The simple economics of motor vehicle pollution: A case for fuel tax

Highlights

• The paper analyzes motor vehicle pollution and optimal policy responses.

• The intensive margin of vehicle use (on-road fuel consumption) is modeled explicitly.

• An optimal fuel tax requires only public information, unlike an optimal distance tax.

• Fuel taxes should remain the core instrument for car pollution control.

• Other policies, such as a car tax, may complement fuel taxes but are not substitutes.

Abstract

The volume of pollution produced by an automobile is determined by driver's behavior along three margins: (i) vehicle selection, (ii) kilometers driven, and (iii) on-road fuel economy. The first two margins have been studied extensively, however the third has received scant attention. How significant is this ‘intensive margin’? What would be the optimal policies when it is taken into account? The paper develops and analyzes a simple model of the technical and behavioral mechanisms that determine the volume emissions produced by a car. The results show that an optimal fuel tax would provide drivers with appropriate incentives along all three margins and that only public information is needed for a fuel tax to be set optimally. In contrast, an optimal distance tax would require private information. Lastly, relative to the optimal fuel tax, a simple uniform fuel tax is shown to be progressive. Thus, being already deployed worldwide, a uniform fuel tax is an attractive second-best policy. These findings should be accounted for when designing new mechanisms to alleviate motor vehicle pollution.

Introduction

This paper models the tailpipe emissions produced by motor vehicles and policies capable of adjusting drivers' marginal costs for these external costs. Air pollutants, including carbon monoxide (CO), nitrogen oxide (NO_x), hydrocarbons (HC), and particulate matter (PM), have been shown to have adverse effects on human health, especially for children (Arceo-Gomez et al., 2012, Chen et al., 2013, Gauderman et al., 2005). CO₂ emissions furthermore contribute significantly to climate change, although there is a debate about its effects and policy responses (Pindyck, 2013, Stern, 2013). The fuel burned in motor vehicles produces all of these emissions and can therefore be considered to result in social and ecological cost (Arceo-Gomez et al., 2012, Bin and Dowlatabadi, 2005, Dietz et al., 2009). The magnitude of these social costs is determined by drivers' behavior along three margins: (i) vehicle selection, (ii) kilometers driven, that is the extensive margin, and (iii) on-road fuel consumption per kilometer, henceforth the intensive margin. Drivers' decisions at the intensive margin include driving style, vehicle maintenance, and other choices affecting on-road fuel consumption.

External costs generate a mismatch between the private marginal costs of driving and the social marginal costs of driving. This means that the amount of driving likely exceeds the socially optimal amount because individual drivers face lower marginal costs relative to the marginal costs born by the society. An analogous argument applies to driving style. Driver behavior along the intensive margin determines the externality per kilometer and thus the total externality.

The existing economics literature concerned with motor vehicle externalities and policies mainly focuses on the extensive margin of motor vehicle use (kilometers driven); the intensive margin (fuel economy and emissions per kilometer) enters only via technical improvements in vehicle efficiency at the production level and subsequent changes in the vehicle stock composition (Austin and Dinan, 2005, Fischer et al., 2007, Frondel and Vance, 2009, Frondel et al., 2012, Fullerton and West, 2002, Greene, 2011, Harrington, 1997, Innes, 1996, Kleit, 2004, Parry and Small, 2005, Parry et al., 2007). This paper differs from these studies in that it explicitly deals with the intensive margin of motor vehicle use, which is determined by the driver–vehicle interaction.² Intuitively, two identical cars may have different fuel consumption rates if one is driven in the countryside and the other one in urban areas or on highways, if one is more often driven in the summer and the other in the winter, if one is used for short distance commuting and shopping while the other is used for long distance travel, or if one is driven by a risk averse, anticipative, driver and the other by an adrenaline-loving youngster. As a result, these two cars will produce different amount of emissions per kilometer driven.

A number of recent studies have identified the intensive margin of motor vehicle use as an important source of potential energy savings and observe that this has received limited attention from researchers as well as policy makers (Barkenbus, 2010, Carrico et al., 2009, Dietz et al., 2009, Gardner and Stern, 2008, Ko et al., 2010, Onoda, 2009, Tong et al., 2000, Van Mierlo et al., 2004, Vandenbergh and Steinemann, 2007, Vandenbergh et al., 2008).³ Drivers may directly influence the fuel efficiency of their vehicles not only by altering their speed and driving style, but also by trip planning, maintaining correct tire pressure, or regularly changing the air filter.

By incorporating the intensive margin into the analysis of corrective tax instruments, this paper complements and connects these two literatures. The studies closest to the present one are Fullerton and West (2002) and Innes (1996), who study vehicle and fuel taxes in general equilibrium models. Similar to their results, optimal distance and fuel taxes derived in this paper are vehicle-specific. However, this paper shows that vehicle–specific distance taxes are optimal only if the intensive margin of driving is kept fixed; or if the tax rate depends on the driver behavior along the intensive margin, that is if it depends on the actual fuel consumption. Yet, a distance tax that depends on the actual fuel consumption essentially is a fuel tax. The explicit modeling of the intensive margin of the real-world driving in this paper thus yields new insights into the relative efficacy of fuel tax as an instrument for the control of pollution.

The intensive margin related to driver–vehicle interaction is a potentially attractive policy target, because it can lead to energy savings and reduced emissions with the existing stock of vehicles, without the costs of accelerated vehicle stock replacement. In addition to the environmental and economic perspectives, the intensive margin is also relevant for transportation safety, as lower speeds and a less aggressive style lead to fewer and less severe accidents (Aarts and van Schagen, 2006, van Benthem, 2015, Grabowski and Morrisey, 2006, Montag, 2014).⁴

The existence of the intensive margin has two main implications relevant to the pollution production ‘technology’: (i) Total fuel consumption, and therefore CO₂ emissions, is affected by kilometers driven, vehicle efficiency, and the on-road fuel economy. (ii) Deviations of the actual fuel economy from the standardized fuel economy generate variation in per-kilometer local pollutant emissions within vehicles over time as well as across vehicles. Both of these effects affect the efficacy of a given policy to control local as well as global pollution, yet they have not been adequately addressed in the economic literature on automobile externalities and policies. This paper aims to fill this gap.