ZEV pathway: Policy design manual

This document is intended to support the information provided in the ZEV pathway: Policy design guide and provide users with the background information required to begin building a ZEV sales standard for their region. This document breaks down the ZEV sales standard into component parts, or design elements. Each design element is discussed in detail and policy design options are presented to help users choose which design approach may be best for their region. The design elements discussed in this document include:

• Scope

  • Regulated vehicles

  Identifies and defines the vehicles being regulated under the standard.

  • Regulated entities

  Identifies and defines the entities being regulated under the standard.

• Standard setting

  • ZEV sales targets

  Set ZEV sales percentage targets across future years.

• Vehicle & credit accounting

  Outlines the credit value of each vehicle type under the standard.

• Reporting

  Stipulates specific reporting requirements for regulated and regulating entities.

• Compliance & enforcement

  Outline metrics for compliance, and penalties for non-compliance.

• Flexibilities

  Describes design elements that can reduce regulatory compliance costs for the regulated entity. Note that some flexibilities have drawbacks that are discussed further in their respective sections.

Of the design elements discussed in this document, scope, standard setting, vehicle & credit accounting, reporting, and compliance & enforcement are all essential elements for the proper functioning of a ZEV sales standard. When designing the SSR, all of these elements must be present. Flexibilities or flexible design elements are not essential to the proper functioning of the SSR and therefore are not required for inclusion in the regulation. However, it may be necessary or desirable to include certain flexible design elements to increase economic efficiency, incentivize overcompliance, or improve stakeholder support for SSRs. This will be discussed further in the Flexibilities section below.

In each of the design element sections, the following information is provided:

• Summary

  This subsection provides users with an overview of what the design element is, and why it may or may not be important for inclusion in the ZEV sales standard.

• What is being done in other regions?

  This subsection provides users with examples of how other regions with existing ZEV sales standards have approached the design element.

• Design considerations

  This subsection provides users with an in-depth discussion on the different ways the design element can be designed. It provides information on the pros and cons, tradeoffs, implications, and consequences of certain design decisions.

• Notes to the policymakers

  This subsection provides users with a summary of the important takeaways from each design element section, including key considerations and best practices.

Refer to the GHG/FE standard: Policy design manual for information on the design of GHG and FE standards.

Scope

Regulated vehicles

Summary of the design element

This design element is intended to identify and define vehicles that are regulated under the SSR. This is important because:

• It determines which vehicles' emissions are counted toward compliance.
• For example, does the standard apply to light-duty cars, heavy-duty trucks, off-road vehicles, electric vehicles, or only gasoline-powered ones?
• The broader the coverage, the more comprehensive the emissions reductions can be.
• Automakers tailor their product strategies based on which vehicles are regulated.
  • If only passenger cars are regulated, SUVs and trucks might proliferate as a loophole.
  • If all on-road vehicles are covered, there's more incentive to decarbonize across the board.

SSRs typically target specific types of vehicles rather than the entire market, focusing on characteristics that align with the goals of the regulation. These classifications often combine several dimensions, such as vehicle size, purpose, drivetrain technology, and vehicle age. This section outlines key considerations in defining regulated vehicles and the implications of these choices for regulatory design.

Vehicle characteristics as regulatory indices

Several vehicle characteristics are commonly used to determine whether a vehicle falls under the scope of regulation and to set the thresholds or limits vehicles must comply with.

1. Vehicle size

   Vehicle size plays a central role in determining regulatory limits, reflecting the physical characteristics of vehicles:

   Gross Vehicle Weight Rating (GVWR): GVWR measures the maximum allowable weight of a fully loaded vehicle, including passengers, cargo, and fuel. Based on GVWR, vehicles are classified into light-duty vehicles (LDVs), medium-duty vehicles (MDVs), and heavy-duty vehicles (HDVs), with each category potentially subject to distinct regulatory requirements. LDVs, which include passenger cars, SUVs, crossovers, and light trucks, typically have a GVWR of 8,500 pounds (3,856 kg) or less and are primarily regulated for fuel economy and emissions. HDVs, such as large trucks and buses, exceed this weight threshold and are regulated separately, often with a focus on emissions, fuel consumption, and road safety. MDVs fall between these categories and may be subject to tailored regulatory frameworks depending on regional policies.

2. Vehicle designation:

   SSRs typically distinguish vehicles based on their intended function, structural characteristics, and operational use. One common classification approach is categorizing vehicles into passenger cars, light trucks, and commercial vehicles, with different requirements applying to each category.

   Passenger cars versus light trucks: Passenger cars and light trucks are both classified as LDVs but are subject to different regulatory targets due to variations in their design and usage. Passenger cars, including sedans, hatchbacks, and station wagons, are primarily designed for personal transportation, prioritizing FE and lower emissions. Light trucks, which include SUVs, pickups, and vans, are designed for a mix of passenger and cargo transport, often featuring higher payload and towing capacities. Due to their larger size and weight, light trucks typically have more lenient fuel economy and GHG standards than passenger cars. This segmentation is particularly relevant in contexts where there is a need to tailor standards that reflect typical usage patterns - such as differentiating between personal transportation and mixed-use or cargo-oriented vehicles. More lenient standards for light trucks may be appropriate where commercial needs require more robust vehicles and the regulator aims to reduce compliance burdens on businesses. However, in markets where consumer preferences shift toward light trucks for personal use, maintaining separate standards can create regulatory loopholes. In such cases, convergence toward a unified standard for both passenger cars and light trucks may be warranted. The EPA's 2024 Automotive Trends Report (Page 184) provides a decision tree as an example of how these distinctions are made in the US¹.

   Commercial vehicles: Commercial vehicles are primarily designed for business or industrial purposes and include delivery vans, cargo trucks, and other work-related vehicles. Unlike passenger cars and light trucks, which serve private transportation needs, commercial vehicles are regulated based on payload capacity, usage patterns, and emissions output, often with separate compliance requirements.

3. Drivetrain technology

   Drivetrain technology is a fundamental consideration in regulatory design, as it directly affects vehicle emissions and performance. Regulating by drivetrain allows standards to reflect the distinct characteristics of BEVs, PHEVs, FCEVs, and ICEs - an approach particularly important in transitioning markets where encouraging ZEV adoption may require tailored compliance pathways and incentives. To avoid strategic misclassification, it is essential to clearly define each technology category. As a best practice, regulations should include minimum requirements for battery capacity, electric driving range, and durability. These definitions help ensure consistency across manufacturers and prevent less-capable technologies from gaining the same regulatory treatment as fully capable ZEVs.

4. Additional specifications

   New versus used vehicles: In most cases, SSRs focus on new vehicles because they are easier than used vehicles to monitor and control through well-established manufacturing and sales channels. However, in regions with significant used-vehicle imports, additional measures may be necessary. For example, some countries impose emissions or safety requirements on imported used vehicles. Japan, for instance, requires imported used cars to meet standards comparable to those of new vehicles, preventing the import of polluting cars while still regulating affordability and accessibility. Policymakers must ensure that focusing on new vehicles does not inadvertently create a backdoor for less-regulated used vehicles to dominate the market, which could undermine the regulation's goals. A potential regulatory challenge is defining what qualifies as a “used” vehicle, as unclear definitions can create loopholes. In some cases, OEMs may have an incentive to register new vehicles as used to avoid stricter regulations. To prevent such regulatory evasion, a clear criteria for what constitutes a used vehicle should be established, specifying a minimum ownership period, mileage threshold, or other objective indicators to ensure that vehicles classified as used have genuinely entered the secondary market. In countries with large used-vehicle imports, regulating used vehicles is critical to maintaining the integrity of emissions and safety standards. Without this, a dual market may emerge in which new vehicles meet strict standards while used vehicles bypass them entirely. However, regulating used vehicles can be administratively challenging and may require robust inspection and enforcement systems. Policymakers should weigh these trade-offs in light of local enforcement capacity and vehicle import patterns.

   Model Year: Regulations typically apply to vehicles based on their model year, which differs from the calendar year. A model year refers to the production cycle of a vehicle, meaning a 2031 model year vehicle may begin production in mid-2030 and be available for sale well before 2031. This distinction has important implications for regulatory targets, as policymakers must account for how model year definitions affect compliance deadlines. For example, if a regulation sets a goal of 50% zero-emission vehicle sales by 2030, it is essential to clarify whether this applies to the 2031 model year or vehicles sold within the 2030 calendar year.

   Two-wheelers and emerging vehicle categories: In many regions, particularly in the Global South, two-wheelers such as motorcycles, scooters, and mopeds constitute a significant portion of the vehicle fleet. These vehicles are often subject to separate regulatory standards that address FE, emissions, and road safety, given their widespread use in urban and rural transportation. The rise of electric two-wheelers further complicates classification, as they may be regulated under motorcycle, bicycle, or new mobility categories, depending on power output and speed capabilities². Regulators focused on four-wheeled vehicles should pay close attention to the growing two-wheeler market, as these vehicles increasingly serve as substitutes for conventional cars, especially in dense urban environments. Their rising adoption presents strategic opportunities: electric two-wheelers can help shift travel demand away from higher-emission vehicles, reducing both congestion and emissions. Promoting two-wheelers, particularly through targeted incentives or dedicated ZEV mandates, can serve as a complementary tool. By integrating both vehicle types into a cohesive policy framework, rather than regulating them separately, policymakers can build broader support and expand low-emission mobility options.

What is being done in other regions?

Table 1 provides a summary of the regulated vehicles in each focus region. Refer to the regulation reference for further detail.

Table 1. Regulated vehicles in focus regions

Design considerations

The highlighted regulations illustrate different approaches to defining regulated vehicles based on weight, designation, and use case. California and the US primarily distinguish between passenger cars and light-duty trucks, with additional classifications for medium- and heavy-duty vehicles. The EU adopts a similar approach but includes specific weight-based thresholds for light commercial vehicles. Australia's framework categorizes vehicles into passenger, light, and medium goods vehicles, with coverage determined by type approval and registration. Additionally, ZEV requirements vary across regions, reflecting different regulatory priorities and stages of market development. For example, California sets specific criteria for electric range and battery durability to ensure long-term performance and build consumer confidence. This is an approach shaped by its early ZEV adoption, market maturity, and focus on technology leadership. In contrast, regions that are earlier in the electrification process or more focused on near-term emissions reductions, such as parts of the EU or Latin America, tend to prioritize tailpipe emissions thresholds over performance metrics. These variations highlight how regulatory scope is shaped by regional policy priorities and vehicle market structures.

Notes to the policymaker

• Vehicle definitions are important in determining ZEV sales outcomes, as they directly influence which vehicles are subject to regulation and how compliance is measured.
• Regulations that appear more or less stringent may actually reflect differences in vehicle classification rather than fundamental policy variations. For example, a policy targeting heavier vehicles may seem less strict than one focused on lighter vehicles, even if both set comparable economy or emissions thresholds.
• To enhance policy effectiveness and comparability across regions, regulators should carefully consider how vehicle definitions align with emissions reduction, improved economy, and economic goals and ensure that classification differences do not create unintended loopholes or market distortions.

Regulated entities

Summary of the design element

Defining who the regulated entity is in the SSR is crucial because:

• The regulated entity is the one legally responsible for meeting the ZEV sales standard.
• This clarity ensures accountability—someone must track, report, and reduce emissions or face penalties.
• Whoever is regulated will bear the cost of compliance (e.g., upgrading tech, purchasing credits).

SSRs regulate the highest upstream vehicle supplier possible. This can include vehicle original equipment manufacturers (OEMs, often referred to in the toolkit as 'auto manufacturers' for simplicity) and entities involved in the production, importation, and sale of vehicles. Identifying key stakeholders can be a first step in identifying groups to regulate³. In most cases, it is the entity that holds the type approval for the regulated vehicle that is regulated under the standard.

Another aspect to consider when identifying regulated entities is domestic versus imported vehicles as a share of the total market. Figure 1 below illustrates the proportions of domestic versus foreign-supplied market compositions across different countries, helping to identify where regulating OEMs, importers, or both might be most effective. Countries with domestic industries should choose to regulate manufacturers, whereas countries that are solely reliant on imports should choose to regulate importers. Sometimes manufacturers and importers are one and the same for import countries. Domestic versus import markets lie on a spectrum and users should determine which entities should be regulated based on their region's context.

Figure 1. Domestic versus imported vehicle supply as a share of the market

What has been done in other regions?

Table 2 provides a (non-exhaustive) list of possible regulated entities, a brief discussion around the regulated entity, and a regional example.

Table 2. Examples of regulated entities across regions

Design considerations

Considerations for small and medium volume auto manufacturers

Regulatory frameworks must balance environmental goals with economic feasibility, particularly for small and medium-sized OEMs (SMEs) that lack the financial, technical, or administrative resources of larger manufacturers. Designing flexible compliance mechanisms ensures equity while maintaining regulatory integrity. Table 3 provides examples of allowances afforded to SMEs in existing SSRs.

Table 3. Small and medium volume auto manufacturer allowances

Notes to the policymaker

Policymakers should note that regulated entities should be identified based on the context of the region. If the region predominantly manufactures vehicles domestically, then the primary regulated entity is auto manufacturers. If the region is predominantly an importer of vehicles, then importers and dealerships may be the primary regulated entities. Design flexibilities for SMEs should be considered for inclusion in the regulation, especially if the industry is skewed toward small and medium manufacturers.

Standard setting

Standards are the benchmark level of ZEV sales that a regulated entity must meet in order to be compliant with the regulation. Standards are set across multiple years with ZEV sales increasing over time across years. Some standards are expressed in model years, while others are expressed in calendar or financial years. The standard usually applies to new vehicle sales.

Existing regulations take different approaches to setting standards that ultimately determine the stringency of the policy. For example, one approach is to target 100% ZEV sales with interim targets in the intervening model years. Another approach is to increase stringency across model years but to not include a final target that would require all vehicle sales to be ZEVs. Refer to the Stringency section in the Navigating design tradeoffs & interactions document for more information.

Standards are usually set multiple years in advance to allow industry to prepare for regulatory change. Time between the release of the final regulation ruling and when the regulation comes into force is usually between one and two years, however, release of proposed rulings and public comment periods are usually well in advance of this time. The regulations themselves usually cover a period of between five and 15 years with an additional regulation being created for following years prior to the end of the existing regulation.

SSR targets should be established in the broader context of a region's economic, social, and environmental goals. Specifically, targets should align with the country's goals around economic development, innovation, domestic industrial development, global market competitiveness, and climate change.

ZEV sales targets

Summary of the design element

For ZEV sales standards, targets set the proportion of new ZEV sales that a manufacturer is required to meet for a given model year (sometimes referred to as the 'annual ZEV requirement'). Unlike the GHG and FE standards where each auto manufacturer has an individual standard based on number of new vehicle sales and vehicle size, the ZEV sales standard targets apply uniformly across all manufacturers. Targets usually increase in stringency across model years by increasing the level of required ZEV sales. Often these standards set a limit for the proportion of PHEVs that can fulfil the annual ZEV requirement.

There are different approaches to designing ZEV sales standard targets based on the level of desired stringency. For example, targets can be designed to achieve 100% ZEV sales by a certain year, or they can stop short of 100% sales. The rate of increase in ZEV proportions can also be modified to achieve more sales in earlier model years or more sales in later model years.

What is being done in other regions?

Table 4 presents a summary of the target setting design element for focus regions with a ZEV sales standard. Refer to the regulation reference for further detail.

Table 4. Targets for ZEV sales standards in focus regions

Design considerations

Transparency

Depending on the types of flexibilities included in a ZEV sales standard, the targets may not always directly translate to the proportion of ZEV sales (see the Flexibilities section for further detail). If the regulation includes flexibilities such as multipliers and off-cycle credits, then a manufacturer may be able to achieve compliance at lower ZEV sales. This is because multipliers and off-cycle credits weigh ZEVs or off-cycle technologies/innovations. One way to improve the transparency of targets is to refer to the 'ZEV sales proportion' as a 'credit percentage requirement' instead. This makes it more clear that the proportion is not a reflection of real vehicle sales but a reflection of credit proportions. See the Multipliers and Off-cycle & air conditioning credits sections for more information.

Target curve designs

The target curve (i.e., the shape of the targets across model years) should aim to minimize cumulative emissions, considering both the final goal and the emissions during the transition period, which are analogous to the area under the curve. For a ZEV sales standard this means maximizing the area under the curve or having standards that require high proportions of ZEV sales early on. If there is an expectation that vehicle turnover may slow over time, it is additionally important to have high ZEV sales in early model years (Figure 2).

Resource allocation

An instance where it may be beneficial to ramp up ZEV sales in later years is if a region has high levels of grid emissions. To maximize GHG emissions reduction, ZEVs are ideally fueled by grids with a high proportion of renewable energy. In regions where the grid is reliant on fossil fuels and government resources are scarce, it may be a more beneficial use of resources to 'green' the grid prior to the transition to ZEVs. However, ideally the transition to a green grid and ZEVs would occur in parallel.

Figure 2. Different approaches to ZEV sales targets across model years

Notes to the policymaker

• Policymakers should note that:
  • If additional flexibilities are included in ZEV sales standards, targets may not reflect actual ZEV sales as generous multipliers, deficit banking, and off-cycle credits can reduce real-world emissions reductions.
  • This discrepancy occurs because some flexibilities allow ZEVs to count as more than one vehicle, making targets based on credit proportions rather than actual sales.
• To enhance transparency:
  • Regulations should clearly differentiate between credit-based targets and real sales proportions.
• To minimize cumulative emissions over time:
  • Targets should aim to maximize the area under the curve across multiple years.
  • An alternative approach may be warranted if grid emissions are high—in such cases, government resources might be better directed toward greening the grid.
• Opposition from the auto industry to SSRs typically focuses on:
  • The flexibilities not the targets themselves. Depending on the flexibility, this may reduce the stringency of the overall regulation. See the 'Flexibilities' section for further details.

Vehicle & credit accounting

Summary of the design element

Vehicle and credit accounting is central to the functioning of ZEV sales standards. Vehicle accounting refers to the process of determining compliance with the standard. By counting the number of vehicles sold, regulated and regulating entities can:

1. Calculate the standard regulated entities are required to meet.
2. Calculate the actual fleet performance of each individual regulated entity.

Flexibilities can have a large impact on the final vehicle & credit accounting outcome with different flexibilities impacting the outcome in different ways. For example, if a regulated entity exceeds their standard, regulated entities may be permitted to generate credits equivalent to their overcompliance. Credits enable the functioning of flexibilities such as banking and trading. If deficit banking is included in the regulation, regulated entities can generate deficits by being under-compliant. These deficits can be banked and 'paid off' in future years through over-compliance. If multiplier flexibilities are included in the regulation, alternative fuel vehicles can be counted as more than one vehicle when conducting the vehicle & credit accounting. This can allow regulated entities to comply with the standard while selling fewer alternative fuel vehicles. If flexibilities are included, clear guidance should be provided to calculate fleet performance. Refer to the Flexibilities section for more information.

What is being done in other regions?

Table 5 presents examples of the fleet standard and performance calculations. Refer to the references for further information.

Table 5. Simplified standard and fleet performance calculation examples

Reporting

Summary of the design element

Guidance and requirements for reporting should be included in all ZEV sales standards. Regulated entities should be required to periodically report information on their new vehicle sales to the regulating entity to determine compliance. Usually, reporting is required on an annual basis and regulated entities must submit reports to the regulating entity within a certain timeframe (usually a few months) after the end of the compliance period. The regulation should stipulate the information and format of the report to be submitted by the regulated entity. For example, some regulations require that the regulated entity determine compliance with the standard while others only require regulated entities to report the information necessary for the regulating entity to determine compliance.

Some regulations also include reporting requirements for the regulating entity. As it is common for compliance data to be made publicly available through a central government database, regulations may stipulate a timeframe for regulating entities to make the data publicly available.

What is being done in other regions?

Table 6 presents a summary of the variables that different regions require under their regulation. Refer to the regulation reference for the full list of reporting requirements.

Table 6. Summary of reporting requirements in focus regions

Notes to the policymaker

• Different reporting requirements can significantly affect administrative workload for both regulators and regulated entities.
• Assigning compliance calculations to regulated entities can reduce the burden on regulatory agencies.
• Public reporting via a central database can enhance transparency, though it may also increase administrative demands.
• Balancing transparency and administrative feasibility is key to effective and sustainable policy implementation.

Compliance & enforcement

Summary of the design element

Theoretical framework for penalty design

Penalties play a critical role in SSRs, serving as an enforcement mechanism that incentivizes compliance and discourages violations. Designing an effective penalty structure requires balancing competing priorities: ensuring that penalties are high enough to deter non-compliance but not so severe as to threaten manufacturers' viability or disrupt the market. This section explores the theoretical foundations, technical considerations, international practices, and implications of penalty setting in SSRs, offering insights for policymakers aiming to achieve regulatory goals efficiently.

Figure 3. The efficient level of emissions

Two key points on this curve are particularly noteworthy: the point of zero emissions ($e^0$) and the optimal abatement point ($e^{*}$). $e^0$ represents the theoretical condition of no emissions, signifying a state where no pollution-induced harm exists. This aligns with the "zero risk" approach, which aims to set standards that protect everyone, no matter how sensitive, from any damage. While this approach may be suitable for certain highly toxic pollutants, it is essentially impossible to achieve for all pollutants due to the prohibitively high abatement costs and practical limitations associated with reaching $e^0$. Instead, regulations aim to reach the point where these two curves intersect, $e^{*}$, which represents the balance between the societal benefits of reducing pollution and the costs incurred by firms to achieve it.

To align incentives with regulatory goals, penalties should be set above the marginal abatement cost, at $e^{*}$. This ensures that compliance remains more cost-effective than paying the fine, thereby encouraging firms to adopt cleaner technologies and reduce emissions efficiently. When penalties fall below the marginal abatement cost, OEMs may find it financially preferable to pay fines rather than invest in compliance measures. By structuring penalties to exceed the cost of abatement, regulators can reinforce the economic rationale for firms to achieve compliance.

Adjusting for firm heterogeneity

To ensure fairness and effectiveness, penalties must account for firm heterogeneity, or variations in size, product mix, and market share across automakers and regulated entities. This ties into the equimarginal principle, which suggests that the marginal cost of abatement should be equalized across firms to achieve the most cost-effective pollution reduction. By designing penalties and credit markets with firm-specific factors in mind, regulators can promote equitable and efficient compliance (See Box 1 for more details). Importantly, to maintain the effectiveness of this trading system, penalties must be set above the prevailing market price for credits. Otherwise, firms may opt to pay penalties, undermining the credit market's function.

Box 1. Balancing compliance costs with the equimarginal principle

Consider two automakers navigating fleet-average GHG standards. Automaker A, a pioneer in electric and hybrid vehicles, produces a fleet with emissions well below the required threshold. Meanwhile, Automaker B, specializing in heavy trucks and SUVs, struggles to meet the standard due to the higher emissions intrinsic to its product line. Under a strict system where every vehicle must meet the same GHG standard, Automaker B faces prohibitively high costs to retrofit or redesign its fleet. This could result in reduced product diversity, layoffs, or even exiting certain markets. Automaker A, with its already compliant fleet, incurs little additional cost but gains no incentive to innovate further. With the equimarginal principle applied, the regulation shifts to a fleet-average system supplemented by a credit trading mechanism. Automaker A, whose cost of reducing emissions further is low, can produce more zero-emission vehicles (e.g., electric cars) and generate surplus credits. Automaker B, facing high marginal abatement costs, can purchase these credits to balance its emissions shortfall. This flexibility allows both automakers to comply in a cost-effective manner. This principle ensures emissions reductions occur where they are cheapest across the industry, minimizing total compliance costs. Automaker A gains an incentive to continue innovating, while Automaker B can adapt without facing insurmountable penalties. From a societal perspective, the result is an overall reduction in emissions at the lowest possible cost, preserving market diversity and encouraging technological advancement.

Dynamic adjustments

Effective SSRs must evolve alongside technological progress and market conditions. As compliance costs decline with technological maturity and economies of scale, penalties should increase over time to sustain deterrence and drive continuous improvement. However, if regulatory stringency increases—such as through stricter emissions targets or higher sales requirements—the penalty itself may remain unchanged while still exerting greater pressure on manufacturers. A graduated penalty structure ensures that as cleaner technologies become more feasible, regulatory incentives keep pace, maintaining pressure on the industry to accelerate clean technology adoption in line with both market readiness and the escalating urgency of emissions reduction.

Technical considerations in penalty setting

Fines can be calculated per non-compliant vehicle based on emissions exceeding the regulatory threshold. A typical formula might involve $\Delta e\times MD$ ($\Delta e=\mathrm{excess\; emissions}$; $MD=\mathrm{marginal\; damage}$, i.e., the marginal external price of emissions). The effectiveness of this approach depends on accurately estimating the marginal external cost of pollution, ensuring that penalties reflect the true societal cost of excess emissions. Different sources exist to approximate these costs. For example, the EU carbon permit price sets a market-based cost per metric ton of CO₂⁴, while the U.S. Social Cost of Carbon (SCC) provides an economic benchmark for assessing the broader societal impact of emissions. These estimates help policymakers determine appropriate penalty levels by quantifying the external costs of emissions and aligning fines with the broader social and environmental damage caused by non-compliance. However, these values are not fixed and evolve based on new economic models, scientific insights, and policy priorities. For example, as of the Biden administration, the SCC is set at $51 per ton of CO₂, an interim figure based on prior estimates. However, the EPA has recently proposed raising this value to $190 per ton, reflecting a reassessment of climate damage and the increasing urgency of emissions reductions. If adopted, such a revision would significantly alter the cost-benefit calculations for firms, making emissions reduction efforts more economically attractive relative to penalties.

What is being done in other regions?

Table 7 presents a summary of our focus regions and their approach to penalty setting. Further discussion of these regulations is provided in the Design considerations section below. Refer to the regulation reference for further detail.

Table 7. Penalty setting in the focus regions

Design considerations

A well-calibrated penalty structure is essential for balancing regulatory effectiveness with market stability across various SSRs. While strict penalties encourage compliance and drive technological change, they can also lead to unintended economic consequences. Research has shown that when penalties are substantial (e.g., $10,000 per non-compliant vehicle instead of $2,500), compliance rates improve significantly. However, higher penalties also increase manufacturers' compliance costs, which they often offset through strategic pricing adjustments⁵. For example, in response to stringent ZEV sales standards, automakers may raise prices on conventional ICEVs to recoup penalty costs or to encourage consumers to shift toward cleaner vehicles. In cases where firms subsidize cleaner technologies to comply, they may compensate by raising prices across their entire fleet, affecting both compliant and non-compliant vehicles. These dynamics suggest that while penalties are necessary to enforce standards, they should be accompanied by complementary policies—such as purchase incentives, infrastructure investments, or credit trading mechanisms—to mitigate potential affordability concerns and ensure a smooth market transition.

Balancing standards and enforcement costs

While penalties can act as a deterrent, they are often insufficient on their own. Efficient enforcement is also required, which demands resources, including monitoring technology, skilled personnel, and an operational legal system. In theory, enforcement costs need to be integrated with abatement costs to identify the efficient penalty size. Stricter regulations for car manufacturers—like those requiring major changes in vehicle designs or engine technologies—tend to demand more enforcement resources due to the significant adjustments needed. However, less strict standards that are easier to monitor can still achieve meaningful pollution reductions at lower enforcement costs.

Enforcement efforts also play a critical role in the considerations of a rational firm that should respond to the regulation. According to Becker's (1968) theory of deterrence, firms compare the cost of compliance with the benefits of avoiding penalties⁶. To calculate the size of the expected penalty, they multiply the size of the penalty by the probability of being detected. This implies that adjustments in inspection rates or penalty amounts should have a symmetric impact on compliance behavior. However, practical constraints such as political and statutory limits on penalty sizes mean that policymakers cannot rely solely on high penalties⁷.

The enforcement approach offers flexibility, ranging from occasional random checks to continuous monitoring. Government agencies can adjust their strategies based on available resources, aiming to achieve economically viable and effective compliance. Even with limited resources, reasonable compliance levels can be maintained through a system that relies primarily on self-assessment and reporting to regulators, supplemented by random checks. This flexibility enables a tailored enforcement strategy that adapts to changing circumstances and resource availability.

Notes to the policymaker

• Designing effective penalty structures in SSRs requires a careful balance between enforcement costs, compliance incentives, and market impacts.
• Fines that are too low may encourage manufacturers to opt to pay rather than invest in cleaner technologies, undermining policy objectives.
• Excessively high penalties can stifle competition, increase vehicle prices, and slow clean technology adoption.
• Policymakers can enhance effectiveness by incorporating flexible enforcement mechanisms, such as random compliance checks, and redirecting penalty revenues toward clean technology incentives, ensuring that regulations drive meaningful emissions reductions without unintended economic distortions.
• Note that often the penalty level is dictated by the law, and the optimal penalty level determined by economics may not align with what is legally permissible.

Flexibilities

Flexibilities or flexible design elements are not essential to the proper functioning of SSRs and therefore are not required for inclusion in the regulation. However, it may be necessary or desirable to include certain flexible design elements to increase economic efficiency, incentivize overcompliance, or improve stakeholder support for SSRs.

Auto industry resistance to SSRs is a sizable barrier to adoption of these regulations. One approach to achieving greater auto industry buy-in is by designing flexible regulations that provide alternative compliance pathways to meet standards. Flexibility exists at multiple levels with different SSR types having different degrees of flexibility and design elements within regulations also providing flexibility. Flexible design elements are an important component of SSRs for regulated entities as they reduce regulatory compliance burden, particularly cost burden. This is because flexible regulations offer firms more pathways to compliance, ultimately lowering costs⁸.

Flexibilities offer cost benefits to firms, however, tradeoffs exist with some flexibilities. While, under certain conditions, some flexibilities allow for reduced compliance burden without reducing the stringency of the regulation, other flexibilities erode the stringency of the regulation by allowing auto manufacturers to meet standards with less GHG emissions abatement/economy gains.

For example, credit trading, and credit banking offer flexibility without compromising real-world emissions reduction. On the other hand, deficit banking, off-cycle credits, and multipliers undermine headline targets. Flexible regulations will likely also generate higher levels of administrative burden for the regulating entities. Additionally, while some evidence suggests that flexible SSRs allow regulated entities to better respond to uncertainty⁹, others argue that flexible regulations generate a level of uncertainty for regulated entities¹⁰. These entities respond to this uncertainty through short term defensive strategies instead of long term innovation. Refer to the Simplicity versus flexibility section in the Navigating design tradeoffs & interactions document for more information.

Decision makers should assess the tradeoffs between the inclusion of flexibilities to reduce regulatory compliance burden, and their potential to reduce the stringency of SSRs and increase administrative burden for regulating entities. If flexibilities are included in the regulation, provisions to sunset (phase out) the ones that reduce real-world GHG emissions abatement should be included.

Credit trading

Summary of design element

Many SSRs permit some form of credit trading between regulated entities. Credit trading allows regulated entities that do not meet their annual target to avoid penalties by purchasing credits or to generate income by selling credits if they are over compliant. While regulations stipulate whether or not trading is permitted, they tend not to specify a procedure for credit trading. Additionally, regulating entities tend not to oversee trading beyond reviewing the trade records in the regulated entities' annual report. Therefore, there is often no formalized or central marketplace for credit trading and it is at the discretion of the regulated entities to come to a trade agreement. Although not explicit in the regulation, credit trading between regulated entities usually involves the exchange of funds for credits. This design element provides flexibility for those regulated entities who may take longer to meet regulatory requirements due to changes in manufacturing, sourcing skilled labor, and changes in the supply chain. Credits can also be 'banked' for multiple years into the future and traded at a later date (see the Credit & deficit banking section for more information).

One way of conceptualizing credit trading is as a tax or subsidy on regulated entities: if a regulated entity is over-compliant, they can sell credits (subsidy) and those that are under-compliant can purchase them (tax). Figure 4 conceptualizes credit trading as a cap-and-trade mechanism where the marginal cost of abatement (MCA) and marginal benefit of abatement (MBA) curves are shown for all regulated entities. A regulated entity would choose to buy credits if their MCA>MBA and sell credits if their MBA>BCA. From an economic perspective, credit trading is more efficient than a no trade scenario as it reduces deadweight loss. While the purchase price of a credit is not publicly disclosed, we can assume that it is less than the penalty for non-compliance (see the Compliance & enforcement section for more information).

Figure 4. Regulated entities with a MCA>MBA will purchase credits and those with an MCA<MBA will sell credits

Pooling

The EU regulation includes a subtype of credit trading: pooling. Car manufacturers can enter into pooling agreements with one another to have their combined credits counted as a single entity by the regulating body. Therefore, if one car manufacturer in a pool is under compliant but another is over compliant, the overall regulated entity or 'pool' may still be compliant. Although credit trading is not explicitly identified in the EU regulation, the implication is that under compliant car manufacturers are paying over compliant manufacturers to enter into a pooling agreement. In this way, car manufacturers may be indirectly or directly paying for credits. From an economic perspective, credit pooling is a less efficient form of credit trading as trading can only happen between those car manufacturers in the pool. However, credit pooling is still more economically efficient than a no trade scenario. Car manufacturers in the EU can enter into pooling agreements for between one and five years.

Trading versus transferring

Many regulations have separate targets for car and truck fleets or passenger vehicle and light commercial vehicle fleets (see Standard setting section for more information). Some regulations allow regulated entities to transfer credits between vehicle fleets (i.e. within manufacturers). For example, a regulated entity that is over compliant with its car standard but under compliant with its truck standard can transfer credits between categories. Some regulations place limits on the volume of credits transferred. This is distinct from credit trading which occurs between regulated entities.

What has been done in other regions?

Table 8 summarizes how the focus regions have implemented credit trading. Refer to the regulation reference for further detail.

Table 8. Credit trading in focus regions

See the Vehicle & credit accounting technical note for more detail around how credits are calculated in different focus regions.

Design considerations

Credit equivalency

An implicit assumption of credit trading is that all credits are equal. This assumption allows regulated entities to trade and bank credits indiscriminately. However, the real-world emissions reduction that one credit represents may differ from another. For ZEV sales standards, the credit equivalency issue arises because vehicle efficiency is not being taken into account. For example, a regulated entity that produces inefficient ZEVs could be eligible for the same number of credits as a regulated entity that produces efficient ZEVs. In this scenario, the credits are being awarded and traded as if those credits are equivalent, whereas in reality, the real-world emissions implications of those vehicles could be vastly different. This is the shortcoming of implementing a ZEV sales mandate without a FE standard.

Oversight and transparency

While credit trading between regulated entities is permitted, the regulating body does not oversee the transactions. The trade is arranged between regulated entities, often with no formalized or central marketplace. Thus, the price of a credit is determined by the regulated entities involved in the transaction and is not disclosed publicly. Regulated entities are required to report the volume of credits traded annually to the regulating entity to determine compliance but beyond this no further transparency is provided.

Motivation for trading

The motivation for trading credits may be purely economic or may include some social capital aspect. Under Compliant regulated entities may be motivated to purchase credits to avoid paying a non-compliance penalty. In this case, we can assume that the credit price is less than the penalty for non-compliance. However, the social cost of non-compliance to a regulated entity that is under compliant may be greater than the non-compliance penalty itself. In this case, we might expect that a regulated entity is willing to pay more for credits than the penalty for non-compliance to maintain certain social perceptions of the regulated entity. Furthermore, the value of purchase credits can help emerging industries bridge the expanding capacity gaps. Trading these credits can reduce the need for direct support for R&D and other measures aimed at expanding industry capacity.

Notes to the policymaker

• Understand who the regulated entities are and assess regulatory capacity: this impacts how credit systems like trading or pooling should be designed and managed.
• Pooling may reduce administrative burden in regions with many manufacturers but could be less economically efficient than credit trading.
• Differentiate between credit transferring (within a manufacturer) and credit trading (between manufacturers) when setting regulatory rules.
• Regulations can limit credit transfers to prevent them from undermining minimum compliance standards.
• Credit trading can support new market entrants, making it a useful mechanism for encouraging competition and innovation.
• Not all credits represent equal efficiency gains due to unaccounted-for alternative fuel vehicle efficiency.
• Policymakers don't need to ensure perfect credit equivalency, but should be aware of its implications. Efforts to correct for this may introduce new complexities or unintended outcomes.

Credit & deficit banking

Summary of design element

Credit banking allows regulated entities that are over compliant in a given year to 'bank' or save those credits for use in future years (see the Vehicle & credit accounting section for further information). A regulated entity might choose to bank credits instead of trading them (see the Credit trading section for further information) for multiple reasons, including:

1. Anticipation of under compliance in future years

   Regulated entities that have banked credits can use them in future years to meet compliance standards, especially as targets increase.

2. Credit saturation for that year (i.e. no demand from other regulated entities for credit trading)

   If there is no demand for credits in a given year, the over compliant regulated entity may choose to bank them for trade in following years.

3. Anticipation of higher credit demand in future years (i.e. higher credit trade prices)

   Regulated entities that generate revenue from credit trades may anticipate higher credit prices in future years and withhold credit sale for future years.

Deficit banking is similar to credit banking but allows regulated entities that are under compliant in a given year to bank those deficits for future years. This mechanism allows regulated entities to avoid non-compliance penalties for a given year. A regulated entity might choose to bank the deficit instead of paying the penalty if it anticipates being over compliant in future years and thus able to clear its deficits.

For credits that have reached their expiration date, they can no longer be used for compliance. For deficits that have reached their expiration date, regulated entities are required to pay penalties for non-compliance. It is often a requirement that credits must be used to offset a deficit in a given year. Regulated entities cannot carry forward credits and deficits. If banking is permitted, it is best practice for credits and deficits to have a brief lifespan (three to five years until expiration) or time limit. For credit banking, this is to avoid an over supply of credits in the market. For deficit banking, this is to encourage regulated entities to meet standards sooner to minimize emissions.

What has been done in other regions?

Table 9 presents a summary of credit and deficit banking approaches across the focus areas. Refer to the regulation reference for further detail.

Table 9. Credit & deficit banking in focus regions

Design considerations

There are multiple benefits to credit banking:

• Firms can over-comply in early years (when it's cheaper or easier) and save credits for later. This helps smooth out compliance costs over time, avoiding spikes in expenses in more stringent future years.
• Credit banking incentivizes early adoption of low-emission technologies. Firms that innovate early or deploy cleaner vehicles ahead of the standard benefit financially by earning and banking surplus credits.
• Banking provides a buffer against future uncertainty, such as demand fluctuations, supply chain disruptions, or regulatory changes. This reduces the risk of non-compliance penalties in future periods.

One major drawback of deficit banking is an increase in real-world GHG emissions. When deficits generated by a regulated entity are banked but 'paid off' in future years through overcompliance, there is no monetary impact to the regulated entity. However, the timing of when GHG emissions are avoided is important because GHGs have higher levels of cumulative radiative forcing the longer they are in the atmosphere. This means that from an emissions reduction and climate change perspective, emissions avoided sooner are more beneficial than emissions avoided later. While credit banking incentivizes regulated entities to sell low and alternative fuel vehicles early, deficit banking incentivizes regulated entities to sell these vehicles later. Thus, the inclusion of deficit banking in vehicle SSRs will have a negative impact on real-world GHG emissions reductions efforts. This magnitude of the impact will be dependent on the number of years of allowable deficit banking with more banking years having a greater negative effect.

Notes to the policymaker

• Credit banking primarily affects timing, not total emissions—it enables earlier reductions but doesn't change overall outcomes significantly.
• Deficit banking delays emissions reductions, which can increase cumulative radiative forcing due to the long atmospheric lifespan of GHGs.
• Policymakers should limit deficit banking, keeping the allowable years conservative to prioritize near-term emissions cuts.
• Regulated entities often advocate for extended banking and ramp-up periods to ease compliance and delay ZEV transitions. This is because it is easier to earn credits early on when the standard is less stringent. Regulated entities then bank these credits and use them in later years when the standards become more stringent.
• Extended flexibility may weaken climate goals, even if politically and economically expedient in the short term.
• Governments may choose to include flexible banking provisions, especially under industry pressure, but should consider phasing them out to maintain long-term ambition.

Multipliers

Summary of design element

A multiplier increases the credit value of certain vehicles—typically zero or low-emission models—allowing them to count more than once toward compliance targets, thereby incentivizing their production and sale. In the case of ZEV sales standards, multipliers assign weights to alternative fuel vehicles when counting vehicle sales for compliance, incentivising their production and sale. Weightings are usually allocated based on the fuel type of the vehicle or allocated based on the electric range of the vehicle. Both of these approaches have similar outcomes in that they weight ZEVs more than PHEVs, however, they incentivize slightly different things: weightings based on range incentivize increased electric range of a vehicle, and weightings based on fuel type incentivize the sale of BEVs (and FCEVs) over PHEVs.

What has been done in other regions?

Table 10 presents a summary of how the focus regions with ZEV sales standards have incorporated multipliers into the regulation.

Table 10. Implementation of multipliers in focus regions

Design considerations

The magnitude of the multiplier has consequences for the stringency of the standard. In both the California (ACC) and Canadian ZEV sales standards, multipliers were initially used to incentivize the production of EVs with higher ranges by awarding up to four credits for a long range ZEV. As auto manufacturers improved battery technology and increased battery size, many ZEVs had a certified electric range that qualified them for the full four credits. As a result, auto manufacturers were able to sell fewer EVs and still meet the ZEV sales standard. In California's latest iteration of their standard, ACC II, ZEVs count as one toward the standard.

In more recent iterations of these standards, one credit is awarded per ZEV with a minimum electric range requirement and PHEVs can be awarded up to one credit if the vehicle meets electric range requirements (among other criteria). The credits awarded for PHEVs usually reduces across model years or the minimum electric range requirement for PHEVs increases across model years to encourage longer electric range PHEVs. Reducing the magnitude of ZEV and PHEV multipliers increases the stringency of the standard and results in the annual ZEV requirements being more representative of the actual number of EVs sold as a proportion of the fleet.

Notes to the policymaker

• Multipliers greater than one can help incentivize the production of more and longer-range ZEVs by allowing them to count more toward compliance targets.
• However, high magnitude multipliers make standards less stringent and enable compliance with fewer ZEV sales.
• Multiplier use should align with the region's environmental goals.
• Policymakers should evaluate the maturity of their region's ZEV market to determine if multipliers are necessary:
  • In regions where ZEVs already make up a significant share of vehicle sales, multipliers may no longer be needed.
  • If ZEVs already feature large batteries and long ranges, range-based multipliers may be redundant or misaligned with policy objectives.
• There is limited guidance on the ideal timing to phase out multipliers, but California and Canada have already reduced them to one, with ZEV market shares of 24% and 15%, respectively.

Additional flexibilities

Some additional flexibilities are listed below. Refer to the regulation links for further information.

Environmental Justice credits

For some regions, especially in the US, the burden of air quality is not equitably distributed across cities. This means that low-income communities and people of color are disproportionately impacted by poor air quality. To address this issue, the California ZEV sales standard includes environmental justice credits (Subsection (e)(2)) intended to encourage the sale of alternative fuel vehicles with low or no tailpipe emissions. Auto manufacturers that sell ZEVs or PHEVs to community-based clean mobility programs are eligible for additional credits. To earn these credits, auto manufacturers must meet certain requirements including vehicle price caps. There are also limits placed on how these credits can be used to meet compliance.

Off-cycle & air conditioning credits

Drive cycles capture most of the GHG emissions, or fuel efficiency associated with the use of a vehicle (refer to the Metrics & measurement methods document for more information). However, there are some emissions saving technologies/features on a vehicle that are not captured through drive cycles. Off-cycle and air conditioning credits (sometimes referred to as 'eco-innovations') can be included in SSRs to capture emissions reduction or efficiency gains through these technologies. A list of pre-approved technologies eligible for off-cycle or air conditioning credits is usually provided in the regulation. Some regulations allow auto manufacturers to propose new technologies for inclusion in the list. There is usually a limit to the number of credits an off-cycle or air conditioning technology can receive. It is common for regulations to reduce the number of credits available for these technologies over time and in some cases, this design element is phased out completely.

Examples of off-cycle and air conditioning credits can be found in the US GHG standard under Sections III.C.4-6 and the EU GHG standard under Article 11.

Early action credits

In addition to banking credits while the SSR is in force, some regulations also allow auto manufacturers and other regulated entities to begin banking credits prior to the start of the regulation. Referred to as early action or early compliance credits, these credits are usually earned if the manufacturer meets some sales threshold for alternative fuel vehicles, low emission vehicles, or vehicles with green innovations. Early action credits incentivizes the early innovation and incentivizes regulated entities to sell ZEVs sooner. However, this can often lead to an over abundance of credits in the market and reduce future efforts by regulated entities to sell ZEV, reduce emissions, or increase efficiency.

Two different types of early action credits exist: Credits awarded before the implementation of a SSR, or credits awarded leading up to the implementation of a new iteration of a SSR. Early action credits are usually only awarded two or three years before the regulation comes into effect. Often limits are placed on the use of these credits including shorter time periods for banking.

Examples of early action credits can be found in the California ZEV sales standard under Subsection (e)(3) and the Canadian sales/GHG standard under Subsection 30.16 and Section 29, respectively.

Footnotes

¹ EPA (2024), Automotive Trends Report, EPA, Washington, D.C. https://nepis.epa.gov/Exe/ZyPDF.cgi?Dockey=P101CUU6.pdf

² Anup, S., & Rokadiya, S. (2024). Designing a zero-emission vehicle sales regulation for two-wheelers in India (Working Paper ID 115). International Council on Clean Transportation. https://theicct.org/wp-content/uploads/2024/03/ID-115-%E2%80%93-ZEV-mandate_paper_final.pdf

³ Bryson, J. M. (2004). What to do when Stakeholders matter: Stakeholder Identification and Analysis Techniques. Public Management Review, 6(1), 21–53. https://doi.org/10.1080/14719030410001675722

⁴ Trading Economics. (2025). EU carbon permits. Retrieved from https://tradingeconomics.com/commodity/carbon

⁵ Bhardwaj, C., Axsen, J., & McCollum, D. (2022). How to design a zero-emissions vehicle mandate? Simulating impacts on sales, GHG emissions and cost-effectiveness using the AUtomaker-Consumer Model (AUM). Transport Policy, 117, 152–168. https://doi.org/10.1016/j.tranpol.2021.12.012

⁶ Becker, G. S. (1968). Crime and punishment: An economic approach. Journal of Political Economy, 76(2), 169–217. https://doi.org/10.1086/259394

⁷ Shimshack, J. P. (2017). Economics of environmental compliance and enforcement. In Oxford Research Encyclopedia of Environmental Science. https://doi.org/10.1093/acrefore/9780199389414.013.444

⁸ Bennear, L. S., & Coglianese, C. (2012). Flexible Environmental Regulation (SSRN Scholarly Paper 1998849). Social Science Research Network. https://papers.ssrn.com/abstract=1998849

⁹ Goulder, L. H., & Parry, I. W. H. (2008). Instrument Choice in Environmental Policy. Review of Environmental Economics and Policy, 2(2), 152–174. https://doi.org/10.1093/reep/ren005

¹⁰ Teeter, P., & Sandberg, J. (2017). Constraining or Enabling Green Capability Development? How Policy Uncertainty Affects Organizational Responses to Flexible Environmental Regulations. British Journal of Management, 28(4), 649–665. https://doi.org/10.1111/1467-8551.12188