The White House and Congress are currently finalizing the auto deal that would bail out (via a series of loans) the Big 3 automakers to the tune of $15 billion.  Yet the best deal that would provide the most long-term stability for the auto industry and the smallest burden on taxpayers is no deal at all.  In other words, let the Big 3 fail if it comes to that.

The hearings in Congress last week, where the Big 3 CEOs practically begged the government for money, failed to reveal the very reasons why the Big 3 are under water: government (a lot of it) and mismanagement (a little bit).  The Big 3 are in dire financial straits because of (1) overbearing government regulations, (2) high corporate taxes, and (3) burdensome union contracts.  The auto deal currently being finalized would simply throw more government intervention at a government-created problem.   

Problem 1: Government Regulations

The Corporate Average Fuel Economy (CAFE) regulations (first enacted in 1975 in the wake of the Arab oil embargo) are federal regulations that aim to improve the average fuel economy of cars, trucks, and SUVs sold in the U.S.  Ironically, since 1975, foreign oil imports have increased, not decreased. 

Moreover, CAFE’s heightened mileage standards have forced automakers to make smaller, less-safe, and more expensive cars that American consumers simply do not want to buy.  For example, Chevy will make a hybrid SUV that costs $10,000 more than the same non-hybrid SUV.  However, the hybrid gets only a marginal increase in fuel efficiency over the standard model.  The consumer never makes back (in gas savings) the extra $10,000 he/she ponied up to buy the hybrid.  

So, by going “green,” the hybrid buyer is paying a lot more money and getting a slower, less-safe, slightly-less-carbon-emitting status symbol.  (For more information on why these cars are of lower quality, skip to Problem 3 below.)

Americans know better.  They’re not buying these hybrids because they prefer stronger, sturdier cars and SUVs with the power to lug their boats and families around.  The automakers know what sells, and it’s not the hybrids they’re being forced to make.  This dilemma places them at a competitive disadvantage with countries like Japan, which already have higher fuel efficiency standards and, thus, can adapt more quickly to such regulations.

Problem 2: High Corporate Taxes

The upper tax rate for corporations in the U.S. is currently 35%.  In a global economy, in which the Big 3 are competing with automakers in foreign countries with lower corporate tax rates, the American corporate tax structure makes it almost impossible to compete.  

When automakers actually make a profit, they have to pay more in taxes than their competitors overseas.  This extra burden drains their cash reserves–which they desperately need during an economic downturn.                  

Problem 3: Burdensome Union Contracts

Due to union contracts negotiated almost 50 years ago, the Big 3 have incurred enormous “legacy” costs that are now torpedoing their balance sheets.  Even if they were making record profits, their obligations to honor these union benefits would hamper their stability.

Under these union contracts, the Big 3 have to pay lavish pension and health care benefits to hundreds of thousands of retirees.  GM, for instance, incurs a $1,500-per-car cost for medical benefits alone. 

Meanwhile, foreign automakers refrained from assuming similar obligations.  Toyota’s obligations for its retirees is zero because it made its employees shoulder the responsibility to save for their own retirements (the way it should be).  Without the costs of such benefits, Toyota and other foreign automakers operating in the U.S. enjoy a competitive advantage.  

This situation is the same as the one where two ice cream shops on the same street compete for customers.  If it costs one ice cream shop $10 more to make its ice cream than the other shop, which one do you think will eventually win out?

In addition, the higher, union-related costs of making cars has forced the Big 3 to cut some corners in its manufacturing.  This facilitation has resulted in lower-quality cars that cost more than their higher-quality, foreign counterparts. 

The Best Auto Deal?  Let Them Fail And Remove Government  

Despite these government- and management-created problems, the Big 3 have resorted to begging Washington for money.  And liberal politicians can’t resist the possibility of exerting even more control over the auto industry. 

Injecting more government into this auto mess will only make matters worse because it will prop up a bad business model (e.g., an industry weighed down by steep union legacy costs) and add more regulation to an already over-regulated industry.  In fact, this $15 billion auto deal will only keep the Big 3 afloat for a few months.  In April, they’ll be back asking for more.   

The best solution is to keep government out of this mess.  This involves, first and foremost, letting the Big 3 fail.  Filing for bankruptcy and/or re-organizing will force these businesses to cut the fat and start from scratch.  They’ll have to re-negotiate their union contracts and figure out how cut back on those obligations and/or honor them while not compromising their ability to compete with foreign automakers. 

Keeping government out also entails some relief from Washington.  The government should lower the corporate tax rate to 15% and leave it there.  This form of tax relief will help the Big 3 realize more profits and keep precious cash on hand for problems similar to our current economic situation.  Moreover, the government should repeal the CAFE regulations.  They are simply too burdensome on American automakers and preventing them from making money on products that Americans actually want to buy. 

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