Cross-Subsidization under Fleet Emissions Standards: Electric Vehicles in the European Car Market

Because the regulation creates a kink in firm profits at the compliance threshold, they smooth the penalty by introducing demand uncertainty, which yields tractable first-order conditions and allows them to recover marginal production costs for firms above and below the target. Their estimates show that the standard generates substantial cross-subsidization within manufacturers' product portfolios. In 2020, about 6 percent of vehicles were sold below their marginal production cost, all of them battery-electric vehicles. Counterfactuals show that tightening the target lowers emissions but has heterogeneous price and welfare effects across firms and countries. They also reveal a non-obvious mechanism: when electric vehicles are removed from firms' portfolios, total emissions fall because manufacturers can no longer use zero-emission sales to relax the fleet constraint and support sales of high-emission vehicles.

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