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Research in Transportation Economics 28 (2010) 2–45
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Research in Transportation Economics
journal homepage: www.elsevier.com/locate/retrec
Part I: Externalities and economic policies in road transportq
Georgina Santos a, *, Hannah Behrendt b, Laura Maconi c, Tara Shirvani c, Alexander Teytelboym b
a
Smith School of Enterprise and the Environment, and Transport Studies Unit, University of Oxford, Oxford, UK
Smith School of Enterprise and the Environment, and Department of Economics, University of Oxford, Oxford, UK
c
Smith School of Enterprise and the Environment, University of Oxford, Oxford, UK
b
a r t i c l e i n f o
a b s t r a c t
Article history:
Received 11 November 2009
Accepted 17 November 2009
Road transport imposes negative externalities on society. These externalities include environmental and
road damage, accidents, congestion, and oil dependence. The cost of these externalities to society is in
general not reflected in the current market prices in the road transport sector.
An efficient mobility model for the future must take into account the true costs of transport and its
regulatory framework will need to create incentives for people to make sustainable transport choices.
This paper discusses the use of economic instruments to correct road transport externalities, but gives
relatively more weight to the problem of carbon emissions from road transport, as this is particularly
challenging, given its global and long-term nature.
Economics offers two types of instruments for addressing the problem of transport externalities:
command-and-control and incentive-based policies.
Command-and-control policies are government regulations which force consumers and producers to
change their behaviour. They are the most widely used policy instruments. Examples include vehicle
emission and fuel standards in the US as well as driving or parking restrictions in Singapore. The
implementation cost of these instruments to the government is small. Although from an economic
perspective these policies often fail to achieve an efficient market outcome, the presence of political
constraints often make them the preferred option, in terms of feasibility and effectiveness.
Economic theory shows how policies, which affect consumption and production incentives, can be
used to achieve the optimal outcome in the presence of externalities. Incentive-based policies function
within a new or an altered market. We first examine incentive-based policies, which cap the aggregate
amount of the externality, such as carbon emissions, by allocating permits or rights to the emitters. The
emitters are then free to trade their permits amongst them. The permit allocation mechanism is
important–although market efficiency would be satisfied by an auction, political influences usually
favour a proportional allocation based on historic emissions. We discuss EU ETS as an example of a capand-trade system, however, no such policy for CO2 emissions in road transport has been implemented
anywhere in the world to date.
Fiscal instruments are, like command-and-control, widely used in road transport, because they are
relatively cheap and simple to implement. They include the use of taxes and charges in order to bridge
the gap between private and the social costs and, in principle, can lead to an efficient market solution.
Registration, ownership, fuel, emissions, usage taxes, and parking and congestion charges have been
implemented in many countries around the world. On the other side of the spectrum, subsidies can be
given to those scrapping old cars and buying fuel-efficient vehicles. Some cities, such as London, have
implemented congestion charges and many states in the United States have introduced high occupancy
lanes. Other interesting possibilities include pay-as-you-drive insurance and other usage charges.
However, the size and scope of taxes and subsidies are determined by governments, and because of their
imperfect knowledge of the market the outcome is still likely to be inefficient.
Governments have many effective economic instruments to create a sustainable road transport model.
These instruments can be used separately or together, but their implementation will be necessary in the
nearest future.
Ó 2009 Elsevier Ltd. All rights reserved.
Keywords:
Road transport externalities
Corrective charges
Road taxes
Fuel duty differentials
Congestion charging
Road Pricing
High Occupancy Toll Lanes
Toll highways
Pay-as-you-drive insurance
Carbon tax
Emission taxes
Vehicle excise duty
Registration taxes
Equity impacts
Cap-and-trade
Tradable permits
Scrappage schemes
Subsidies
q This paper was produced under the Future of Mobility project, funded by Shell International Petroleum Co. Ltd., conducted at the Oxford University Smith School of
Enterprise and the Environment, directed by Prof. Sir David King.
* Corresponding author. Tel.: þ44 1865 614 917; fax: þ44 1865 614 960.
E-mail addresses: [email protected], [email protected] (G. Santos).
0739-8859/$ – see front matter Ó 2009 Elsevier Ltd. All rights reserved.
doi:10.1016/j.retrec.2009.11.002
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
List of abbreviations
ALS
ANPR
ARF
ATAC
CAC
CAFE
CARS
CBD
CO
CO2
CO2e
COE
CZ
EEA
ERP
ETR
EU ETS
GHG
HC
HOT
HOV
HVF
Area Licensing Scheme
Automatic Number Plate Recognition
Additional Registration Fee
Agenzia per i Trasporti Autoferrotranviari del Comune
di Roma (which translates as Agency for Auto-rail-tram
transport in the Municipality of Rome)
Command-and-control
Corporate Average Fuel Economy
Car Allowance Rebate System
Central Business District
Carbon Monoxide
Carbon Dioxide
Carbon Dioxide equivalent
Certificate of Entitlement
Charging Zone
European Environment Agency
Electronic Road Pricing
Express Toll Route
European Union Emission Trading Scheme
Greenhouse Gas
Hydrocarbons
High Occupancy Toll
High Occupancy Vehicle
Heavy Vehicle Fee
1. Introduction
Road transport plays an essential role in today’s world economy.
For example, in 2004 the road share of passenger-kilometres was
89 per cent for the US and 85 per cent for the EU-25 (Eurostat, 2007,
Table 5.24, p. 103). In 2003 the road share of tonne-kilometres was
33.4 per cent for the US and 72 per cent for the EU-25 (Eurostat,
2007, Table 5.1).
An efficient equilibrium is defined as a situation in which
marginal social costs are equal to marginal social benefits. Externalities are a form of market failure, which means that the market is
incapable of reaching an efficient equilibrium.
Although the presence of negative externalities in the transport
sector was never in doubt, there has recently been some debate
with respect to the presence of positive externalities. On the one
hand, the idea of transport being associated with positive externalities seems to be mistaken. While positive externalities would
materialise in the form of increased productivity and economic
growth made possible by transport, to the extent that increased
productivity and growth lead to increased individual income, these
benefits are not external (European Commission, 1995). On the
other hand, if transport (in the form of, for example, transport
infrastructure investment) has an impact on agglomeration economies1 then it can certainly be thought of as causing positive
externalities. Venables (2007) argues that an increase in employment resulting from a transport project is associated with two
positive externalities. First, a transport project which increases
1
Agglomeration economies refer to the benefits that economic agents obtain
when locating near each other. For example, when firms are spatially clustered
together they tend to face lower production costs and greater access to markets
to buy from and sell to. The concept applies both to firms within the same industry
and in different industries.
3
IB
Incentive Based
IEA
International Energy Agency
LCCS
London Congestion Charging Scheme
LEZ
Low Emission Zone
LTZ
Limited Traffic Zone
NAP
National Allocation Plan
NOx
Nitrogen Oxides
PM
Particulate Matter
PARF
Preferential Additional Registration Fee
PAYD
Pay-as-you-drive Insurance
insurance
PQP
Prevailing Quota Premium
RPS
Road Pricing Scheme
RZ
Restricted Zone
Sulphur Dioxide
SO2
TfL
Transport for London
UK DfT UK Department for Transport
UNEP
United Nations Environment Program
US DoT US Department of Transportation
US EPA US Environmental Protection Agency
US NHTSA US National Highway Traffic Safety Administration
VAT
Value Added Tax
VKT
Vehicle-km Travelled
VQS
Vehicle Quota System
VOSL
Value of a Statistical Life
WHO
World Health Organization
employment increases the productivity not just of the new workers
but also of the workers who were employed before the project
went ahead and who now reap the benefits of a larger urban
agglomeration. Second, higher urban productivity and associated
higher wages (net of taxes) are, in equilibrium, matched by higher
commuting costs and higher rents. The key point here is that this
equality of higher commuting costs, higher rents and higher wages
is achieved with wages net of taxes. The value of the extra product
by the new workers is higher than the costs incurred, with the
difference going to the government, in the form of income tax
(Venables, 2007).
As fascinating as the debate on positive externalities from road
transport may be, with the UK Department for Transport (UK DfT)
currently revising their guidelines on how to appraise transport
projects, the focus of the present review is on negative externalities.
As advanced above, in the presence of a negative externality the
market is incapable of reaching an efficient equilibrium, when the
total benefit of road transport is maximised (there is no way of
increasing any road user’s benefit without reducing another’s).
From an economic theory point of view, this problem can be
solved by implementing corrective instruments, such as for
example Pigouvian taxes or cap-and-trade systems, which can
achieve efficiency, or at least reduce the magnitude of the inefficiency or deadweight loss. In addition, there are a number of
complementary policies, for instance, land use and transport
planning, incentives to public transport and information
campaigns, which can act in combination with corrective instruments to achieve more efficient outcomes. Finally, in some cases, it
is simply a question of implementing a regulation and introducing
a new technology. The example of catalytic converters has become
standard in the road transport literature.
This paper concentrates on economic policies, stretching the
concept to include command-and-control measures. Although the
idea of corrective instruments to equate marginal social costs with
4
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
marginal social benefits is attractive in theory, there are three
problems associated with the implementation of such instruments
in the transport sector.2 The first problem is that the marginal
external cost imposed by vehicles is not easy to measure. Even
when the marginal physical damage can be assessed, monetisation
is not always straightforward. Hence, typically, it is virtually
impossible to implement first best policies.3 The second problem
relates to the fact that any new instrument will usually be introduced in a system characterised by pre-existing corrective instruments and regulations. As a consequence, the interaction between
new and existing instruments may lead to over-charging (thus,
double-internalising the externality) and therefore to inefficient
outcomes that reduce welfare (Zatti, 2004). The third problem is
that even in the case where marginal external costs could be
perfectly measured and first best policies implemented in the road
transport sector, there would be no guarantee of an efficient
outcome due to distortions in other (related) sectors in the
economy, which are not priced according to marginal cost For
example, inefficiencies caused by adverse selection in the insurance
sector will affect the efficiency of the road transport sector. Another
important example of a related sector is the labour market, which
does not typically operate perfectly, mainly due to the presence of
distortionary labour taxes (Verhoef, 2000, p. 328).
Bearing that caveat in mind, this paper consists of a survey that
concentrates on road transport economic policies in theory and in
practice.
There is consensus in the literature that the most important
negative externalities from road transport include accidents, road
damage, environmental damage, congestion and oil dependence
(Maibach et al., 2008; Newbery, 1990; Parry, Walls, & Harrington,
2007; Small & Verhoef, 2007). We now turn to briefly describing
these externalities before moving on to the discussion on
policies.
1.1. A brief summary of the main road transport externalities
1.1.1. Accidents
Accident externalities arise ‘whenever extra vehicles on the road
increase the probability that other road-users will be involved in an
accident’ (Newbery, 1990, p. 24). Although it is reasonable to
assume that the more vehicles there are, the higher is the probability of accidents, there is evidence of compensating behaviour, as
drivers tend to drive at lower speeds and pedestrians and cyclists
tend to be more careful in heavier traffic (Newbery, 1990, p. 24;
Parry et al., 2007, p. 381). The impact of one extra vehicle on the
severity-adjusted accident risk is difficult to pin down (Brownfield
et al., 2003). An extra vehicle increases the collision risk, but
because vehicles would drive slower due to higher congestion, each
collision would be less deadly. Although this may reduce the
number and the severity of accidents, this compensating behaviour
is itself costly, so it should not be considered a positive externality
(Parry et al., 2007, p. 381). Unfortunately there is not much
empirical evidence on the net effect.
External accident costs are the accident costs ‘not covered by risk
oriented insurance premiums’ (Maibach et al., 2008, p. 36). If insurance premiums covered all accidents costs, the externality would
then be fully internalised. In the US, for example, only about half of all
accident costs are paid by private insurers (Blincoe et al., 2002).
Accident costs (regardless of whether they are internalised or
not) include material damage, insurance administration, legal and
court costs, police and fire services costs, medical costs, lost
2
3
The problems are common to other areas of the economy as well.
At most, it might be possible to impose an ex-ante expected first-best policy.
economic output,4 and the pain, grief and suffering imposed on the
victims, and their friends and families (Maibach et al., 2008, p. 36;
UK DfT, 2009a, p. 1).5
Different countries adopt different methodologies to estimate
accident costs, but they all, to a greater or lesser degree include the
impacts listed above. The number of accidents and the number of
casualties are therefore key quantitative indicators (UK Df T, 2009a,
p. 1). In developed countries, these statistics are not usually problematic to collect. In developing countries, on the other hand, some
accidents go unreported, or reported but not properly recorded
(Peden et al., 2004, p. 53). The main complication, however, arises at
the time of monetising these different accident costs. Although items
such as material damages, various administrative costs, healthcare
costs, and lost product are relatively straightforward to value, the
pain, grief and suffering imposed on the victims, and their friends
and families are not. Indeed, the most important and controversial
component is the value of a life saved or the cost of a life lost.
Although there could be some instinctive rejection towards the
idea of putting a value on human life, two points should be borne in
mind. First, when estimating the value of a statistical life (VOSL), it
is not the life of a specific human being in a given accident which is
being valued, but rather, the value of the life of an average or
representative victim before the accident takes place. Second, even
when no such value is explicitly estimated, individuals make
decisions and trade-offs in their daily activities, all of which involve
higher or lower risks, and government departments choose some
policies over others, thus, implicitly assuming a VOSL (Freeman,
2003, p. 11). The question is not how much an individual would
be willing to pay to avoid his certain death or the certain death of
another person (e.g., the ransom for a kidnapped relative) or how
much compensation that individual would require to accept that
death, as most people would be willing to pay everything they have
and will ever have in order avoid certain death (Freeman, 2003, pp.
299–300, italics added by us). The VOSL is computed on the basis of
willingness to pay to achieve a small reduction in the probability of
death or willingness to accept compensation6 to accept a small
increase in that probability over a certain period of time (Freeman,
2003, p. 300, italics added by us).
There is abundance of VOSL estimates in the literature, typically relating to one geographic area and time period. Examples
include estimates for Chile (Rizzi & Ortuzar, 2003), Malaysia
(Mohd Fauzi, Nor Ghani, Radin Umar, & Ahmad Hariza, 2004),
Thailand (Vassanadumrongdee & Matsuoka, 2005), Sweden
(Hultkrantz, Lindberg, & Andersson, 2006; Andersson, 2007),
4
Lost economic output is the output lost due to the death or injury of a person,
which can in principle be estimated as the discounted present value of that person’s
earnings over the reminder of his expected life. A representative victim is used for
this calculation, as otherwise the elderly, already out of the work-force, and the
disabled, would be less valued, and so would be young children, due to the discounting process before they enter the work-force, or women or people from ethnic
minorities on lower wages. Other problems include whether that person’s productivity should be measured net of or inclusive of his own consumption, whether
stay-at-home spouses’ productivity (completely outside the market) should be
assumed equal to the productivity of the domestic service or to the opportunity
cost of staying at home, which could be measured by the average earnings of
workers (Freeman, 2003, pp.302-303). It should be noted that lost economic output
is just one element of the value of a statistical life (VOSL), discussed below, and does
not constitute the whole VOSL, as the human capital approach would propose.
5
Accident costs are considerable: in the US, for example, they were estimated at 2.
3 per cent of GDP in 2000. Property damage costs for all accident types (fatal, serious
and slight) represented 26 per cent of all costs. Present and future medical costs due
to injuries accounted for 14 per cent of the total costs (Blincoe et al., 2002).
6
In 1993, a Panel commissioned by the US National Oceanic and Atmospheric
Administration with the task of assessing the reliability of contingent valuation
methods concluded, amongst other things, that willingness-to-pay is a more reliable measure than willingness-to-accept compensation (Portney, 1994, p.9).
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
Delhi (Bhattacharya, Alberini, & Cropper, 2007), and Spain (Perez,
Perpinan, & Prades, 2007), to name only some recent ones.
Dionne and Lanoie (2004) review 85 studies and find VOSL
estimates ranging from CA$0.16–33 million at 2000 values and
prices or CA$0.23–47 million (£0.11 m to £22 m; V0.16 m to V32 m;
$0.22 m to $44 m) at 2007 prices and values and exchange rates.7
De Blaeij, Florax, Rietveld, and Verhoef (2003) conduct a metaanalysis of the variables that explain the variation in VOSL estimates reported in the literature and find that the magnitude of VOSL
estimates depends on the methodology adopted (stated preference
or revealed preference), and for contingent valuation studies, not
surprisingly, on the type of payment vehicle and elicitation format.
More importantly, they conclude that VOSL estimates cannot simply
be averaged over studies because the magnitude of VOSL is
‘intrinsically linked to the initial level of the risk of being caught up
in a fatal traffic accident and to the risk decline implied by the
research set-up’ (De Blaeij et al., 2003, p. 973).
Understandably, different governments, and often different
departments within the same country, have their own VOSLs. The
UK DfT, for example, uses a VOSL of £1.1 million at June 2007 values
and prices (UK DfT, 2009a, p. 3), roughly equivalent to V1.6 million.
The US Department of Transportation (US DoT) uses a VOSL of $5.8
million (£2.9 m, V4.2 m) at 2007 values and prices (US DoT, 2008a,
p. 1). The Australian Government uses a VOSL of AU$3.5 million
($3 m; £1.5 m; V2.1 m) at 2007 values and prices. Transport Canada
uses a VOSL of CA$1.75 million at 2000 prices and values (Dionne &
Lanoie, 2004), or CA$2.5 ($2.4 m; £1.2 m; V1.7 m) million at 2007
prices and values.
Governments in developing countries do not typically have
official VOSLs and studies are scarcer than in developed countries.
Attempts to approximate VOSLs for developing countries mainly
consist of regression estimates based on models originally fitted for
developed countries (Bowland & Beghin, 2001; Miller, 2000). One
obvious (and perhaps worrying) result is that VOSLs for developing
countries tend to be lower than for developed ones, implying that
human life is less worth in the poor world. Income or GDP per
capita is found to be an important explanatory variable (Bowland &
Beghin, 2001; De Blaeij et al., 2003; Miller, 2000) with elasticities in
the range of 0.50 (Blaeij et al., 2003) to 0.85 and even 1 (Miller,
2000).
1.1.2. Road damage
Road damage costs include the costs of repairing the damage
caused by the passage of vehicles, which is a cost borne by the
highway agency, and by other drivers, who bear extra vehicle
operating costs caused by this damage (Newbery, 1990, p. 25). The
damage caused by a vehicle increases as the fourth power of the
axle load. Thus most of the damage is caused by heavy vehicles
(such as big lorries) on thin roads (Newbery, 1990, p. 25).
Newbery (1988) proves an interesting result that if (a) the
highway agency follows a condition-responsive maintenance
policy, that is, if they repair roads when these reach a predetermined state, (b) the only cause of road damage is traffic (with
no damage attributable to weather), (c) traffic flow is constant
over time (i.e., there is no traffic growth), and (d) the age distribution of the road network is uniform, then the average road
damage externality is zero. This makes imposing efficient road
user charging very simple: the charge should equal the average
cost of repair. The result holds because ‘the externality caused by
vehicles damaging roads, which raises the operating cost of
subsequent vehicles, exactly cancels out when averaging over
7
The average exchange rate in the period Jan-Dec 2007 was £1 ¼ $2 ¼ AU$2.4 ¼
CA$2.1 ¼ V1.5 (IMF Exchange Rate Query Tool).
5
roads of differing ages’ (Newbery, 1988, p. 313). The conditions for
this theorem, however, are not verified in reality. In particular,
there is evidence of road damage being caused partly by bad
weather. The fraction of road damage allocated to weather varies
from 20 to 40 per cent in hot dry climates to 40–80 per cent in very
cold ones, with the higher figures corresponding to more stringent
maintenance criteria and/or lower traffic volumes (Newbery, 1990,
p. 25).
1.1.3. Environmental damage
The environmental externalities from road transport include the
impacts from emissions, noise and vibration, changes to landscape
and townscape, impacts on biodiversity, heritage of historic
resources, and water (UK DfT, 2004). From these externalities the
two which have been best quantified and monetised are noise and
emissions. The others tend to be assessed using qualitative techniques. These may include a description of the problem in question
(such as for example, the threatened biodiversity or heritage), an
assessment of its importance, and an overall scoring on a predetermined scale.
Noise harms human health and interferes with people’s daily
activities. According to the World Health Organization (WHO),
noise from road transport affects the health of almost one third of
people in Europe (WHO, 2007). The main impacts from noise
include ‘pain and hearing fatigue, hearing impairment, annoyance,
interferences with social behaviour (aggressiveness, protest and
helplessness), interference with speech communication, sleep
disturbance and all its consequences on a long and short term basis,
cardiovascular effects, hormonal responses (stress hormones) and
their possible consequences on human metabolism (nutrition) and
immune system, performance at work and school’ (WHO, 2007).
Protection from noise pollution is costly: households may have to
double-glaze their windows and local governments often install
noise barriers around motorways. Noise can be measured in decibels and noise costs are typically estimated with hedonic property
price models (Parry et al., 2007).
Most of the energy consumed by road transport comes from
fossil fuels. This causes emissions, not just from fossil fuel
combustion but also from the evaporation of petrol during
production, storage and distribution, and evaporative emissions
from the gas tank and carburettor of petrol-engined vehicles. Here,
however, we concentrate on emissions due to fossil fuel combustion, which is the main source of road transport emissions. Emissions from road transport have negative impacts at local, regional
and global level.
At local and regional level, there are a vast range of air pollutants, which cause a variety of effects on the environment and
health. The main emissions from road transport with effects at local
level are nitrogen oxides, hydrocarbons and carbon monoxide,
accounting for 58 per cent, 50 per cent and 75 per cent respectively
of all such emissions in the EU (European Parliament Fact Sheets,
2006). Other pollutants include sulphur dioxide and particulate
matter. Their impacts are summarised below.
1.1.3.1. Nitrogen oxides (NOx). NOx emissions are formed in the
combustion of fossil fuel. They include nitrogen dioxide and nitric
oxide. Nitrogen dioxide can negatively impact the human respiratory system and reduce lung function. NOx also contribute to the
formation of ozone, which is a harmful secondary pollutant in the
lower atmosphere. High levels of ozone increase susceptibility to
respiratory disease and irritate the eyes, nose throat and respiratory system, particularly in urban areas (UK DfT, 2007a, p. 51).
1.1.3.2. Hydrocarbons (HC). HC are the result of incomplete
combustion of fossil fuels and cause eye and throat irritation and
6
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
coughing (Banister, 1998, p. 4). They also cause damage to crops and
trees, and this may lead to crop losses.
Average and Marginal Costs
MSC
1.1.3.3. Carbon monoxide (CO). CO is also produced by the incomplete combustion of fossil fuels and interferes with the absorption of
oxygen. After being inhaled, CO molecules can enter the bloodstream,
where they inhibit the delivery of oxygen throughout the body. This
in turn leads to dizziness, headaches, and fatigue, and can affect
fertility and general levels of health. CO interferes with respiratory
bio-chemistry and can affect the central nervous and cardiovascular
systems (UK DfT, 2007a, p. 50). Other pollutants can exacerbate its
effects (Banister, 1998, p. 4). The fitting of catalytic converters to all
new vehicles virtually around the world in the late 1980s and
throughout the 1990s has substantially reduced emissions of CO.
M
D = MPB = MSB
F
ASC = MPC
1.1.3.5. Particulate matter (PM). PM is a generic term used to
describe a complex group of air pollutants that vary in size and
composition. The two main types of interest here are PM10 and
PM2.5, which are particles with aerodynamic diameters of up to 10
microns and 2.5 microns, respectively.8 PM has been linked to
numerous adverse health effects including increased hospital
admissions and emergency room visits, respiratory symptoms,
exacerbation of chronic respiratory and cardiovascular diseases,
decreased lung function, and premature mortality (Bell, Samet, &
Dominici, 2003, p. 8).
Particulates are the main pollutants causing deaths in Europe
today, with an estimate of 348,000 premature deaths in Europe due
to exposure to anthropogenic PM2.5 for the year 2000 (European
Environment Agency, EEA, 2005a, p. 98) or loss of statistical life
expectancy of approximately 9 months (EEA, 2005b, p. 47). In some
areas of Europe, such as the Benelux area, in northern Italy and in
parts of Poland and Hungary, the average loss of life expectancy
from particulates is up to two years (EEA, 2005a, p. 98).
Impacts on health, crops, buildings, etc from local and regional
pollutants can be physically measured and monetised.9 Once the
link between emissions and concentration of a pollutant has been
established, the next step involves the estimation of a doseresponse function, which relates pollutant concentration to the
physical impact on the receptor (for example, population in
a town). Finally, the impact resulting from exposure can be valued
using stated and/or revealed preference methods and/or combinations of both.
It should be noted however, that emission rates per km of air
pollutants with local and regional impacts has been decreasing in
virtually all countries, due to the introduction of ever more stringent regulations on new vehicle models.
At global level, the main pollutant is carbon dioxide (CO2), the
anthropogenic greenhouse gas (GHG) which most contributes to
global warming, and the unavoidable product of fuel combustion.
In the period 1990–2002 the growth rate of energy consumption in
the transport sector was the highest among all the end-use sectors,
and road vehicles account for 77 per cent of that energy use (Kahn
Ribeiro et al., 2007, p. 328). With 95 per cent of transport energy
8
One micron is one micrometer or one millionth of a meter (1 mm ¼ 1000 mm,
where mm: microns).
9
Spadaro and Rabl (2001), for example, argue that the impacts on health account
for more than 90 per cent of the cost of automotive air pollution.
B
A
G
1.1.3.4. Sulphur dioxide (SO2). SO2 affects the lining of the nose,
throat and airways of the lung, in particular, among those who
suffer from asthma and chronic lung disease (UK DfT, 2007a, p. 51).
It causes respiratory illness, in particular bronchitis, and it also
contributes to acid rain (Banister, 1998, 4).
H
C
E
e
q
m
q
Traffic flow (PCU/lane hour)
Fig. 1. The economics of congestion.
coming from oil-based fuels and only small differences in the
carbon content of the different fuels, CO2 emissions from the
different transport sub-sectors are roughly proportional to their
energy use (Kahn Ribeiro et al., 2007, p. 328). Indeed CO2 emissions
are closely related to the quantity of fuel consumed, and this, as we
shall see in the sections that follow, has important implications for
policy instrument design.
Valuing the impact of global warming is undoubtedly a challenging task. A number of models have been developed10 with
estimates varying according to the impacts (and some times
adaptation) taken into account, the assumptions made, and the
discount rate used.
1.1.4. Congestion
Traffic congestion is a road condition characterised by slow
speeds. It takes place when the demand for road space is greater than
road capacity. The impacts are well-known: longer and unreliable
travel times and ultimately, negative economic effects as a result of an
inefficient distribution and delivery of goods, services and resources.
In his seminal paper on the economics of congestion, Walters
(1961) established the isomorphism between travel time on
a given length of highway as a function of traffic flow (speed-flow
relationship), on one hand, and average cost as a function of flow,
on the other hand. That was Walters’ fundamental original
contribution. An adequate conversion from time into cost,
combined with a demand curve, makes the analysis of the whole
picture from an economic point of view possible. Fig. 1 presents the
standard diagram of the economics of traffic congestion on a link.
Higher traffic flows lead to lower average speeds and higher
travel times and costs per km. Additional traffic imposes an
external cost on all other road users. Under congested conditions,
particularly in urban areas, and in the absence of efficient road
pricing, traffic will be undercharged and hence, excessive.
In Fig. 1, road users are assumed identical apart from their
marginal willingness to pay for a trip, given by the inverse demand
curve D, which represents marginal private and social benefits.
Marginal private (MPB) and marginal social benefit (MSB) are
assumed identical (i.e., distributional considerations are ignored).
The efficient equilibrium is at point H, where the marginal social
10
These models are reviewed in Schneider and Lane (2005), Hope (2005) and
Stern (2006).
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
cost (MSC) is equal to the MSB. The market equilibrium however is
at point C, where the average social cost (ASC) is equal to the MSB.
At this point drivers are paying for their ASC but not for their MSC,
leaving thus a congestion externality or marginal congestion cost
(MCC), which can be measured by the segment MC. The inefficiency
of incorrect pricing of scarce road resources or deadweight loss is
then measured by the area HMC.
It should be noted that the MCC at the efficient level of traffic qe is
positive and equal to the segment HE. In other words, zero congestion would not be an optimal situation, but rather, would reflect
a waste of resources. Estimates of congestion costs are mainly based
on assumptions on the value of time and value of reliability.11 These
have been subject to extensive empirical and theoretical research.
Some important recent contributions include Brownstone and Small
(2005), Calfee and Winston (1998), De Borger and Fosgerau (2008),
Fosgerau (2006), Hensher (2006), Hensher (2008), Hensher and
Goodwin (2004), Lam and Small (2001), Mackie et al. (2003),
Ramjerdi and Dillen (2007), Steimetz and Brownstone (2005),
Tseng and Verhoef (2008), and, Wardman (2001).
There is substantial heterogeneity in values of time and reliability across the population and these depend on a number of
factors. Some widely agreed upon determinants include income
and trip purpose. Although the correlations are far from perfect, in
general we expect that a higher income leads to a higher value of
both working and non-working time; and the more important the
trip purpose (work as opposed to shopping, and their corresponding delay penalties) the higher the value of time savings. The
value of reliability also varies with income and trip purpose,
although gender differences, reflecting childcare commitments,
also have an influence.
Elasticities of the value of time with respect to income are also
important. Mackie at al. (2003) conduct a meta-analysis of value of
time studies and conclude that reasonable assumptions would be 1
for the working time and 0.8 for the non-working time elasticities,
respectively (p. 11) and the UK DfT has adopted these values (UK
DfT, 2009b, p. 5).
1.1.5. Oil dependence
Oil dependence is a problem for oil importing countries. These
countries are vulnerable to volatile oil prices and oil price shocks.
This has the potential of threatening national security and the
economy of a country, especially if this country does not have
enough market power to influence world prices.
Roughly 42 per cent of world oil is produced by OPEC countries,
and from this, 68 per cent comes from Iran, Iraq, Kuwait, Saudi
Arabia and United Arab Emirates (Parry & Darmstadter, 2003, p. 3).
These countries, together with Venezuela, and two non-OPEC
countries, Mexico and Norway, are willing to produce well below
their capacity in order to keep their influence over world prices
(Parry & Darmstadter, 2003, p. 5). OPEC is an organization that
influences production and ultimately prices (Kaufmann, Bradford,
Belanger, McLaughlin, & Miki, 2008) via capacity utilisation,
production quotas, and the degree to which OPEC production
exceeds these quotas (Kaufmann, 2004, p. 81).
Virtually every activity in developed countries relies on oil
directly and/or indirectly, and as a consequence, world oil prices
impact GDP, other goods and services’ prices, and employment, to
name just a few economic indicators (Cleveland & Kaufmann, 2003,
p. 488), as well national security. Reducing vulnerability to oil price
volatility requires a reduction in oil use, regardless of where it is
produced (Cleveland & Kaufmann, 2003, p. 488).
11
The cost curves in Fig. 1, if expressed in monetary units, are obtained by
assuming a value of time.
7
The question of how to measure the costs of oil dependence has
attracted some attention, especially in the US (Greene & Ahmad,
2005; Leiby, 2007; Parry & Darmstadter, 2003). These costs
include the transfer of wealth from the importing country to the oil
producing country, a decrease in the maximum product the
importing country would be capable of if oil prices were competitive (as opposed to monopolistic or oligopolistic) and any macroeconomic adjustment costs driven by price shocks, which impact
prices and wages and as a consequence, employment of resources,
such as capital and labour (Leiby, 2007). Some consequences of oil
dependence, such as its effect on foreign policy and national
security, are much more difficult to quantify (Leiby, 2007).
1.2. Command-and-control vs. incentive based policies
Having summarised the most important road transport externalities the next question is whether anything ought to be done
about them and why. As explained above, the market is incapable of
reaching an efficient equilibrium in the presence of externalities.
This calls for some action from the government in order to correct
the market failure, at least in part, and achieve, or at least get close
to, an efficient equilibrium.
From an economic point of view, policies to reduce negative
externalities can be divided in two groups: command-and-control
(CAC) and incentive based (IB). IB mechanisms can be further categorised into price controls and quantity controls.
A CAC policy is essentially a regulation, or a ‘‘command’’, which
needs to be ‘‘controlled’’ or enforced. When there is an externality,
the regulator (or government) can impose a maximum level of the
activity causing it, or a restriction over the behaviour of economic
agents, or characteristics of products. CAC measures give rise to
predictable outcomes and are relatively easy to implement, enforce,
and understand (Button, 1990). However, they are inflexible and
they do not provide incentives to go beyond the mandatory standard
(Button, 1990). Every time a change is envisaged, the measure needs
to be revised, thus leading to an additional bureaucratic burden.
IB policies, on the other hand, provide economic incentives to
the targeted agents and act to directly alter private utility or private
benefit from a given behavioural response. Consequently, they are
crucial instruments to induce behavioural change.
Price control IB policies put a price on a good or an activity, such
as emissions or congestion. These can take the form of taxes (or fees
or charges) or subsidies, both providing incentives to reduce the
level of the externality. A foregone subsidy can have a similar
impact to that of a tax.
A tax to internalise an externality, also known as a Pigouvian or
corrective tax12 (or fee or charge) is a tax set equal to the marginal
external cost of the activity at the efficient equilibrium. Thus, the
corrective tax brings the marginal private cost up to the level of
marginal social cost.
A subsidy, on the other hand, encourages the agent to reduce the
level of activity by compensating him for his loss. Thus, a car manufacturer may be given a subsidy to produce cleaner cars or a road user
may be given a subsidy as long as he stops travelling by car during the
rush-hour.13 However, it may be difficult to measure baseline emissions to estimate emissions reductions under a subsidy.
More importantly, Baumol and Oates (1988, chap. 14, pp. 211–
234) highlight a number of differences between the impacts from
taxes and subsidies at firm and industry level:
12
These taxes are called Pigouvian in honour of Arthur Pigou, a Cambridge Neoclassical economist, who also developed the concept of externalities. They are also
called corrective because they are aimed at correcting a market distortion.
13
In practice this could translate, for example, into a subsidy to public transport
fares.
8
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
It may be profitable for the firm to start off by emitting more than
it would have otherwise in order to qualify for larger subsidies.
There is less of an incentive to introduce new technologies
under subsidies than under taxes.
An unprofitable firm under taxes may become profitable under
subsidies.
While taxes will typically drive firms out of a competitive
industry and this will usually result in a decrease in its
production, a subsidy may attract new entrants, thus increasing
the level of production of that industry.
Under perfect competition, a subsidy will yield a reduction in
emissions at firm level, but an increase in emissions at industry
level, even beyond the level of emissions there would have
been without any intervention.
Quantity control IB policies usually assume the form of cap-andtrade systems. They target a certain level of activity (for example,
emissions), assign property rights (permits) to match the targeted
total quantity and let consumers, firms and other entities trade these
permits at an endogenously determined price. To the extent that
quantity control instruments involve a trading mechanism, they also
provide price incentives to the regulated parties (Hepburn, 2006).
Cap-and-trade systems were theoretically articulated by Dales
(1968), who built his ideas on the basis of work by Coase (1960).
The rights or permits initial allocation method is a decision
which needs to be made early in the process. There are mainly two
possible initial allocation methods: grandfathering and auctioning.
With grandfathering, permits are allocated by the regulator for free
to each polluter, according to their past (historic) emissions. With
auctioning, polluters pay for the permits they wish to buy,
according to the price that emerges from the auction.
Auctioning reduces barriers to entry in the case of industry,
increases regulation stringency, prevents the possibility of windfall profits, and generates revenues that can be recycled for environmental purposes and/or cutting distortionary taxes. Grandfathering, on the other hand, is a more widely accepted option, as
essentially trading parties are allocated permits for free, but does
not apply the ‘‘polluter pays’’ principle in full.14
The main advantage of IB (both price and quantity control)
instruments over CAC ones is their cost effectiveness. Economic
agents (producers or consumers) with low costs of abatement will
find it relatively easier to reduce their level of externality than to
buy permits or pay taxes, while those with high costs of abatement
will prefer to buy permits or pay taxes. The cost of reducing the
externality is thus minimised compared to the more direct regulatory approach of setting standards (Baumol & Oates, 1988,
Chapters 6 and 8). Having said that, the magnitude of these cost
savings varies greatly across specific cases (Newell & Stavins, 2003,
p. 46). Tietenberg (1985, in Newell & Stavins, 2003) compares the
costs of air pollution control across ten different examples and finds
ratios ranging from 1.1 to 22.15
Another advantage of IB instruments over CAC is that they lead
to self-revelation of private information through the choice made
14
At first sight, an initial free allocation of permits might lead to the conclusion
that the ‘‘polluter pays’’ principle is not applied at all. However, one must consider
the opportunity costs that come with the use of permits: by using a permit, the
permit holder is giving up the earning he would make by selling it at the market
price. The incentive, however, is smaller than in the case of auctions, where
polluters must pay upfront for the permits.
15
Newell and Stavins (2003) attempt to fill the niche in research on the relationship between the nature and magnitude of the heterogeneity in abatement costs
and the potential cost savings from IB instruments. They develop an analytical
framework linking cost savings from IB instruments relative to CAC and different
sources of heterogeneity in abatement costs, including the slope of the marginal
cost curve, baseline emissions and firm size.
by regulated consumers or producers; and they exploit the market’s capability of private information aggregation (Hepburn, 2006,
p. 228). This makes IB instruments more efficient to CAC measures
when the information basis is not complete and cannot be inferred
by the regulator. The advantage of IB instruments over CAC is
particularly marked when the regulated entities are not homogeneous16 and their optimal response is not uniform (Hepburn, 2006,
pp. 228–229), or when there are time and spatial variations in
problems (European Commission, 1995).
However, IB mechanisms can lead to market failures and blunt
miss of objectives. This can happen, as explained above, when
incentives are not correctly calibrated due to difficulties in determining the marginal external cost (and therefore of efficient level of
activity), the system already having corrective instruments and
regulations in place (whose effects will be added to the new IB
instrument’s), and the presence of distortions in other (related)
sectors in the economy. In these cases, the effectiveness of the
instruments in meeting the targets may be impaired. Transaction and
implementation costs may also be higher for IB mechanisms than for
CAC, due to the need of advanced monitoring systems (European
Commission, 1995). However, costs are likely to decrease as technology progresses.
Finally, CAC may be preferable to IB instruments when there are
no informational asymmetries, there is little risk of government
failure, and the regulated entities are required to respond in the same
way. An instance when CAC would be advisable is when the optimal
level of an externality, for example a certain polluting activity, is zero.
The activity in this case should simply be banned (Hepburn, 2006, p.
229). This happens when after reducing emissions by 100 per cent
the marginal social benefit is higher than the marginal social cost.
Obvious cases of this are bans on the use of dichlorodiphenyltrichloroethane (DDT) as a pesticide and asbestos in construction,
which were implemented by many countries in the 1980s. The lead
phase-out from petrol, discussed in Section 2, is another example.
1.3. Incentive based: quantity vs. price control under asymmetric
information
A cap-and-trade system guarantees a quantity of externality or
activity producing the externality, regardless of the abatement
costs. A tax, on the assumption that polluters (either consumers or
producers) are cost minimisers, guarantees that the marginal
abatement cost will be equated to the tax, regardless of the
resulting quantity of the externality or activity producing the
externality (Baumol & Oates, Chapter 5).
Under perfect information a system of Pigouvian taxes and
a system of marketable permits are equivalent and yield the same
efficient outcome. In general ‘it is neither easier nor harder to name
the right prices than the right quantities because in principle exactly
the same information is needed to correctly specify either’ (Weitzman,
1974, p. 478).17 If the optimal number of permits is issued by the
regulator, their price will be bid up on the free market to precisely the
level of the Pigouvian tax. At that point, it makes no difference to the
polluter whether he pays a tax equal to his marginal external cost to
the authorities, or whether he pays that same amount to buy permits
that will allow him to produce the same level of externality and
marginal external cost (Baumol & Oates, 1988, chap. 5).
16
Permit trading provisions may, however, solve the cost heterogeneity problem.
It should be noted, however, that in the case of road transport most pollutants with
local or regional impacts, exhibit a marginal damage curve which is approximately flat.
In such cases, the optimal tax will be the same, regardless of the shape of the demand
(or marginal social benefit) curve. Under these assumptions estimating the efficient tax
requires less information than estimating the efficient quantity.
17
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
9
In an imperfect information setting, the conclusions are very
different. Lack of enough relevant information on the part of the
regulator is a crucial factor that can lead to regulatory failure under
price as well as under quantity control mechanisms.
The source of uncertainty can lie in the marginal abatement cost
curve or in the marginal social benefit curve. When there is perfect
information regarding marginal abatement costs but lack of information regarding marginal social benefits, the policy, either taxes
or permits, will not be optimal. The cost of the error, however, will
be the same under either policy (Weitzman, 1974, in Baumol &
Oates, 1988) and so in the presence of uncertainty with respect to
marginal social benefits it makes no difference to choose one or the
other. The reason for this is that the resulting permit price, after the
regulator has determined what he thinks is the optimal quantity,
and the resulting quantity, after the regulator has determined what
he thinks is the optimal tax, depend exclusively on marginal
abatement costs and are independent from marginal social
benefits.
When there is imperfect information regarding marginal
abatement costs, the outcome will be inefficient. In this case, the
cost of the error under a permit or tax system may be different.
In general, both permits and taxes will yield inefficient
outcomes. When the assumed marginal abatement costs are lower
than the actual ones, the reduction of the externality under a capand-trade system will not be enough, and the reduction of the
externality under a tax will be excessive. The opposite holds when
the assumed marginal abatement costs are higher than the actual
ones (Baumol & Oates, Chapter 5).
The inefficiency arising from lack of information on marginal
abatements costs under permits and taxes depends on the relative
slopes of the marginal abatement cost and marginal social benefit
functions. An important result from Weitzman (1974), digested in
Baumol and Oates (Chapter 5) is that:
lower monitoring and enforcement expenditures (Gallagher et al.,
2007). In general, policy is not designed to follow economic principles but rather to maximise votes (Helm, 2005, p. 213).
Hybrid instruments also constitute an alternative. These
combine price and quantity instruments. An example is a cap-andtrade scheme with a price ceiling or price floor. The government
commits to selling or buying permits at a certain price when the
market price hits the ceiling or the floor (Hepburn, 2006, p. 230).
Finally, a multiple instrument package can also be implemented
(Hepburn, 2006, p. 231). Such a package can include permits, taxes,
subsidies and regulations. The danger in this case, in terms of
efficiency, is the double-charging or double-penalising of an
externality, as its reduction in that case would be excessive.
Aldy, Ley, and Parry (2008) discuss the design of CO2 taxes at the
domestic and international level and the choice of taxes versus
permits. They find a strong case for taxes on uncertainty, fiscal, and
distributional grounds, especially if permits are grandfathered. First,
taxes provide certainty with respect to the price for emissions, and
therefore the marginal abatement costs, while permits fix quantity
but not price, which fluctuates with market conditions, and hence,
the uncertainty is larger. Second, unlike permits distributed for free,
taxes offer revenues to the government, helping a healthier fiscal
balance. These revenues can then be used to reduce distortionary
taxes in the economy, thus increasing efficiency. Third, governments
can use revenues from CO2 taxes or auctioned permits to benefit
lower income groups, thus reducing any initial regressive effects.
They point out that the main disadvantage of taxes is that if they were
implemented at an international level, individual countries could
reduce other taxes, even taxes on sources of other GHGs, to offset the
burden. To solve this problem they propose a CO2 tax which takes into
account pre-existing energy taxes or subsidies.
When the marginal social benefit and the marginal abatement
cost curves are linear and the absolute values of their slopes are
equal, the magnitude of the distortion caused by cap-and-trade
and a tax will be identical (p. 67).
The steeper the slope of the marginal social benefit curve, the
less severe the magnitude of the distortion caused by a capand-trade system will be, compared to that of a tax (p. 64).
The steeper the slope of the marginal abatement cost curve, the
more severe the magnitude of the distortion caused by a capand-trade system will be, compared to that of a tax (p. 66).
The most important externalities caused by road transport are
accidents, road damage, environmental damage, congestion and oil
dependence. In the presence of externalities the market is incapable of achieving an efficient equilibrium. This problem can in
theory be solved by implementing corrective taxes or introducing
cap-and-trade systems. These are equivalent instruments under
perfect information but errors can be made under imperfect
information. The cost of the error is identical if there is lack of
information regarding marginal social benefits or if there is lack of
information regarding marginal abatement costs and the marginal
social benefit and the marginal abatement cost curves are linear
with equal slopes in absolute value. If there is lack of information
regarding the marginal abatement cost and the slopes of the cost
and benefit curves are different, the cost of the error varies
depending on which curve is steeper. There are also a number of
complementary policies, such as for example, land use and transport planning, which can act in combination with corrective
instruments to reduce the level of externalities. Command-andcontrol measures and new technologies also have a very important role to play.
Finally, when the slope of the marginal benefit and marginal
cost curves are both uncertain, quantity control will in general be
preferred, since ‘prices can be a disastrous choice of instrument far
more often than quantities can’ (Weitzman, 1974, p. 486).
Taxation leads to price stability, while permits may lead to price
fluctuations. The volatility associated with permits will add up to
the intrinsic uncertainty over returns in technology development,
and may reduce investment incentives by risk-averse firms
(Gallagher, Collantes, Holdren, Lee, & Frosch, 2007, p. 18). Riskaversion therefore may play a role in instrument selection. All
else being equal, when the regulated entities are risk-averse, price
control tends to be preferred to quantity control. In fact, the volatility of cap-and-trade systems may be avoided through taxation
(Baldursson & von der Fehr, 2004, in Hepburn, 2006).
Other considerations that go beyond pure economic theory are
also relevant in instrument selection. For example, regardless of any
efficiency criteria, permits tend to be more costly in regulatory terms,
in the sense that they require an institutional setting, definition of
property rights and initial allocation, and enforcement procedures
(Helm, 2005, p. 212). Taxes, on the other hand, require relatively
1.4. Concluding remarks
2. Command-and-control policies
As explained in Section 1.2, CAC policies are not efficient from an
economic point of view: even in a context of perfect information
when the regulation or standard is set at the optimal level, the
target is not achieved at minimum cost, and, worse yet, the social
costs could exceed the potential benefits (thus replacing market
failure with government failure). Despite being inefficient policy
instruments, they are the most widely used ones to regulate environmental and other externalities. In many cases, however, the
10
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
choice of instrument is justified by the severity of the problem,
with the extreme case of lethal fumes being the prototype example.
The transport sector is no exception, and throughout the world
there is a plethora of examples of CAC policies targeting different
transport externalities. In this section, some of these examples are
briefly described and discussed, mainly to illustrate how the
regulations were set and to give an idea of their success or failure.
state of California in 2007. The Low Carbon Fuel Standard requires
fuel providers to reduce GHG emissions of the fuel they sell. The
programme intends to achieve a 10 per cent reduction in the carbon
intensity of transport fuels by 2020 (Farrell & Sperling, 2007).
2.1. Fuel standards
Vehicle standards are CAC policies which typically regulate
vehicle safety, tailpipe emissions and fuel efficiency. In general,
different countries set their own vehicle standards, although the EU
sets standards for all its members.
Typically, safety standards set front and side impact tests which
vehicles have to pass before they are introduced into the market.
There are also regulations regarding compulsory fitting of headrestraints and seat-belts, and on the minimum depth of tyre
treads, brakes, and annual safety checks (Acutt & Dodgson, 1997,
p. 19). In general, safety standards have become more stringent over
time and newer vehicles tend to be safer than older ones.
One prominent example of a CAC policy relating to tailpipe
emissions is that of catalytic converters. These were first introduced in new cars in the US in 1975 in order to reduce the toxicity of
emissions from internal combustion engines. The converters also
facilitated the compliance with the Clean Air Act of 1970, according
to which all new vehicles sold in the US from 1975 onwards had to
meet US EPA standards on HC, NOx and CO emissions (US EPA
website b).
The EU made catalytic converters mandatory in new cars with
the Council Directive 91/441/EEC of 26 June 1991, on measures to be
taken against air pollution by emissions from motor vehicles
(Council of the European Communities, 1991).21 The main systems
of vehicle emission standards are those from the US and the EU.
Having said that, most developed countries (and some developing
ones), including Australia, China, Japan, Switzerland, South Korea
and Taiwan have implemented some type of fuel economy or CO2
standard (Clerides & Zachariadis, 2008, p. 2658), although in many
instances they closely follow (or import) the standards in place in
the US or Europe (Faiz, Weaver, & Walsh, 1996).
In general, when a country or group of countries adopts a standard, this standard applies to new vehicles sold, rather than to
those already on the road. The US was the first country in the world
to set standards for vehicle emissions.22 Under the North American
Free Trade Agreement these standards were later also adopted by
Canada and Mexico (Faiz et al., 1996, p. 1).
There are a number of landmarks that have shaped the development of vehicle emission standards and fuel economy around the
world. One important such landmark was the introduction of the
Corporate Average Fuel Economy (CAFE) in the US, enacted by
Congress in 1975 and still in place as of 2009. The purpose of CAFE
is to reduce energy consumption by increasing the fuel economy of
cars and vans. Regulating CAFE is the responsibility of the US
National Highway Traffic Safety Administration (US NHTSA) and
the US EPA. The US NHTSA sets fuel economy standards for cars and
vans sold in the US, and the US EPA calculates the average fuel
economy for each manufacturer (US NHTSA website a). Typically,
a manufacturer can meet the standard by producing fewer large
vehicles and more small vehicles or by improving the mileage of all
of the vehicles it produces.
These are standards that countries impose on motor-vehicle
fuels. The most notable example is the ban on lead in petrol, which
has been implemented virtually all over the world as of 2009. Lead
had been used as an additive since the 1920s. It was a pollutant of
great concern, mainly due to its effects on children’s brains and was
therefore phased out and finally banned in most countries.
In the US, for example, the Environmental Protection Agency
(US EPA) started a lead phase-down program in 1973,18 with the
objective of reducing the lead content in petrol from 1.7 grams per
gallon (0.45 grams per litre) down to 0.5 grams per gallon (0.13
grams per litre) by 1980 in large refineries and by 1982 in small
refineries. The standard allowed refineries to average their total
(both leaded and unleaded) output to reach the 0.5 standard. In
1982, the US EPA loosened the standard to 1.1 grams per gallon
(0.29 grams per litre) but eliminated the provision that allowed
averaging between unleaded and leaded petrol. In July 1985 the
standard was tightened again to 0.5 grams per gallon (0.13 grams
per litre) and finally, in January 1986, to 0.10 grams per gallon (0.03
grams per litre) (US EPA, 1985). Although this was mainly a CAC
policy, it was also complemented with a form of credit trading, an
early ancestor of cap-and-trade.19 By 1995, unleaded petrol sales
accounted for 99 per cent of the petrol market in the US (US DoT,
2008b).
Meanwhile, in the UK the maximum amount of lead allowed in
petrol was reduced from 0.45 grams per litre to 0.40 in 1981 and
then again to 0.15 grams per litre in December 1985. In 1986
unleaded petrol was first sold in the UK and a final ban was
imposed on leaded petrol at the end of 1999 (UK DfT, 2007a, p. 51).
Most developed countries followed similar paths in the 1980s
and 1990s. On top of that, the United Nations Environment
Program (UNEP) led a campaign to eliminate leaded petrol
completely everywhere in the world and as of 2009 very few
countries still use it.20
Fuel standards are widely used in many (mainly developed)
countries and thanks to them, the emissions of benzene, sulphur
dioxide, and other harmful pollutants have been reduced.
Much less common are regulations on CO2 emissions from fuel.
One exception is the Low Carbon Fuel Standard, introduced by the
18
During the early 1970s catalytic converters, discussed below, were being developed for mass production in the US. These were (and still are) incompatible with
leaded petrol, as the lead coats the working surfaces of the catalyst, encapsulating
it and preventing it from treating the exhaust. Unleaded petrol therefore ended up
serving two objectives: the objective of reducing lead emissions and the objective
of not jeopardising the function of catalytic converters.
19
To facilitate the phase-down, the US EPA allowed two forms of trading: interrefinery averaging during each quarter and banking for future use or sale (US
EPA website a). These are briefly discussed in Section 3, as they constitute an IB
policy.
20
Apart from Bosnia and Herzegovina, which plan to phase-out leaded petrol by
January 2010 and Serbia, which will probably do it around 2015–2020, no phaseout date is yet known for any of the following countries: Macedonia, Kazakhstan,
Tajikistan, Turkmenistan, Afghanistan, Fiji, Micronesia, Myanmar, North Korea,
Solomon Islands and Tonga (UNEP, 2007). Uzbekistan had plans to phase it out in
2008 but Taylor (2008) lists the country as not having done so. The rest of the world
has completely phased leaded petrol out thanks to standards, regulations and bans,
implemented on a country-by-country basis.
2.2. Vehicle standards
21
It should be noted that although catalytic converters remove HC, NOx and CO
harmful to human health and the local air, the exhaust gases leaving the engine
through the catalytic converter are two important GHGs: carbon dioxide, which
remains in the atmosphere for a long time, and nitrous oxide.
22
California was the first US state to develop vehicle emission standards. Often,
Californian standards were later adopted at federal level (Faiz et al., 1996, p.2).
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
CAFE standards in the US have typically been ‘‘technologyforcing’’ as opposed to ‘‘technology-following’’ (Faiz et al., 1996, p.
1). Technology-forcing standards are standards set at a level which,
although feasible, remains to be demonstrated in practice, and in
the case of the US, have pushed technological advances forward.
Although consumers may regard CAFE as a good policy (all else
being equal, they spend less on fuel to drive the same distance, or
they spend the same and drive more), CAFE has been seen as an
inefficient CAC policy for two reasons: (a) it encourages excess
investment in fuel efficiency and distorts the mix of large and small
vehicles (Godek, 1997, p. 495); and (b) it is less cost effective than
fuel taxes at reducing petrol consumption because by lowering fuel
costs per km driven it increases (rather than reduces) vehicle use
(Austin & Dinan, 2005; Kleit, 2004; West & Williams, 2005; Parry,
2007, in Fischer, Harrington, & Parry, 2007). Referring to standards
in general, although not necessarily to CAFE standards in particular,
Gruenspecht (1982) shows that more stringent standards for new
vehicles prolongs the retention of old, high emission ones and as
a result aggregate emissions may increase in the short run (p. 328).
CAFE standards could have been tightened periodically since
they were implemented. In practice, however, CAFE standards for
cars have remained the same since 1990, and are, as of 2009, still
27.5 miles per gallon (11.7 km per litre). CAFE standards for vans
have indeed been tightened, albeit in very small increments. They
are 23.1 miles per gallon (9.8 km per litre) and 23.5 miles per gallon
(10 km per litre) for the years 2009 and 2010 respectively.
Portney, Parry, Gruenspecht, and Harrington (2003, p. 204)
show that higher real petrol prices together with new standards in
the US had a substantial combined impact on fuel economy. They
point out that new car and new van fuel economy rose by over 30
and 35 per cent respectively between 1978 and 1982. At that point
fuel prices decreased and yet fuel economy continued to increase,
very likely as a result of the CAFE program. However, the increase in
the share of vans,23 subject to less stringent standards, meant that
the combined new vehicle average fuel economy declined 6 per
cent between 1987 and 2002. This increase in the share of vans is
a direct impact from CAFE (Fischer et al., 2007, p. 2; Godek, 1997, p.
496). As of 2007, vans accounted for half of new passenger vehicle
sales in the US (Fischer et al., 2007, p. 2).24
On 19 May 2009 President Barack Obama announced new
tighter CAFE standards, covering models for the period 2012–2016
and reaching an average of 35.5 miles per gallon (15 km per litre) by
2016 (The White House Office of the Press Secretary, 2009). Portney
et al. (2003, p. 216) warn that, although tightening CAFE standards
may reduce fuel consumption and CO2 emissions, they will also
reduce the cost of driving and thus create a stronger incentive to
drive. The external cost of the ‘‘rebound effect’’ of additional
23
Vans, or light trucks, in US terminology, include sport utility vehicles, minivans
and pickups (Fischer et al., 2007, p.1). More specifically, they are defined as: ‘a 4wheel vehicle which is designed for off-road operation (has 4-wheel drive or is
more than 6000 pounds of gross vehicle weight and has physical features consistent with those of a truck); or which is designed to perform at least one of the
following functions: (1) transport more than 10 people; (2) provide temporary
living quarters; (3) transport property in an open bed; (4) permit greater cargocarrying capacity than passenger-carrying volume; or (5) can be converted to an
open bed vehicle by removal of rear seats to form a flat continuous floor with
the use of simple tools’ (NHTSA website b).
24
This change in vehicle share may have had an impact on accident rates and
their severity in the US. There are studies (Gayer, 2004; White, 2004 in Brozovic
& Whritenour Ando, 2009) showing that in multi-vehicle collisions drivers of
vans are less likely to die than drivers of cars. Thus, consumers may have an incentive to buy vans instead of cars not just because they feel better protected in case of
an accident but also because other consumers have already chosen vans and there
are more vans around. Brozovic and Whritenour Ando (2009) estimate that with
current accident rates and levels of van aggressivity in the US, damage from accidents would be minimised if the fleet contained no vans at all.
11
driving, they argue, could be as large as the benefits from CAFE.
Small and Van Dender (2007), on the other hand, point out that the
rebound effect has recently halved in the US due to rising incomes
and diminished significance of fuel costs.
Until the mid-80s, vehicle emission regulations in Europe were
designed by the Economic Commission for Europe, to be later
adopted and enforced by individual countries, and were typically
much less stringent than US standards, as they had to be agreed by
so many countries (Faiz et al., 1996, p. 8). The turning point in
Europe came with the Consolidated Emissions Directive 91/441/
EEC, which was adopted by the Ministers of the European
Community in June 1991, made effective from 1 July 1992 for new
models and from 31 December 1992 for all production (Faiz et al.,
1996, p. 8). Since then emission standards have been adopted at
a European level without the need for unanimous agreement from
all countries.
Like in the US, EU standards increase their stringency with time.
As of 2009, emissions of NOx, HC, CO and PM are regulated for cars,
vans and lorries and for other vehicle types. While CAFE standards
in the US regulate fuel economy and in doing so, CO2 emissions, the
EU still lacked similar legislation until recently.25 Naively, Europe
relied on voluntary changes and information campaigns to reduce
CO2 emissions from the road transport sector.
In 1995, the EU heads of state and government set themselves the goal of reducing emissions of CO2 from new cars to
120 grams per kilometre by 2012. This is roughly equivalent to
a fuel efficiency of 22 km per litre for diesel cars and 20 km per
litre for petrol cars (EurActiv website). The strategy relied mainly
on voluntary commitments from car manufacturers, improvements in consumer information and the option of individual
countries implementing fiscal measures. In 1998, the European
Automobile Manufacturers Association committed to reducing
average emissions from new cars sold to 140 grams of CO2 per
km by 2008 and, in 1999, the Japanese and Korean Automobile
Manufacturers Associations also committed to reaching the
same target by 2009 (European Commission, 2007). However, by
the beginning of the year 2007, it became clear that while some
progress had been made towards the target of 140 grams of CO2
per km by 2008/9, the Community objective of average emissions from the new car fleet of 120 grams of CO2 per km would
not be met by 2012 in the absence of additional measures
(European Commission, 2007).
Later that year, the European Commission proposed mandatory
reductions of emissions of CO2 to reach the objective of 130 grams
of CO2 per km for the average new car fleet, through improvements in vehicle motor technology, and a further reduction of 10
grams of CO2 per km by other technological improvements (fuelefficient tyres and air conditioning, traffic management and ecodriving26) and by an increased use of biofuels (European
Commission, 2007).
In December 2008 the European Parliament voted to adopt the
regulation (European Commission, 2008). The fleet average to be
achieved by all cars registered in the EU is 130 grams per kilometre.
Heavier cars are allowed higher emissions than lighter cars while
preserving the overall fleet average and the requirements will be
phased in, starting with 65 per cent of each manufacturer’s newly
registered cars having to comply on average with the limit,
25
Interestingly, this did not result in higher fuel economy in the US than in
Europe. For the year 2006, the average fuel economy for all cars in the US was
22.4 miles per gallon (9.52 km per litre) (US DoT, 2008b, Table 4.23). The average
fuel economy for all cars in the UK, also for 2006, was 26.7 miles per gallon (11.3
km per litre) (UK DfT, 2008, Table 3.4). Note that the fuel economy listed in UK
DfT (2008) is 32 miles per UK gallon, and 1 UK gallon ¼ 1.2 US gallons.
26
Eco-driving is discussed in Part II of this volume.
12
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
increasing to 100 per cent from 2015 onwards (European
Commission, 2008). In order to maintain the diversity of the car
market the CO2 emission targets are defined according to their
mass, so different vehicle sizes are subject to different targets. Also,
manufacturers are allowed to form pools so that the average
emissions of the pool as a whole do not exceed the target emissions
for the pool (European Commission, 2007). As of August 2009, the
European Commission is developing a new legislative proposal to
reduce CO2 emissions from light commercial vehicles (vans and
minibuses).
Clerides and Zachariadis (2008) explore the impacts of fuel
standards (and also of fuel taxes) on new car fuel economy in
Australia, Canada, the EU, Japan and the US, in the period 1975–2003.
They find that fuel standards have contributed to fuel economy
improvements in the US, Europe and Japan. They also find that new
car fuel economy becomes less sensitive to fuel prices after the
implementation of standards (p. 2671) and show that in Europe and
Japan the impact of a fuel economy standard on new car fuel
consumption has usually been more pronounced than that of an
increase in fuel prices (p. 2671).
Although fuel economy standards have had impacts on fuel
economy, Aldy et al. (2008, p. 496) argue that standards for the
average fuel economy of vehicles in a manufacturer’s sales fleet do not
encourage mitigation outside the automobile industry, or downstream sequestration activities, or reduction in road user mileage.
Portney et al. (2003) conclude that fuel taxes (or carbon taxes) and
tradeable permits would make more efficient tools for reducing fuel
consumption and GHG emissions. One way of making fuel standards
slightly more efficient, they suggest, would be to provide some flexibility by making fuel economy credits transferable between car and
van fleets and between different manufacturers (p. 216).
2.3. Other CAC policies in the road transport sector
Other CAC policies include restrictions on vehicle circulation,
vehicle ownership, parking, and emissions in certain areas or on
certain days. In this section we give some examples.
2.3.1. The low emission zone in London
The Low Emission Zone (LEZ) in London was implemented in
February 2008. The zone covers most of Greater London, which can
broadly be defined as the area inside the M25 motorway. Vehicles
driving on the M25 without entering Greater London are not
subject to the emission limits. The main objective of the scheme is
to deter the most polluting diesel vehicles from driving inside
Greater London.
The regulation includes diesel lorries, buses, coaches, large vans
and minibuses. It also includes a number of other specialist vehicles, such as for example, breakdown and recovery vehicles, gritters
and road sweepers. Cars, motorcycles and small vans are not
included in the LEZ. The scheme operates 24 h a day, seven days
a week, every day of the year (Transport for London website).
There are number of exemptions and discounts. Exempt vehicles
include historic vehicles (built before 1973), military vehicles and
vehicles which are mainly for off-road use, but which may be used
on the road for limited purposes, such as tractors, cranes and farm
machinery.
If a vehicle subject to the regulation neither meets the LEZ
standards nor qualifies for an exemption or discount, it is subject to
a daily charge. This is £100 for large vans and mini-buses and £200
for lorries.
The implementation is being phased. Although LEZ started in
February 2008, there are different phases through to January 2012.
Different vehicles will be affected over time as increasingly tougher
emission standards apply.
2.3.2. Restrictions on vehicle circulation
Restrictions to circulation have been widely implemented in
towns and cities throughout the world. It is very common to see
pedestrianisation of streets, which are closed to traffic at all or
some times of the day. It is also common to see streets where only
public transport and taxis can circulate. This type of CAC policy is
equitable, in the sense that it affects all drivers and does not
differentiate by their willingness to pay for using the road (i.e. by
their ability to pay).
Many (historic) towns in Europe have such types of areas. In
general they do not harm the local economy, but rather, create
a better environment for shoppers in the area. Parkhurst (2003)
evaluates evidence from a pedestrianisation scheme in Oxford,
UK, which was implemented in 1999 and is still in place today. He
finds that as a result of the program there was a reduction of 17 per
cent in the number of car trips to the centre but such reduction did
not affect overall visitor numbers.
Another type of road space rationing has been to restrict certain
licence plates from circulating. Such a policy can be found in cities
like Athens, where cars with even (odd) number plates are allowed
to drive on even (odd) days only. The problem with this type of
policy is that even if the final number of vehicles using the road as
a result of this type of policy was optimal from an economic point of
view, there is no guarantee that the most efficient trips, with the
highest marginal benefit (made by those drivers with the highest
willingness to pay) would be the ones taking place (Verhoef,
Nijkamp, & Rietveld, 1995, p. 141).
A similar scheme was implemented in Mexico City in 1989 to
control air pollution from cars. The Hoy No Circula27 program bans
most drivers from using their vehicles one weekday per week on
the basis of the last digit of the vehicle’s licence plate. The restrictions apply Monday to Friday, from 5:00 a.m. to 10:00 p. m. and
affect most residential and commercial vehicles. Taxis, buses, and
emergency vehicles (police cars, ambulances, and fire engines), as
well as commercial vehicles operating with liquid propane gas, and
commercial vehicles transporting perishable goods are all exempt.
Davis (2008) measures the effect of the driving restrictions on air
quality and finds no evidence of the restrictions having improved
air quality. He does find evidence, however, of the restrictions
having led to an increase in the total number of vehicles in circulation as well as a change in composition towards high-emissions
vehicles. Eskeland and Feyzioglu (1997) find that many households bought an additional car to be able to drive on any day of the
week and the amount of driving increased. The use of old cars also
increased as well as weekend driving.
Another type of restriction on vehicle circulation is the Italian
limited traffic zones, which have been implemented in a number of
historic centres of medieval cities in Italy, such as for example,
Rome. The Limited Traffic Zone (LTZ) in the historic centre of Rome
is an area with restricted traffic. There are different permit types
that allow different driving and parking arrangements. There are
seven sectors inside the LTZ and different types of permits allow
circulation with and without parking in different sectors at
different times. Permits are restricted to a limited number of
essential users. Those qualifying for permits include residents,
some types of workers (such as doctors, nurses and teachers who
work inside the LTZ), workers who have parking in the premises
where they work, automobile mechanics, journalists, cars carrying
children to school, school buses, goods vehicles, and disabled
27
Hoy No Circula translates as ‘Today it does not circulate’.
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
Table 1
Results for May 2009 second COE open bidding exercise.
Category
Quota
QP (S$)
PQP (S$)
A – Car (1600cc & below) &Taxi
B – Car (Above 1600 cc)
C – Goods Vehicle & Bus
D – Motorcycle
E – Open (any type of vehicle)
1402
774
238
393
725
9889
9180
7600
810
10,046
7178
6971
6586
921
Category
Received Successful Unsuccessful Unused
A – Car (1600cc & below) &Taxi 1999
B – Car (Above 1600 cc)
1051
C – Goods Vehicle & Bus
320
D – Motorcycle
535
E – Open (any type of vehicle)
1285
1383
774
228
378
724
616
277
92
157
561
19
0
10
15
1
Note: QP: Quota Premium, PQP: Prevailing Quota Premium.
S$: Singapore dollar. The average exchange rate in the period Jan-May 2009 was
S$1 ¼ £0.46 ¼ V0.51 ¼ $0.67 (IMF Exchange Rate Query Tool).
people amongst others (ATAC website).28 Permits are valid for
a year and there is a fee for each type of permit according to the
sectors and the user, but this fee is fixed by the city council in
advance, rather than determined at auction.
The scheme operates in the historic centre only, which has an
area of 4.6 km2 (1.8 mi2), representing only 0.36 per cent of the area
of Rome, which is 1290 km2 (500 mi2). The area is considerably
smaller than the Charging Zone in London, which is discussed on
Section 5. The hours of operation of the LTZ are Monday to Friday
from 6:30 a.m. to 6:00 p. m., except public holidays, and on
Saturdays from 2:00 p.m. to 6:00 p.m. (ATAC website).
The LTZ in Rome is a CAC policy for two reasons: (a) the permits
are not tradeable and (b) not everyone can qualify for a permit,
which means that drivers who are willing to pay may not be
allowed into the LTZ.
2.3.3. Restrictions on vehicle ownership
Another way of controlling vehicle use is through restrictions on
vehicle ownership. The only example of a direct quantity control of
this sort is the Vehicle Quota System (VQS), a policy implemented
in Singapore in 1990 and still in place today.
Prospective vehicle owners are required to purchase a Certificate of Entitlement (COE), which is a licence that lasts ten years,
except for taxis, for which it lasts seven. The government sets
a quota on COEs for different vehicle categories a year in advance, in
May each year.
The allocation of COEs is done through open auction. When
a person submits a bid (something which is done electronically) the
current successful price is known and the person can adjust his bid.
As the number of bids usually exceeds the set quota, there are
usually unsuccessful bidders.
There are two COE Open Bidding exercises every month. The
bidding exercises usually start on the first Monday and third
Monday of the month and last for three working days. The exercise
that finished on 20 May 2009, for example, yielded the results
shown in Table 1.
The Prevailing Quota Premium (PQP) applies to those who wish
to extend the COE of their vehicles. Vehicle owners do not need to
bid for a COE as the PQP payable will be based on the moving
average of the last three months Quota Premium results. For
example, the PQP in May 2009 is the average COE prices of March,
April and May 2009. Thus, the PQP payable for each month will be
different.
28
ATAC stands for Agenzia per i Trasporti Autoferrotranviari del Comune di Roma,
which translates as Agency for Auto-rail-tram transport in the Municipality of Rome.
13
Since there are bids this policy can be seen as an incentive based
rather than a command-and-control one. However, the COEs are
not tradeable, so the policy cannot be classified under the cap-andtrade umbrella. It falls into a grey area.
2.3.4. Parking restrictions
Parking restrictions can indirectly reduce traffic levels, and in
doing so reduce most traffic externalities. Parking as an activity
entails costs because parked vehicles use public space, which has
an opportunity cost, as the land used for parking could be used for
something else (Verhoef et al., 1995).
Verhoef et al. (1995) show that under strict assumptions (each
individual drives the same distance, congestion is equally spread
over the urban road network, the regulator has full control over all
parking space available, every car is parked in a publicly managed
parking space, and all cars are parked for the same length of time)
quantitative restrictions on parking (in other words, a CAC policy)
can achieve the optimal volume of traffic in terms of marginal
congestion costs and marginal parking costs,29 just as they would
with an IB policy. However, they point out that there would be no
guarantee that the most valuable trips would be the ones that are
realised. They also note that under quantity restrictions on parking, a market for parking permits could develop spontaneously, as
drivers would try to secure parking for the most valuable trips.
Finally, reducing the number of parking spaces available, could
result in more congestion, as more drivers would spend time
looking for an available parking slot (Arnott & Inci, 2006; Arnott &
Rowse, 1999).
2.4. Concluding remarks
CAC is not efficient from an economic point of view because even
when the standard is set at the optimal level, it is not achieved at
minimum cost. Despite that, CAC is the most widely used type of
instrument in the road transport sector. Fuel and vehicle standards,
which are used in virtually every country in the world, are the most
prominent example. There are also some less spread regulations,
which include parking restrictions, the Low Emission Zone in London, restrictions on vehicle circulation (pedestrianisation of streets,
odd and even number plates allowed to circulate on alternate days,
etc) and the restrictions on vehicle ownership in Singapore. The
success of these measures varies, but in general they are all
perceived as equitable by the motoring public, only because they do
not involve payments, which tend to hit harder on the poorer.
3. Incentive based policies: quantity control
An IB policy based on quantity control is a system of marketable (transferable or tradeable) permits, credits, allowances or
rights in which the regulator determines a cap or aggregate
quantity of emissions, pollution or waste and leaves their allocation amongst polluters to be determined by the market (Baumol &
Oates, 1988, p. 59).
There are three steps involved in implementing and maintaining
a system of this sort. First, the regulator sets the quantity or
aggregate quota. Under a perfect information scenario, the regulator sets the quantity at the point at which marginal abatement
costs are equal to marginal social damage. In reality, however, the
regulator hardly has enough information to determine the efficient
aggregate quantity of emissions, and sets a limit based on incomplete information. He is also often influenced by political factors,
29
This result can probably be extended to other externalities.
14
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
such as lobby groups. Second, the regulator allocates the permits,
which together do not exceed the cap. As already mentioned in
Section 1, there are mainly two allocation methods: grandfathering
and auctioning. These can be used in their pure form or they can be
combined. With grandfathering, permits are allocated for free to
each polluter, according to their past (historic) emissions. With
auctioning, polluters pay for the permits they wish to buy, according
to the price that emerges from the auction. An example of combination of both methods could be one in which 90 per cent of permits
are distributed for free, according to past emissions, and 10 per cent
are allocated through auctioning. Third, emitters trade their
permits. Usually, those with lower marginal abatement costs sell
permits and those with higher abatement costs buy permits. Permit
trading amongst sources establishes the market-clearing price.
There are other allocation methods, although these have not
been discussed very much in the literature. These include free
distribution of permits, updating and benchmarking. Free distribution differs from grandfathering only insofar as the permits are
not distributed on the basis of past (nor future) emissions or usage
(Watters & Tight, 2007, p. 7), but on the basis of other criteria (e.g.
equal per capita allocation). Updating also allocates permits for
free, but on the basis of information (e.g. over level of activity)
which is updated over time (Watters & Tight, 2007, p. 6). According
to this method, higher usage today will lead to more permits
tomorrow. Benchmarking allocates permits for free to each
polluter, according to each polluter’s emissions’ efficiency against
a sector average.
It is important to emphasise that a cap-and-trade system is very
different from the CAC approach discussed in Section 2. Under
a CAC system, the regulator specifies a level of emissions or waste
for each source and no trading is allowed afterwards.
Due to the novelty of the concept, penetration of cap-and-trade
systems as a policy measure has been slow. In the 1970s a number
of credit-based emission trading schemes, a very embryonic
version of modern marketable permits, evolved in the US to deal
with air quality.
In the 1980s the US EPA instituted two forms of trading: interrefinery averaging during each quarter and banking for future use
or sale (US EPA website a). The objective was to facilitate the phasedown of lead in petrol.
Inter-refinery averaging operated from November 1982 to
December 1985, and allowed refineries to trade rights to add lead to
petrol (Hahn & Hester, 1989, p. 381). If a refinery added less lead to
petrol than was permitted, it could then sell lead rights to another
refinery in an amount equal to the difference between the actual and
allowed quantity (Hahn & Hester, 1989, p. 382). The other refinery
was then allowed to add more lead than the standard allowed.
Banking for future use or sale was introduced in 1985 (Hahn &
Hester, 1989, p. 382). Essentially refineries were allowed to bank
credits for use until the end of 1987, in effect extending the life of
lead credits to that date (US EPA website a).
Hansjürgens (2005, pp. 5–6) summarises the history of cap-andtrade systems in the US, following the US Clean Air Act of 1990.
These included the Regional Clean Air Incentives Market in
Southern California, trading sulphur oxides and nitrogen oxides
(1994), the Acid Rain Program, trading sulphur dioxide (1995), the
Northeast NOX Budget Trading Program, a multi-jurisdictional
partnership between the federal and nine state governments,
trading nitrogen oxides (1999), later expanded to include nineteen
states and the District of Columbia (2004).
The biggest scheme to have ever been implemented, however, is
the EU Emission Trading Scheme (EU ETS). Before the EU ETS, some
governments, such as the UK in 2002 and the Australian state of
New South Wales in 2003, had already implemented carbon
trading (Hepburn, 2007, p. 377). The EU ETS is a permit-trading
system implemented at European level to help achieve the Kyoto
target of an 8 per cent emission reduction of GHG in the EU by 2012.
The EU ETS only covers emissions of CO2. For the first two trading
periods, 2005–2007 and 2008–2012, aggregated emission caps
were imposed on the most energy-intensive sectors (cement, glass,
ceramics, paper, steel and iron, and power) (European Commission,
2003, Annex I), which were responsible for more than half of EU
CO2 emissions from 2005 to 2007 (European Commission, 2005, p.
5). Permit allocation is made through grandfathering and combined
with a very small percentage of auctioning (5 per cent and 10 per
cent at most, for the first and second periods respectively). Allocation decisions are made at EU level, based on each country’s
National Allocation Plan (NAP) (European Commission, 2000, p. 18).
NAPs determine the total quantity of CO2 emissions that Member
States grant to their companies, which can then be sold or bought
by the companies themselves. This means each Member State must
ex-ante decide how many allowances to allocate in total for
a trading period and how many each plant covered by the Emissions Trading Scheme will receive.
Aviation will be included in the EU ETS from 2012 and as of 2009
there are already some discussions about the prospects of including
road transport as well (UK DfT, 2007b). However, a cap-and-trade
system to deal with the external costs briefly described in Section
1 has not been implemented for road transport anywhere yet.
There have been proposals and studies of marketable permits in
road transport regarding different transport externalities (Verhoef,
Nijkamp, & Rietveld, 1997), including air pollution (Raux, 2004) and
CO2 (Albrecht, 2001; Raux & Marlot, 2005; Wadud, Noland, &
Graham, 2008; Watters, Tight, & Bristow, 2006). If a cap-andtrade system were to be implemented in the road transport
sector, there would be a number of issues to consider. The Albrecht
(2001), Grubb and Neuhoff (2006) and UK DfT (2007b) highlight
a number of points that need to be assessed and decided upon the
introduction of a cap-and-trade system for CO2 emissions (in the
road transport sector). These are:
Allocation of permits:
o How to allocate (auctioning vs. grandfathering)
o Whom to allocate (individual motorists, vehicle manufacturers, fuel producers)
o How many permits to allocate (cap on emissions)
Area of applicability of the policy (regional, national,
international)
Duration of the permit (time scale)
Decision over whether the emission trading scheme is a standalone scheme, or part of a broader emission trading scheme
across sectors
Interaction of the road transport emission trading scheme with
other schemes, such as the EU ETS, and other policies, such as
fuel taxation
Credibility of the scheme continuation
Costs and benefits for firms, road users and government
Long-term marginal abatement costs (which in transport
depend on intermodal shifts, penetration of highly fuel efficient vehicles, and behavioural change, amongst others)
Ellerman, Jacoby, and Zimmerman (2006) point out that the
main challenges in the introduction of emission trading schemes in
the transport sector come from the fact that emission sources are
small, dispersed and mobile, hence difficult and costly to monitor,
and from the fact that the transport sector is already highly regulated. This means that cap-and-trade systems need to be carefully
coordinated with existing policies if they are to achieve the desired
effects at the minimum cost, without imposing excessive burdens
on the targeted agents.
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
A baseline-and-credit system could also be envisaged instead of
a cap-and-trade system (Watters & Tight 2007, p. 8). In a baselineand-credit system, a baseline consumption of the resource is
established for each user. A period of time is then established for
compliance with the baseline. If actual emissions are lower than the
baseline, users are given credits. If they are higher, they must
purchase credits. The problem is that the emission limit is userspecific rather than universal. Hence, total emissions could
increase if new users entered the market (i.e. started using road
transport). On the other hand, under a cap-and-trade system a limit
of emissions for the whole sector (or for the whole country) is
established. Permits are allocated and participants are allowed to
trade these permits in a secondary market.
3.1. Grandfathering versus auctioning
The way in which permits are allocated to the relevant parties is
important. The two ends of the spectrum are grandfathering and
auctioning. As we explained above, grandfathering is an allocation
method based on historic emissions or indicators: the number of
permits allocated to an agent (a firm or a group of firms, a consumer
or a group of consumers, etc) has some degree of proportionality to
its historic emissions. Grandfathering is the method most
commonly used in practice, due to its greater political acceptability,
when compared to auctioning. Auctioning involves polluters bidding for emission permits, and is, from an economic point of view,
the most efficient as well as the most equitable allocation system,
as we will discuss below.
Any system of emission permits raises the prices of the goods
and services affected directly or indirectly by the scheme. Firms
needing emission permits will typically pass on their costs to
consumers.30 Consumers needing permits themselves will also end
up paying a higher final price for the good or service in question.31
However, the market price of permits is independent from the
allocation method (grandfathering versus auctioning).
Grandfathering however allows companies to make windfall
profits. This raises equity as well as implementation issues. To the
extent that shareholders of the profiting firms are richer than average,
this amounts to a transfer to the relatively rich. Equity considerations
also concern the treatment of new entrants versus incumbents.
Grandfathering discourages entry if new entrants, unlike the
incumbents, have to buy all the permits they need and are not allocated a share of permits for free (Watters & Tight, 2007). Implementation problems under grandfathering relate to the difficulty in
establishing historic emission levels, especially if the trading parties
are individuals (Watters & Tight, p. 6), such as for example, drivers.
Auctioning creates revenues for the government, which can be
redistributed in the form of, for example, tax cuts (Cramton & Kerr,
1999, p. 256). Hence, the use of auctioning has the potential to
correct distributional impacts. Revenues from auctioning permits to
fuel producers could also be channelled into investments in transport infrastructure, public transport, R&D of cleaner technologies,
etc. However, it has been argued that individuals or entities with
30
Obvious examples include an electricity company charging higher utility bills or
a car manufacturer raising the sale price of the cars he produces. On the other hand,
in the US, the power generation market in many states remains under cost-ofservice regulation. This prevents the electricity utilities from passing on the opportunity cost of free permits to consumers, reduces the price impacts of allocation
policies and causes suboptimal electricity conservation (Beamon, Leckey, &
Martin, 2001; Burtraw, Palmer, Bharvirkar, & Paul, 2001).
31
For example, if petrol consumption were included in an emission trading
scheme drivers would pay for petrol and for the permit to consume that petrol.
Drivers would perceive no change only in the case that permits replaced fuel duties
and the final average amounts paid were roughly similar.
15
greater financial power are in a better position to buy as many
permits as they require during the auctioning phase, thus threatening equity (although upper regulatory limits could be imposed to
prevent this effect) (Watters & Tight, p. 6). Finally, auctioning
provides more transparency and clearer long-term price signals
compared to grandfathering. Periodic auctions could improve price
stability and the management of uncertainty (Hepburn, Grubb,
Neuhoff, Matthes, & Tse, 2006, p. 147).
An important element to consider when evaluating emission
trading proposals is the impact of the scheme on the competitiveness of the industry it regulates. In the long term, the chosen
allocation method does not normally affect competitiveness.32
Grandfathering acts as a temporary subsidy to participants in the
scheme. It does not normally affect marginal costs, and marginal
costs determine competitiveness. Furthermore, evaluating
different proposals on the basis of competitiveness is only possible
in industries which are exposed to competition from countries
outside the scheme (which might not apply to road transport,
depending on whom the permits are allocated to), and which face
significant cost increases. The final point regarding competitiveness
is that auctioning has the advantage of making some border-tax
adjustments feasible. These can only be based on real cost
incurred as a result of the regulation under World Trade Organization rules. Auctioning helps align total costs (inclusive of
opportunity costs) with real costs (Hepburn et al., 2006).
Auctioning is to be preferred to grandfathering also from
a dynamic perspective in relation to the incentives it creates.
Theoretically, auctioning enhances incentives for innovation. This is
due to the fact that innovation ultimately leads to a decrease in
demand for permits, and consequently a decrease in prices of
permits. This reduces the scarcity rents which belong to the
industry under a grandfathering scheme, but do not under
auctioning (Cramton & Kerr, 2002). Hence, only the beneficial pricereduction effect is internalised by the industry under auctioning.33
In addition, grandfathering may lead to perverse dynamic
incentives in emissions reduction. This occurs when future rights
are a function of current emissions (which always occurs under
updating). In this case, regulation induces a higher amount of
current emissions than optimal. Also, when allocation of permits to
new plants is subject to more restrictive criteria than allocation of
permits to the incumbent, incentives to invest in new plants will be
reduced, and incentives for plant life-time extension will be
enhanced in a distortionary manner (Hepburn et al., 2006).
The case for free allocation of permits is mainly due to the fact
that it minimises problems of social and political acceptability
(Raux & Marlot, 2005). Also, in some instances, free allocation may
be administratively less costly. If an emission trading scheme were
to be implemented amongst motorists, free allocation would
allow at least a certain amount of fuel to be consumed at no
additional cost (Raux & Marlot, 2005). Even taking into account
the opportunity cost for a motorist of not selling the permit, this
opportunity cost would be the lost revenue but would not be an
‘‘additional’’ cost on top of what he paid for fuel previously.
Auctioning permits to such a large number of individuals would
not be practically feasible. Grandfathering has already been
shown to involve lobbying activities to get the preferred allocation
(Hepburn, 2007), and this would cause a loss of resources. Also,
a grandfathering allocation of permits among drivers would
32
This is so unless grandfathering allows an unprofitable firm to survive.
This is true unless permits are auctioned many years in advance, in which case
grandfathering and auctioning provide the same incentives (Kerr, 2000, in Cramton
& Kerr, 2002). Also, empirically, there is little difference between R&D efficiency
gains under auctioning and under grandfathering (Fisher et al., 2003).
33
16
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
involve administrative costs to collect the historic data necessary
for the allocation. These administrative costs would be even
higher under updating.
Finally, Parry (2003) analyses both carbon taxes and tradeable
carbon permits in a setting where there are pre-existing tax
distortions in the labour market (which is very likely to be the case
in virtually any economy) and finds that although both policies can
cause substantial efficiency losses in the labour market (relative to
abatement costs), these can be offset, or even more than offset, if
revenues from carbon taxes or auctioned permits are used to
reduce distortionary taxes. Thus, he concludes that there is a case
for using carbon taxes or auctioned permits rather than grandfathered permits.
3.2. Target group
The question of whom the permits should be allocated to - fuel
producers, vehicle manufacturers, or individual motorists - is not
easy to answer, and we shall evaluate each option separately.
Trading among fuel producers or car manufacturers is called
‘‘upstream’’ trading, while trading among individual motorists is
called ‘‘downstream’’ trading.
If the target group were fuel producers, they would be required
to hold permits to cover the total amount of emissions resulting
from the fuel they sell (UK DfT, 2007b). Oil refineries in the EU are
currently included in the EU ETS on the basis of their direct
combustion emissions, i.e. CO2 emitted during the fuel production
process. They are therefore already familiar with the EU ETS. In the
UK, regulating twenty fuel producers would cover 99 per cent of
fuel sales (UK DfT, 2007b). This means that the administrative costs
of this option would be relatively low. However, fuel producers
have few tools at their disposal for reducing emissions, mainly
efficiency increases in the production process and the alteration of
carbon composition of petrol. The main effect of emission trading in
the short run will be an increase in fuel prices, as refineries are
likely to pass on at least part of the cost of emission trading permits
to consumers. The likely short-term effect of the policy is a nonequitable regressive effect, similar to that of an additional tax on
fuel (Watters & Tight, 2007).34 A tax would have the advantage of
being less volatile, more easily adjustable, and requiring less
monitoring. The exact burden share between refineries and final
consumers of fuel would depend on supply constraints and the
level of competition, amongst other factors (Millard-Ball, 2009).
By and large, the main short-term impact on emissions of
upstream trading would be a reduction in fuel consumption due to
an increase in fuel prices (UK DfT, 2007b). Short-term responses by
motorists would be a reduction in the amount of travel and adoption of a more responsible travel behaviour (such as for example,
eco-driving, using public transport, walking or cycling, which are
discussed in Part II of this volume). In the long run, demand may
lean more towards more fuel-efficient vehicles (UK DfT, 2007b).
Demand for vehicle travel is relatively inelastic, especially in the
short term. Consequently, if the trading system was part of a multisector system (like the EU ETS), the transport sector would tend to
purchase credits rather than reduce emissions itself. Hence,
upstream trading would miss out on the potential for numerous
low-cost transport abatement measures (Millard-Ball, 2008).
Another weakness of an upstream emission trading scheme in
the transport sector is that it would undermine the effectiveness of
alternative measures to reduce emissions below the cap level. In
fact, investment in public transport improvement and demand
management policies, which lead directly to a reduction in
34
Regressivity of fuel taxes has been widely debated, as summarised in Section 4.
emissions, indirectly produce emission increases elsewhere in the
transport sector or in other sectors. This occurs through the price
channel. As emissions are reduced through some measure that is
not covered by the scheme, the permit price falls, and an increase in
emissions will be observed elsewhere in the economy. The implication is that the benefits from programs that could further reduce
emissions below the cap level are economic (reducing compliance
costs elsewhere) rather than environmental (reducing aggregate
emissions) (Millard-Ball, 2009).
Another emission trading scheme option in the road transport
sector would target vehicle manufacturers. Under such an
arrangement, manufacturers would be required to purchase
permits for emissions imputed to their vehicles (UK DfT, 2007b;
Millard-Ball, 2008). It would be difficult to retroactively cover all
vehicles in circulation but it would certainly be possible to cover all
new vehicles sold. The disadvantage of this approach is that it could
potentially boost the second-hand market, increase second-hand
car prices, prolong the life of fuel inefficient vehicles, and hit the
new vehicle market.
If car manufacturers were to trade emission permits, these could
be required to cover all expected future life-time emissions of the
fleet (total carbon approach), or emissions in grams of CO2 per km.
Since there are few car manufacturers, the ‘administrative costs
would be low’ (German, 2007, p. 95).
On the other hand, if the cap were based on expected life-time
emissions of the fleet and the estimates were not precise, the
desired carbon reduction objective could be missed. Furthermore, if
transport emissions were to be covered in the EU ETS, the adoption
of future emissions as a standard would risk undermining its
integrity because the EU ETS is based on current emissions.
A solution could be the setting up of a separate regulation for car
manufacturers, so that they would only be allowed to buy but not
sell emission permits in the EU ETS (UK DfT, 2007b).
Tradeable certificates would increase the involvement of the car
industry in the development of fuel-efficient vehicles (Millard-Ball,
2008) and create incentives to innovate. They would provide
a direct financial reward to the reduction of emissions from vehicles
(both in terms of type of car and type of fuel the car uses) and give
car manufacturers that have invested in fuel-efficient cars
a competitive advantage (Millard-Ball, 2008). The total carbon
approach would create incentives to reduce emissions at all
possible levels (German, 2007, p. 97). Beside the development of
new low-emission technologies, and the reduction in average
vehicle size, car manufacturers could respond with an increase in
marketing efforts to sell low emission vehicles (Watters & Tight,
2007). At the same time, if the permit price were high, highly
efficient cars would be made relatively cheaper and this would
stimulate their market penetration.
Not only would regulation at the manufacturers’ level have low
administration costs from an administrative point of view, as
already pointed out above, but it would also have the advantage of
avoiding politically-sensitive increases in fuel prices. However, it
has been argued that fuel-economy standards and feebates may be
equally effective in targeting the optimal fuel-efficiency of the
vehicle fleet (Millard-Ball, 2008). One of the major weaknesses of
a cap-and-trade scheme designed to target car manufacturers is
that it has a negligible influence on vehicle usage. This happens
because the number of permits and the consequent market price
are determined prior to the car-use decision made by consumers.
Double-counting is yet another potential problem if upstream
producers in another sector (e.g. fuel producers) are also included
in the emission trading scheme (Millard-Ball, 2008).
An option suggested by Gallagher et al. (2007) would be to
establish a market of permits that includes both vehicles manufacturers and fuel producers. This would increase the flexibility of
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
the system, but has greater implementation challenges and shares
most of the downsides of an upstream trading scheme discussed
above.
Downstream trading refers to the inclusion of individual
motorists into the cap-and-trade scheme. The inclusion could occur
under different formats:
Motorists could be required to use permits against the
purchase of fuel. Permits could be allocated for free by the
regulator or auctioned. Individuals could then trade their
permits. Bank operators or petrol stations could act as
intermediaries in the purchase and sale of permits (Raux &
Marlot, 2005). This would make this option similar to allocation to fuel producers (UK DfT, 2007b). A problem with this
option could be cross-border refuelling, unless and entire
region adopted such a system.
Motorists could be required to use permits against the
purchase of a vehicle. The number of automobiles would be
capped and vehicle ownership permits would be traded
(Millard-Ball, 2008).
Motorists could be required to use and trade parking permits or
vehicle kilometres travelled allowances, or tradeable driving
day rights.
Motorists could be endowed with personal carbon quotas or
domestic tradeable quotas to cover their entire carbon footprints,
including personal transport emissions (Millard-Ball, 2008).
Although downstream trading at individual motorist level could
be extremely costly to implement and monitor it would also have
a number of advantages.35 First of all, the maximum efficiency of an
economic incentive instrument is achieved when it operates at the
most decentralised level (Raux & Marlot, 2005). Second, a large
number of consumers would yield a large and liquid market for
permits (Watters & Tight, 2007). Third, a free allocation of permits to
individuals would create strong incentives for emission reduction,
due to the opportunity cost of using them, i.e. the clear monetary
benefit they would gain by selling excess permits on the market. In
the short run the system would probably act as a disincentive on car
usage. In the long run, it would act as an incentive to purchase lowemission vehicles. Finally, if permits were freely allocated in equal
amount to motorists, the system would be perceived as equitable
and politically acceptable (Watters & Tight, 2007).
Having said all that, the introduction of a downstream
scheme would not be free from weaknesses. In particular, if
permits were allocated for free in proportion to the number of
cars held by the individual, individuals would buy too many cars,
and would have no incentive to buy fuel efficient ones (Watters
& Tight, 2007).
If motorists were required to use permits against the purchase of
a vehicle, the link between car ownership and emissions would be
weak. Only parking externalities and emissions from construction
and scrapping of vehicles are directly related to car ownership
(Verhoef et al., 1997). Unless the number of permits were made
proportional to the emissions of the car, there would be no incentive
to shift towards more fuel-efficient cars. If that happened, the scheme
would miss the important connection between car usage and emissions, which matters more than the choice of vehicle type. Furthermore, the sale of permits through a bidding procedure (as in
Singapore, discussed in Section 2) in such a setting would disproportionately penalise individuals with lower income (Verhoef et al.,
1997).
35
An upstream system for fuel refiners with a number of permits proportional to
the carbon content of refined fuel would have similar advantages.
17
As already mentioned above, any of these downstream schemes
would entail substantial administrative and transaction costs, from
implementation to monitoring and enforcement (Watters & Tight,
2007), since the scheme would include a large number of emitters, each accounting only for a relatively small volume of emissions
(UK DfT, 2007b). The intermediation of retailers such as fuel
stations would certainly act to contain these costs and simplify
monitoring and enforcement (Verhoef et al., 1997).
3.3. Other considerations
Amongst other important considerations in the design of
trading schemes there are: the definition of the area of applicability
of a trading scheme, the possibility of integration of a (road)
transport trading scheme within other broader trading schemes,
and the choice of time validity of the permit. For example, it may be
advantageous to have a wider area covered by a trading scheme due
to the added liquidity in the permits market. In fact, a wider area
would mean a larger number of players, which would facilitate
finding a trading partner. With regards to the length of the validity
of the permit, there are potential trade-offs. The shorter is the
permit duration, the lower is its tradability, and the higher are the
transaction costs. However, the longer is the validity of a permit,
the greater is the uncertainty about future prices. Uncertainty, in
turn, undermines the efficiency of the trading system.
If the road transport sector were included in the EU ETS drivers
would probably become net buyers of permits, at least in the shortrun. This would be likely to happen unless permit prices were so
high that alternative technologies became attractive, or unless
additional requirements were imposed. It should be stressed that
motorists, fuel producers or car manufacturers becoming net
buyers is a desirable characteristic of economic instruments and not
an imperfection. Reductions would be made where the marginal
abatement costs are lower, which would be in other sectors of the
economy,36 rather than the road transport sector. If the regulator’s
objective were to guarantee a certain level of emission reduction
from road transport, then a separate scheme (perhaps linked in
some way) to the EU ETS would need to be designed.
3.4. Concluding remarks
A cap-and-trade system is one in which the regulator determines a cap on emissions, pollution or waste and leaves their
allocation amongst polluters to be determined by the market.
Polluters can trade permits: those with lower marginal abatement
costs sell permits and those with higher abatement costs buy
permits. There are mainly two initial allocation methods: grandfathering and auctioning. With grandfathering, permits are allocated to each polluter for free, according to their past (historic)
emissions. With auctioning, polluters pay for the permits they wish
to buy, according to the price that emerges from the auction.
Although there have been and there continue to be proposals to
introduce cap-and-trade to deal with different externalities (lately
with CO2 emissions), no such system has been implemented in the
road transport sector anywhere in the world yet.
Implementing tradeable permits in road transport would entail
a number of decisions, including how to allocate (auctioning vs.
36
However, Parry (2007) argues that the benefits from auctioned (rather than
grandfathered) permits (and also taxes) to reduce road transport emissions are
larger than the costs when account is taken of (a) their impact on reducing other
road transport externalities such as accidents, congestion, local air pollution and
oil dependence and (b) interactions with the broader fiscal system such as the
use of revenues to reduce distortionary labour taxes.
18
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
grandfathering), whom to allocate (individual motorists, vehicle
manufacturers, fuel producers), how many permits to allocate
(actual cap on emissions), area of applicability of the policy
(regional, national, international) and duration of the permits, to
name just a few.
Although fuel and vehicle taxation is already in place, and
adjusting it would be administratively less costly than introducing
an entirely new system, such as cap-and-trade, there seems to be
a trend around the world to favour or welcome the novelty of the
concept of tradeable permits, and just because of that reason, capand-trade may have a role to play in the road transport sector in the
short, medium and long-run.
4. Incentive based policies: fiscal policy instruments
Governments use taxes for two reasons: either to generate
revenues and to redistribute part of the revenues to achieve
a ‘‘fairer’’ distribution of resources in society and provide goods or
services that the market by itself would not provide (such as for
example, defence) or to correct market failures. The first type of
taxes are distortive taxes, the second type are corrective taxes.
What the two types of taxation have in common is that they act as
incentives (or disincentives) on behaviour, by increasing the
marginal cost of certain activities. What they differ on is that the
first type of taxes is introduced in an otherwise efficient economy.
Their introduction generates a deadweight loss, by ‘inserting
a wedge between marginal cost and price’ (Cramton & Kerr, 2002, p.
339). The second type of taxes, on the other hand, is introduced in
an otherwise inefficient economy, in order to correct the distortions
and change behaviour so as to restore efficiency.
The road transport externalities discussed in Section 1 are
examples of the type of inefficiency that can arise in an economy. As
it was already advanced in that section, one possible instrument
that can be used to correct the distortion is a corrective or Pigouvian tax, charge or fee. Such a corrective tax can help align marginal
private costs with marginal social costs.
In practice, any economy will have inefficiencies, and any
government will try to provide at least some of the services which are
not typically provided by the market and pursue some equity goals. As
a consequence, both distortive and corrective taxes will typically be
present. Corrective taxes, besides tackling the market failure,
generate revenues that the government can use to finance expenditures or (at least partially) to substitute for distorting taxes.37
Taxes have been widely implemented in the road transport
sector around the world, both in developed and developing countries. These have been introduced as either IB instruments to
influence travellers’ behaviour in such a way as to induce a given
response that reduces or corrects market failures, or as revenue
raising instruments. For example, the taxation of cars can be
structured so as to limit ownership, promote adoption of cleaner
vehicles, change age and class car structure within a market, and
improve car maintenance (Hayashi, Kato, & Teodoro, 2001, p. 124),
at the same time as generating revenues. The effectiveness of taxes
as corrective instruments depends on the strength of the link
between the externality they are targeting and the tax itself. If this
link is weak, then drivers, polluters, or road users may respond in
an inefficient way (Crawford & Smith, 1995, p. 40).
Parry and Small (2005) attempt to compute the optimal petrol
tax in the US, if this were to internalise congestion, accidents and
local and global air pollution. Parry (2008) conducts a similar
exercise for diesel tax in the US, accounting for accidents, road
damage, noise, energy security, and local and global pollution
37
This is the double dividend hypothesis, which is discussed in Section 4.5.
externalities. Although Parry and Small (2005, p. 1277) recognise
that global warming is ‘the only component for which the fuel tax is
(approximately) the right instrument’, they still estimate what the
fuel tax should be if it were to internalise most road transport
externalities, and assuming no other tax or charge were implemented simultaneously.
There are many types of taxes and charges in road transport.
Several factors determine the ideal policy instrument to be selected
(Timilsina & Dulal, 2008). These are the type of externality that the
government wants to target, e.g. emissions versus congestion,
global emissions versus local emissions; the flexibility the
government has to meet the targets; the nature of information
asymmetries; the specific characteristics of the location; and ultimately the (administrative and monitoring) costs and benefits
associated with each instrument. For example, fuel consumption is
closely related to the global warming impact of a vehicle. However,
PM emissions and noise also strongly depend on location, weather
conditions and congestion levels prevailing at the time the vehicle
is driven. Hence, even though fuel taxes may be good instruments
to target global warming, they may be less effective for targeting
local air pollution (Crawford & Smith, 1995, p. 34). Proost, Delhaye,
Nijs, and Van Regemorter (2009) argue that (high) fuel taxes are
imperfect instruments to internalise all transport externalities
simultaneously.
Another important consideration concerns the distinction
between first best and second best policies. While in a first best
context one instrument can suffice to reach the optimal allocation,
in a second best context,38 many instruments may need to be
combined to obtain the best feasible allocation. This may involve
the taxation of activities that are complementary to the taxation
of fuel and vehicles, when these cannot account for the full social
costs, and subsidisation of substitute activities. Hence, additional
parking charges or subsidisation of public transport may be
advisable (Crawford & Smith, 1995, p. 44). Second best situations
are likely to be the rule rather than the exception in a context of
transport externalities and corrective taxes (Verhoef, 2000, p.
308).
4.1. Taxes on purchase and ownership of a vehicle
Many countries impose taxes on the purchase of vehicles, and/or
a periodic (e.g. annual) licence fee on the ownership of a vehicle.
Purchase taxes are direct tools to address CO2 emissions generated
during the manufacturing and disposal of vehicles. However, CO2
emissions generated during purchase and disposal account for only
a small share of life-time vehicle emissions, which purchase and
ownership taxes do not directly tackle (Hayashi et al., 2001) in their
basic undifferentiated form. In fact, as such, the primary impact of
a purchase tax is a reduction in the number of vehicles in circulation (Chia Tsui, & Whalley, 2001), and a longer tenure. A longer
tenure implies increase in the usage rate of vehicles (De Jong, 1990,
in Barter, 2005). This is a perverse incentive that induces overconsumption of older and more polluting models. In addition,
Pritchard and DeBoer (1995, in Timilsina & Dulal, 2008) point out
that if higher taxes on new vehicles are not matched by higher
taxes on second-hand ones the policy may fail to bring about
a reduction in car ownership. Higher taxes on new vehicles only can
otherwise result in a perverse effect, shifting purchase behaviour
towards older and more polluting vehicles. In general, purchase and
ownership taxes also increase business costs of a country and harm
its competitiveness (Barter, 2005). However, more sophisticated
38
Second best refers to the optimal policy when the true optimum (the first best)
is unavailable due to constraints on policy choice.
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
forms of purchase and ownership taxes can be envisaged that
better target vehicle usage emissions and internalise (at least
partly) environmental externalities. These are differentiated taxes,
on the basis of fuel economy characteristics of vehicles, or other
vehicle characteristics.
In the case of purchase taxes, these can be differentiated on the
basis of fuel consumption per mile, type of fuel supported, horsepower, size of engine, vehicle weight, and retail price. Jonhstone
and Karousakis (1999, p. 101) identify model year, mileage and
the presence of fuel injection as the most significant factors that
contribute to emissions of HC, NOx and CO. In the case of ownership
taxes, relevant characteristics also include vehicle age. Such
a differentiation provides price signals to consumers that act as
incentives or disincentives on their purchase decisions (Evans,
2008) and can, for example, encourage a shift towards smaller
cars (Acutt & Dodgson, 1997, p. 23). However, there is often a tradeoff between the precision of the characteristics as a basis for
emissions correction, and the easiness in adoption of such a basis.
For example, engine size is straight-forward to tax. However, its
correlation with emissions of conventional pollutants might be
weak compared to a tax on emissions-per-km. Emissions-per-km
are, however, less easily measured, since they depend on engine
size, vehicle age, fuel cleanliness and pollution control equipment,
as well as driving style (Fullerton & West, 2003 p. 5; Fullerton &
Gan, 2005, p. 300).
Differentiated taxes are potentially effective tools and administratively relatively simple, since a tax system is already in place.
Moderate costs can arise from modifications to the tax collection
system that may be required if the tax structure is changed (Acutt &
Dodgson, 1997). Although purchase and ownership taxes are low
relative to the total cost of purchase, ownership and usage of a car,
they can have a significant impact by influencing choice of car
ownership at the margin (Knight, Vanden Branden, Potter, Enoch, &
Ubbels, 2000). Differentiated vehicle tax systems have an impact
both on the supply and on the demand of vehicles. They incentivise
manufacturers to improve the fuel efficiency of vehicles, so as to
reduce consumers’ tax burden and they provide incentives for
consumers to privilege fuel economy in their purchase choice (Evans,
2008). However, a danger exists that imposing a tax on a certain
characteristic will elicit a manufacturer’s response in vehicle’s design
that eludes the tax and breaks down the observed relationship
between characteristic and emissions. As a consequence, these
policies are more effective in countries that do not have significant
manufacturing capacity (Jonhstone & Karousakis, 1999).
An ideal differentiated tax to internalise emissions would be set
equal to the present value of the social costs of emissions, the
vehicle’s emissions per mile or km, and the life-time mileage choice
(Jonhstone & Karousakis, 1999). However, this is difficult to
implement in practice for several reasons. Firstly, assessing the
social costs of emissions is a complex and costly task. Secondly, if
the tax is calculated at the time of purchase, the life-time mileage
choice is an ex-post decision, and the fixed tax remains an initial
sunk cost. As a consequence, the tax does not present the driver
with the correct subsequent incentives for mileage choice, pollution control equipment maintenance, and length of vehicle lifetime. For this reason, it might be advisable to combine a purchase
tax with a fuel tax and/or a congestion charge, measures which act
directly on usage decisions (Jonhstone & Karousakis, 1999; Sterner,
2003, in Evans, 2008).
When taxes are combined, one classic problem if the combination is not carefully designed is that of double charging. For
example, a tax based on the size of engine is superfluous when a tax
on fuel is already in place, since larger engines are associated with
greater fuel consumption (Fullerton & West, 2003). If the vehicle
tax was determined on a periodic basis, then periodic odometer
19
readings could lead to efficient internalisation of usage choices,
since intensity of car use could be taxed. However, individuals
would have incentives to roll back their odometers (Fullerton &
West, 2003, p. 53). This, however, is becoming increasingly
harder, as electronic odometers are being introduced.
Whether the tax is levied on purchase or on an annual basis has
consequences on incentives. If purchase of both used and new
vehicles is taxed, then, as previously argued, the turnover of the
vehicle stock is reduced, as the price of new vehicles increases. This
slows down emissions reduction, as new vehicles are typically
cleaner than older ones (Jonhstone & Karousakis, 1999). A tax
proportional to age of the vehicle bought (or a subsidy on new
vehicles) could counteract these perverse incentives and play
a significant role in reducing emissions, by discouraging the
purchase of older vehicles (Fullerton & West, 2003). A periodic tax
makes consumers bear the costs of continued operations of
a polluting vehicle, and can potentially foster maintenance activities that reduce emissions. In addition, a periodic tax allows the
adjustment of the tax on the basis of time-variant characteristics
that are linked to pollution, e.g. age. Age is highly correlated with
emissions, and is easier to observe and tax than emissions per km.
However, Fullerton and Gan (2005, pp. 303–304) find that a tax on
age is not very effective in reducing emissions, compared to a tax on
fuel or on emissions-per-km.
The distributional effect of differentiated tax policies on
purchase and ownership depends on the characteristics taxed, and
on the characteristics of the households in the location where the
policy is implemented. For example, Fullerton and West (2003)
show that in California, a tax on vehicle size would be progressive, as household wealth is positively correlated with vehicle size.
However, West (2004) shows that overall in the US a tax on size
would be regressive, since higher income households’ preferences
for size are non-homogeneous across vehicle age: ‘households with
higher incomes that own 1980s-vintage vehicles prefer smaller
engine sizes, while those with 1990s vehicles prefer larger engine
sizes’ (p. 738). Thus, expenditure on the size-tax would account for
a smaller share of household income in high income compared to
low income households. A subsidy to encourage the purchase of
new vehicles would also be regressive, since higher income
households prefer newer vehicles (West, 2004, p. 738). Similarly,
a tax based on vehicle age would also typically have a higher impact
on lower income families (Fullerton & West, 2003).
4.1.1. Subsidies to efficient vehicles and feebates
Subsidies for the purchase of fuel efficient or alternative fuel
vehicles are an important economic instrument to encourage the
purchase of low (or zero) emission vehicles. Consumers may choose
not to buy a cleaner (but more expensive) vehicle, especially if the
annual distances driven provide no opportunity to capture the
benefits from fuel savings over the life of the vehicle (McKinsey &
Company, 2009, p. 19). In these cases, subsidies may be effective in
tilting consumers’ preferences. However, they may also lead to an
increase in the number of car ownership, offsetting the subsidies’
beneficial effect. The choice of subsidy policies needs to be carefully
matched to technological information and information about the
specific local characteristics. For example, if electric cars were to be
subsidised, the way in which the electricity they consume is
produced (e.g. coal vs. nuclear power stations) would need to be
taken into account. Similarly, from a fuel consumption and CO2
emissions point of view, hybrid cars are a good choice in towns and
cities, where speeds are low and congestion is a problem. On trunk
roads, on the other hand, the advantage of hybrids over conventional petrol cars is much smaller.
An alternative to subsidies would be deductions from taxable
income to make up for part or all of the vehicle cost, or tax credits
20
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
for the purchase of cleaner vehicles. In designing tax credit
schemes, care must be taken not to inadvertently create perverse
incentives. In the US, for instance, the CAFE credits given to hybrid
vehicles are discounted so as to reduce the extent by which
manufacturers can cross-subsidise fuel inefficient vehicles by
producing some extremely efficient ones (US NHTSA website b).
Another crucial observation is that the distributional impact of
a subsidy is not the same as the distributional impact of a tax
deduction or tax credit. In fact, the primary and (perhaps the only)
beneficiaries of tax deductions and tax credits are those individuals
who earn taxable income, i.e. the relatively rich in the population.
In addition, if the chosen format is deductions from taxable income,
the benefits will be higher the higher the income when taxation
systems are progressive, hence the system would be regressive, and
for this reason, not desirable from an equity point of view.
A particularly attractive form of subsidisation is that of feebates,
a term used to describe a scheme which combines fees and rebates.
This could take the form of for example, purchase taxes on fuel
inefficient vehicles, and rebates on the price of fuel efficient ones.
Feebates reduce the burden on the government’s finances
compared to simple subsidies. By financing the subsidisation of fuel
efficient vehicles through taxation of less efficient ones, feebates
have the potential to be budget neutral instruments (BenDor &
Ford, 2006; Koopman, 1995).
Feebates can shift both demand and supply of vehicles. In fact,
not only do they alter the purchase price of a vehicle, but they also
encourage manufacturers to develop and adopt low emission
technologies on the vehicles offered, in order to best exploit the
feebate system in place, and get a head start over competitors. The
supply response to the feebates incentive occurs also when feebates
are offered directly to consumers. Consumers’ demand, however,
does not shift when feebates target manufacturers on the basis of
their sales mix within a model year. This suggests that consumers
should be the privileged target for the application of such schemes.
Feebates can provide an incentive to meet vehicle standards in
a more efficient way than through the internal pricing strategy each
vehicle manufacturer would undertake under normal competitive
conditions. They can also work alongside congestion charges and
fuel taxes as additional price signals (Greene, Patterson, Singh, & Li,
2005), by strengthening the life-time fuel saving linkage to the
purchase decision (Evans, 2008), which may be weak due to
‘imperfections in the market for fuel economy’ (Kunert & Kuhfeld,
2007, p. 315). The shortcoming of feebates is that they target only
the new vehicle fleet. Hence, the emissions reduction that they
achieve is gradual, and their full potential can only be achieved
within the span of one or two decades as the whole fleet renews
(BenDor & Ford, 2006). For this reason they are considered longterm measures. The effect of feebates on emission reduction will
also be mitigated by the rebound effect (Evans, 2008). This effect
arises whenever consumers buy more fuel efficient cars, thus face
a lower cost per km and travel longer distances in response.
One of the appealing features of feebates is their potential
neutrality on government finances. This is a theoretical possibility
that stems from the fact that there always exists a zero-point level
(where no taxes or subsidies are imposed) and a feebate structure
such that the expected revenues equal the expected costs of the
policy. In practice, however, calculating the optimal structure
presents an important challenge, due to the uncertainty regarding
consumers’ response to feebates and the elasticity of substitution
between different car models. This uncertainty makes it difficult to
determine the optimal feebate rate (Gallagher et al., 2007).
However, Ford (1995, in BenDor & Ford, 2006, p. 1200) demonstrates that despite the uncertainties over market shares, it is
possible to maintain a reasonable balance and control the finances,
provided that the subsidisation plan is flexible enough.
4.1.2. Scrappage incentives
Scrappage incentives, also known as voluntary accelerated
vehicle retirement programs, are rebates granted to owners of old
vehicles upon scrappage (Evans, 2008).39 These incentives directly
act on the fleet of old vehicles in circulation, which are responsible
for a (relatively) disproportionately higher share of emissions than
newer vehicles (Evans, 2008). The immediate benefit that this
policy aims at is an earlier scrappage of some vehicles and
a consequent reduction in fuel consumption due both to the higher
fuel efficiency of newer vehicles, and to a reduction in the number
of vehicles if the old ones are not replaced (Acutt & Dodgson, 1997).
However, Alberini, Edelstein, and McConnell (1994) point out that
scrappage incentives may lead some individuals to keep their
vehicles longer so as to reach the age at which they become eligible
for the scrappage scheme. Similarly, De Palma and Kilani (2008)
show that scrapping premia may perversely delay the replacement of vehicles due to the fact that an old car will be more
valuable with the scrapping scheme than without. The costs
imposed by scrappage schemes on the government consist of the
subsidies and administration costs. The schemes are generally
considered relatively easy to implement (Hsu & Sperling, 1994, pp.
90–98). However, many scrappage programs have been financed by
private companies as a way to achieve imposed regulatory standards or to obtain emissions offsets (Alberini, Harrington, &
McConnell, 1998).
Assessing the benefits of a scrappage scheme is not an easy task,
since there are a number of uncertainties over car use and emissions
(Hsu & Sperling, 1994). Another problem associated with the evaluation of the cost effectiveness of scrappage schemes is that of moral
hazard (only the worst cars get scrapped, which are hardly used
anyway),40 which makes it difficult to adequately ‘reward actual
emissions reduced by scrapping a vehicle’ (Hahn, 1995, p. 239). The
problem can be worse if it is difficult to estimate the remaining lifetime of a particular vehicle (Hahn, 1995, p. 239).41 Vehicles that are
scrapped under a scrappage scheme are likely to be those in worst
condition and almost at the end of their life (Alberini et al.,1994). Old
vehicles that are not replaced upon scrappage are likely not to have
been in active use prior to being scrapped. Hence, their contribution
to emissions and consequent social costs would have probably been
lower than the scrappage bonus.
This may explain why the literature is not unanimous in its
assessment of the benefits of scrappage schemes on emissions.
BenDor and Ford (2006) predict that, even if all vehicles scrapped
are immediately replaced, the scheme leads to large and immediate
(HC) emissions reductions (BenDor & Ford, 2006). Sandström
(2003), on the other hand, points out that the effect of scrappage
policies on emissions is ambiguous. Alberini et al. (1998) show that
the reduction in emissions is small unless a substantial scrappage
premium is offered, which reduces the cost effectiveness of the
scheme. Van Wee, Moll, and Dirks (2000) go further and claim that
scrapping programs may lead to an increase in CO2 emissions over
the life-cycle of vehicles. This is due to the fact that an increase in
39
Sometimes the rebate is conditional on the purchase of a new car (on which
a purchase tax is levied).
40
Moral hazard is related to the problem of asymmetric information, a situation
in which one party in a transaction (such as for example the car owner) has more
information than the other (the regulator). Moral hazard occurs when the party
with more information (e.g., about the vehicle being very old and not even in use
or about to be scrapped anyway) has an incentive to hide the information from
the other party (e.g., the regulator, who is about to pay the owner of the vehicle
an amount for scrapping the vehicle).
41
A common assumption in policies is that scrappage vehicles are similar to the
average vehicle in a given model year cohort in terms of remaining life, distance
driven and emission levels. But the self-selection bias makes this assumption wrong
(Alberini, Harrington, & McConnell, 1995).
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
car production leads to increased emissions in assembly and new
cars are faster and bigger than the old cars they replace. Retrofitting
high-pollutant vehicles may thus be more cost effective than
scrapping.
Careful design of eligibility requirements for scrappage schemes
is a fundamental issue. Some scrappage schemes require that the
vehicle be driven to the scrappage site so as to prevent appropriation of bounties for vehicles that would not have produced
emissions because they were not operational. When the scrappage
system is local, and aimed at reducing local air pollution, another
important requirement is that the vehicle be registered in the local
area, so as to prevent an inflow of vehicles from other areas with
the sole purpose of scrapping them (Hahn, 1995). The effectiveness
of a scrappage program in reducing emissions is greater if lowquality cars are the largest emitters, which may not always be
the case. If a large portion of high-quality used cars contributes
to pollution, and their value is higher than the scrappage
premium, the achieved emissions reduction from the scheme will
be relatively low (Mazumder & Wu, 2008). This is due to the fact
that the value of cars is not necessarily negatively correlated with
the emissions produced, since for example a larger car (of higher
quality), may have the same market value as a smaller newer car
which produces less emissions. Hence the subsidy will not be
enough to induce scrappage of these high-quality high-emitters.
Scrappage schemes can be either permanent measures, or
temporary measures introduced, for example, to boost car demand
at a specific moment. A permanent scrappage scheme will accelerate the vehicle fleet turnover as it is equivalent to a negative
purchase tax. If a purchase tax is levied, and refunded with interests
at the time of scrappage, the system is revenue neutral (i.e., it has
no impact on the government’s finances), and the life-length of
vehicles is reduced, although the size of the vehicle fleet is not
affected. Sandström (2003) argues that a scrappage scheme will
lead to an increase in the size of the vehicle fleet, which increases
emissions. As a consequence, emissions may not be reduced, and
may even increase.
A temporary scrappage scheme, on the other hand, will not have
a long-term impact on the life-length of vehicles (Sandström, 2003).
Temporary scrappage schemes have the potential to reduce emissions and burst sales in the short-term. The temporary burst of sales
will also depend on the fact that people will typically delay their
scrapping decision between the time the policy is announced and
the time the policy becomes effective.42 The medium-term effect
will be a reduced level of activity, since the age distribution of the
vehicle fleet will have changed (Adda & Cooper, 2000). The scrappage scheme might even lead to an increase in emissions relative to
the no-scrappage incentive scenario, if some technological breakthrough appears when cars have just been replaced as a consequence of the scheme (Sandström, 2003). Finally, it should be noted
that there is no market failure rationale for scrappage policies and
they can even be efficiency-reducing if petrol is priced according to
marginal social cost.43
The introduction of scrappage incentives has an impact on the
second-hand car market. Used cars will be imported either to be
scrapped so as to take advantage of the bonus, or to replace vehicles
which have been scrapped (Hahn, 1995). This may partially off-set
the emissions reduction, depending on the age of migrating vehicles (Dixon & Garber, 2001 in Evans, 2008). Policy-makers can avoid
this effect through the introduction of taxes on imports, or through
42
Sales tend to over-react, hence they are not a good benchmark when analysing
car markets (Sandström, 2003).
43
If petrol is priced according to marginal social cost, all the externalities have
been internalised already and there is no need for any further measures.
21
restrictions on program eligibility (Hahn, 1995). Careful design of
the scrappage program is thus essential, in particular, in order to
avoid creating demand for old vehicles (Gorham, 2002, p. 116).
Scrappage subsidies could theoretically lead to an increase in the
price of used vehicles due to an increase in their demand (Alberini
et al., 1994). This price increase would weaken the scrappage
incentive (Gorham, 2002) and have regressive distributional
effects, since people on lower incomes are more likely to purchase
used cars. This problem can be avoided by implementing strict
eligibility requirements for scrappage, for instance, requiring that,
prior to scrappage, a car must have been registered for a certain
amount of time in the area with the scrappage policy in place.
Regarding the distributional effects, it should also be noted that
people on low incomes are generally also more likely to own old
vehicles and hence benefit from the scrappage premium (Acutt &
Dodgson, 1997).
The appeal of scrappage schemes weakens over time. As the
vehicle fleet approaches a zero emissions level,44 the gains to be
made by scrapping old vehicles decreases. Hence, a scrappage
scheme is best suited to be a transitional strategy (Hahn, 1995). The
effectiveness of a scrappage program is also a function of location.
In fact, local schemes do not affect the supply of used cars and are
therefore less costly, as they do not need to respond to increases in
the value of used cars by offering higher premia (Alberini et al.,
1994). Furthermore, the emissions-reducing potential of scrappage schemes is stronger in highly polluted metropolitan areas
with a large share of old vehicles (Hahn, 1995).
Scrappage schemes need not be stand-alone measures and
indeed are unlikely to be effective instruments for emissions
reduction, if adopted alone (Alberini et al., 1998, p. 20). It is possible
to combine scrappage incentives with a system of feebates, or to
graduate incentives on the basis of the fuel economy of the
purchased car. This combination would have the additional benefit
of creating incentives regarding both old and new vehicles,
promoting adoption of the cleanest new vehicles (Evans, 2008). The
system would lead to both a short-term and a long-term decrease
in vehicle emissions, and fees on high-emitting new cars could
finance subsidies on clean new vehicles and scrappage (BenDor &
Ford, 2006).
The existence of inspection and maintenance programs can also
affect the effectiveness of scrappage incentives. More stringency in
inspection and maintenance leads to more scrappage for a given
bonus, but could reduce cost effectiveness (Hahn, 1995, p. 222).
Alberini et al. (1998) show that the introduction of a scrappage
program under an existing inspection and maintenance program
can be welfare-increasing. Gorham (2002) discusses the possibility
of tying a scrappage program to the grant of a free public transport
pass. Other alternative policies to scrappage incentives include
a reduction of purchase taxes relative to usage taxes, or a differentiation of usage taxes on the basis of age (Sandström, 2003).
4.2. Taxes on usage of a vehicle
Usage taxes are imposed on the basis of a vehicle’s usage. If the
vehicle is left idle, there are no usage taxes to be paid. Examples of
these charges include fuel taxes, tolls, congestion charges and
parking charges. Together with ownership taxes, usage charges
constitute an important policy, which affects demand and supply
44
This statement depends on the type of emissions and fuel in question. While
local air pollutants may be reduced and even approach zero, as long as vehicles
run on oil-based fuels carbon dioxide emissions may go down in time but they
will never approach the zero level. Carbon emissions are an inevitable product of
oil-based fuel combustion.
22
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
and reduces road transport externalities, in particular environmental externalities, such as global warming resulting from CO2
emissions.
4.2.1. Emission taxes
Emission taxes are in theory direct Pigouvian taxes, which
should be set equal to the marginal cost of the actual level of
emissions generated by each vehicle. Emission taxes are the first
best instrument to correct emission externalities and induce the
optimal driving behaviour and vehicle’s purchase and usage choice
(Acutt & Dodgson, 1997, p. 23; Jonhstone & Karousakis, 1999, p.
100). However, under current technology, direct charging for
emissions is not feasible due to the lack of cost effectiveness and
impracticability of monitoring techniques (Fullerton & Gan, 2005, p.
300; Fullerton & West, 2000, p. 1; Plaut, 1998, p. 194).
The level of emissions generated by a vehicle does not only
depend on fuel usage, but also on contingencies that are less easy to
pin down. These include vehicle characteristics such as size, age,
and maintenance, driving behaviour such as frequency of cold-start
ups and speed, location and time-dependent characteristics such as
air temperature (Fullerton & West, 2000, p. 3). Hence, implementation of an emission tax would require monitoring of actual
pollution generated by each vehicle on circulation (Jonhstone &
Karousakis, 1999). Remote sensing of emissions with infrared
beams has been suggested as a possibility for effective monitoring.
However, this system has many weaknesses. Complexity, lack of
detection of non-tailpipe emissions and of some types of tailpipe
pollutants reduces its appeal (Johnston and Karousakis, 1999, p.
100; Fullerton & Gan, 2005, p. 300).
Given the practical obstacles to the implementation of an
emissions tax, Fullerton and West (2002) demonstrate that the
same efficiency can be achieved with a petrol tax that depends on
fuel type, engine size and pollution control equipment or with a tax
that depends on distance. Having said that, given that emissions of
air pollutants per km (which have mainly local and regional
impacts rather than global impacts) have declined substantially
with the introduction of tighter standards in different countries
around the world, a tax to control these emissions may not be
necessary after all.45
One type of emission tax that focuses on a specific type of
emission, namely carbon, is a carbon tax. This instrument would be
almost ideal in the fight against global warming. Almost refers to the
fact that other GHG such as methane are emitted from vehicles and
contribute to global warming (Harrington & McConnell, 2003).
A carbon tax would be implemented as a tax on the carbon content
of fuel,46 and could be paid at the moment of fuel purchase, as it is
currently the case with fuel duties. A carbon tax has an impact both
on the choice of fuel type and on the aggregate fuel demand, as
determined by vehicle fuel economy and vehicle usage (Gorham,
2002). It could lead to dynamically efficient choices of ‘ever
cleaner technology and energy conservation’ (Pearce, 1991, p. 942).
The tax could be accompanied by reductions in incentive distorting
taxes such as income taxes (double dividend feature), so as to be
revenue neutral on the government’s budget.
An ‘‘optimal’’ carbon tax would be one designed to meet
a specific target of CO2 emissions reductions. However, there are
several drawbacks, which must be considered. First, in order to
design such a tax, it would be necessary to know with precision the
inter-fuel substitution elasticities (since the carbon tax on a fuel
45
This does not apply to CO2 emissions, which have not been subject to the same
type of standards.
46
In its application a carbon tax would effectively be a specific type of fuel tax.
Fuel taxes are discussed in more depth in Section 4.2.2.
varies by its carbon content), as well as the income and price
elasticities.47 Second, a carbon tax is potentially regressive, since
lower income households may spend more on carbon intensive
activities. Third, the tax may impact competitiveness of the country
where the tax is imposed relative to other countries (Pearce, 1991).
Lastly, a tax based only on CO2 may distort incentives in emissionreducing activities towards activities that increase local air pollutants, since CO2 emissions and other emissions may be negatively
correlated.
4.2.2. Fuel taxes
Fuel taxes are applied in virtually every developed and developing country in the world, as they constitute a low cost effective
revenue generating instrument. However, they are typically
defended by politicians on environmental grounds (Newbery,
2005a, p. 24) and indeed they have a potential role as emissions
reducing instruments. The most striking advantage of fuel taxes
over other policy instruments is their administrative simplicity, due
to the fact that a tax collection system is already in place. Collection
of fuel taxes can occur at the level of fuel wholesalers or refineries,
of which there are relatively few, thus reducing collection costs and
the likelihood of fraud or evasion (Wachs, 2003), or it can occur at
the level of retailers, e.g. at the petrol station. The tax burden will
ultimately fall on consumers, regardless of where they are
collected, as the cost is likely to be passed on to them. Although fuel
taxes generate revenues for the government which can be reinvested profitably, the burden on drivers, and spill-over effects on
the economy contribute to making fuel taxes unpopular, and reduce
the political viability of a tax increase.
Fuel taxes can serve as price signals (Wachs, 2003) to drivers on
the social cost of the externalities they produce. In order for this to
occur, it is crucial that the structure of the taxes be transparent and
the composition of the tax well understood by motorists. If
motorists are not aware of the changes in behaviour that will
reduce their tax payments, the tax will not have the desired effects
(Gorham, 2002). CO2 emissions are closely correlated to fuel
consumption, and thus they can be easily internalised through
a fuel tax. Congestion, accidents, and local air pollution are externalities which are only indirectly targeted by fuel taxes. The total
costs of these externalities, however, have been estimated as being
14 times the cost of GHG emissions (Evans, 2008). Hence a tax
based on local emissions, distance driven, or peak-time congestion
would be better suited than a fuel tax to internalise these other
externalities (Newbery, 2005a; Parry & Small, 2005).
An optimal fuel tax requires a fair amount of information on
private and social costs and benefits for its calculation. If ad valorem,
the optimal tax would ideally need to be readjusted as oil prices
change (Watters et al., 2006, p. 2). Fuel prices, however vary on
a daily basis and there is typically going to be an implementation
lag that prevents the adoption of the correct tax. Adjustment of
taxes to match the oil price would also create uncertainties in
government’s revenues (Leicester, 2005).
Nonetheless, fuel taxes have been cited as an extremely effective
climate policy instrument. Sterner (2007) for example, stresses
their importance as instruments to reduce environmental externalities and keep emissions under control. He argues that had
Europe followed the US pattern of low fuel taxes, it would have had
twice as much fuel consumption as it has now. Hence any attempt
to abandon fuel taxation light-heartedly, e.g. as part of integration of
transport into the EU ETS, could be dangerous.
47
Note that this information can be learned and the tax adjusted iteratively.
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
The immediate effect of an increase in fuel taxes is on demand,
in the form of a reduction in km driven, through the impact of taxes
on the marginal cost of driving. More long-term effects include
incentives to scrapping old vehicles,48 reducing car ownership, and
favouring vehicles with higher fuel economy at the time of
purchase. Cobb (1999) finds that the predominant effect of an
increase in petrol tax in the US would be a shift towards more fuel
efficient vehicles; this would be accompanied by a modest modal
shift in the direction of public transport, and a minor shift to carpooling. A supply effect is also triggered by the fuel tax, by
providing price-incentives to invest in cleaner technology and
produce vehicles with higher fuel economy to gain a competitive
advantage. Surveying the literature, Graham and Glaister (2004, pp.
270–271) and Goodwin, Dargay, and Hanly (2004, p. 282) report
the short-run price elasticity of fuel demand to average around
0.2 to 0.3, and the long-run elasticity to average around 0.6 to
0.8. Small and Van Dender (2007), on the other hand, report
a more moderate long run elasticity of 0.43 (p. 26). The immediate
reduction in driving will be low; hence the environmental conditions will not improve in the short-term (Sipes & Mendelsohn,
2001). Fuel taxes thus have greater potential to reduce emissions
in the long-term than in the short-term, although in the long-term
a rebound effect may be observed. This occurs if a higher fuel
economy of vehicles is accompanied by an increase in distance
travelled, due to the reduced cost per km.
The distributional impacts of fuel taxes have been subject to
considerable debate in the literature. In determining the distributional impact of fuel taxes it is important to keep in mind whether
the measure of income considered is based on annual income, or
the less variable life-time income. Poterba (1989) thus shows that
fuel taxes may be much less regressive if calculated on the basis of
life-time, rather than annual income.
There is general agreement that when all households are
considered, fuel taxes are progressive, but if only car-owning
households are considered fuel taxes are regressive (Acutt &
Dodgson, 1997; Blow & Crawford, 1997; Leicester, 2005; Johnson,
McKay, & Smith, 1990; Santos & Catchesides, 2005; West, 2004).
Apart from car-ownership, other factors that play a role in the estimation of distributional impacts are the extent to and the way in
which revenues are recycled. Bento, Goulder, Henry, Jacobsen, and
von Haefen (2005) find that if revenues are recycled to households
in proportion to their fuel-tax payments, the impact of the fuel tax is
close to proportional. On the other hand, if revenues are recycled in
proportion to households’ income, the impact of the fuel tax is highly
regressive. Wachs (2003) argues that fuel taxes are less regressive
than sales taxes as instruments to finance public transport expenditures, whose primary beneficiaries are lower income people.
Graham and Glaister (2004, p. 270) find that the income elasticity of
fuel demand is between 0.3 and 0.5 in the short-run and between 0.5
and 1.5 in the long-run. Goodwin et al. (2004, p. 284) report the mean
income elasticity of fuel consumption to be 0.39 in the short-run and
1.08 in the long run. This is equivalent to saying that a household that
doubles its income in the short-run will increase fuel demand by
roughly 30–50 per cent. In other words, fuel taxes will hit harder on
lower income groups, unless they are redistributed.
4.2.2.1. Fuel duty differentials. Different levels of taxes can be
applied to fuels that differ in composition. Since different types of
48
On the other hand, de Palma and Kilani (2008) argue that the higher the price
of petrol, the later a vehicle will be replaced, and hence the older the cars in circulation will be. This result differs from previous results (Fullerton & Gan, 2005;
Fullerton & West, 2002) because it accounts for the fact that less usage leads to
a lower replacement rate.
23
fuels are associated with different types and intensities of emissions, fuel duty differentials typically affect the mix of emissions
(Acutt & Dodgson, 1997). Tax differentials can thus become
important and cost effective instruments to discourage the use of
the more environmental damaging fuels (Knight et al., 2000).
Taxation of certain components of fuel, such as lead, sulphur,
oxygen content or octane rating may also create strong incentives
to change the fuel content (Gorham, 2002). It may not always be
easy to find the efficient tax, i.e., the tax which covers the marginal
external costs caused by a specific pollutant.
4.2.2.1.1. Diesel vs. petrol taxation. In the Pre-Euro I phase (pre1993) when petrol cars were not equipped with a three-way catalyst, diesel was superior to petrol in terms of emissions (CO, HC,
NOx, CO2) per vehicle kilometre in urban conditions, with the only
exception of PM emissions, where petrol was far superior. However,
under Euro IV (post-2006), diesel cars emit less CO49 and less CO2
than petrol cars with three-way catalysts, but their emissions of HC,
NOx and PM particulates are greater (UK DfT, 2008, Table 3.6, p. 55).
However, the difference between diesel- and petrol-fuelled cars in
terms of their emissions of HC, NOx and PM gradually decreased
over the period 1993–2006, as cleaner fuels and vehicles were
introduced in Europe (UK DfT, 2008, Table 3.6, p. 55). Although
these conclusions are drawn on the basis of European data, similar
conclusions would be reached for countries which adopted similar
standards. For countries that have not regulated emissions in this
way, the case of Europe proves that it is (technologically) possible to
achieve such emission differentials.
To compare the external costs of diesel and petrol, or in other
words, to decide whether diesel or petrol should be favoured, either
shadow prices need to be determined for each pollutant (a practical
difficulty which is common to all Pigouvian taxes) or at least, some
(subjective) weighting needs to be assigned. Crawford and Smith
(1995, p. 46) suggest the use of relative weights but emissions
from petrol and diesel have changed drastically since they wrote
their paper. It is now clear from the data on emissions that, unless
carbon monoxide and CO2 have a much higher social cost than all
the other emissions, the use of diesel should now be discouraged
and one way of doing this is through higher taxes.
Along these lines, Mayeres and Proost (2001a) argue that diesel
has much higher environmental costs than petrol, since the social
costs of PM emissions are high. Having said that, the difference in
emissions of PM between petrol and diesel cars has declined
between 2001 (when they wrote their paper) and 2009. If climate
change and CO2 emissions were to be given the highest weight,
there could be an argument for lower taxes on diesel than on
petrol. Whatever the reason, EU countries have not increased
diesel taxes relative to petrol taxes over time.
Mayeres and Proost (2001a) further argue that when there are
constraints on the choice of tax instruments, a change in ownership
taxes to discourage the use of diesel cars is an important instrument. Constraints could arise, for example, from a difficulty in
differentiating fuel taxes between private and commercial use, and
between cars and lorries. Giblin and McNabola (2009) find that
ownership taxes have a higher impact on new vehicle purchases
than any fuel duty differentials.50
49
Although it may be argued that outdoor concentrations of CO are too small to
harm human health, CO has been linked to a number of problems, briefly described
in Section 1. McCubbin and Delucchi (1999, Table 3, p.270) estimate the health costs
of a number of pollutants from road transport in the US for 1990. Although PM is by
far the most costly, CO is not zero.
50
They model the potential impacts of the new carbon based tax system for new
vehicles purchased from 1 July 2008 by the Irish government and find that CO2
emissions from private transport will be reduced by 3 per cent with respect to
2007 levels.
24
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
In practice, many countries tax diesel less than petrol, and
produce an artificial price differential that is much higher than that
warranted by international prices. The rationale behind these
differentials is often political, to protect the competitiveness of
sectors such as agriculture, that rely on diesel (Gorham, 2002). An
economic rationale for the observed duty differential lies in the
increased efficiency of taxation when applied to consumers,
combined with the fact that diesel is used as an input in production
by lorries and industries more than petrol. Diesel enjoys an intrinsic
fuel economy advantage over petrol, since kilometres per litre of
diesel are higher, all else being equal. The tax incentives add to that
intrinsic advantage and constitute an added incentive for the use of
diesel, which may not be warranted from a welfare perspective. The
lower usage cost of diesel cars is also responsible for a rebound
effect, i.e. an increase in distances travelled, triggered by a lower
cost per km, which partially offsets the fuel savings (Gorham,
2002).51
Finally, let us return to a point mentioned above, which could
serve as an argument for having lower taxes on diesel than on
petrol. Since CO2 emissions per vehicle km from diesel are lower
than those from petrol, increasing the share of diesel vehicles
would reduce CO2 emissions. If the key objective of the tax were to
address the issue of climate change, putting a greater weight on
CO2 relative to other emissions could then be justified.
4.2.2.1.2. Cleaner fuels. In order to promote the adoption of
cleaner fuels (unleaded instead of leaded petrol or low-sulphur
instead of high-sulphur diesel, etc) governments can, and indeed
have, set duty differentials or subsidies, so that cleaner fuels
become more attractive. These subsidies or duty differentials can
help curb emissions in transport, although their effect on congestion need not be beneficial (Timilsina & Dulal, 2008), as longer
distances may be driven. Some specific successful examples are
discussed in Section 5.
When alternative fuels can be utilised in existing vehicles
without any adaptation, then theory prescribes that relative taxation should reflect the relative environmental damage produced by
different fuels. When major adaptations on existing vehicles or
their replacement is needed to adopt cleaner fuels, then both fuel
and vehicle taxation matter. In particular, if cleaner fuels are subsidised, the risk is that subsidies will benefit users who drive long
distances and would have found it profitable to buy the cleaner
vehicles even without any fiscal incentives. Such a policy may thus
imply a higher deadweight loss than a policy that subsidises cleaner
vehicles rather than cleaner fuels (Crawford & Smith, 1995).
4.2.3. Vehicle km travelled taxation
A type of usage tax that can be used as an alternative or
complement to fuel taxation in order to reduce emissions from road
transport is a tax on distance driven. Such a tax could be levied once
a year, as part of the annual ownership tax, on the basis of km
travelled as registered on the odometer. Kilometres could be
checked during regular mandatory safety inspections so as to reduce
the administrative cost. Vehicle-km travelled (VKT) taxes are associated with a high incentive to cheat by rolling back old odometers.
New electronic odometers will be more cheat-proof in this respect.
The advantage of a VKT tax is that it avoids the rebound effect
previously discussed for fuel taxes, and acts directly to reduce
distance travelled. Indirectly, a VKT tax will reduce congestion
(Ubbels, Rietveld, & Peeters, 2002). However, such a tax is unlikely
to trigger any technological emission abatement improvement, or
51
A different tax on diesel could in theory be applied to cars and lorries (or
private and commercial vehicles) but this could in practice prove administratively
expensive.
any shift in demand for more fuel efficient vehicles. Hence its
benefit is more limited. This drawback could be reduced by
differentiating the VKT charge on the basis of the vehicle’s fuel
economy (European Commission, 1995).
4.2.4. Congestion charges
The simple idea behind a congestion charge that reflects the
additional social costs of congestion is to confront the trip maker
with the true social cost of his journey. In theory, a congestion
charge is a corrective, or Pigouvian, tax, set equal to the marginal
cost of congestion. A congestion charge ensures that only costjustified journeys are made and the scarce road space is allocated
to those who value it most. The effect of charging is to reduce travel
demand and congestion, and to increase speeds and the total net
benefits of travel.
An efficient equilibrium is one in which the only journeys made
are those whose value exceed their marginal social cost. Thus,
journeys are made until the least valuable trip yields a benefit equal
to the marginal social cost, which is equal to the private cost plus
the congestion externality.52 The efficient congestion charge can be
measured by the segment DE in Fig. 1 (in Section 1). The charge is
equal to the MCC at the efficient level of traffic, qe, in Fig. 1. The
government revenue from this charge is FDEG and the social gain is
DMC. The disbenefit to those who are priced off is given by area
DCB, which can be approximated by (qmqe * FA)/2. The total loss of
consumer surplus can be measured by FADC and the loss for
existing users who continue to drive is FADB. The benefit to existing
users (in the form of higher speeds) is given by area AGBE.
This description gives a very simplified representation of the
problem. Nonetheless it is useful and conclusions do not change that
much when the model is made more complex. This simple model of
congestion charging has been extended in several directions.
Vickrey (1969) proposed a bottleneck model, where congestion
is assumed to arise when vehicles queue behind a bottleneck. If
commuters need to arrive at work at a certain time and there is
a bottleneck on the way, they will bear costs associated with early
and late arrival, which together with the congestion charge, are
added to the cost of the trip. This bottleneck model was further
extended, mainly by Arnott, De Palma, and Lindsay (1988, 1990a,
1990b, 1992, 1993, 1994, 1998) to include heterogeneous
commuters, route choice, stochasticity in capacity, elastic demand,
and time-varying congestion charges.
Congestion charges in the static model and in the bottleneck
model are first best solutions, as the underlying assumptions are
that there are no constraints of any sort (i.e. the regulator can price
any link at any time) and no imperfections in the rest of the
economy. However, in real world situations, due to constraints,
congestion charges are likely to be second best solutions.
Constraints could include a situation where only part of the road
network or only some road users are priced (Liu & McDonald, 1999;
Small & Yan, 2001; Verhoef, 2000, 2002a, 2002b; Verhoef, Nijkamp,
& Rietveld, 1996). Ignoring these constraints and naively implementing first best congestion charges (equal to marginal congestion costs) can lead to lower welfare gains from pricing than the
gains from second best pricing, which by definition achieves the
highest gains given the constraints that apply (Small & Verhoef,
2007). Second best scenarios may also include complements to,
52
In this simple model other externalities (such as accidents, air pollution, climate
change, etc) are initially ignored. However, marginal social cost includes a number
of externalities, each of which should be internalised in order to achieve an efficient
equilibrium. In this section we focus our attention on the congestion externality
and the use of a congestion charge to internalise it. Further below we discuss the
possibility of a congestion and environmental charge.
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
and substitutes for, a priced link or area. Parking charges, for
example, have frequently been suggested as an alternative to
congestion charges (Verhoef et al., 1995).
Another problem that would interfere with first best pricing is
that of distortions in other sectors of the economy. One classic
example is that of pre-existing distortionary taxation on labour. The
interaction between congestion charges and distortionary labour/
income taxes has been analysed by Mayeres and Proost (2001b) and
Parry and Bento (2001). An important result in this respect is that
the overall welfare gains from congestion charging not only depend
on the initial impacts of the charge, but also on the use of the
revenues, which could be allocated, as already discussed for the
case of fuel taxes, to reducing distortionary taxes in the economy,
such as for example, labour/income taxes.
Parry and Bento (2001) thus find that congestion taxes tend to
increase the total cost of commuting (although this is partly offset
by lower travel time costs), discouraging labour force participation,
leading to a welfare loss that can be greater than the Pigouvian
welfare gain resulting from the internalisation of the congestion
externality. A positive net impact on labour supply, on the other
hand, can be achieved by using the congestion charge revenues to
reduce income taxes, raising ‘the overall welfare gain from the
congestion tax by around 100 percent’ (Parry & Bento, 2001, p. 645).
Furthermore, the congestion charge could be set so as to also
internalise the environmental externalities from driving, thus
becoming a combined congestion and environmental charge. As
already explained in Section 1, the environmental externality
includes a variety of elements, ranging from local, regional and
global pollutants, to noise, water contamination, and visual intrusion. A corrective charge could then be designed to include both the
congestion and the environmental externality (Button, 2004, p. 14).
As discussed above, however, fuel taxes can approximate optimal
environmental charges because most environmental externalities
are closely dependent on fuel consumption.
Finally, an important link to congestion charges is that of
capacity choice. Keeler and Small (1977) build on previous work by
Mohring and Harwitz (1962), Vickrey (1963), Strotz (1964, in Keeler
& Small, 1977), and Mohring (1970, in Keeler & Small, 1977) and
show that revenues from an efficient congestion charge (equal to
the marginal congestion cost) are equal to the rental cost of the
highway under the assumptions of constant returns to scale, indivisibility of road construction, and independence of demand in
each period from prices in other periods. They define rental cost of
the highway as the sum of construction costs (on which interest
and amortisation are computed), maintenance costs, and land
acquisition costs. Although at first sight there may seem to be no
link between efficient congestion charges and the rental cost of the
road there is one, and this is given by a function of net benefits that
includes both benefits and costs to the users and the costs of the
highway. By maximising the net benefits of all trips on that road
over the life of the road, computed as the difference between the
net benefits to road users and the rental cost of the road they arrive
at fairly standard results: (a) the price paid by the road user should
equal the average rental cost plus the congestion externality, and
(b) lane capacity (or width) should be expanded to the point where
the marginal cost of an extra unit of capacity is equal to the
marginal value of user cost savings (typically vehicle operating and
time cost savings) brought about by that expansion. Combining
these results, simple algebraic manipulation shows that the
revenue from the efficient congestion charge is exactly equal to the
rental cost of the road, under the assumptions already listed above.
The main problem with the model above is that it assumes the
rental cost of the highway to be exclusively dependent on its width,
and not on traffic. Newbery (1989) improves the model by
assuming that maintenance to repair road damage does depend on
25
traffic. Rather than having just a congestion charge, he proposes
that vehicles should also be charged for the damage they cause on
the road. A road user charge would then include a congestion
charge element and a road damage charge element.
4.2.5. Parking charges
Much of the literature on pricing relates to parking as a common
property resource, which is over-exploited if under-priced
(Anderson & de Palma, 2007). The provision and use of the parking
slot entails a marginal cost (Verhoef et al., 1995). The search for
parking space in congested urban areas is also one of the factors
contributing to travel congestion itself (Arnott & Rowse, 1999, Arnott
& Inci, 2006). Nonetheless, it is not uncommon in urban areas for
drivers to park for free, at least at the workplace. The problem of
parking being under-priced when considering its social costs has
a simple efficient solution: appropriate pricing of parking slots. The
administrative complexity of the system is likely to be low, requiring
little investment costs and being easy to introduce. Political
acceptability for parking fees is likely to be higher than for congestion charging (Zatti, 2004). Revenues raised through parking fees can
be reinvested. However, there is the need for monitoring and for
setting penalties to mitigate the risk of avoidance of parking charges
(Acutt & Dodgson, 1997).
Parking charges have also been suggested in the literature as
a second best instrument to deal with road transport externalities,
such as for example, congestion (Verhoef et al., 1995) and emissions. Parking charges increase the total cost of a trip (Timilsina &
Dulal, 2008). This could reduce the attractiveness of a given
urban area altogether, or discourage vehicle usage, resulting in
a decrease in the inflow of vehicles (Eisenkopf, 2008).53 In addition,
the introduction of parking fees could help matching demand with
supply, thus reducing parking search time, and improving mobility
(Zatti, 2004). However, parking policies are not optimal instruments (in a first best sense) to regulate costs that are largely
dependent on length and route of the trips. They may even be
counterproductive, as they charge the average, rather than the
marginal, external cost, thus cross-subsidising longer trips through
shorter trips (Verhoef et al., 1995).
The possible effects of a parking charge on drivers include,
according to Feeney (1989, in Timilsina & Dulal, 2008, p. 27)
a change in parking location and/or trip destination, a change in
journey-time, a modal change, or the cancellation of the trip altogether. The long-term effect could also be a reduction in carownership level, although the impact is likely to be marginal
(Acutt & Dodgson, 1997, p. 27).
Efficient or inefficient parking fees, however, both allocate
scarce parking spaces without necessarily reducing peak traffic
congestion and emissions. These charges affect drivers whose
destinations are in the area where the parking charges apply, and
fail to differentiate according to trip lengths or routes followed
(Verhoef et al., 1995) and emission levels. Thus, parking fees are not
effective in reducing through traffic. In fact, the number of drivers
passing through the area and the length of their trips may increase
in response to the parking charges, as they extend their trips to take
advantage of free parking slots outside the area where the charges
apply. One way to counteract this would be to avoid discontinuities
in the charges applied, and to have uniform charges in wide areas to
increase effectiveness (Zatti, 2004).
Although information and enforcement intensive, parking
charges could be designed to vary according to time of day, location
53
This comes at a cost in terms of competitiveness of the city, if they are applied
on a large scale (Eisenkopf, 2008). On the other hand, effective, fast and reliable
public transport provision may counteract this effect.
26
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
of the parking place, and according to the vehicle’s fuel economy. The
first option is an important element both as a first best instrument to
regulate time-dependent parking externalities, and as a second best
instrument to regulate time-dependent driving externalities. The
second option is important because external costs vary with the
congestion of the area. For example, external costs tend to be higher
in the city centre, and generally lower for off-street parking places
(e.g. underground) than for on-street ones (Zatti, 2004).
Glazer and Niskanen (1992) show that when road usage charges
are sub-optimal, parking charges can increase welfare if they are
lump-sum fees, but not if they are increasing in parking time. In fact,
if charges vary with length of stay, people park for a shorter time,
and more people use the parking slots, thus increasing traffic.
Verhoef et al. (1995) show that efficient parking charges can only
reduce traffic congestion (by mimicking congestion charges) under
very restrictive assumptions. These assumptions were already
summarised in Section 2, and include: (a) each individual drives the
same distance, (b) congestion is equally spread over the road
network, (c) the government (regulator or local authority) has full
control over all parking spaces, (d) every car is parked in a public
parking space, and (e) all cars are parked for the same length of time.
Arnott, De Palma, and Lindsay (1991) and Calthrop, Proost, and
van Dender (2000) show that congestion and parking charges
need to be set simultaneously. Using the bottleneck model, originally
developed by Vickrey (1969), Arnott et al. (1991) demonstrate that
the joint implementation of an optimal congestion charge and
a location-dependent parking fee yield an efficient equilibrium.
Using a numerical simulation model and assuming a cordon
charging system, Calthrop et al. (2000) find that as parking charges
approach their efficient level, the level of optimal cordon charges
falls. Similarly, with a cordon charge, the level of efficient parking
charges falls. In this sense, parking charges can be seen as a substitute
for congestion charges. However, Button (2006) argues that the
effectiveness of parking fees as a road pricing surrogate are highly
context specific, which brings us back to the restrictive assumptions
made by Verhoef et al. (1995).
Arnott and Inci (2006) develop a model which integrates traffic
congestion and saturated on-street parking, with cars causing
congestion when looking for a parking space. They find that the efficient on-street parking charge is a charge that eliminates the activity
of driving to find a parking space, regardless of whether the quantity
of on-street parking spaces is optimal or not. Arnott and Rowse (2009)
extend that model to include on-street parking, off-street privately
provided parking,54 and traffic congestion, and conclude that
increasing on-street parking charges generates efficiency gains that
may be several times as large as the increased revenue raised.
Arnott (2006) and Calthrop and Proost (2006) arrive to similar
conclusions using different models which integrate both on-street
and off-street privately provided parking. Arnott (2006) finds that
the number of cars looking for a parking space adjusts to equalise the
full prices of on-street and off-street privately provided parking
spaces. Calthrop and Proost (2006) show that the optimal on-street
parking charge equals the marginal cost of providing off-street
parking spaces at the optimal quantity. If off-street parking is
supplied under constant returns to scale, they prove that the efficient
on-street parking charge should be equal to the off-street one.
An alternative to parking charges would be a mandated
restriction on parking supply. Verhoef et al. (1995) show that
mandated restrictions are inferior on the basis of information and
efficiency arguments, as discussed in Section 2. In fact, individuals
may not know that there are parking restrictions, hence undertake
the trips anyhow, and then drive around to find a parking place.
54
They call it ‘‘parking garages’’.
Parking charges discriminate on the basis of willingness to pay,
while parking restrictions do not.
4.2.6. Pay-as-you-drive insurance
Pay-as-you-drive (PAYD) insurance differs from standard
insurance in that the premium is dependent on the annual distance
travelled. Thus, insurance becomes a variable cost (Litman, 2008).
As in standard insurance, the premium can be conditioned on the
driver’s rating factor (Parry et al., 2007, p. 394), which is a function
of age, crash record, and region (Parry, 2005, p. 288). The advantage
of PAYD insurance over conventional insurance is that it pricediscriminates more successfully between travellers on the basis of
the distance they drive, which is correlated to their willingness to
pay for insurance. As PAYD insurance reduces premia for short
distances driven, implementing such insurance schemes can be
expected to reduce the number of uninsured drivers (Parry, 2005, p.
288). Insurance schemes such as PAYD are also more accurate, as
they increase the correlation between premia and expected claims
to the insurance company (Litman, 2008). Under PAYD, travellers
do not ‘‘over-consume’’, or ‘‘over-drive’’, as the amount they pay
increases with distance, very different from a scenario where they
pay a fixed sunk-cost at the beginning (Evans, 2008).
Parry (2005) argues that although fuel taxes are more cost
effective in reducing emissions and improving fuel economy, PAYD
insurance, which is politically more acceptable, reduces distancerelated externalities, such as congestion, accidents and local emissions, ‘far more than fuel taxes’ (p. 288). He also shows that PAYD is
slightly more efficient than a VKT tax for a given reduction in
demand for petrol. Evans (2008) also argues that the extra-premium
paid by drivers who drive longer distances will net-out with the
lower premium paid by drivers who drive shorter distances.
The distributional impacts of PAYD insurance have been suggested to be progressive, since there is a positive correlation
between income and km travelled. Bordoff and Noel (2008) thus
note that on average families on low incomes will benefit from PAYD
insurance schemes, as they ‘make up a disproportionately large
fraction of the low-mileage drivers within any risk class’ (p. 39).
However, Wenzel (1995) argues that PAYD insurance could be
regressive, as the burden of the scheme relative to a standard
insurance scheme could be higher for lower and middle-income
households. It should also be noted that if the elasticity of distance
driven with respect to income is lower than 1, PAYD insurance is
likely to be regressive.
Considering the issue of political feasibility, PAYD insurance
schemes may compare favourably to other policy measures such as
fuel taxes. Unlike fuel taxes, implementing PAYD insurance
schemes does not transfer large tax payments from motorists to the
government. For the average driver, PAYD schemes do not increase
driving costs, leading Parry (2005) to conclude that ‘hence political
opposition to this policy should be more muted’ (p. 288).
Implementation of PAYD at a large scale may be difficult because
insurance companies would have to incur costs of monitoring that
would outweigh their direct benefits. A socially inefficient choice
by insurers (i.e. failure to implement PAYD insurance schemes) is
likely, as the benefits to society from such a scheme would be large,
but these benefits would not be internalised by insurance companies. Edlin (2003, pp. 56–57) lists the positive externalities or social
benefits from PAYD. These include: reduction in accident costs
(which benefits insured vehicles, with or without PAYD, uninsured
and underinsured ones), reduction in congestion, reduction in
pollution and reduction in road maintenance costs.
The main concern with PAYD insurance implemented at a large
scale is related to monitoring costs. Odometer reading would be
needed to determine the appropriate charges, and fraud would be
an obstacle as it is quite possible to roll odometers back (Bordoff &
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
Noel, 2008; Edlin, 2003). Electronic odometers, more difficult to
tamper with, may be the solution.
Other implementation costs include the calculation of new
premia and development of new procedures for the insurance
companies (Litman, 2008).There exist patents for PAYD schemes
that may discourage adoption of the system by other insurers
(Bordoff & Noel, 2008). In addition, first-movers will face adverseselection in consumers’ choice, reducing the benefits of PAYD.55 In
order to counteract this effect, an increase in the average premium
of the fixed insurance schemes could be introduced at the same
time in order for the insurance companies not to make losses.
Insurers also have concerns that the distance foregone (not driven)
after the introduction of a PAYD scheme will be less risky than the
average driven distance or average number of km. Hence, the
reduction in the premium will be more than the reduction in claim
costs, leading to losses for the insurers. Litman (2008) argues that
empirical evidence suggests that the opposite holds: the reduction
in cost claims is more than one to one with the reduction in km
travelled. Along the same lines, Bordoff and Noel (2008) argue that
the number of accidents increases less than one to one with
vehicle-km travelled. In any case, if the adoption of a PAYD scheme
is successful and leads to a reduction in km travelled, the total
premia will be reduced. This, even if matched by a corresponding
reduction in claim costs, will lead to a lower investment income for
insurance companies, and hence to lower profits (Litman, 2008).
4.3. Ownership vs. usage taxes
The transport economics literature is very critical of ownership
taxes, because they are blunt and indirect tools to address transport
externalities. However, ownership taxes are easier to implement
and may face less political opposition (Barter, 2005). The choice of
tax weights applied to the different stages of ownership, purchase,
usage and scrappage of a vehicle is a key determinant of purchasing
and travel behaviour, and consequently of the life-time CO2 emissions of a vehicle from production to usage, maintenance and
disposal (Hayashi et al., 2001). In principle, variable taxes such as
fuel duties, distance based taxes and congestion charges are
superior to fixed taxes (on purchase and/or ownership) at tackling
externalities.
However, when the government is constrained in its capability
to impose the efficient variable taxes, fixed taxes can be important
second best instruments (De Borger & Mayeres, 2007, pp. 1178–
1179). Ownership and purchase taxes may be better tools for
directing purchase behaviour towards vehicles associated with less
negative externalities (Barter, 2005, p. 526), since consumers’
choice of vehicle class and their decisions regarding vehicle
disposal and repurchase are less directly targeted by usage taxes
(Hayashi et al., 2001).
Koopman (1995) compares the CO2 emissions reducing potential of a range of fixed and variable taxes through simulations with
a partial equilibrium model of European passenger transport. He
finds that carbon taxes are superior to feebate schemes; these in
turn perform better than annual ownership taxes, while purchase
taxes are the least cost effective instrument. Different policies
induce different behavioural responses. Feebates induce vehicle
fleet compositional change, towards more fuel efficient vehicles.
The purchase of more fuel efficient vehicles leads to a moderate
rebound effect, since the lower marginal cost of driving leads to
55
Adverse selection refers to a situation where an individual’s demand for insurance is positively correlated with the individual’s risk and the insurance company
cannot introduce that correlation in the premium. PAYD would probably be chosen
by those who already drive less.
27
higher usage. Feebate schemes are increasingly more costly relative
to CO2 taxes as CO2 reduction targets tighten, as the costs of
achieving a given fuel efficiency ‘increase more than proportionally’
in the fuel efficiency target. Finally, a feebate scheme may be
needed in combination with a CO2 tax if consumers underestimate
the total vehicle life-time fuel consumption at the time of purchase
(Koopman, 1995, p. 67).
De Borger and Mayeres (2007) construct a numerical optimisation model to study optimal fixed and variable taxes on petrol
and diesel cars in Belgium. They find that shifting the balance of
taxes towards variable taxes does not necessarily improve welfare.
They also show that the combination of peak road pricing with
revenue recycling in the form of higher transport subsidies or lower
petrol taxes is the policy with the highest marginal effect.56
Fullerton and West (2003) show on the basis of Californian data
that a fuel tax alone can achieve 62 per cent of the welfare gain
obtained in a first best scenario with a tax on emissions. The introduction of a two-part schedule consisting of a fuel tax and a subsidy
to new cars is an improvement upon this, achieving a welfare gain
that is 71 per cent of that obtainable in the first best scenario.
However, distributional effects and administrative costs are not
considered in the analysis, and may lead to different conclusions.
Chia et al. (2001) compare ownership and usage taxes on the
basis of Singapore’s data in the mid 1990s. They assume that
travellers can choose whether to travel by car or by bus. Trips by car
entail fixed costs, but lower variable costs. Usage taxes are found to
be superior to ownership taxes for internalising congestion externalities, but are less revenue-efficient. They argue that when
combining ownership and usage taxes, one should first optimise
over ownership taxes, and then introduce usage taxes.
Newbery (2005a, p. 29) argues that petrol and diesel taxes can
be set at equal rates, as long as the difference in the damage caused
by emissions from diesel and petrol vehicles is collected through
the annual vehicle excise duty.
4.4. Company cars and other incentives
The tax treatment of commuting expenses and employer provided
transport-related fringe benefits plays an important role not only in
transport policy but also in environmental policy (Potter, Enoch, Rye,
& Black, 2002). Company cars are cars provided by employers to
employees and can typically be used for both business and private
trips (Cohen-Blankshtain, 2008, pp. 66–67). The provision of
company cars acts as a disincentive to the use of public transport or
other modes such as car-pools. Hence, from an environmental point
of view, company cars should be limited (Cohen-Blankshtain, 2008).
Taxation can help integrate employers’ behaviour with employees’
behaviour towards a low carbon transport economy. Commuting
expenses can be seen as personal expenses, subject to income taxation, or as tax deductible expenses (Potter et al., 2002). Whether
commuting expenses are taxed or not can make a big difference to
commuters’ incentives regarding their travel behaviour.
If travel is classified as an intermediate good, the Diamond–
Mirrlees productive efficiency result applies - intermediate goods
in production should not be subject to distortionary taxes
(Diamond & Mirrlees, 1971).57 Related to that is the idea that
expenses incurred in earning income should not be part of taxable
56
Their analysis is based on a logit model and takes a partial equilibrium
approach which ignores international competition issues.
57
It should be noted, however, that this sub-section, dealing only with
commuting and work-related trips, ignores a large proportion of trips that people
make. According to the 2001 US National Household Travel Survey, for example,
only 14.8 per cent of trips made were commuting trips, with an additional 2.9
per cent of trips for other work-related purposes (US DoT, 2003, p. 10).
28
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
income (Richter, 2006). According to this principle, commercial
vehicles (and the fuel they consume) that are used as inputs in
production should only be taxed to correct for externalities, but not
for the sole purpose of raising revenue for the government.
Whether a commuting trip is considered an intermediate good or
not can be subject to debate. In the UK commuting trips are not
considered working trips and therefore taxes on commuting trips
are not refundable. Furthermore, the UK DfT (2009b) places very
different values on working and commuting time.
One approach towards company cars is to differentiate taxation
at the purchase and ownership level, by making excise duties
refundable for commercial vehicles, even if they are going to be
used for private trips as well. Fuel taxes, on the other hand, can be
made refundable for working trips only (and commuting trips,
depending on the individual government’s view).
This lower tax while in the course of production is also one of
the rationales behind the lower taxation of diesel versus petrol.
However, this may distort incentives of private individuals
towards purchase and usage patterns that create more damage to
the environment. Economic theory suggests that the optimal tax
on a company car should be based on the total net cost for the
company of providing the car to the employee. This is the case in
the US but not in many other countries (Gutiérrez-i-Puigarnau &
van Ommeren, 2007). The tax treatment of employer provided
transport benefits in kind (such as company cars, reimbursement
of commuting business related travel expenses) is an important
factor directly affecting modal choice and travel behaviour at large
(Knight et al., 2000). This has significant impacts on road transport emissions control, especially in countries where company
cars have a high share (e.g. the UK) and in urban centres where
travellers commute long-distances. In some countries, commuting
expenses can be deducted from taxable income.
The tax on a company car can be based on the fuel economy,
engine size or on the vehicle’s CO2 emissions, the latter being
currently the case in the UK (UK Inland Revenue website, Gross
Heptonstall, Anable, Greenacre, & E4tech, 2009, Evidence Table:
Company Car Tax). Another key issue is the tax treatment of car
purchase by companies, because it directly affects the incentives of
the company to provide the car in the first place. The extent to
which the purchase price can be treated as a capital allowance and
the amount of yearly allowable writing-down against corporation
tax is also important, as is the treatment of value added tax (VAT)
on purchase and VAT on fuel as a recoverable or not-recoverable
input tax.
Some employers provide company cars, free parking spaces, or
public transport passes to the workplace (Knight et al., 2000). The
tax treatment of these benefits in kind is important in strengthening or weakening these incentives on the basis of environmental
considerations. Taxation of employer provided parking as a benefit
would be an important tool to reduce employers’ subsidies to
automobiles. However, there could be valuation issues, since some
employers may provide parking on private premises that could not
be profitably used for other purposes. An alternative to taxation
would be the requirement of employers to provide monetary
benefits (parking ‘‘cash-outs’’) for employees who decide not to
take advantage of the free parking places (DeCorla-Souza, 2004;
Toder, 2007). Making employer provided public transport passes
a non-taxable benefit could be an option to encourage modal shift
towards public transport. However, this policy need not be the most
cost efficient, and may raise equity issues (Di Domenico, 2006), as it
targets only a (relatively wealthy) share of the population.
Furthermore, under-taxation of one benefit to compensate for
under-taxation of a substitute benefit need not be the right
approach. Di Domenico (2006), for example, argues that correcting
the under-taxation of employers’ provided parking spaces in
Canada through another distortion, namely non-taxed transport
passes is not the direction to take. The best approach is to appropriately tax the benefit derived from free parking provision.
Tax concessions for commuting expenses58 are found to induce
distortions in residential land use (Wrede, 2003), stimulate
commuting by car and longer trips (due to distorted location choice
of residence and or/working place), with negative effects on the
environment (Potter et al., 2002). Non-deductibility could be
justified by a lack of other instruments to internalise congestion
and environmental externalities (Wrede, 2003). The literature is
not unanimous on the optimal treatment of commuting expenses.
Even if concessions are only targeted to public transport
commuting expenses, they need not be advisable. In fact, they
contribute to trip lengthening, and they impose a heavy burden on
finances (Potter et al., 2002).
4.5. Revenue allocation
The use of revenues generated through road transport policies
that correct externalities has important welfare and distributional
consequences, and is ultimately one of the determinants of the
political acceptability of these policies. Revenues can be redistributed as lump-sum subsidies, to counteract the regressive
impacts of the policy itself. They can thus be used to cut labour/
income taxes or other distortionary taxes, or be earmarked for
investment in specific sectors, in particular, the transport sector.
Earmarking revenues means that the revenues generated
through a tax program will be used towards specific pre-defined
projects. Earmarking can increase the political acceptability of
certain policies; it can establish a link between tax and use of
a resource if, for example, road taxes are spent on roads projects; it
is also a way to ensure a stable revenue flow to government needed
for undertaking desirable governmental functions. However, earmarking revenues hampers flexibility for the government, since it
may prevent adaptation to changing conditions or to a greater
amount of available information. Earmarking may also allocate
revenues in an inefficient way, or to projects that have lower
priority (Santos, 2005). Funds may be misallocated among functions, and a lack of periodic review may leave systems in place
beyond the necessary time (Knight et al., 2000). However,
Bracewell-Milnes (1991) argues that in an imperfect world, earmarking can serve as an instrument for better decision-marking, for
instance, earmarking can solve policymakers’ time inconsistency
problems to some extent (Marsiliani & Renstrom 2000).
When a government does not have any need for raising additional revenue or when it can use lump-sum taxes, economic theory
suggests that taxation for environmental damage should equal
marginal external costs. When the government needs additional
revenues, environmental taxes may be raised above the marginal
damage (Fullerton, 1997). Along these lines, West and Williams
(2007) show that since petrol is a complement to leisure, the
optimal petrol tax is much higher than the marginal external cost.
Early research suggested that environmental taxes can generate
a ‘‘double dividend’’. This refers to the idea that not only do environmental taxes correct a market failure, but they also generate
revenues which can be used to reduce distortionary taxes. Pearce
(1991) emphasises the role of the double dividend argument in
carbon taxation policy, as ‘the corporate and public acceptability of
such a tax is greatly enhanced if the tax is introduced as part of
a ‘‘package’’ of fiscally neutral measures’ (Pearce, 1991, p. 940).
58
For more on the tax treatment of commuting and work-related expenses, see
Baldry (1998), Richter (2006) and Wrede (2001, 2003).
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
However, later analyses have refined the notion of the ‘‘double
dividend’’ (Goulder, 1995). In particular, we can differentiate
between ‘‘weak’’ and ‘‘strong’’ versions of the concept. The ‘‘weak’’
version, broadly supported by empirical literature, refers to the idea
that reducing distortionary taxation using carbon tax revenues leads
to greater welfare gains than would be achieved through lump-sum
redistribution (Parry, 1994; Goulder, 1995). The ‘‘stronger’’ version
contends ‘that revenue neutral swaps of environmental taxes for
ordinary distortionary taxes involve zero or negative gross costs’
(Goulder, 1995, p. 157). Numerical evidence for the strong form,
however, is mixed at best (Goulder, 1995). Parry and Bento (2000)
show that, under certain circumstances, a revenue-neutral emissions tax, whose revenues are recycled to reduce income taxes,
could produce a double dividend.59 The reasons for the failure of the
‘‘strong’’ version of the double dividend arise from general equilibrium analysis. Environmental taxes applied to inputs60 exacerbate the distortions created by labour taxes, thus imposing costs that
more than offset the benefits of tax substitution (Parry, 1994). This is
due to the fact that taxing a polluting input through environmental
taxes will distort the production mix (Bovenberg & Goulder, 1997).
As a consequence, the double dividend feature of corrective taxes
does not completely hold, if interpreted to mean that the taxes on
dirty goods should be increased more on top of the environmental
externality than the taxes on clean goods to generate revenues
(Fullerton, 1997). The interdependency effect between corrective
and distortive taxes works to reduce welfare (Parry, 1994). It follows
that the difference between the optimal tax on a dirty good and the
optimal tax on a clean good in a world characterised by distortionary
taxes is below the Pigouvian tax, i.e. below the marginal environmental cost (Bovenberg & de Mooij, 1994; Fullerton, 1997). An
environmental tax will be less desirable as a way to finance public
spending the larger the efficiency cost on the economy of existing
taxation (Bovenberg & Goulder, 1996). An alternative taxation
schedule consists of a combination of higher taxes on labour with
a subsidy to clean goods (Fullerton, 1997).
4.6. Concluding remarks
Taxes act as incentives (or disincentives) on behaviour by
increasing the marginal cost of certain activities. Corrective or
Pigouvian taxes close the difference between marginal private and
marginal social cost. Their effectiveness depends on the strength of
the link between the externality they are aimed at correcting and
the tax itself.
There are many types of taxes and charges in the road transport
sector. These include taxes on purchase and ownership of a vehicle
and taxes on usage of a vehicle, such as emission taxes, fuel duties,
distance travelled taxes, congestion and parking charges, and payas-you-drive insurance. Also, subsidies to efficient vehicles can be
used in combination with feebates and/or scrappage incentives, to
help consumers decide towards cleaner vehicles, even when these
are more expensive than more polluting ones.
The use of revenues generated through these taxes has important welfare and distributional consequences, and may help
increase public and political acceptability.
5. Taxes and charges in the road transport sector
Except for the very early attempts of credit and permit systems
in the US, including the inter-refinery averaging and banking of
59
It must be noted, however, that this result is particular to the US, and need not
apply to other countries, such as the UK.
60
Fuel is also an input to production to the extent that it is used by commercial vehicles.
29
credits instituted by the US EPA in the 1980s to facilitate the phasedown of lead in petrol, cap-and-trade has not been implemented in
the road transport sector in any country or region to date. Its
application has been and still is contemplated and debated, to deal
mainly with congestion and emissions, and in particular with CO2
emissions. In this section we concentrate on IB policies that have
been implemented, and thus, we focus on fiscal measures and omit
permits.
Taxes and charges on road transport are used extensively
throughout the developing and developed world. From an economic
point of view, Pigouvian fiscal measures can correct externalities
and achieve efficient levels of traffic (and therefore congestion and
emissions).61 This, however, has not historically been the reason for
the introduction of taxes and charges, which existed even before any
concerns regarding externalities in general, and climate change in
particular, were raised. Governments need funds, not just to build
and maintain roads, but also to provide other public goods and
services, such as defense, education and health care. Road transport
increasingly became an excellent source of revenues, regardless of
any consideration of negative externalities.
Nevertheless, road taxes and charges have helped (perhaps
unintentionally) to reduce excessive levels of negative externalities.
This is not to say that they have been designed to reduce them or
that they have reduced them to their efficient levels.
In what follows, we collate evidence of different types of road
transport taxes and charges applied in different countries, their
relative differences and, to the extent which is possible within
a review, their impact.
5.1. Taxes on purchase and ownership of a vehicle
5.1.1. Purchase and registration taxes
All European countries levy a value added tax (VAT) on the
purchase of new motor vehicles, just as they do on purchases of
most goods and services. VAT rates vary between 15 per cent and 25
per cent, with Denmark, Hungary and Sweden at the higher end.
Many countries also levy a registration tax, based on the pre-tax
price, fuel consumption, cylinder capacity, CO2 emissions and/or
other emissions, and vehicle length (European Automobile
Manufacturers’ Association, 2009a, p. 1).62
Registration taxes are typically charged when the vehicle is
registered for the first time. The exceptions are Belgium and Italy,
where the registration tax is levied every time the vehicle changes
ownership (Knight et al., 2000, p. 37). Kunert and Kuhfeld (2007, p.
309) show that registration taxes exhibit great variations across
countries, with Denmark, Ireland, Malta and Norway imposing the
highest registration taxes in Europe.
Ryan, Ferreira, and Convery (2009) conduct a study for the EU15 and find that registration taxes are significant in purchasing
decisions (especially regarding the decision of whether to buy
a petrol or diesel car) when the specificities of each country
(country fixed effects) are ignored, but they stop being significant
when country fixed effects are included in the model (pp. 372–373).
They also find that registration taxes are not significant in changing
average vehicle CO2 emissions (p. 372) and highlight the fact that
registration taxes in the EU are levied mainly on cars and that such
taxes apply at reduced rates, if at all, to commercial vehicles like
buses, vans or lorries (p. 36).
61
Note that, as explained in Section 1, the efficient level is not zero, but that at
which marginal social costs and marginal social benefits are equal.
62
Bulgaria, the Czech Republic, Estonia, Germany, Lithuania, Luxemburg, Slovakia,
Sweden and the UK do not have any registration tax (European Automobile
Manufacturers’ Association, 2009a, p. 1).
30
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
The case of Singapore is worth highlighting, as it has very high
ownership taxes. On top of the COE described in Section 2,
motorists need to pay the Additional Registration Fee (ARF). The
ARF is an ad valorem duty on a vehicle’s open market value63
payable by buyers of new motor vehicles, in addition to an
administrative fee, referred to as the Basic Registration Fee. The ARF
rate was raised through the 1970s, reaching 125 per cent in 1978
and 150 per cent in 1980 (Santos, Li, & Koh, 2004). However, as the
ARF rate rose, it also discouraged existing vehicle owners from
replacing their cars and encouraged new car buyers to buy used
cars. Concerned with a stock of aging vehicles, when the applicable
ARF rate was raised to 100 per cent in 1975, the government
introduced a Preferential Additional Registration Fee (PARF) to
counterbalance the disincentives on vehicle renewal. The purchaser
of a new vehicle paid a substantially lower PARF rate if he
de-registered an old vehicle (i.e. by exporting or scrapping it) of
the same engine category at the time of his new purchase.
Since 1997, the PARF has been amended to a system where the
applicable discount is a function of the age of the vehicle to be
de-registered.64 Vehicles older than ten years no longer qualify for
PARF treatment.
5.1.3. Subsidies to efficient vehicles and feebates
A showcase example of this type of subsidies is the ‘ecoauto
Rebate Program’, which was run in Canada between March 2007
and March 2009. The idea behind it was to encourage Canadians to
buy new fuel efficient vehicles.
Eligible vehicles included cars with fuel efficiency of 6.5 litres
per 100 km or better, vans with fuel efficiency of 8.3 litres per
100 km or better, and flex-fuel vehicles, running on a combination
of petrol and ethanol, with a combined fuel consumption rating of
13 litres per km or better (Banerjee, 2007, p. 2).66
During the two years that the program operated, applicants who
purchased or leased (12 months or more) eligible 2006, 2007 and
2008 model-year, fuel efficient vehicles, could apply for and receive
rebates ranging from CA$1000 to CA$2000 (£502–£1004 or V655–
V1310 or $925–$1850).67 By the time the program finished it had
issued over 167,000 rebates, amounting to CA$187.7 million
(Transport Canada website).
The rebate was combined with a tax on fuel inefficient vehicles,
the Green Levy, which started at CA$1000 for vehicles with fuel
(in)efficiency of between 13 and 14 litres per 100 km and increased in
CA$1000 steps for every litre in consumption up to 16 litres per
100 km, at which point the tax was capped and all vehicles using
16 litres per 100 km or more paid a maximum tax of CA$4000
(Banerjee, 2007, p. 2).
The impact of the program on new vehicle purchases and
emissions has not been published by the Canadian Government yet,
and therefore it is difficult to assess its success.
5.1.2. Ownership taxes
Annual ownership taxes, sometimes also called annual circulation taxes or vehicle excise duties, are levied in most countries,
usually on private and commercial vehicles. In Europe, the criteria
to set these taxes vary across countries. For cars these include
cylinder capacity, fuel efficiency, vehicle age, gross weight, CO2
and/or other emissions; and for commercial vehicles, which tend to
be heavier and damage roads more, these depend mainly on
weight and axles, although also on noise and CO2 and/or other
emissions (European Automobile Manufacturers’ Association,
2009a, p. 2).
In the UK, for example, vehicle excise duties levied on cars
registered on or after 1 March 2001 depend on the amount of CO2
emitted by the automobile (Driver and Vehicle Licensing Agency,
2009). Excise duties have varied over the years. The levels
applying from 1 May 2009 are as follows. If the car emits less than
100 grams per km the vehicle is exempt from vehicle excise duty.
Cars emitting between 101 and 120 grams per km are charged £35
(V40, $56)65 per year, cars emitting between 121 and 140 grams per
km are charged £120 (V138, $193) per year, cars emitting 141–150
grams per km are charged £125 (V144, $200) per year, and cars
emitting 151–165 grams per km are charged £150 (V173, $241) per
year. The charge continues to increase with the CO2 emitted per km
and reaches a maximum of £400 (V461, $642) per year when CO2
emissions exceed 226 grams per km (Driver and Vehicle Licensing
Agency, 2009).
Some European countries, however, do not levy any annual tax.
These include the Czech Republic, Estonia, France, Lithuania, Poland,
Slovenia and Slovakia (European Automobile Manufacturers’
Association, 2009a, p. 2).
Ryan et al. (2009, p. 373) find that annual ownership taxes, in
contrast with registration taxes, show a strong impact on total new
car sales in Europe. Consumers seem to be more sensitive to taxes
they will pay every year for as long as they own the vehicle than to
one-off registration taxes.
5.1.4. Scrappage incentives
A number of European countries have scrappage schemes in
place. In December 2007 France introduced a system of bonuses
and penalties on the purchase of new vehicles with a bonus
between V200 and V5000 on vehicles emitting less than 130
grams of CO2 per km and penalties between V200 and V2600 for
vehicles emitting more than 160 grams of CO2 per km. The system
also included a ‘‘super-bonus’’ - a scrappage scheme offering an
additional incentive of V300 for scrapping a car more than fifteen
years old. In December 2008, as part of an economic stimulus
program, the policy was reviewed, increasing the ‘‘super-bonus’’
to V1000, and extending it to include the scrapping of cars more
than ten years old and the purchase of new vehicles emitting less
than 160 grams of CO2 per km. The maximum total bonus under
the revised scheme is V2000, which would be attained by
replacing an old vehicle by one emitting less than 100 grams of
CO2 per km (French Ministry for the Environment, Energy,
Sustainable Development and the Sea website). In Germany the
incentive is V2500 for scrapping cars older than nine years and
buying new fuel efficient cars, which are required to satisfy the
Euro 4 criteria on emissions (German Federal Ministry of
Economics and Technology, 2009).
The scrappage scheme in the UK was launched on 18 May 2009
and will last until the end of February 2010, or until the £300
million (V346 m; $482 m) funding is exhausted (if this occurs first),
offers an incentive of £2000 (V2307; $3212) to scrap a car over ten
years old and buy a new one, where £1000 of this incentive is
provided by the government and £1000 from the vehicle manufacturer. The scheme, not specifying any restrictions on the new
63
The open market value is essentially similar to Cost plus Insurance and Freight
(CIF). It includes purchase price, freight, insurance and all other charges incidental
to the sale and delivery of the car to Singapore.
64
This is a common feature with scrappage incentives, discussed in Section 5.1.4.
65
The average exchange rate in the period May-July 2009 was £1 ¼ V1.15 ¼ $1.6
(IMF Exchange Rate Query Tool).
66
These numbers are equivalent to 15.4 km per litre for cars, 12 km per litre for
vans, and 7.7 km per litre for flex-fuel vehicles. The only eligible vehicles for the
rebate in Canada, however, were essentially either hybrid or compact, or running
on a combination of petrol and ethanol.
67
The average exchange rate in the period Mar 2007 - Mar 2009 was CA$1 ¼ £0.5
¼ V0.65 ¼ $0.93 (IMF Exchange Rate Query Tool).
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
car’s CO2 emissions, is mainly intended to provide a short-term
boost to the demand for cars (UK Department for Business,
Innovation and Skills website).
Other European countries, including Austria, Cyprus, Italy, Luxemburg, Portugal, Romania, Slovakia, Spain and The Netherlands
have also introduced scrappage schemes (European Automobile
Manufacturers’ Association, 2009b, website). Although many
of the scrappage schemes in Europe specify conditions regarding
CO2 emissions, the main reason for the proliferation of these
incentives is the economic recession and its impact on the car
industry.
While many countries in Europe have been keen to adopt
scrappage schemes, these schemes have not been limited to Europe.
In the US a scrappage scheme was introduced with the signing into
law of the Consumer Assistance to Recycle and Save Act of 2009, by
President Barack Obama in June 2009 (US NHTSA website c). The Car
Allowance Rebate System (CARS),68 is an incentive scheme which
aims to both stimulate car and lorry sales while also removing older
and less fuel efficient vehicles from the roads. The scheme offers an
incentive of either $3500 (£2141; V2491) or $4500 (£2753;
V3203)69 for the purchase or long-term lease (minimum 5 years) of
a new vehicle, when they trade in their old vehicle. The incentive
depends on the type of vehicle and the difference in fuel economy
between the new vehicle and the one traded in. The car or van
traded in must be 25 years old or newer and have a combined city/
trunk road fuel economy of 18 miles per gallon (7.7 litres per km) or
less.70 The scheme will run until 1 November 2009, or until the $1
billion allocated to it by the federal government runs out (US NHTSA
website c).
The Japanese government’s stimulus package approved by the
Japanese Cabinet in April 2009 includes a scrappage scheme as well
as incentives for the purchase of environmentally friendly vehicles
without scrapping requirements. The vehicle replacement incentive scheme applies to cars and mini-vehicles as well as lorries,
requiring the scrapped vehicles to be at least 13 years old. For cars
in the standard and small categories the subsidy upon replacement
of an old car by one meeting the 2010 fuel efficiency standards is
U250,000 (£1647; V1884; $2588)71 per vehicle (Japan Automobile
Manufacturers’ Association website).
5.2. Taxes on usage of a vehicle
5.2.1. Emission taxes
As discussed in Section 4.2.1, although these would be the first
best instrument to internalise CO2 emissions from road transport,
direct charging for emissions is not feasible under current technology due to a lack of cost effectiveness and impracticability of
monitoring techniques.
There is a very good proxy for emission taxes, however, that
would be virtually as effective: a carbon tax. This would be a tax on
the carbon content of the fuel in question or on the estimated CO2
emitted in the fuel combustion process. The idea of a carbon tax,
however, has frequently encountered public and political opposition, even more so than the idea of a cap-and-trade system. In 1992,
1995 and 1997 the European Commission advanced proposals for
a European carbon tax (Vehmas, Kaivo-Oja, Luukkanen, & Malaska,
31
1999, p. 344). These, however, failed due to strong opposition from
industry and several member states (Richardson, 2002, p. 194).
There are some countries in Europe that have implemented
a carbon tax, but the efforts have never been coordinated or agreed
at EU level. These countries are Finland, which introduced a carbon
tax in 1990, Sweden and Norway, in 1991, the Netherlands in 1992,
Denmark in 1993 (Richardson, 2002, p. 194), and Italy, in 1999.
Although most countries argue that these carbon taxes have
decreased CO2 emissions to some extent (Vehmas, 2005, p. 2180),
looking at Fig. 3 it is evident that the carbon tax component of the
petrol and diesel duties have not made them significantly different
from those applied in other countries.
In July 2008 British Columbia in Canada implemented a carbon
tax (British Columbia Ministry of Small Business and Revenue,
2008). It started at CA$10 (£5, V6.4, $9.4)72 per tonne of carbon
dioxide equivalent (CO2e)73 and will rise by CA$5 per year reaching
CA$30 in 2012. The petrol tax will then reach 7.24 Canadian cents
per litre (British Columbia Government website), equivalent to 4.6
Euro-cents, which represent a very small increase relative to the
current tax component of 22 Euro-cents shown on Fig. 2.
5.2.2. Fuel taxes
Although fuel taxes are in place in most countries, they vary
widely from one to another. In fact, no other product seems to be
subject to such divergent treatment (Gupta & Mahler, 1995, p. 101).
Fig. 2 shows unleaded petrol taxes and prices for OECD countries
during the third quarter of 2008 in V per litre.
As it can be easily seen from Fig. 2, Mexico and the US have
remarkably low petrol taxes, when compared to the rest of the
OECD countries. Unsurprisingly there is not that much difference in
the pre-tax price across countries, except, as expected, for Mexico.
There is, however, considerable variation regarding taxes.
Fig. 3 shows fuel duties for the same countries, expressed as
percentage of pre-tax price. It should be noted that these shares
change with the pre-tax price, increasing when oil prices decrease
and decreasing when oil prices increase (Newbery, 2005a, p. 6).
Most countries have fixed petrol and diesel taxes, rather than ad
valorem. The advantage of this practice is that stable revenues are
guaranteed regardless of world oil prices. In order to keep a constant
revenue flow, governments would need to adjust ad valorem taxes
every time there was an important change in oil prices. Gupta and
Mahler (1995, p. 103) point out that ‘if the international price of
the product is subject to wide variations, the quantities of petroleum
products consumed may be more stable than the value of the
petroleum product consumed’ and in that case revenues from
a specific tax would be more predictable and stable, while revenues
from ad valorem taxes would be more elastic. On the other hand, ad
valorem taxes are automatically adjusted with inflation whereas
fixed rates need to be adjusted to keep up with changes in domestic
prices and exchange rates, if the real value of taxes is not to be eroded
through inflation (Smith, 2006). In the EU inflation and exchange
rates are not volatile, and hence the preferred practice of fixed fuel
duty rates does not pose the inconveniences it may pose in developing countries.
Issues related to inflation and exchange rate volatility, however,
can be a problem in African countries, for instance. Metschies
(2001, in Smith, 2006) argues that in countries where the
domestic currency is substantially devalued, regulated fuel prices
68
In the US this type of scheme is usually referred to as Cash for Clunkers.
The average exchange rate in the period June-July 2009 was $1 ¼ £0.6 ¼ V0.7
(IMF Exchange Rate Query Tool).
70
The requirements for work lorries are different and the CARS Act limits the
amount of funds that can be used to provide credits for purchases or leases of
work lorries to 7.5 per cent of the funds available for the program.
71
The average exchange rate in the period April-July 2009 was £1 ¼ U152 ¼ V1.14
¼ $1.57 (IMF Exchange Rate Query Tool).
69
72
The average exchange rate in the period Jan-Dec 2008 was CA$1 ¼ £0.51 ¼ V0.
64 ¼ $0.94 (IMF Exchange Rate Query Tool).
73
Using a stoichiometric conversion factor of 44/12 ¼ 3.6667, this is equivalent to
CA$ 2.23 per tonne of carbon.
32
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
Turkey
Norway
Netherlands
Belgium
United Kingdom
France
Germany
Portugal
Denmark
Italy
Finland
Sweden
Pre-tax price
Tax component
Austria
Korea
Poland
Slovak Rep.
Ireland
Hungary
Luxembourg
Czech Rep.
Spain
Switzerland
Japan
Greece
New Zealand
Australia
Canada
United States
Mexico
0
0.25
0.5
0.75
1
1.25
1.5
1.75
2
Fig. 2. Unleaded petrol taxes and prices for OECD, V per litre (3rd quarter 2008 or latest available). Note: Tax includes both fuel duty and VAT (or equivalent sales tax). In some
countries, like in the US, both federal and state taxes apply. In these cases, the graph shows state and federal taxes as weighted averages, based on petrol sold in all states
(International Energy Agency, IEA, 2008, p. 296) (An average fuel tax in the US of 8.6 Euro-cents per litre of unleaded petrol for the third quarter of 2008 is equivalent to 50 cents per
gallon). Source: IEA (2008), Fig. 8, p.xxxiv.
(and taxes) fall relative to world prices, and the government loses
real revenues, effectively providing a subsidy to drivers.
Fig. 4 shows fuel duty as a percentage of pre-tax fuel prices for
some selected Sub-Saharan countries. 1991 is the last year for
which data was available. For poor and/or developing countries, it is
not unusual to find contradictory information in different sources
regarding fuel tax rates.
From Figs. 3 and 4, it is puzzling that countries so close to each
other geographically and some times members of the same
economic community, have such variations in fuel duty rates across
them.
Newbery (2005a, p. 6) points out that the European Commission
aims at harmonising energy taxes within the EU and that a European approach to reducing emissions requires that each country
and GHG source face the same charge per tonne of carbon. The
argument is perfectly reasonable from an economic point of view,
since, as explained in Section 1, marginal abatement costs need to
be equalised across polluters to achieve efficiency. The EU therefore
faces the challenge of getting all its member states to agree on
a uniform rate of petrol and diesel taxes.
The next question is what this uniform rate ought to be. Should it
be at the lower end, like the one applied in Greece, or at the higher
end, as in the UK? If the revenue raising component of fuel taxes is
the VAT, the fuel duty is left to cover the external costs from road
transport that may be deemed worth internalising through fuel
duties.
Parry and Small (2005) develop a model that estimates the
optimal fuel tax and they calibrate such a model for the US and the UK.
The externalities they include are damage from CO2 emissions and air
pollution, congestion and accidents. They conclude that for the year
2000 the optimal petrol tax in the US would have been $1.01 per US
gallon (26 cents, 28 Euro-cents, 17 pence per litre),74 more than twice
the actual rate for that year, and the optimal petrol tax in the UK
would have been $1.34 per US gallon (35 cents, 38 Euro-cents, 23
pence per litre), slightly less than half the rate for that year (p. 1283).
Newbery (2005b, Table 7.3, p. 217) finds that the external costs
of road damage,75 air pollution, global warming, water pollution
and noise in the UK in 2000 amounted to 36 pence per litre of
74
The average exchange rate in the period Jan-Dec 2000 was $1 ¼ V1.08 ¼ £0.66
(IMF Exchange Rate Query Tool).
75
Newbery (2005b) points out that the damage per litre of fuel varies across
vehicle types and ages, and although the vehicle excise duty can be fine-tuned to
allow for those differences, fuel duties cannot.
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
33
Germany
United Kingdom
Finland
Netherlands
France
Sweden
Turkey
Norway
Italy
Belgium
Portugal
Denmark
Slovak Rep.
Ireland
Poland
Hungary
Switzerland
Czech Rep.
Petrol
Luxembourg
Diesel
Korea
Austria
Spain
Greece
Japan
New Zealand
Australia
Canada
United States
0
20
40
60
80
100
120
Fig. 3. Fuel duties as percentage of pre-tax price for OECD countries (3rd quarter 2008)*. Note: Canada does not have any duty on diesel and New Zealand’s duty on diesel is only 0.3
per cent of the pre-tax price. Source: Own calculations using IEA, (2008)*or latest available.
petrol.76 Since the fuel duty in the UK for the year 2000 was 48.8
pence per litre (UK DfT, 2008, Table 3.3, p. 53) it can be concluded
that the fuel duty more than covered those externalities.
Both Newbery (2005b) and Parry and Small (2005) conclude
that the UK had a fuel duty that more than covered the environmental costs of petrol. The numbers could be easily updated to
2009 and the same conclusions would be reached.
This is the kind of analysis that would need to be done when
trying to agree on a harmonised European rate of fuel duties.
Smith (2006) highlights an additional problem resulting from
such large differences in fuel duties across African countries. He
explains that if neighbouring countries in Africa have very different
fuel taxes, this can lead to problems of smuggling and some
diversion of activity. Harmonisation even in poor countries makes
sense, if only to address the problems of smuggling, reduced fuel
tax revenues, and diversion of transport routes and economic
activity to regions where taxes are lower.
It is worth keeping in mind that in the UK, and probably in
other countries with comparable fuel tax rates, the global
76
Note that Newbery (2005b) excludes accidents and congestion from these
calculations.
warming externality seems to have already been internalised,
which would make substantial increases in tax rates inefficient
from an economic point of view. CO2 emissions from road transport in these countries are probably lower than they would have
been had no such high taxes been in place (Sterner, 2007), but
they still seem to be too high to meet the various commitments
that different governments have adhered to. The only way to
defend higher fuel tax rates would be to use a much higher
shadow price of carbon, and this in turn would need to be justified by the type of models mentioned in Section 1. The effects
from climate change can only be modelled (not predicted with
certainty) and this modelling process involves making a large
number of assumptions regarding possible impacts and adaptation, discount rates and other parameters.
It is also worth bearing in mind that there are countries with
significant scope to increase fuel taxes, especially when the idea of
harmonisation is brought into the discussion.
5.2.2.1. Fuel duty differentials
5.2.2.1.1. Diesel vs. petrol taxation. It is evident from Figs. 3 and 4
that diesel is often favoured by governments relative to petrol. The
reasons for and against this were discussed in Section 4.2.2.1.
34
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
Senegal
Angola
Ivory Coast
Cameroon
Uganda
Mauritius
Burkina Faso
Petrol
Diesel
Rwanda
Namibia
South Africa
Ethiopia
Mozambique
Malawi
Madagascar
Botswana
Tanzania
Lesotho
Zimbabwe
Swaziland
Zambia
Nigeria
0
50
100
150
200
250
300
Fig. 4. Fuel duties as percentage of pre-tax prices for selected Sub-Saharan countries for 1991. Source: Smith (2006, Table 5.2).
Newbery (2005a, p. 29) points out that similar tax rates on
petrol and diesel can be compensated with differentiated vehicle
excise duties, by charging higher duties to heavy goods vehicles,
which cause more road damage and run on diesel.
Ryan et al. (2009) find that when diesel fuel prices and diesel
vehicle taxes are high, the share of petrol vehicles increases,
although these impacts disappear when the specificities of each
country are controlled for. The reason for this, they argue, might be
that fuel and vehicle taxation are political decisions and, as a result,
the favouring or not of diesel cars and fuels is determined by
country and is a fixed country effect (p. 371, p. 373).
Whatever the reason for governments to favour diesel in their
tax policy, diesel passenger car market penetration in the EU was
40 per cent in 2003, with Austria and France reaching 60 per cent
(Zervas, Poulopoulos, & Philippopoulos, 2006, p. 2848). The
percentage penetration for that year was at least 30 per cent in
every EU-15 country, with the exception of Ireland, Finland,
Sweden and Greece where it was 17 per cent, 13.6 per cent, 7 per
cent and 1 per cent, respectively (Zervas et al., 2006, p. 2850).
5.2.2.1.2. Cleaner fuels. Governments can use taxes to incentivise
motorists to switch to cleaner petrol, when this becomes available in
the market. The main economic advantage of this type of taxes is that
they leave the user to decide how best to respond, rather than
forcing him to choose one fuel. In the UK for example, the higher tax
on leaded than on unleaded petrol, raised the proportion of motorists buying unleaded petrol from five per cent in 1988 to 63 per cent
by 1993 (Newbery & Santos, 1999, p. 117). Similarly, in Sweden the
tax differential between leaded and unleaded petrol decreased the
share of leaded petrol from 70 per cent in 1986 to practically zero in
1994 (Ekins & Speck, 1999, p. 384).
A few years later, the differential duty on unleaded petrol and
ultra-low sulphur petrol followed in the UK. In October 2000 the
fuel duty on ultra-low sulphur petrol, which at the time was difficult to find at petrol stations, was cut down by 1 penny per litre. In
March 2001 it was further cut down by two pence. The pumpprices were 78.2 and 75.9 pence per litre (UK DfT, 2008, Table 3.3,
p. 53). At that point most drivers switched from unleaded petrol to
unleaded ultra-low sulphur petrol, and by 2006 unleaded petrol
was eventually phased out.
5.2.3. Vehicle km travelled taxation
Switzerland introduced a Heavy Vehicle Fee (HVF) in January
2001, which applies to lorries over 3.5 tonnes. The HVF varies with
their gross weight, kilometres driven within Switzerland, and
emission category of the model (Suter & Walter, 2001, p. 383).
The fee is collected with the help of on-board units, which
record distances driven and routes taken. At the end of each month
the data are transmitted to the Swiss Customs Agency either by
mail or over the Internet. This information is used to generate a bill
that is sent to the vehicle owner.
As a result, the total volume of goods transported by road
through the Alps increased by 3 per cent but lorry trips declined 14
per cent between 2000 and 2005, indicating that pricing encourages more efficient use of lorry capacity.
5.2.4. Congestion charges
Although congestion charging has been advocated by transport
economists for many decades its implementation has been limited.
The main barriers are typically public and political opposition,
linked to equity concerns. As a result, there are only a few examples
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
of congestion charging as of 2009. These are briefly described
below.
5.2.4.1. Norwegian toll rings. The Norwegian toll rings, very often
cited in the road pricing literature as examples of congestion
charging, were designed to generate revenues to finance infrastructure. The aim was not to manage traffic demand. Nonetheless,
since it has become common practice to bring them into any
discussion on congestion charging, they deserve a mention.
Since the late 1980s - early 1990s a number of towns in Norway,
including Oslo and Bergen amongst others, have tolls, usually
surrounding the whole town rather than the city centre, with daily
charges which never exceed NOK 20 (roughly £2 or V2.2)77 for cars
and light vehicles. All schemes in Norway have flat rates 24 h a day
every day, except for Namsos, where the scheme only operates
Monday to Friday, from 6:00 a.m. to 6:00 p.m.
Since the original aim of these toll rings was not to reduce traffic
levels and congestion, the decrease in demand for car travel has
been low, with estimates varying from zero to 10 per cent reduction
at most. Similarly there have been no significant changes in private
car occupancy rates or demand for public transport (Ramjerdi,
Minken, & Østmoe, 2004).
5.2.4.2. Toll highways. There are a number of toll highways
around the world. Although the only objective of many of these
schemes is to generate revenue, some also aim at relieving
congestion. Examples include the M6 Toll in England, the 407
Express Toll Route (ETR) in Toronto and a number of roads in
major Australian cities, such as for example, City Link in Melbourne and the Westlink M7 Toll Road in Sydney. In all these
cases the toll highways are in privately owned or managed.
Drivers have the option of choosing between the toll road with
lower journey times and the publicly provided alternative with
higher journey times.
The M6 Toll in England is a parallel78 segment to the M6
motorway, which extends 27 miles (43 km). Drivers have the
option of using the publicly provided alternative for free or using
the toll road. The M6 toll runs from junction 3a on the M6 and
rejoins it at junction 11a. Charging is done at toll plazas along the
road or at the exit and is not electronic.
The Highway 407 ETR in Toronto extends 67 miles (108 km)
from Brock Road in Pickering in the east to the QEW/403 interchange near Hamilton in the west. The 407 ETR charges tolls
electronically, based on distance driven.
The City Link in Melbourne is a toll road in the centre of Melbourne in Australia, which extends 14 miles (22 km), from Tullamarine Freeway to the West gate Freeway and the West Gate
Freeway to the Monash Freeway. The system operates electronically
and charges per trip made along the toll segment.
The Westlink M7 Toll Road in Sydney extends 35 miles (40 km),
connecting the M2, M4 and M5 motorways. It operates electronically and charges per distance driven.
5.2.4.3. High occupancy toll lanes in the US. High Occupancy Toll
(HOT) lanes in the US are lanes where tolls are applied on low
occupancy vehicles wanting to use lanes which are free to use for
high occupancy vehicles (HOV). High occupancy is usually defined
as vehicles with two or more occupants.
77
The average exchange rate in the period Jan-May 2009 was NOK 1 ¼ £0.10 ¼
V0.11 (IMF Exchange Rate Query Tool).
78
It is not parallel in the strict sense, as it arcs around the north-east of the West
Midlands conurbation before re-joining the M6.
35
The State Route 91 (SR-91) Express Lanes, which opened in
December 1995, were the first practical example of congestion
pricing in the US (Sullivan & El Harake, 1998).
Although they were originally privately operated, in January
2003 their operation was taken over by the Orange County Transportation Authority. The SR-91 Express Lanes, which extend 10
miles (16 km) operate between the Orange/Riverside county line
and the Costa Mesa Freeway (SR-55) interchange in eastern
Anaheim.
Tolls apply 24 h a day, 7 days a week, with the lowest one being
$1.25 and the highest one, $9.50 (Orange County Transportation
Authority, 2008).
As of 2009 there are an additional seven HOT lane projects in
operation in the US, which have been partly funded by the Value
Pricing Pilot program or by its predecessor, the Congestion Pricing
Pilot Program. Projects include segments of the I-15 in San Diego,
California (implemented in 1996), the I-25 in Denver, Colorado
(implemented in 2006), the I-394 in Minneapolis, Minnesota
(implemented in 2005), the Katy Freeway (I-10) and the US 290 in
Houston, Texas (implemented in 1998 and 2000 respectively), the I15 in Salt Lake City, in Utah (implemented in 2006), and the SR 167
in King County, Seattle, Washington (implemented in 2008). The
individual designs vary, and tolls range from 50 cents to $9. In some
cases tolls apply in the morning peak, in others in the afternoon
peak, and in others they change in real time with traffic demand. In
this case, drivers are informed of the toll rate changes through
variable message signs located in advance of the entry points.
An advantage of HOT lanes over other congestion charging
systems is that with HOT lanes drivers ‘can choose between
meeting the vehicle occupancy requirement or paying the toll in
order to use the HOV lane’ (DeCorla-Souza, 2004, p. 288).
5.2.4.4. Singapore. In 1975, congestion pricing was implemented in
Singapore. The system was a paper-based area licensing scheme
(ALS). Vehicles had to purchase a licence and display it on their
windscreen before entering the restricted zone (RZ). The charge
was per day, not per entry, meaning that they could enter and leave
the RZ an unlimited number of times during the day. Exemptions
included police cars, ambulances, fire engines and public transport
buses. Motorcycles, goods vehicles and carpools were initially
exempt, but from 1989 onwards they were also required to buy
a licence (Chin, 2002). No discounts or exemptions were given for
residents living inside the RZ, although driving inside the zone
without crossing the boundary could be done for free. The hours of
charging and the levels of the charges varied throughout the years.
They started with the morning peak Monday to Saturday, but later
included the inter-peak period, from mid-morning till middle
afternoon, and the evening peak. Drivers could purchase a wholeday licence, which allowed them to drive inside the RZ at any
time during the hours of operation of ALS, or a part-day licence,
which only allowed them to drive during the inter-peak hours on
weekdays and the post-peak period on Saturdays.
The system was manually enforced by enforcement officers
standing at the boundaries of the RZ, and was thus prone to error.
The impacts on traffic were drastic. Phang and Toh (1997, p. 99)
report that the introduction of ALS increased average speeds from
11.8 to 22.4 miles (19–36 km) per hour, exceeding the government
target of 12.4–18.6 miles (20–30 km) per hour. According to
Willoughby (2000, p. 10), traffic volumes during the morning peak
hours fell by 45 per cent, well above the expected reduction of 25–
30 per cent. Car entries were reduced by 70 per cent.
This project was for many years the only congestion charging
project in the world. It has to be borne in mind that Singapore is
a very special case, and as such, replication of the ALS elsewhere
would not have been straightforward. Geographically, it is an island
36
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
city-state, which measures 26.1 miles (42 km) East to West and 14.3
miles (23 km) North to South. It has 1955 miles (3149 km) of roads
for a population of about 4.2 million people and 707,000 registered
motor vehicles in the year 2002 (Santos et al., 2004). Politically,
there is a dominating political party, the People’s Action Party,
which has won all the elections since 1959.
In June 1995, a paper-based Road Pricing Scheme (RPS), operating in the same way as the ALS, was implemented on an
expressway (East Coast Parkway). This was later extended to other
expressways. The aim of the RPS was to reduce congestion on the
expressways during morning peak times, and to familiarise Singaporeans with both linear passage tolls and road charging outside
the CBD (Goh, 2002).
In September 1998 Electronic Road Pricing (ERP) replaced the
ALS. Rather than a licence to use the RZ, charges apply per-passage.
The charging area is divided into central business districts
(including the areas previously covered by ALS), where charging
applies from 7:30 a.m. to 8:00 p.m., and expressways/outer ring
roads, where charging applies from 7:30 to 9:30 a.m., Mondays to
Saturdays, except public holidays. Vehicles are charged automatically on an electronic card, which is inserted in an In-vehicle Unit,
each time the vehicle crosses a gantry. If the charge cannot be
deducted from the card, either because it is not properly inserted or
because it does not have sufficient credit, a fine is issued to the
vehicle owner.
The only exemptions include emergency vehicles, such as
ambulances, fire engines and police cars. ERP rates vary with
vehicle type, time of day and location of the gantry. Charges for
passenger cars, taxis and light goods vehicles for example vary
between S$0.50 and S$3.50,79 charges for motorcycles vary
between S$0.25 and S$2, charges for heavy goods vehicles and light
buses vary between S$0.75 and S$6, and charges for very heavy
goods vehicles and big buses vary between S$1 and S$8.
In February 2003 a graduated ERP rate was introduced in the
first five minutes of the time slot with a higher charge in order to
discourage motorists from speeding up or slowing down to avoid
higher charges (Land Transport Authority website). Since the
graduated rate is introduced in the more expensive band, drivers
save some money. For example, where the charge for passenger
cars would be S$2 between 8:00 and 8:30 a.m. and S$3 between
8:30 and 9:00 a.m., it is now S$2 between 8:05 and 8:30 a.m.,
S$2.50 between 8:30 and 8:35 a.m., and S$3 between 8:35 and 8:55
a.m., when it changes to S$2.
The Singaporean ERP is the most fine-tuned road pricing system
in the world to date. Since charges vary with vehicle type, time of
day and location of the gantry and are only debited per passage,
they incorporate a fair degree of differentiation.
5.2.4.5. London. The introduction of congestion charging was
a central part of Ken Livingstone’s manifesto for the mayoral election in May 2000. After a number of public consultations, the
London Congestion Charging Scheme (LCCS) was implemented in
February 2003. All vehicles entering, leaving, driving or parking on
a public road inside the Charging Zone (CZ) between 7:00 a.m. and
6:00 p.m.80 Monday to Friday, excluding public holidays, must pay
the congestion charge. This was initially £5, but in July 2005 it was
increased to £8 per day. Payment of this charge allows road users to
enter and exit the CZ as many times as they wish to and drive inside
the CZ as much as they want on that day.
79
The average exchange rate in the period Jan-May 2009 was S$1 ¼ £0.46 ¼ V0.51
(IMF Exchange Rate Query Tool).
80
The end time was originally 6:30 p.m. but it was brought forward to 6:00 p.m.
when the zone was expanded to the West in February 2007.
The CZ is relatively small. It covers roughly 15 mi2 (39 km2),
representing 2.4 per cent of the total 617 mi2 (1579 km2) of Greater
London. No charge is made for driving on the roads that limit the CZ
and there are two free corridors: one north to south, crossing
roughly in the middle of the CZ, and another one north-west of the
zone, east to west, as the diversion route would have been too long
for drivers just wanting to cross a short segment of an A-road81 that
falls inside the CZ.
The charging zone is set to shrink. The new Mayor of London, Boris
Johnson, who took post in May 2008, conducted a public consultation
on the Western Extension between September and October 2008,
giving the public and stakeholders the options of keeping it,
removing it or altering it. Following this consultation, in November
that same year, he announced that the Western Extension would be
removed, although not earlier than 2010 (Transport for London, TfL,
2008b). When this eventually happens, the new CZ will be the
original one, only 8 mi2 (21 km2), or 1.3 per cent of Greater London.
There are a number of exemptions and discounts, which apply
to two-wheelers, emergency vehicles, vehicles used by or for
disabled people, buses, taxis and mini-cabs, some military vehicles,
alternative fuel vehicles (with stringent emission savings), roadside
assistance and recovery vehicles. Finally, vehicles registered to
residents of the CZ are entitled to a 90 per cent discount when
buying at least a week worth of congestion charge. Enforcement is
undertaken with Automatic Number Plate Recognition (ANPR), and
violators (vehicles with number plates using the CZ without having
paid the charge) are fined.
Both the number of vehicles with four or more wheels entering
the original CZ as well as the number of vehicle-kilometres driven
by vehicles with four or more wheels inside the original CZ during
charging hours decreased by around 20 per cent, with most of this
reduction having taken place in the first year of the LCCS and
maintained throughout (TfL, 2007, p. 17 and Table 2.4, p. 26, TfL,
2008a, p. 41).
Congestion, defined as ‘the difference between the average
network travel rate and the uncongested (free-flow) network travel
rate in minutes per vehicle-kilometre’ (TfL, 2003, Table 3.1, p. 46),
decreased by 30 per cent in the first year of the LCCS. This reduction
in congestion deteriorated over the period 2005–2007, when
average delays eventually went back to pre-charging levels, despite
the decrease both in the number of vehicles entering the original CZ
and in the number of vehicle-kilometres driven by vehicles with
four or more wheels having stayed constant between 2003 and
2007. TfL gives a number of reasons explaining the increase in
congestion, including a high number of road works, particularly in
the second half of 2006, as well as during 2007 and into 2008 (TfL,
2007, point 3.2, p. 35 and point 3.10, p. 45), traffic management
programs to reduce the number of road traffic accidents, improved
bus services, and a better environment for pedestrians and cyclists
(TfL, 2007, p. 2). In other words, part of the newly recovered
network space was allocated to users other than private car drivers.
The two main modes of public transport in London are buses
and the underground. The LCCS had impacts on bus use but not on
underground use. The number of bus passengers entering central
London increased by 18 per cent and 12 per cent respectively
during the first and second years of the LCCS, and have since settled
(TfL, 2007, p. 58, TfL, 2008a, p. 86). By the time congestion charging
started, bus services had been improved by a combination of more
frequent services, new and altered routes, and bigger buses.
The LCCS is an unsophisticated flat charge, which does not
differentiate by vehicle type or time of day. However, it achieved its
81
An A-road in the UK is a main road.
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
objective of reducing car use. Although speeds increased in the first
two years, they then started to deteriorate and by 2007 delays were
back at pre-charging levels. The decrease in average speeds
however, is not linked in any way to an increase in traffic but rather,
to a reallocation of network space to buses, cyclists and pedestrians,
plus the unfortunate timing of road works in central London.
5.2.4.6. Stockholm. The congestion tax in Stockholm was implemented in August 2007 with the objectives of reducing traffic
congestion and emissions. It is a cordon toll system, with a cordon
that surrounds the entire Stockholm City, which has a total area of
roughly 13.7 mi2 (35.5 km2). Like in London, enforcement is
undertaken with ANPR, with cameras located at each of the 18
entry and exit points.
Each passage into or out of the area surrounded by the cordon
costs SEK 10, 15 or 20 (roughly between £0.8 and £1.7 or V0.9 and
V1.8)82 depending on the time of day. The accumulated passages
made by any vehicle during a particular day are aggregated and the
vehicle owner is liable for either the sum of the charges or SEK 60,
whichever is lower.
Exemptions include emergency vehicles, buses, diplomatic
cars,83 motorcycles, foreign registered vehicles, military vehicles,
disabled parking permit holders, and vehicles that according to the
Swedish Road Administration’s vehicle registry, are equipped with
technology for running (a) completely or partially on electricity or
a gas other than LPG or (b) on a fuel blend that predominantly
comprises alcohol (Swedish Road Administration, 2007). In addition, vehicles driving on the motorway which goes through the
charging zone are also exempts, as there are no alternative routes.
Finally, traffic to and from Lidingö island, with its only access to the
mainland through the charging zone, is also exempt.
The congestion tax is paid retroactively. The payment must
reach the Swedish Road Administration within 14 days of crossing
the cordon. Regular users can set up a direct debit. Other ways of
paying include cash or credit card at convenience stores, credit or
debit cards on the congestion tax website, or directly to the Road
Administration’s account (Swedish Road Administration, 2007).
Drivers not paying the tax within 14 days are issued a fine.
Eventually, if the vehicle owner continues to refuse to pay, his
name is entered in the Enforcement Register (Swedish Road
Administration, 2007).
5.2.5. Parking charges
Parking charges can be divided into three groups: parking
charges for using a space on a public road, parking charges for using
a space in a privately provided parking lot, and parking charges for
parking at the workplace.
Except for the charges paid in privately provided spaces, which
typically cover all costs of parking and even yield some profit to the
owner, the other charges tend to be low or non-existent.
Zatti (2004) discusses the effectiveness of the parking charges
in the city of Pavia (Italy). In Pavia, the parking charges are
limited to a small area, the charges are modest, and many categories of drivers are exempt from payment. He argues that these
factors, together with the vast use of illegal parking contribute to
make parking fees in the city of Pavia a revenue instrument
rather than an instrument to internalise externalities. In fact, the
82
The average exchange rate in the period Jan-May 2009 was SEK 1 ¼ 8 pence ¼ 9
Euro-cents (IMF Exchange Rate Query Tool).
83
Under the 1961 Vienna Convention, diplomats are exempt from paying taxes.
Staff at the US and German embassies refuse to pay the congestion charge in London, arguing that under the 1961 Vienna Convention, they are exempt from paying
taxes. However, the London congestion charge is not a tax but a charge. The Stockholm congestion tax on the other hand is a tax.
37
majority of the burden falls disproportionately on occasional
visitors to the city.
The Transport Act 2000 (Acts of Parliament, 2000) gave local
authorities in England and Wales powers to introduce workplace
parking levies. However, as of August 2009, Nottingham City
Council is the only local authority to have concrete proposals for
a workplace parking levy, and the scheme will not start until
specific regulations regarding workplace parking charges have
been detailed (Nottingham City Council website). All employers
with more than ten parking spaces would be liable and the Council
hopes that the policy will reduce peak-time congestion and
encourage the use of an improved public transport system.
5.2.6. Pay-as-you-drive insurance
Parry et al. (2007) report that PAYD schemes are slowly
emerging at state level in the US. Oregon has offered insurance
companies a state tax credit of $100 per motorist for the first 10,000
motorists who take up a PAYD policy and Texas has passed legislation which allows insurance companies to offer PAYD (p. 394).
In May 2009 the New America Foundation Climate Policy
Program published a survey of 33 US states climate change emission reduction plans (New America Foundation website). Twelve
include PAYD as a transport emission reduction strategy.84 These
states include Arizona, California, Colorado, Maryland, Maine,
Minnesota, New Hampshire, New Mexico, North Carolina, Rhode
Island, Vermont and Virginia. The degree of emphasis and support
for PAYD varies. For example, the Rhode Island plan, while
endorsing the importance of the strategy, explicitly says that the
state will likely wait for other states to figure out how to promote
PAYD insurance before it does so. The California Department of
Insurance is now in the process of rule making to support PAYD
(California Department of Insurance website).
There are some limited examples in other countries, with some
companies offering PAYD in Australia, Israel, the Netherlands and
South Africa. It is not a widely spread practice yet, and so there are
not many implementation examples to report on or assess.
5.3. Revenue allocation
As already explained in Section 4.5, revenues from taxes can be
earmarked for specific uses, such as for example, the road transport sector. Thus, road infrastructure and public transport and/or
other environmentally friendly transport projects can be financed
with a stable flow of revenues from ring-fenced taxes or from the
general government funds. Many governments depend on fuel
and other road taxes for general revenues. Fuel taxes are relatively
easy to administer and collect and so it is difficult for governments
to let go.
The US, however, allocates most of the fuel tax revenues to
expenditure on building and maintaining the national highway
system. Although this used to be enough in the past, it only covers
about one third of total expenses now, and the gap is financed
with real estate and other taxes (Schäfer et al., Chapter 7, p. 224).
Fuel taxes in the US are lower than in other developed countries,
as was shown in Section 5.2.2. About three-quarters of the
revenue goes to the highway account, a small portion is allocated
to public transport and only the residual goes to the general
budget.
In the UK, fuel duties and vehicle excise duties, exclusive of VAT
receipts, amounted to almost £26 (V28.6) billion in 2002–2003, or
6.7 per cent of total tax revenue, around 2 per cent of GDP. Only £5.5
84
The excel sheet summarising the plans is available on www.newamerica.net/
files/State%20Climate%20Policy%20Tracker%205-4-09.xls
38
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
billion of this revenue was spent on roads85 (National Statistics
Online, 2004, Table 7.13). Newbery and Santos (1999) report
similar gaps since the 1950s. Interestingly, the allocation of road tax
revenues to other sectors in the economy is not taking place
because there is no need for investment in roads. In fact, investment in the road network in the UK is failing to keep up with the
growth in traffic levels. Between 1991 and 2001, road traffic in the
UK increased by 15 per cent, yet road length only grew by 9 per cent
(RAC, 2003).
Most countries in Europe also depend on motor fuel excises,
which typically represent 4–6 per cent of total tax revenues. If these
taxes were earmarked for road transport only, other sectors in need
of funding would suffer.
Gupta and Mahler (1995) show that the taxation of domestic
consumption of oil products is an important source of revenue in
most countries. In developing countries, they argue, these revenues
represent between 7 and 30 per cent of total tax revenues, or
between 1 and 3.5 per cent of GDP (p. 101).
In other words, tax revenues from fuel are significant enough for
governments to be reluctant to earmark them. It is worth fastforwarding a couple or so decades in time, and trying to imagine
what would happen if oil-based fuels were completely or at least
mostly replaced by alternative fuels (be it biofuels, electricity, etc).
For these alternative fuels to achieve such a market penetration,
governments would probably need to offer tax reductions on these
types of energy (as well as subsidies to buy the vehicles that would
support them).86 Consequently, the tax revenues from petrol and
diesel would be seriously compromised, leaving most governments, developing and developed, in need of finding new ways of
raising such sums.
Having said that, there are some exceptions, as not all governments rely heavily on revenues from fuel taxes. Such countries
include mainly those where fuel prices are regulated, or where oil
importing, refining and distribution activities are publicly-owned
(Smith, 2006) and oil-exporting countries (Gupta & Mahler, 1995).
In these countries, pump-prices tend to be lower, and taxes, either
non-existent or just about sufficient to subsidise the losses from
publicly-owned companies.
Up to this point, revenue allocation from fuel and vehicle taxes
has been briefly discussed. Revenues from congestion charges pose
different challenges and opportunities. It is now also worth highlighting the difference between a charge and a tax. According to the
System of National Accounts 1993 (OECD, 1993):
‘Taxes are compulsory, unrequited payments . to government
units. They are described as unrequited because the government
provides nothing in return to the individual unit making the
payment, although governments may use the funds raised in
taxes to provide goods or services to other units, either individually or collectively, or to the community as a whole’ (OECD,
1993, p. 46).
In other words, the revenues from a tax can go to the general
fund, as the government does not need to provide anything ‘in
return to the individual unit making the payment’, or they can be
specifically earmarked for some use. The revenues from a charge,
on the other hand, do not need to be specifically earmarked, as they
already are, ipso facto.
85
This expenditure included new construction, improvement, structural maintenance, bridge maintenance and strengthening, safety and public lighting.
86
The UK government, for example, announced in April 2009 that they would
provide subsidies of between £2000 and £5000 to help consumers buy their first
electric and plug in hybrid cars, when these become widely available, from 2011
(UK DfT Press Release, 2009).
While the Stockholm congestion tax has been classified as a tax,
the London and Singapore congestion charges have been classified
as charges, not taxes. All three schemes, however, generate revenues which are allocated to the road transport sector. In the case of
Stockholm, these have been earmarked for new road construction
in and around Stockholm and for improvement of public transport.
In the case of London, the London Greater Authority Act (Acts of
Parliament, 1999), which gives the Mayor power to introduce
congestion charges, requires that net revenues are used for the local
transport plan. Most have and continue to be allocated to the bus
network. A smaller percentage is allocated to improvement of roads
and bridges, road safety, walking and cycling facilities and facilitation of distribution of freight (TfL, 2007, Table 6.3, p. 114). In the
case of Singapore, which has the longest history of congestion
charging, revenues are also used to finance projects in road
transport.
The fact that net revenues from the urban congestion charging
schemes have been earmarked to road transport has helped political acceptability. Surveys carried out in London between March
and August 1999 found that people changed their attitude towards
the idea of congestion charging when they were told that revenues
would be earmarked to transport. 67 per cent of the general public
thought that road user charges in central London would be a good
idea if net revenues were spent on transport improvements, and
the proportion increased to 73 per cent when the respondents’
spending preferences were introduced (ROCOL Working Group,
2000, p. 57).
5.4. Concluding remarks
Taxes and charges in the road transport sector are used extensively throughout the world. Most countries levy a registration tax
on new vehicles and annual vehicle excise duties. More recently
many have also introduced subsidies to efficient vehicles, feebates
and/or scrappage incentives.
Most countries also have fuel duties, some taking the form of
carbon taxes. Fuel taxes vary substantially from one country to
another. Mexico and the US, for example, have very low petrol
taxes, when compared to other OECD countries. Great differences
can also be observed across African countries.
Many European countries depend on motor fuel excises, which
typically represent 4–6 per cent of total tax revenues. If these taxes
were earmarked for road transport only, other sectors in need of
funding would suffer. If the road transport sector were decarbonised and alternative forms of energy were exempt from taxes,
governments would need to introduce taxes in other sectors of the
economy to make up for the loss of revenues they would suffer.
6. Conclusions and policy recommendations
6.1. Conclusions
In this paper we have summarised the main road transport
externalities and economic policies proposed and implemented to
deal with them.
The most important negative externalities from road transport
include accidents, road damage, environmental damage, congestion and oil dependence.
Since the market is incapable of reaching an efficient equilibrium in the presence of externalities, a number of government
interventions have been suggested in the literature. From an
economic point of view, these interventions fall under two headings: command-and-control (CAC) and incentive-based (IB) policies. CAC policies are essentially regulations, which force
consumers and producers to change their behaviour. IB policies are
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
designed to mimic in some way the functioning of the market, by
providing financial incentives to consumers and producers to
change their behaviour. These can be further categorised into price
controls and quantity controls. Price controls tend to be either
taxes, charges or fees. They can also take the form of subsidies, as
a foregone subsidy can have a similar impact to that of a tax.
Quantity controls are systems of tradeable permits, where a cap is
imposed by the regulator and permits can be traded among
economic agents.
The main advantage of IB policies (both price and quantity
control) over CAC ones is their cost effectiveness. Producers or
consumers with low costs of abatement tend to reduce the amount
of externalities generated by themselves, rather than buying
permits or paying taxes, while those with high costs of abatement
choose to buy permits or pay taxes. The cost of reducing the
externality is thus minimised compared to the more direct regulatory approach of setting standards, which obliges everyone to
reduce their generation of externalities to the level fixed by the
regulator, regardless of how costly abatement for each firm or
individual is.
A number of CAC and IB policies have been reviewed.
CAC policies are not efficient from an economic point of
view: even in a context of perfect information when the regulation
or standard is set at the optimal level, the target is not achieved at
the minimum cost, and worse yet, the social costs could exceed the
potential benefits (thus replacing market failure with government
failure). Despite all this, they are the type of instrument most favoured by policy makers.
Regulations, however, seem to be adequate for regulating
fuel quality, perhaps complemented with a duty differential or
a facility for trading credits. This approach was successful, in
phasing out leaded petrol in many countries, including the US and
those in Europe, as well as in reducing the sulphur content of petrol
and other harmful emissions.
Standards also seem to be adequate for regulating tailpipe
emissions: standards can become increasingly stringent over
time, and they can regulate emissions of nitrogen oxide,
hydrocarbons, carbon monoxide and particulate matter. They
could also serve for regulating CO2 emissions, although this is
a much more problematic area, where the inefficiency of CAC
becomes evident. A carbon tax, or, at least, a fuel tax would be
better suited as an instrument for reducing CO2 emissions. We
return to this point below. Fuel economy standards for vehicles, not
too dissimilar from CO2 caps per km, reduce fuel consumption but
also cause a rebound effect.
The Low Emission Zone (LEZ) in London is a CAC policy.
However, its cost effectiveness may not be as poor as that of other
CAC instruments, mainly because it is being phased-in. In reality,
the vehicles affected by the regulation are few, as the increasing
standards, required for circulation inside the LEZ, kick in years after
the EU-standards, on which they are based, come into effect.
Bans on vehicle circulation, especially of the types imposed in
Athens and Mexico City, do not ensure that the most valuable
trips will be made. Worse yet, they may result in more, rather
than less, driving. This is because motorists may acquire second
hand cars, or forge licence plates to be able to drive every day of
the week.
Parking restrictions pose a similar problem to a ban on vehicle
circulation: the trips that are made may not be the most valuable
ones. Thus, an inefficiency will occur. Also, drivers may
contribute more to congestion while looking for an available
parking space.
IB policies do not impose any choices, but rather leave
consumers and producers to make decisions according to their
costs and benefits, preferences and constraints.
39
The use of revenues generated through IB road transport
policies that correct externalities has impacts on social welfare
and equity and is an important determinant of the political
acceptability of these policies. In general, using these revenues to
reduce distortionary taxes increases the efficiency of the system,
and investing them in the transport sector (on roads, public
transport, R&D) increases equity.
Except for the inter-refinery averaging and banking of credits
instituted by the US EPA in the 1980s to facilitate the phase-out of
leaded petrol in the US, cap-and-trade schemes have not been
implemented in the road transport sector in any country or region
to date.
The main candidate for a permit system in the road transport
sector is CO2 emissions. One important difficulty is that emission
sources in road transport are small, dispersed, and mobile, which
makes enforcement difficult. This obstacle could, however, be
overcome by implementing a system that would work at the pump
(and in that case it would essentially be similar to a fuel tax) or one
at upstream level, designed either for fuel producers or car
manufacturers.
Although tradeable permits would in principle incentivise the
development of fuel-efficient and alternative fuel vehicles, there
are a number of potential problems relating to their implementation: (a) auctioned permits would awake public and political
opposition, whereas grandfathered permits would deprive
governments of revenues, which could be allocated to reducing
distortionary taxes or for investment in R&D of new technologies;
(b) permits with shorter life would have higher tradeability, but
also transaction costs, and permits with longer life would have
greater uncertainty about future prices; (c) including road transport in a much larger scheme, such as the EU ETS, would achieve
reductions in emissions, although not necessarily in road transport.
Designing a separate system, would guarantee emission reductions
in road transport, but not necessarily in other sectors with lower
abatement costs.
Taxes and charges have been widely implemented in the road
transport sector around the world, both in developed and developing countries. Their effectiveness as corrective instruments,
however, depends on the link between the externality they are
targeting and the tax or charge itself.
Vehicle purchase and ownership taxes can be designed to take
into account the road damage they cause, so that heavier vehicles
pay higher taxes. However, these taxes are unlikely to influence
travel behaviour. Travel behaviour can be altered with congestion
charges, PAYD insurance, and fuel duties.
Congestion, which varies with vehicle type, road and time
of day, is best targeted with a congestion charge than with
a fuel tax. A fuel tax may reduce demand for travel, but may not
reduce it (enough) during congested periods. Examples of
congestion charging are limited, with only three urban schemes,
the ones in Singapore, London and Stockholm, and a few High
Occupancy Toll lanes in the US. The most fine-tuned system is the
Electronic Road Pricing scheme in Singapore, which charges
different rates to different vehicle types, at different locations and
times of the day.
Congestion charging is an IB policy which has and continues to
face fierce public and political opposition. Concerns are usually
linked to pervasive distributional impacts. In reality, however, car
users are not willing to pay for something they have always had for
free. As anecdotal evidence, implementation of the Manchester
congestion charge was halted after the results of a public referendum. The scheme did take into account a number of potential
negative effects and proposed solutions. These included exemptions for low-paid workers, additional school buses, and significant
improvements in public transport and Park & Ride facilities. None of
40
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
these compromises were enough to make the scheme more
acceptable.
Pay-as-you-drive (PAYD) insurance could reduce the number
of trips made, which would also have a welcome impact on
congestion and emissions. This would also increase the efficiency
of insurance systems because the link between distance driven per
year and the premium would be strengthened.
The variation in fuel duties across countries is large. Although
these were originally introduced as revenue-raising instruments,
they are now also increasingly being regarded as corrective taxes to
internalise road transport externalities.
Bearing in mind that these are excellent instruments (only
second to carbon taxes) to internalise the global warming externality the very fact that fuel duties are so different indicates the
presence of an inefficiency. This inefficiency is of particular
concern, given that the externality is global, regardless of where the
emissions originate.
Harmonisation of fuel duties across countries in a region
would support coordinated policies to reduce CO2 emissions,
with just one (implicit) shadow price of carbon. One important
problem regarding fuel tax harmonisation is that countries would
need to agree on the tax rate.
Virtually all countries have mechanisms in place for collecting fuel duties. Thus, in addition to being fairly effective and
internalising the global warming externality, a carbon tax on
motor fuels, or at least blunter fuel duties, have the advantage of
already being place. In addition, they are easy to monitor and
enforce, inexpensive to collect, and guarantee some level of price
stability. Permits are more costly in regulatory terms, in the
sense that they require an institutional setting, definition of
property rights and initial allocation, as well as enforcement
procedures. However, there seems to be some preference, both
from politicians and from consumers and producers, for tradeable
permits. This is evident in the trends regarding initiatives to tackle
climate change.
The EU ETS was designed and implemented after proposals for
a European carbon tax failed in the 1990s. In the US there are
currently proposals for cap-and-trade systems, rather than carbon
taxes, let alone substantial increases in fuel taxes.
Since cap-and-trade systems seem to be better accepted,
perhaps in the hope that they will be grandfathered following
insistent lobbying from affected parties, the time may have come to
start thinking globally on how to design and implement new
systems that will be compatible with each other. Better yet, would
be a unified carbon market. This would entail international agreements on country-level quotas and long and costly negotiations,
but may finally result in the world-wide institution of a truly global
carbon market.
6.2. Policy recommendations
On the basis of our survey, which considers economic
theory and policy implementation of instruments to ameliorate
road transport externalities, we offer the following policy
recommendations.
Regulations and standards are not efficient from an economic
perspective, but they are excellent instruments under the following
circumstances:
if the level of an activity, such as emitting a lethal substance,
needs to be drastically reduced or altogether eliminated;
when the constraints faced by the regulator, such as public and
political acceptability of incentive based measures, are severe;
as complements to incentive based policies, as long as the two
instruments - the command-and-control and the incentive
based one - are not designed to achieve the same reduction in
activity (because otherwise the reduction would be beyond
optimal).
In general, regulations on fuel composition and vehicle emissions have worked well, and are both feasible and effective
instruments.
Given that incentive based policies are efficient from an
economic point of view, but in reality, do not always fulfill their cost
minimisation potential, we do not recommend widespread adoption of this type of instrument blindly. However, taxes, charges and
permits are excellent instruments in the following cases:
when the revenue generated from taxes or permit auctions by
the government can be used to reduce distortionary taxes in
the economy, such as income taxes, and/or be returned to the
road transport sector in the form of investment in public
transport or R&D of cleaner technologies;
as a driver to change economic agents’ behaviour, such as
driving fewer km or increasing the use of public transport;
When faced with the choice between permits and taxes,
governments may find that taxes are more practical and administratively easier to implement in the case of road transport.
However, given the general current trend throughout the world to
consider permits a refreshing alternative to taxes, the time may be
optimal to move towards tradeable permits to internalise the
external costs of CO2 emissions, if only because they seem to be
more acceptable. It should also be highlighted that, if a global
carbon market emerged, with the participation of most countries
and economic sectors, the price signals would make decisions
easier at all levels (production and consumption, as well as
investment) , as well as targeting them towards lower carbon
choices.
Taxes and charges, on the other hand, should be used when
there is a strong link between the tax or charge and the externality
in question. Congestion charging and PAYD insurance, for instance,
are good examples.
Governments can choose from a variety of excellent policy
instruments, which reduce carbon emissions from road transport
and address the problem of climate change – ‘the greatest and
widest-ranging market failure ever seen’ (Stern, 2006, p. i). Implementing these will require political will and commitment. But
given the high costs of postponing these decisions, the best policy is
to act now.
Acknowledgements
We are grateful to Jack Jacometti, Stewart Kempsell and Sylvia
Williams, from Shell International, as well as Stephen Skippon,
from Shell Global Solutions, for fruitful discussions about the work
presented in this paper.
We are also thankful to all our colleagues at the Smith School
of Enterprise and the Environment, and especially to Oliver
Inderwildi, Xiaoyu Yan, Aaron Holdway, Chris Carey and Nick
Owen, who also worked on the Future of Mobility, and to Stephen
Smith, from University College London and Todd Litman, from the
Victoria Transport Policy Institute, for helpful pointers.
Finally, we are indebted to our external reviewer, Ian Parry, from
Resources for the Future, for helpful comments and suggestions
that improved this paper.
Any remaining errors or shortcomings are our own. Any views
or conclusions expressed in this paper do not represent those of
Shell, the Smith School of Enterprise and the Environment or
Oxford University.
G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45
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