The recent "cash for clunkers" program is the latest fine example of a government program supported by twisted logic and economic hokum.

For those not familiar with the program, owners of cars that get 18 or less miles per gallon can trade in the car and get a rebate of $3,500 or $4,500 dollars, depending on the fuel efficiency difference between the old and new car, if the new car gets at least 22 miles per gallon.

At first glance, the program sounds like a good idea: it will reduce energy dependence while stimulating the economy by providing additional auto sales.

But, a closer look reveals the program is unlikely to provide much if any reduction in energy usage while destroying wealth rather than creating it.

The program mandates than any cars traded in for the credit must be destroyed. The program even describes how dealers must replace the engine oil with sodium silicate and then run the car, which will fill the engine with molten glass until it seizes. Only minor parts not related to the engine and drivetrain can be salvaged and the vehicle must be entirely destroyed within 180 days of trade-in.

Most of the cars being traded-in are in perfectly fine condition. In fact, the program requires cars being traded-in be in drivable condition and excludes any cars more than 25 years old.

This may actually have a damaging effect on the American auto industry by reducing market share. As of August 3, the top ten models being traded-in under the program are U.S. brands while only one of the top five being purchased is American (see chart below). Taking these American-made cars out of the market means a loss of potential spending on them in the aftermarket for maintenance, parts, and repairs. And owners who trade from domestic to foreign may be lost as loyal customers once they get a taste of that foreign quality they couldn't afford previously. So in the long term, the program actually manages to hurt U.S. dealers and auto makers more than it helps them.  

But is it good for the typical American who takes advantage of the program? Let's look at typical scenario.

For the sake of the example, assume I own a 2005 Ford Explorer 4WD, the model most-often traded-in under the program. I bought it in August 2005 for around $34,000, which I financed over 48 months (just got paid off this month!). It gets an average of 16 mpg.

I'm going to trade it in under the program for a 2009 Ford Escape 4WD V6. The Escape gets an average of 22 mpg. Because my gas mileage will improve by at least 4 but less than 10 mpg, I qualify for the $3,500 credit.

Since I had just paid off my old vehicle, I've now taken on $17,150 in debt I didn't have previously. Luckily my credit is good and I got it at 0% APR. But still, that's $350 I won't have to spend each month.

Will the improvement in my fuel efficiency make up for my new debt? I typically drive 1,000 miles each month, so in my Explorer, it cost me $156 a month for gas (assuming $2.50/gallon). My Escape will cost me $114 per month in gas, saving me $42. Too bad I have that extra $350 monthly payment, though.

So my overall monthly "savings" under cash for clunkers is a negative $308. How will that help stimulate the economy?

It turns out the new car is fun, and I just can't get enough of that new car smell, so I find myself driving a lot more the first few months. Oops, I just negated my gas savings!

And wait, we also need to factor in the cost to taxpayers of the program itself. Today, President Obama signed an extension to the original bill that adds an additional $2 billion to the $1 billion that was already spent. In 2006 (the last year for which figures are readily available), 136.1 million federal income tax returns were filed. Doing the math, the $3 billion cash for clunkers costs each taxpayer $22. So my overall benefit from the program is now adjusted down to negative $330. 

So what about the benefits to the country as a whole? With our $3 billion, we are buying a marginal improvement in overall gas efficiency. This seems worthwhile until we consider the amount of energy consumed in producing the new cars (and other environmental effects).

Economically, the program makes no sense. We are destroying perfectly fine existing cars while putting Americans further into debt. Not to mention we've now added another $3 billion to our national debt. 

This program is an excellent example of the broken window fallacy, in which people think a shopkeeper's broken window is a good thing for the economy since it will provide work for the window maker who will then spend his money for food, benefiting the grocer, who will in turn benefit the farmer, who will then buy something in the shop, etc. The reality, of course, is that the shopkeeper still has to pay for the window and must forgo spending on something else. So there is no net benefit. We have the same thing with cash for clunkers. 

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