The court also said the administration failed to include in the new rules heavier trucks driven as commuter vehicles, among several other deficiencies found.
Judge Betty Fletcher wrote that the administration "cannot put a thumb on the scale by undervaluing the benefits and overvaluing the costs of more stringent standards."
Charles Miller, a Justice Department spokesman, said the administration was in the process of reviewing the decision. "We will consider all of our options," he said.
California and 10 other states, two cities and four environmental groups sued the administration after it announced the new fuel economy standards last year.
"It's a stunning rebuke to the Bush administration and its failed energy policy," California Attorney General Jerry Brown said.
The court ordered the administration to draw up new rules as soon as possible, but automakers complained Thursday they're already deep into developing light trucks through 2011 based on the new standards.
"Any further changes to the program would only delay the progress that manufacturers have made toward increasing fleet-wide fuel economy," said Dave McCurdy, president and chief executive of the Alliance of Automobile Manufacturers. McCurdy said the industry is dedicated to developing more fuel efficient automobiles, "but adequate lead time is necessary in order to fully integrate these technologies into the marketplace."
Former Transportation Secretary Norman Mineta announced to much fanfare the new rules in March 2006, proclaiming they were the "most ambitious fuel economy goals" yet for SUVs and their ilk. Mineta called the plan "pragmatic," balancing fuel conservation against auto industry costs and jobs.
The standards required most passenger trucks to boost fuel economy from 22.5 mpg in 2008 to at least 23.5 mpg by 2010. Passenger cars are required to meet a 27.5 mpg average.
"The idea of raising vehicle efficiency 1 mile per gallon is pathetic and shocking," said Brown, who along with Gov. Arnold Schwarzenegger is suing the Bush administration over its refusal to act on California's fuel economy plan for cars in the state.
The court ordered the White House to examine why it continues to consider light trucks differently than cars. Regulators made a distinction between cars and light trucks decades ago when most trucks were used for commercial purposes.
NHTSA had argued that it considered the intent of the manufacturer in making light trucks, rather than their actual highway use, in developing the new fuel standards.
"But this overlooks the fact that many light trucks today are manufactured primarily for transporting passengers," Fletcher wrote for the three-judge panel.
Fletcher also wrote that the administration failed to consider the benefit to reducing greenhouse gas emissions.
"It did, however, include an analysis of the employment and sales impacts of more stringent standards on manufacturers," Fletcher wrote.
The court also took the administration to task for refusing to include in the new standards trucks weighing more than 8,500 pounds, a class that includes the Hummer H2, Ford F250 and other popular large vehicles.
The court ordered NHTSA to develop fuel standards for these large trucks or give a better reason than the agency's argument that it has never regulated those large trucks and that more testing needs to be done.
"This historic ruling vindicates our fight against fuel economy standards that are a complete sham and a gift to the auto industry," said Connecticut Attorney General Richard Blumenthal, who also joined the lawsuit.
Along with California and Connecticut, plaintiffs in the lawsuit filed last year include Maine, Massachusetts, Minnesota, New Jersey, New Mexico, New York, Oregon, Rhode Island, Vermont, New York City, the District of Columbia and several environmental groups.
