Which Tax is More Environmentally Friendly: Fuel Tax or Car Product Tax?

Despite European consumers' moderate undervaluation of future fuel costs, fuel taxes are more effective at encouraging consumers to purchase fuel efficient cars than product taxes based on the fuel economy of cars. These results hinge on the important premise that consumers differ in their fuel use and their preference for car characteristics.

McMaster Researcher

Citation

REYNAERT, Mathias, 2014. "Abatement strategies and the cost of environmental regulation: Emission standards on the European car market," Working Papers 2014025, University of Antwerp, Faculty of Applied Economics. Retrieved from: https://lirias.kuleuven.be/bitstream/123456789/471967/1/DPS1434.pdf

 

What is this research about?

Governments implement a variety of policies to reduce CO2 emission from passenger cars. This research investigates whether governments ought to tax fuel or tax cars based on their fuel economy. Cars in the European market use either diesel or gasoline. Diesel cars have greater fuel efficiency but are more expensive whereas gasoline cars have less fuel efficiency but are less expensive. A critical assumption is that consumers differ in their fuel usage and preferences for car characteristics. The purpose of this research is to determine:

  1. To what extent do car buyers undervalue future fuel costs?
  2. How does the consumer's view of future fuel costs affect the effectiveness of the fuel tax and product tax?

What did the researchers do?

The researchers constructed a mathematical model to estimate the demand for cars using data on car models and engine types (diesel or gasoline) for a panel of seven European countries during 1998-2011. They explored consumers’ responses to fuel costs by examining the change in fuel prices across countries and over time, and their interactions with variations in fuel economy across different cars. The investigators then compared the effectiveness of fuel taxes and fuel economy-based product taxes in reducing total fuel usage and CO2 emission.

What did the researchers find?

The researchers found that:

  • European consumers moderately undervalue future fuel cost savings if differences in consumer fuel usage and their preference for car characteristics are accounted for
  • Both taxes encourage consumers to buy cars with higher fuel economy.
  • Although product taxes are commonly thought to be more effective at encouraging consumers to purchase more fuel efficient cars than fuel taxes, due to European consumers' moderate undervaluation of future fuel cost savings, fuel taxes are actually more effective in this situation. This is because taxing fuel affects low and high mileage consumers differently, thereby causing high mileage consumers to switch to more fuel efficient cars. This consequently decreases total consumer fuel use and CO2 emission.
  • Selectively increasing the tax of gasoline leads to even more reduction in total annual fuel usage than increasing the tax of diesel because the increased gasoline tax further encourages consumers to switch to diesel-powered cars.

How can you use this research?

The framework used in this study can be applied to investigate the effects of other long-term economic policies on consumers, producers, and the environment. Furthermore, the findings may be applied to discriminatory taxing of other fuels to encourage the adoption of cleaner fuels, such as methanol.

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Research Impacts

Vox EU Column

January 10, 2015

Using a rich dataset for the European car markets, this column shows that consumers moderately undervalue future fuel costs.

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