deduction thresholds on the acquisition
tax prior to the introduction of the large ETI between 2001 and 2008 when these tax de-
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ductions were much smaller under the old system,48 and thus incentives for manipulation
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were lower. We would expect to observe a smaller effect on the fuel economy gap at their
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eligibility thresholds.
In contrast to Figure 3 Panel A, Figure 3 Panel B provides visual evidence that
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a discontinuity at the eligibility threshold is absent; instead it illustrates a standard

monotonic increase in the fuel economy gap, as official fuel economy increases (thus
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resembling Appendix Figure ?? in showing a positive and monotonic association between

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the gap and official fuel economy).

In Table 6 Column (1), we find that the estimates are substantially lower in magnitude,
negative in sign, and not statistically significantly distinguishable from zero despite a
much larger sample and greater precision in the point estimate. The lack of treatment
effects during this period provides quasi-placebo evidence that the tax-incentive eligibility
per se does not cause discontinuities in the fuel economy gap. Rather, it is the high-
powered tax incentives that gave rise to the gap. We call this quasi-placebo evidence
because there could be a discontinuity at these eligibility thresholds that could simply
be explained by manipulation to render vehicles eligible for even the relatively small tax
incentives. In contrast, the absence of discontinuity at these thresholds provides strong
48
Note that as aforementioned, there were no incentives on the tonnage tax during this period.
30
evidence that it is indeed the large magnitudes of the ETI after 2009 that induced the
large fuel economy gap.
The finding above carries two other important implications. One is that it rejects
the hypothesis that drivers of eligible vehicles drive in a more fuel-consuming way than
those of ineligible vehicles simply due to the signaling effect that their vehicles are highly
efficient, leading to an increased fuel economy gap.
The other implication of the finding that there is no discontinuity at the eligibility
thresholds in 2001–2008 is that it undermines the effect of an alternative policy on the fuel
economy gap. In particular, the government has traditionally instituted tax incentives
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on the automobile tax under the Green Tax System since 2001 (See Appendix ?? for
a detailed description). Note that, in most years, the first eligibility threshold for the
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Green Tax System coincided with that for the ETI after 2009 or the tax deductions on
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the acquisition tax before 2008. Moreover, in the three years during which the thresholds
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differ, the thresholds for the Green Tax System were a subset of those for the ETI (in 2010,
2011, 2014). While this institutional structure allows us to disentangle the independent
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effect of the ETI by looking at the eligibility threshold only for the ETI, we cannot
estimate the effect of the Green Tax System alone, leaving it a confounding policy. Despite
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the fact that the estimates after 2009 include the effects of both the ETI and the Green
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Tax System, we can infer the effect of the Green Tax System alone by exploring the
differences in the effects before and after 2009. Because the size of tax incentives is similar
(and small) for the automobile tax between before and after 2009 (see Appendix Figure
??), we would expect to observe similar treatment effects between the two periods, if the
effect of the Green Tax System is of the first order. The lack of such evidence suggests
that the Green Tax System alone did not create the fuel economy gap. Rather, it is the
ETI that created incentives for the pronounced fuel economy gap. Note that the authors
are aware of no other policy that uses similar eligibility thresholds.
Lastly, we conduct a placebo test by exploring whether the levels of fuel economy
that defined the tax-incentive eligibility in one period exhibit any discontinuity in the
fuel economy gap for vehicles produced in the other period during which these levels were
31
not tied to the tax incentive eligibility. If these cut-offs in particular coincide with levels
of fuel economy that create a large fuel economy gap after 2009, we would expect to
observe such gaps even at these placebo cut-offs.
First, we explore a fuel economy gap at 10 percent above the 2015 fuel economy
standards in 2009–2011, as this is the lowest level of cutoffs used in 2012–2014 but not
in 2009–2011.49 These cut-offs correspond to the eligibility for an 80 percent (75 percent)
reduction in the acquisition (tonnage) tax in 2012–2014 but are well above the highest
cut-off used in 2009–2011 (which is 25 percent above the 2010 standards or the 2015
standards). Note that most vehicles produced in 2009–2011 report fuel economy figures
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measured by the 10.15-mode test cycle, whereas the 2015 fuel economy standards are
based on the newly adopted JC08-mode test cycle. Thus, Table 6 Column (2) directly
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compares the subset of the sample vehicles whose fuel economy is available in the JC08
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mode to the placebo 2015 standards. It shows that the point estimate is negative and
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statistically insignificant, suggesting that the fuel economy gap is continuous, if not lower,
at the thresholds. Column (3) analyzes all vehicles produced in this period, and we
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designate 38 percent above the 2010 standards as equivalent to 10 percent above the
2015 standards for vehicles whose fuel economy is only reported in the 10.15 mode.50 The
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point estimate remains statistically insignificant. Note that the rather wide bandwidth
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applied in the analysis is likely to overstate the coefficient by virtue of being driven up
by the fuel economy gaps at the true cut-offs as found in the main analysis. Indeed,
the coefficient becomes much smaller and virtually close to zero when employing much
smaller bandwidths.
Second, we explore the fuel economy gap at 15 percent above the 2010 standards
level in 2012–2014, as this is the highest level of cutoffs used in 2009–2011 but not
in 2012–2014.51 Contrary to the previous case, most vehicles produced in 2012–2014
report fuel economy measured by the JC08 mode, whereas the 2010 standards are based
49
We focus on the lowest level to preserve the largest number of observations above the threshold.
50
This is what is used by the MLIT for vehicles whose fuel economy is reported only in the 10.15-mode
test cycle to determine their eligibility for the tax incentives in 2012–2014.
51
While we focus on the highest level to preserve the largest number of vehicles below the threshold,
this is indeed the only level that can be exploited for the placebo test.
32
on fuel economy in the 10.15-mode test cycle. Column (4), thus, focuses on the small
subset of vehicles produced in 2012–2014 whose fuel economy is also reported in the
10.15 mode to afford easy comparison to the eligibility thresholds. The point estimate is
negative, small, and statistically indistinguishable from zero. Additionally, in Column (5),
we utilize all vehicles produced in fiscal years 2012–2014. For vehicles whose fuel economy
information is available only in the JC08 mode, we convert the data to be equivalent
to 10.15-mode levels.52 It shows that the point estimate is negative and statistically
insignificant, indicating that the fuel economy gap is continuous, or if anything smaller,
at the cutoffs.
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All things considered, it is unlikely that the levels of fuel economy used to determine
the tax incentive eligibility are the result of any confounding variables that would explain
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the inherent existence of a fuel economy gap even in the absence of the ETI. Rather, the
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evidence suggests that the fuel economy gap is amplified at the eligibility thresholds only
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when they are associated with large tax incentives.

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VI. The Magnitudes of the Effect of the Fuel Econ-

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omy Gap
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This section aims at presenting back-of-the-envelope calculations of the partial equilib-

rium impact of the fuel economy gap we find thus far on additional fuel costs for a given
distance travelled and on pollution emissions due to vehicles with lower-than-expected
fuel economy. It is important to acknowledge that our aim here is not to conduct a total
welfare analysis or cost-benefit analysis of the policy by simulating a counterfactual with
no equivalent policy but rather it is to present the excessive costs implied by the fuel
economy gap relative to the situation with no such gap under the current policy regime.
To this end, we use the model parameters that the average price of gasoline between
52
To do so, we inflate fuel economy in the JC08-mode test cycle by 10 percent, as fuel economy is on
average 10 percent lower in the JC08-mode than in the 10.15-mode test cycle. For example, the average
fuel economy of the fleet manufactured in 2004 was 15.0 km/L under the 10.15 mode but was 13.6 km/L
under the JC08 cycle (Agency for Natural Resources and Energy (ANRE) and the Ministry of Land,
Infrastructure and Transport (MLIT) 2006).
33
2009 and 2014 was U148 ($1.4) per liter, the annual distance travelled was 10,000 km,
fuel economy was 20.5 km/L, the total number of the ETI eligible vehicles sold was
21,634,888, and that of ineligible 6,108,044.53 Because we cannot know the numbers of
vehicle sales for each individual model but know only the total eligible and ineligible
vehicles sold, some extrapolation is in order here. In particular, we take the estimates
in the pooled analysis in Table 2 Column (1) in the main text to infer the effect of the
entire fuel economy gap, both naturally occurring and amplified by the ETI, and take
the average of the five estimates at the individual thresholds in the two policy periods in
Columns (4)–(5) to infer the effect of the fuel economy gap associated only with the ETI.
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This suggests that the average fuel economy gap of ineligible vehicles is 20.8 percent
greater, and that of eligible vehicles 51.0 percent greater than expected, resulting in a
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44.4 percent greater gap on sales-weighted average, of which a 10.5 percent greater fuel
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economy gap is driven by the ETI. These translate into approximately U32,000 ($310)
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greater annual fuel costs per driver, or U889 billion ($8.5 billion) in total in 2009–2014,
incurred by the entire fuel economy gap, of which U7,600 ($73) annual fuel costs per
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driver, or U164.7 billion ($1.6 billion) in total, are explained by the fuel economy gap
induced by the ETI.
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Increased fuel consumption directly relates to additional pollution emissions, mitigat-

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ing the effects of efforts to curb GHG emissions. In 2014, Japan’s CO2 emissions totaled
1.27 billion tons. The transportation sector, which accounted for about 17 percent of
total CO2 emissions in 2014, has made steady reductions in CO2 emissions since peaking
in 2001, largely through the increased fuel economy of passenger cars. However, such
decline is overstated in the prevalence of the fuel economy gap. The estimated extra fuel
consumption due to the fuel economy gap results in an additional 13.9 million tons of
CO2 emitted into the air in 2014 in total, of which 2.6 million tons is attributable to the
ETI.54
The above calculations probably substantially understate the overall costs of the fuel
53
The information on the gasoline price is obtained based on the general retail price of gasoline with tax
reported by the Oil Information Center, and other information comes from MLIT. The number of eligible
and ineligible vehicle sales are reported each year by Japan Automobile Manufacturers Association.
54
We use CO2 emission coefficient of 2.32 kg-CO2 /L.
34
economy gap. For example, vehicles constitute the major source of carbon monoxide
(CO), nitrogen (NOx ), or particulate matter (PM), all of which have adverse effects on
human health. Moreover, increased CO2 emissions are likely to accelerate global climate
change. Further, the fuel economy gap has likely given rise to distortions in the allocation
of public funds in tax revenues as well as consumer choice of vehicles, both of which
adversely impact social welfare. The calculation of the total welfare impact of the fuel
economy gap is far beyond the scope of this research but offers an important topic for
future research.55
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VII. Conclusion
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Recently, nearly every major automaker worldwide has come under increased scrutiny af-
ter several automakers have been accused of—and in some cases have admitted to—falsifying
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fuel economy and emission data. Using novel data in Japan, our study suggests that
incentive schemes to boost the consumption of fuel-efficient vehicles underlay the ma-
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nipulation of automakers’ compliance with fuel economy and emission regulations. Our
evidence demonstrates that such environmental policies, especially those with nonlinear
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eligibility criteria, had limited efficacy because they unwittingly induced automakers to
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improve reported fuel economy without equivalent improvements in actual vehicle per-
formance. Our finding of an increased fuel economy gap at the eligibility thresholds calls
for continuous monitoring and rigorous enforcement to verify compliance with legislation
under real-world conditions.
Further, our data, which include a sample of drivers who are potentially more sensi-
tive to actual fuel economy than the general population, reveal a sizable fuel economy
gap even beyond those associated with tax incentives. A simple disparity between testing
procedures and real-life driving conditions may or may not explain the positive relation-
ship between the fuel economy gap and official fuel economy as well as increased gaps
55
For instance, the ETI induced consumers to purchase more fuel-efficient vehicles than those they
would have purchased without the ETI. Even if the actual fuel economy turned out be lower than
expected, the net welfare gain to consumers could be still positive, making the ETI still the second best
policy.
35
over time. Future research is expected to better understand these aspects. It is critical to
address the fuel economy gap because its existence undermines the worldwide effort to
achieve greater stringency in the regulation of atmospheric emissions from the automobile.
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36
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40
Figure 1: Initial Tax Payment
Panel A: Time-series
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Panel B: Cross-sectional
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Notes: These figures describe the sum of the acquisition and ton-
nage taxes at the time of vehicle purchase. Panel A presents the
amounts with and without tax incentives, when purchasing an aver-
age passenger vehicle, priced at U3,000,000 ($28,700), weighing 1.5
metric tons, and with a displacement size of 2 liters. The vertical
dashed line represents the beginning of the Eco-Car Tax Incentives
in 2009. The shaded areas correspond to the periods when the Eco-
Car Subsidies were additionally provided. Panel B presents the local
polynomial smoothing of individual tax payments for each vehicle in
the data produced in 2009–2014. Each dot represents an average fuel
economy gap with a bandwidth of 1 km/L bin in the x-axis value.
The average exchange rate is $1 = U104.51 in 2001–2014 and is $1
= U90.75 in 2009–2014.
41
Figure 2: Sales Share of Vehicles Eligible for the Eco-Car Tax Incentives
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Notes: This figure shows monthly sales shares of vehicles that are
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eligible for the Eco-Car Tax Incentives.
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Data source: The Japan Automobile Manufacturers Association, Inc.
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Figure 3: Fuel Economy Gap around the Eligibility Threshold
Panel A: 2009–2014
f
r oo
e -p
Pr
Panel B: 2001–2008
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Notes: These figures plot the locally smoothing functions of fuel

economy gap over official levels of fuel economy normalized at the
first threshold to be eligible for the tax incentives. Each dot rep-
resents the fuel economy gap for an individual driver-vehicle pair.
Panel A focuses on the period of 2009–2014, during which the Eco-
Car Tax Incentives were in effect, while Panel B focuses on the period
of 2001–2008 during which tax incentives were substantially smaller.
See Appendix ?? for related figures.
43
Table 1: Descriptive Statistics
N Mean SD.
Panel A: Drivers’ characteristics
Actual fuel economy by mean (km/L) 50,979 11.791 3.361
Actual fuel economy by median (km/L) 50,979 11.673 3.461
Fuel economy gap by mean 50,347 0.305 0.171
Fuel economy gap by median 50,347 0.318 0.179
SD of fuel economy 50,324 1.601 0.897
f
Male (0/1) 26,232 0.886 0.317
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Age 25,952 36.77 8.18
Average days to refuel 51,142 12.66 5.79
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Number of reports 52,199 54.18 54.13
Odometer (km)
Panel B: Vehicles’ characteristics
e -p 51,142 40,720.5 37,344.3
Official fuel economy (km/L) 1,618 16.504 5.075

Pr
Weight (kg) 1,606 1,210.6 350.15

Displacement (cc) 1,697 1,549.2 898.7
Year of production 1,697 2,006.5 3.86
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Month of production 1,697 7.398 3.404

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Seating capacity 1,650 4.902 1.2079

Price (in U10,000) 1,626 188.8 100.6
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Regular gasoline (0/1) 1,697 0.803 0.398

Automatic transmission (0/1) 1,697 0.825 0.380
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Passenger vehicle (0/1) 1,697 0.618 0.486

Notes: This table reports descriptive statistics (the number of observations in the
second column, the mean value in the third, and the standard deviation in the last)
of the key variables used in the analysis. The sample includes vehicles produced after
2001. Driver characteristics measured at the driver-vehicle level in Panel A include:
real-world fuel economy using mean values, real-world fuel economy using median
values, fuel economy gap measured by mean real-world fuel economy, fuel economy
gap measured by median real-world fuel economy, standard deviation of real-world
fuel economy, male dummy, age (limited to 18 to 65 years old), average days to refuel,
the number of reports, and odometer values. Official vehicle characteristics measured
at the vehicle configuration level in Panel B include: official fuel economy (km/L),
weight in kilogram, displacement size in cubic centimeter, year of production, month
of production, seating capacity in the number of people, price in U10,000 ($96),
a dummy for regular gasoline as opposed to high octane gasoline, a dummy for
automatic transmission (i.e., automatic and continuous variable transmission) as
opposed to manual transmission (i.e., manual and sequential manual transmission),
and a dummy for passenger vehicles as opposed to minicars.
44
Table 2: The Effect of the Eco-Car Tax Incentives on the Fuel Economy Gap
Model year 2009–2014 2009–2011 2012–2014

(1) (2) (3) (4) (5)
1st threshold 0.060*** 0.057** 0.051** 0.054* 0.069***
(0.023) (0.023) (0.022) (0.020) (0.023)
N 5,484 5,484 5,484 3,654 1,830
2nd threshold 0.038* 0.041*
(0.022) (0.023)
N 3,839 1,913
3rd threshold 0.062***
(0.020)
N 1,862
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Driver controls N Y Y N N
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Vehicle controls N N Y N N
Notes: This table reports the estimate of the fuel economy gap at the respective eligibility
r
thresholds to the Eco-Car Tax Incentives. The sample includes vehicles manufactured
-p
in years specified at the column head. The dependent variable is the log of official fuel
economy divided by real-world fuel economy calculated based on mean fuel economy at
e
the driver-vehicle level. The standard errors are clustered at the vehicle configuration
level (445 clusters in total in 2009–2014). Appendix Table ?? provides the coefficients
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of other control variables in Columns (1)–(3).

*p<0.1, **p<0.05, ***p<0.01
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Table 3: Alternative Specifications
Specification Coeff.
Use median 0.060***
(0.021)
Bandwidth = 6km/L 0.049**
(0.023)
Bandwidth = 10km/L 0.062***
(0.022)
Quartic in trend 0.163**
(0.071)
Weight by # of reports 0.051**
(0.023)
Two-way cluster 0.060***
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(0.023)
Case-level observations 0.049**
(0.021)
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Trend in percentage 0.048**
Triangular kernel
e -p (0.024)
0.050**
(0.024)
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Notes: This table presents analogous figures to Table 2 Column (1) with
various alternative specifications. The first uses median values of real-
world fuel economy when computing fuel economy gaps. The second row
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uses a smaller and the third a larger bandwidth than the main analysis.
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The fourth includes up to a quartic polynomial in the relationship between

fuel economy gap and deviation of official fuel economy from the eligibility
thresholds. The fifth uses the weighted least squares weighted by the
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number of reports. The sixth uses the two-way cluster of standard errors
at the individual driver (5,377 clusters) and vehicle configuration level
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(461 clusters). The seventh row uses individual case level observations (N
= 202,666), in which standard errors are two-way clustered at the driver
and vehicle configuration levels. The eighth uses a percentage deviation
from the eligibility thresholds with the bandwidth of 40% (N = 5,619).
Lastly, the triangular kernel weighting function is used in place of the
uniform one.
**p<0.05, ***p<0.01
46
Table 4: Exploring Mechanisms
Mean
Eligible Marginal effect
(2009–2014)
(1) (2) (3)
Panel A: Drivers’ characteristics
Male 0.898 -0.051 -0.012
[0.303] (0.031) (0.012)
Age 40.7 -0.832 0.002***
[7.85] (0.895) (0.000)
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SD of actual fuel economy 1.74 0.013 0.008**
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[0.972] (0.073) (0.004)
Number of reports 35.17 -7.124** -0.00035***
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[31.25] (3.245) (9.62e-05)
Odometer
e -p
16,000
[20,463]
-2,227
(1,936)
-5.96e-07***
(2.08e-07)
Fuel price 149.7 0.480 -0.00073*
Pr
[8.953] (1.984) (0.000410)

Panel B: Vehicles’ characteristics
Weight 1,194.3 -106.282 -0.00008
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[335.1] (84.316) (0.00006)

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Displacement 1,462.6 -376.182* -0.00005***

[738.3] (200.631) (0.00002)
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Registration year 2,010.9 0.416 0.011***

[1.468] (0.353) (0.0037)
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Registration month 7.98 0.052 0.002

[3.28] (0.781) (0.001)
Seating capacity 5.09 0.471 0.0177**
[1.29] (0.288) (0.00711)
Regular gasoline 0.861 0.009 0.051***
[0.346] (0.114) (0.019)
Automatic transmission 0.912 -0.089 0.117***
[0.284] (0.072) (0.019)
Notes: This table explores discontinuities for individual drivers’ characteristics in Panel A and
vehicles’ characteristics in Panel B at the eligibility thresholds for the Eco-Car Tax Incentives.
The sample includes vehicles produced in 2009–2014. Column (1) presents the mean values of
respective variables, and the numbers in square brackets represent standard deviation. Column
(2) presents the estimated discontinuities at the eligibility thresholds, and Column (3) presents
marginal effects of each variable on a fuel economy gap estimated in a single regression (N =
6,253). The numbers in parentheses are standard errors clustered at the vehicle configuration
level.
*p<0.1, **p<0.05, ***p<0.01
47
Table 5: Heterogeneity in the Extent of Fuel Economy Gap
N Coeff. SE
Mitsubishi 161 0.077*** 0.023
A 979 0.097** 0.038
B 457 0.079 0.031
C 923 0.038 0.054
D 769 0.005 0.099
E 819 -0.017 0.028
F 901 -0.123*** 0.051
Notes: This table provides heterogeneity in the extent of the fuel economy
gap at the 1st eligibility thresholds across automakers. To avoid identifi-
cation of individual automakers, the names of automakers are anonymized
except for Mitsubishi whose manipulation of fuel economy has already been
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admitted.
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*p<0.1, **p<0.05, ***p<0.01
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48
Table 6: Placebo Tests
(1) (2) (3) (4) (5)

Eligible -0.007 -0.024 0.035 -0.004 -0.030
(0.013) (0.037) (0.032) (0.032) (0.043)
N 44,091 2,217 4,086 219 1,402
Threshold 1st eligibility 2015+10% 2015+10% 2010+15% 2010+15%
Model year 2001–2008 2009–2011 2009–2011 2012–2014 2012–2014
Mean Treat 0.67 0.30 0.19 0.98 0.88
Notes: This table reports the discontinuity estimates from the placebo tests. The placebo
threshold in Column (1) is the actual first eligibility thresholds for tax incentives in 2001–2008
before the Eco-Car Tax Incentives (ETI) were introduced. The placebo thresholds in Columns
(2)–(5), specified in the table, are those that were not used for the specified model years but
were used for models in the other period of the ETI. For instance, “2015+10%” denotes the
f
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level of 10% above the 2015 fuel economy standard, corresponding to the second tax-eligibility
threshold in 2012–2014. Note that most vehicles report fuel economy only in the 10.15-mode
test cycle in 2009–2011 or the JC08-mode test cycle in 2011–2014. On the other hand, the
2010 fuel economy standards are established based on fuel economy measured by the 10.15
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mode, while the 2015 fuel economy standards are based on the JC08 mode. Therefore, Columns
(2) and (4) use the sample of vehicles whose fuel economy figures are reported in the mode
directly comparable to the placebo standards. In contrast, Columns (3) and (5) additionally
e
include vehicles whose fuel economy figures are converted into the comparable measures to the
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placebo thresholds. In particular, the 2015+10% thresholds in the JC08 mode are equivalent
to the 2010+38% thresholds in the 10.15 mode as determined by MLIT for vehicles whose
fuel economy figures are not reported in the JC08 mode. Also, the JC08-model fuel economy
is converted into the 10.15 mode by inflating by 10%. The bottom row indicates the share of
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observations that are eligible for the tax incentives.

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49

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To appear in: Journal of Environmental Economics and Management

Received Date: 8 October 2019

© 2020 Published by Elsevier Inc.

Keywords: fuel economy gap, feebate policy, manipulation, automobile industry

much of the observed gap remains unexplained by driver or vehicle characteristics,

Keywords: fuel economy gap, feebate policy, manipulation, automobile industry

JEL Codes: H23, Q58, L62, L51

to improvements in official fuel economy.4

II. Institutional Background and Data

A. The Feebate Policies in Japan8

[Figure 1 About Here]

[Figure 2 About Here]

driving habits and simultaneously reducing gasoline costs.

We made a special agreement with the company to obtain case-level observations

τ = E[Yv (1) − Yv (0)], (1)

τ = E[Yv (1) − Yv (0)|Dv = D∗ ], (2)

Yiv = α + β × 1(Dv ≥ D∗ ) + f (Dv ) + εiv , (3)

manipulation, β will be positive as manipulation will be manifested as an increased gap at

f (Dv ) = γ1 × (Dv − D∗ ) + γ2 × (Dv − D∗ ) × 1(Dv ≥ D∗ ). (4)

sumption almost inevitably holds, as individual thresholds are exogenously determined

lim E[Yv (1)|Dv = d] = lim∗ E[Yv (0)|Dv = d]. (5)

lim E[Yv (1)|Dv = d] > lim∗ E[Yv (0)|Dv = d], (6)

lim E[Yv (1)|Dv = d] < lim∗ E[Yv (0)|Dv = d], (7)

IV. Empirical Results

can interpret the discontinuity at the threshold observed in Panel A as a shift up in

the 5 percent level.

From an economics perspective, an important question related to the automakers’ cheat-

and 3.8 percent at the second threshold.

[Table 3 About Here]

configurations and drivers. The standard error is unchanged.

[Figure 4 About Here]

First, we explore heterogeneity in drivers’ characteristics at the eligibility cutoffs.

are achieved) or illegally through outright fabrication of data.

loopholes in vehicle testing procedures have allowed manufacturers to game opportuni-

In the case of Mitsubishi, the company executives admitted to deliberately falsifying

E. Heterogeneity in the Treatment Effects

V. Validity of the Identification Assumption

a discontinuity at the eligibility threshold is absent; instead it illustrates a standard

resembling Appendix Figure ?? in showing a positive and monotonic association between

the gap and official fuel economy).

when they are associated with large tax incentives.

VI. The Magnitudes of the Effect of the Fuel Econ-

This section aims at presenting back-of-the-envelope calculations of the partial equilib-

Increased fuel consumption directly relates to additional pollution emissions, mitigat-

vehicle weight dispersion and accident fatalities. Mimeo.

Bento, A. M., L. H. Goulder, M. R. Jacobsen, and R. H. von Haefen (2009). Distri-

Calonico, S., M. D. Cattaneo, and R. Titiunik (2014). Robust nonparametric confidence

spending. American Economic Journal: Applied Economics 9 (3), 1–35.

International Council on Clean Transportation (2015b). From laboratory to road: A 2015

Economists 4 (1), 51–87.

Lee, D. S. and T. Lemieux (2010). Regression discontinuity designs in economics. Journal

of Economic Literature 48 (281-355).

Oliva, P. (2015). Environmental regulation and corruption: Automobile emissions in

Notes: These figures plot the locally smoothing functions of fuel

Official fuel economy (km/L) 1,618 16.504 5.075

Weight (kg) 1,606 1,210.6 350.15

Month of production 1,697 7.398 3.404

Seating capacity 1,650 4.902 1.2079

Regular gasoline (0/1) 1,697 0.803 0.398

Passenger vehicle (0/1) 1,697 0.618 0.486

Model year 2009–2014 2009–2011 2012–2014

of other control variables in Columns (1)–(3).