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Why Cash for Clunkers Won't Save the Economy

By Dan Caplinger - Updated Apr 6, 2017 at 1:24AM

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Onerous restrictions make it hard for most to take advantage.

Until now, most of the money used to bail out ailing businesses has gone directly to companies themselves. Now, though, a few select car owners will be able to take advantage of a new program designed to encourage them to trade in their old clunkers for brand new vehicles.

The administration's Car Allowance Rebate System, known more popularly as Cash for Clunkers, rolled out earlier this month. Under the program, those who qualify will be eligible to receive between $3,500 and $4,500 from the government to buy a new car, truck, or SUV. Two industries may benefit directly:

  • Although the move comes too late to keep Chrysler and GM out of bankruptcy, you can imagine that automakers like Ford (NYSE:F), Toyota (NYSE:TM), and Honda (NYSE:HMC) are hoping for an uptick in demand.
  • Also, car dealers such as AutoNation (NYSE:AN) and CarMax (NYSE:KMX) will try to cash in on higher shopping traffic.

Devil in the details
Yet while the program sounds like a great deal, the number of people who'll actually benefit from it is likely far lower than you'd think. That's because the rules of the program narrow down the transactions that are eligible for the program. To get an idea of this, take a look at the rules of the program:

  • The vehicle being traded in must be in drivable condition, be no more than 25 years old, and get no more than 18 miles per gallon (mpg).
  • The same person must have owned and had the car insured for at least one year before trading it in.
  • You must buy a new vehicle. Used vehicle purchases aren't eligible for the program. Moreover, the vehicle can't cost more than $45,000.
  • If you buy a new passenger car, it must get at least 22 mpg. If it gets 4-9 mpg more than the car you traded in, then you'll get a $3,500 rebate. If the new car is better by 10 mpg or more, then you get a $4,500 rebate.
  • If you buy a new truck or SUV, the rules are different. "Category 1" trucks, which include most SUVs, pickups, and vans, must get 18 mpg. Those that get 2-4 mpg more than the traded-in vehicle earn the $3,500 rebate, while a 5-mpg difference or greater earns $4,500. Category 2 trucks, which include larger trucks and vans, must get 15 mpg, and their breakpoints are 1 mpg and 2 mpg or greater.
  • The program is scheduled to run from July 1 to Nov. 1. But once the program runs out of money, you'll no longer be eligible for the credit, even if you would otherwise qualify.
  • Traded-in vehicles must be destroyed and sold for scrap rather than resold by the car dealer. Therefore, you won't receive full trade-in value for your vehicle; you'll get the lower scrap value instead.

As you can see, that's a lot of rules to deal with. The credit definitely isn't aimed at the consumer who buys new cars frequently, since the scrap requirement will usually make it more cost-effective simply to trade in a late-model used car. Meanwhile, the ownership requirement prevents a burgeoning market in clunker cars to take advantage of the program.

On the other hand, many of those who tend to run their cars into the ground would typically replace old cars with late-model used cars rather than new ones. And during these tough times, stretching to buy a new car even with a good-sized rebate may not be at the top of budget-conscious consumers' lists of things to do.

Much ado about nothing
In the end, given all the restrictions and conditions of the program, I think the Cash for Clunkers program will have little impact on car-buying behavior and the businesses that hope to benefit from it. Until a clearer trend toward economic recovery comes, investors will do better with companies like parts sellers AutoZone (NYSE:AZO) and O'Reilly Automotive (NASDAQ:ORLY) that cater to consumers trying to extend the lives of their vehicles as long as possible.

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Fool contributor Dan Caplinger has never owned a car that got bad enough gas mileage to be eligible for government rebates. He doesn't own shares of the companies mentioned in this article. CarMax is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy won't stall out on you.

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Stocks Mentioned

Ford Motor Company Stock Quote
Ford Motor Company
$16.18 (2.21%) $0.35
Honda Motor Co., Ltd. Stock Quote
Honda Motor Co., Ltd.
$27.04 (0.15%) $0.04
Toyota Motor Corporation Stock Quote
Toyota Motor Corporation
$161.31 (1.71%) $2.71
AutoNation, Inc. Stock Quote
AutoNation, Inc.
$124.71 (0.70%) $0.87
AutoZone, Inc. Stock Quote
AutoZone, Inc.
$2,259.18 (1.27%) $28.35
O'Reilly Automotive, Inc. Stock Quote
O'Reilly Automotive, Inc.
$731.59 (1.69%) $12.18
CarMax Inc. Stock Quote
CarMax Inc.
$101.59 (-0.11%) $0.11

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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