metadata: authors: 0: author: He He
1: author: Kim,Chaeyoung
count: World
docna: 0: docna: Vehicle and Fuel Taxation for Transport
            Demand Management : Learnings from the Literature through a
            Development Lens
docty: Policy Research Working Paper
abstracts: cdata!: Correctly pricing private vehicles and
            their use is paramount to building sustainable, safe, and
            equitable transportation systems. However, determining the
            &#x201c;right&#x201d; price &#x2013; the
            combination of taxes on vehicle purchase, ownership, and use
            &#x2013; is a complex problem. Although a rich
            literature exists on the subject, it is built on evidence
            from developed countries. This paper synthesizes the lessons
            learned from the literature, theoretical and empirical, on
            vehicle and fuel taxation for managing private vehicle
            demand. In particular, the paper examines the efficiency and
            distributional impacts of purchase, ownership, and use
            taxes. The literature is unequivocal that taxing use
            dominates taxing purchase or ownership on efficiency
            grounds. Nonetheless, the latter instruments can still have
            important roles to play, for example, addressing specific
            market failures, for equity and political acceptability
            considerations, or for ease of enforcement. The paper also
            discusses the practical challenges of saliency, gaming, and
            evasion of taxes; how the effectiveness of taxes as policy
            instruments also depends on the availability of alternatives
            to driving; and what the emergence of electric vehicles
            means for optimal taxation. Importantly, the paper considers
            how these lessons, mostly derived from high-income countries
            with mature automobile markets, apply to developing
            contexts. In addition to the policy discussion, the paper
            conducts two exercises compiling empirical evidence. It
            compiles and compares estimates of the externality costs
            associated with private vehicle use, including congestion,
            local air pollution, greenhouse gas emissions, injuries, and
            noise. Similarly, it compiles and compares demand response
            elasticities to vehicle purchase, ownership, and use taxes.
            Both serve as useful references for researchers, development
            practitioners, and policy makers.
display_title: Vehicle and Fuel Taxation for
            Transport Demand Management : Learnings from the Literature
            through a Development Lens
listing_relative_url: /research/2023/12/34216042/vehicle-fuel-taxation-transport-demand-management-learnings-literature-through-development-lens
topicv3: Transport Economics m1326662 162,Fuel Taxes m1326912 1815,Carbon Emissions and Transport m1327367 1822,Motor Vehicle Transport m1505385 4050,Transport Pricing m1582817 4247
publishtoextweb_dt: 2023-12-15T00:00:00Z
dois: 10.1596/1813-9450-10647
origu: Off of Sr VP Dev Econ/Chief Econ (DECVP)
no_of_pages: 68
author_keys: 0: author_key: NA
1: author_key: 2341417
model_extractions: Policy Research Working Paper 10647 Vehicle and Fuel Taxation for Transport Demand Management Learnings from the Literature through a Development Lens _He He Chaeyoung Kim_ Infrastructure Chief Economist Office January 2024 A verified reproducibility package for this paper is available at http://reproducibility.worldbank.org, click **here** for direct access.
Policy Research Working Paper 10647

# **Abstract**

Correctly pricing private vehicles and their use is paramount to building sustainable, safe, and equitable transportation systems. However, determining the “right” price—the combination of taxes on vehicle purchase, ownership, and use —is a complex problem. Although a rich literature exists on the subject, it is built on evidence from developed countries. This paper synthesizes the lessons learned from the literature, theoretical and empirical, on vehicle and fuel taxation for managing private vehicle demand. In particular, the paper examines the efficiency and distributional impacts of purchase, ownership, and use taxes. The literature is unequivocal that taxing use dominates taxing purchase or ownership on efficiency grounds. Nonetheless, the latter instruments can still have important roles to play, for example, addressing specific market failures, for equity and political acceptability considerations, or for ease of enforcement. The paper also discusses the practical challenges of saliency, gaming, and evasion of taxes; how the effectiveness of taxes as policy instruments also depends on the availability of alternatives to driving; and what the emergence of electric vehicles means for optimal taxation. Importantly, the paper considers how these lessons, mostly derived from high-income countries with mature automobile markets, apply to developing contexts. In addition to the policy discussion, the paper conducts two exercises compiling empirical evidence. It compiles and compares estimates of the externality costs associated with private vehicle use, including congestion, local air pollution, greenhouse gas emissions, injuries, and noise. Similarly, it compiles and compares demand response elasticities to vehicle purchase, ownership, and use taxes. Both serve as useful references for researchers, development practitioners, and policy makers.

This paper is a product of the Infrastructure Chief Economist Office. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at hhe2@worldbank.org. A verified reproducibility package for this paper is available at http://reproducibility.worldbank. org, click **here** for direct access.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
Vehicle and Fuel Taxation for Transport Demand Management: Learnings from the Literature through a Development Lens<sup>◊</sup> He He, Chaeyoung Kim _Keywords_ : taxation, externality, international development, motorization _JEL_ : O18, R41, R48

> ◊ The authors thank Jevgenijs Steinbuks and Stéphane Straub for their insightful comments. Opinions expressed in this study are of the authors alone and do not necessarily reflect the views of The World Bank, its Board of Directors, or its member states.
# 1. Introduction

Correctly pricing private vehicles and their use is paramount to building sustainable, safe, and equitable transportation systems. Although cars and motorcycles provide great mobility, their use is disproportionately responsible for road injuries and deaths, congestion, transport-related greenhouse gas (GHG) emissions, and local air pollution. With the accelerated motorization in many low- and middle-income countries, managing vehicle demand is an increasingly pressing challenge. The urgency is underlined by the World Bank’s Country Climate and Development Reports (CCDRs), which have consistently found transport sector emissions to be among the most rapidly growing (World Bank, 2023). Sound management of transportation demand is crucial for achieving the decarbonization objectives of the Paris Climate Accords and contributes to several Sustainable Development Goals (SDGs), including building inclusive, safe, and sustainable cities and communities, reducing inequality, and taking climate action. Price instruments on private vehicles and their use – including taxes, subsidies, fees, and rebates – are important tools in the transport policy toolbox. Using these instruments to change the price of vehicles that households face enables policy makers to incentivize more sustainable behavior. However, in many developing and developed countries alike they are underutilized or inappropriately designed for this purpose. Determining the “right” price, i.e., combination of instruments on vehicle purchase, ownership, and use, is a complex problem. There are many, and often competing, objectives involved in determining what to tax and by how much. In addition to being useful levers for building sustainable transport systems, vehicle and fuel taxes serve as important sources of government revenue. In many cases, portions of these revenues are earmarked for transportation infrastructure investment and maintenance. Hence, any changes will have wider implications on fiscal budgets. On the consumer side, there is often a broad aversion towards increasing taxes. Making matters worse, taxation of vehicles and fuels will generally burden some people more than others, and choosing winners and losers inevitably creates contention. Consequently, the determination of vehicle and fuel taxes is intensely political, and concerns about emissions and economic efficiency often end up falling by the proverbial wayside. Furthermore, the optimal tax scheme for a given country today is different from that of next year or that of a neighboring country. The optimal tax depends on consumer preferences, which continue to evolve with spatial development and technological innovation. Crucially, the proliferation of electric vehicles (EVs) can fundamentally change the calculus of fuel and vehicle 2
use taxes. It is also important to recognize that vehicle and fuel taxation should not be viewed in isolation. Their effectiveness for managing transport demand depends on numerous contextual factors, such as income levels, built environment, and the availability and quality of mobility alternatives, particularly public transportation.

The importance of vehicle and fuel tax policies has not escaped the attention of the academic literature. On the contrary, the climate crisis has shone a spotlight on emissions in the transport sector and brought out a wealth of studies in recent decades. However, the empirical evidence supporting this work comes overwhelmingly from developed economies with mature transport systems and automotive markets. Transportation systems in developing contexts differ in a number of meaningful ways. It is typically characterized by a combination of: low but very rapidly growing motorization; ubiquity of two- and three-wheelers and older, more polluting vehicles; poor mobility alternatives including public transportation services and infrastructure for non-motorized travel; and distorted markets and lacking enforcement. How well the lessons from high-income countries apply to developing contexts remains an open question.

The purpose of this paper is to serve as a guide for researchers, policy makers, and development practitioners to the recent literature. In particular, it aims to provide a conceptual understanding of different price instruments, including their advantages and limitations vis-à-vis economic efficiency, distributional impacts, and enforceability. This will enable the reader to engage in policy discussions with an understanding rooted in first principles rather than merely standard practice. Additionally, the paper collates a series of relevant parameters, including external costs of vehicle use and price elasticities of vehicle and fuel demand, which the reader can use as reference for both back-of-the-envelope calculations and further reading.

We organize the remainder of the paper as follows: Section 2 motivates the use of price instruments by discussing and quantifying the external costs of private vehicle use; Section 3 reviews the central themes in the vehicle and fuel taxation literature as they relate to transport demand management; Section 4 collates relevant elasticities; Section 5 discusses what lessons can be learned and applied to development practice, focusing particularly on contextual differences and potential pitfalls; finally, Section 6 concludes.

3
# 2. The External Costs of Private Vehicle Use

In deciding whether or not to purchase a vehicle, a household considers the utility the vehicle provides relative to the costs of the vehicle over its lifecycle, including both the initial outlay, maintenance costs, and cost of day-to-day use. Similarly, at the trip-level, a car owner decides whether or not to drive by comparing the travel time, costs, and comfort of driving relative to those of other modes. Notably, these decisions take into account the costs borne by the consumer. However, driving a private vehicle imposes substantial costs on the wider society. These so-called externalities take several different forms, including crashes leading to injuries and deaths, congestion, GHG emissions, and local air and noise pollution.

Numerous studies have quantified the various external costs of private vehicle use. One such study determined the average external cost of each kilometer traveled by road is $0.24 (Sovacool et al., 2021). In other words, every kilometer driven costs society 24 cents in addition to the costs already paid by the driver, such as value of time lost in traffic, price of fuel, and vehicle wear and tear. At an estimated 36.5 trillion kilometers traveled per year globally, this translates into an annual external cost imposed on society at large of $8.8 trillion, corresponding to 8.7% of annual global GDP.

Table 1 summarizes the externality costs of private vehicle use, measured in dollars per 1,000 vehicle-kilometers. The numbers in the table represent simple averages across estimates from the literature. Please refer to Appendix A for the full list of 89 estimates with notes on geographic context, spatiotemporal scope, fuel types, and other study details. It should be noted that the averages in Table 1 only include estimates reported by vehicle kilometers or units directly convertible to that. Estimates in other units, e.g., dollars per metric ton of CO2, can be found in Appendix A but are excluded from the Table 1 summary calculations.

4
_Table 1: Externality costs of passenger transport by private vehicle [$/1000 vehicle-km]_

|**Scope**|**Congestion**|**Air**<br>**pollution**|**GHG**<br>**emissions**|**Crashes**|**Noise**|**Total**|
|---|---|---|---|---|---|---|
|All|244.65|17.10|9.74|26.87|9.13|307.49|
|_Spatial_<sup>1</sup>|||||||
|Urban|457.81|31.56|17.12|51.38|17.87|575.75|
|Rural|69.79|8.13|13.51|19.26|0.32|111.01|
|_Temporal_<sup>1</sup>|||||||
|Peak|275.45|21.40|15.04|32.85|5.11|349.84|
|Off-peak|53.42|12.07|16.26|29.57|13.76|125.09|

1 Estimates that do not match the specified scope have been excluded from the spatial and temporal breakdowns.

Several patterns emerge comparing these data. Notably, congestion costs make up the bulk of the total externality costs associated with vehicle use at 80% of total mean costs. On the other hand, GHG emissions, which has received increasing attention recent years, contribute only 3% of the external costs. This value may be on the low end, since several studies in the catalogue of literature we reviewed are somewhat dated and the impacts of climate change have become clearer in recent years. Nonetheless, the highest cost estimate for GHG emissions in our catalogue ($44.44 / 1,000 vehicle-kilometers) still only represents a relatively small fraction of the total external cost of private vehicle use. That said, the point here is not to downplay the importance of decarbonization. On the contrary, climate change is one of the major challenges of this generation. Rather, the point is that managing demand for private vehicles should be a priority for numerous reasons, and it contributes benefits along multiple dimensions that are important to justify policies and investments. The potential imbalance of attention has been noted in the literature previously (Lindsey & Santos, 2020).

Breaking down the estimates by their spatial and temporal scope reveals some of the underlying variation. As expected, externality costs are higher in urban compared to rural areas because the external costs naturally apply to more people in dense areas. For the same reason, externality costs are more severe during peak hours than during the off-peak. Noise pollution is a notable exception to this trend. This is likely a result of higher sensitivity to noise at night.

5
<!-- Start of picture text --> 1500<br>1400<br>1300<br>1200<br>=> 1100<br>&<br>= 1000 100<br>S<br>= 900<br>TM<br>& 800<br>g<br>oO 700<br>= 600<br>FI 500<br>Ee<br>fo 400<br>300<br>200<br>100<br>0 0<br>Congestion Air pollution GHG emission Crashes Noise<br><!-- End of picture text -->
<!-- Start of picture text --> P<br>S (private + social costs)<br>Deadweight loss<br>S (private costs)<br>Poptimum ~TT<br>Pnarket 4 Connon panne SSS<br>| | D<br>Joptimum market Q<br><!-- End of picture text -->
in terms of political justifications, fiscal implications, and enforcement challenges. However, they are tied together by conceptually similar expected consumer responses. This subsection provides an overview of commonly used price instruments in each of the three categories – summarized in Table 2. The remainder of the section takes a deeper dive into the key considerations in designing an appropriate taxation scheme, namely efficiency, distributional impacts, gaming and enforcement, interactions with public transportation, and the emergence of EVs.

_Table 2: Overview of common vehicle and fuel price instruments for transport demand management_

|**Instrument Type**|**Examples**|
|---|---|
|_Purchase_|Vehicle excise tax<br>Import duty<br>Environmental levy or feebate scheme<br>Vehicle attribute standard|
||Scrappage credit|
||Registration fee|
|_Ownership_|Licensing fees|
||Certificates of Entitlement|
||Fuel tax|
|_Use_|Distance-based tax|
||Congestion charge|

# _3.1.1. Instruments on Purchase_

Purchase taxes are the simplest and most ubiquitous form of price instrument on vehicles. In many cases, these taxes are motivated by priorities, past and present, other than transport demand management. First, vehicles are subject to the general consumption value-added tax (VAT). However, governments have numerous reasons to tax vehicles beyond the baseline level. Historically, for example in the UK, road taxes, i.e., tax revenue earmarked for building and maintaining road infrastructure, were charged upfront on vehicle purchase. In countries with a domestic automotive manufacturing sector, governments will commonly impose import taxes on vehicles to promote the competitiveness of that sector. Finally, in many developing countries, where private vehicles remain unaffordable to most, governments tax vehicle purchases as a 8
luxury goods tax to raise additional revenue without angering broad swarths of the population. The primary advantage of purchase taxes, and the reason for their ubiquity, is their relative ease of collection. Being a one-time payment, whether at import, transaction, or registration, purchase taxes are far more straightforward for governments to collect and enforce.

Purchase taxes can also be designed to encourage substitution towards more sustainable vehicles. Where the policy motivation is decarbonization of the transport sector, governments often opt for a revenue-neutral approach to make the policy more politically palatable. Such approaches can take the form of a combined fees and rebates scheme – so-called feebates. For example, consumers can be incentivized to purchase vehicles with better fuel economy by subsidizing high fuel economy vehicles and conversely charging a tax on low fuel economy ones. Similarly, vehicle age and engine size are commonly used as proxy attributes for how polluting a vehicle is.

Although not directly price instruments, standards can be formulated to produce equivalent outcomes. There is a symmetry between price instruments and quantity instruments. Intuitively, this can be understood as intervening along either of the two axes in the supply-demand curve in Figure 2 to achieve the optimal outcome. The most well-known example comes from the environmental regulation literature with the equivalence between a carbon tax (price instrument) and a cap-and-trade program (quantity instrument). For example, rather than a feebate scheme, the US has made use of the Corporate Average Fuel Economy (CAFE) standards to incentivize manufacturers to improve vehicle fuel economy since 1975. The CAFE standards require each auto manufacturer to ensure that the average fuel economy of all the vehicles they sell meets a certain target, lest they pay a fine. In turn, manufacturers adjust the prices of vehicles in their portfolio so as to reach this target – effectively achieving the same outcome as a feebate scheme. This symmetry between price and quantity instruments means that the intuitions, advantages, and limitations of purchase taxes broadly apply to standards, and vice versa. See Gillingham (2013) for a comprehensive examination of the symmetry between fuel economy standards and feebates.

Finally, scrappage programs – despite their name – can also be considered instruments on purchase. A typical scrappage program awards car owners credit towards buying a new and more fuel-efficient car when they scrap an old one with poor fuel economy. The credit effectively works as a purchase subsidy. However, linking it to the disposal of an old vehicle enables scrappage programs to affect the existing stock of vehicles that are otherwise out of reach for 9
typical price instruments on purchase. In addition to improving fuel economy, scrappage programs provide economic stimulus targeted at the auto industry. This led to their rise in popularity following the 2008 global recession in many countries with mature automotive markets, including the US, Japan, and much of Europe.

# _3.1.2. Instruments on Ownership_

Instruments on ownership, such as registration fees or licensing fees, serve as property taxes on private vehicles. They are typically collected annually and often increase with engine size. A positive property tax discourages ownership across the board, while a taxation structure that penalizes more polluting vehicles pushes consumers towards greener choices. Compared to typical taxes on purchase, ownership taxes are more effective for driving changes in the vehicle population, since they affect both new purchases and existing stock. However, they require somewhat greater institutional capacity to enforce. Consequently, they are not as ubiquitous, but common in high-income countries and to a lesser extent in middle-income countries.

In Singapore, a Certificate of Entitlement (COE) is required to own a car. Only a limited number of COEs, set by the government, are available at any given time. Singaporeans looking to own a car must first acquire a COE through an official auction. Once acquired, the certificate entitles the holder to own a car for 10 years, after which the COE expires and must be renewed. Additionally, should the COE holder wish to deregister their car before the 10-year term, they will be refunded the prorated cost of their COE according to the time remaining on it. With the continued growth of the Singaporean economy and the cap on quantity, COE prices recently reached US$100,000 (Tjoe, 2023). Interestingly, the COE program functions as an instrument on both purchase and ownership. The COEs’ 10-year term must be paid for upfront. Additionally, the refund value is prorated according to the price originally paid for the COE rather than the live COE auction price, making subsequent changes to COE quantities an ineffective policy instrument for reaching existing COEs. However, at the same time, the prorated refunds and 10year renewal requirements provide car owners incentives to deregister their vehicle.

# _3.1.3. Instruments on Use_

Fuel taxation is the most prominent price instrument on private vehicle use. From a transport demand management point-of-view, the purpose of fuel taxes is to put a price on the externalities of vehicle use. However, for many countries this purpose is superseded by fuel taxes’ 10
considerable impact on government budgets. Similar to purchase taxes, this prominence is owed to the ease of collection, specifically at import (Timilsina & Dulal, 2008). Fuel taxes have also historically been, and in many places continue to be, earmarked for road funds. However, with the advent of alternative fuel vehicles, particularly EVs, traditional fuel taxes are at risk of becoming ineffectual, both for raising government revenue and for internalizing the externalities of private vehicles that remain beyond the transition to a greener fuel source.

To address the eventual decline in fuel consumption and associated tax revenue, many economists have touted the advantages of distance-based taxes (Heine et al., 2012; Langer et al., 2017). As their name suggests, distance-based taxes, also colloquially known as VMT (for vehicle-miles traveled) or VKT (for vehicle-kilometers traveled) taxes, charge drivers a fee based on the distance their vehicles travel. This provides policy makers an alternative, and arguably more direct, instrument to charge for the use of private vehicles. The fee can in theory be differentiated by relevant vehicle attributes, when and where the vehicle was driven, and even characteristics of the vehicle owner, such as income. The flexibility enables the design of a more efficient price instrument. However, granular targeting of these taxes requires similarly granular data on both vehicle use and the user. Not only does this put higher demands on tracking technology, but the collection of such data, especially location data, naturally raises privacy concerns among the public. As a consequence of both the technological and political acceptance barriers, distance-based taxes have yet to become widespread. Numerous pilots have been conducted. Most notably, vehicle owners in Oregon state in the US have since 2015 been able to sign up to pay distance-based taxes in exchange for fuel tax credits and reduced vehicle registration fees. Participants install a third-party telematics device in their vehicle that logs mileage, fuel consumption, and optionally, GPS location.

Several demand management measures from the transport engineering practice are also price instruments on use. Cordon charges, road tolls, and parking fees all put a price on the externalities of vehicle use. However, unlike fuel and distance-based taxes, these congestionrelated instruments are inherently spatial. For example, the toll on a congested road should be high to reflect the external cost of delays imposed on the many fellow travelers. Similarly, where space is at a premium, parking fees should be expensive to reflect the opportunity cost of occupying the space with a parked vehicle. Fuel taxes cannot directly capture these spatial 11
considerations. Conversely, congestion-related instruments cannot directly capture the emissions-related externalities. Hence, the instruments serve as complements.

# 3.2. Efficiency

Restoring efficiency is the primary economic argument for taxing private vehicles and their use. Absent government intervention, equilibrium car use yields excessive miles driven and suboptimal social welfare due to the negative externalities. These externalities arise from the use of private vehicles, as opposed to their purchase or ownership. Hence, instruments on use align most closely with the Pigouvian tax principle and are broadly the most appropriate for restoring efficiency.

Despite its conceptual simplicity, implementing an optimal Pigouvian tax is exceptionally complex in practice. As discussed in Section 2, there are numerous different externalities associated with vehicle use. Unfortunately, no single existing tax instrument can by itself capture all these externalities. For example, fuel taxes can accurately internalize the damages caused by GHG emissions. However, local air pollution impacts depend not only on how much a vehicle is used but importantly also on where it is used. That is, driving a polluting car in a densely populated area multiplies the number of impacted people and by extension the total external cost. Conversely, congestion-related instruments, such as cordon charges, can more accurately capture spatiotemporal variations but are inherently crude vis-à-vis the actual use (Santos et al., 2010a). Furthermore, estimates of the magnitudes of each externality span wide ranges as documented in Table 1. In other words, determining the optimal taxation structure requires, first, selecting a combination of instruments with adequate granularity and dimensionality to match that of the different externalities, e.g., spatial, temporal, emissions, etc.; and then, setting the tax rates such that they most accurately approximate the external social costs of private vehicle use. Complicating matters further, a Pigouvian tax is strictly speaking optimal when considered in isolation. However, in practice, any new price instrument will exist within an existing system of taxes on substitutes and complements. If these are suboptimal and unalterable, the optimal new price instrument will not generally be a Pigouvian tax (Sandmo, 1975). In the transport sector context, this is particularly relevant when fuel taxes are set below optimal levels but cannot be raised, e.g., due to political opposition. Despite these complications – not to mention equity, enforceability, and other practical considerations – the broad consensus remains that taxing the 12
use of private vehicles is the preferred price instrument for restoring economic efficiency (Anderson & Sallee, 2016). Additionally, even though the Pigouvian ideal is rarely achievable in practice, it still serves as useful intuition and guiding principle.

The direct effect of a fuel tax is straightforward. It encourages drivers to consume less fuel, whether by driving less or by using more fuel-efficient vehicles. However, a fuel tax also has several indirect effects on both drivers and vehicle manufacturers that are slightly less obvious. The first indirect benefit relates to road injuries and fatalities. In case of a vehicle collision, being hit by a heavier vehicle increases both the injury severity and fatality risk, while being the driver of a heavy vehicle is safer for the occupant. In other words, driving a heavier vehicle further externalizes the social costs of road injuries and fatalities. Over the past half century, the average vehicle weight has grown continuously in the U.S. (U.S. EPA, 2022). Some authors hypothesize that, all else equal, this favors the purchase of increasingly heavy vehicles, and has likely contributed to creating an “arms race" effect in vehicle weight. A simple distance-based tax can price in the social cost of road injuries and fatalities at average incident rates, i.e., the average cost of road incidents per kilometer driven. However, such a tax fails to account for vehicle weight. Conveniently, a vehicle’s fuel consumption scales positively with its weight. Hence, a fuel tax can simultaneously internalize mileage and weight externalities. This can be another argument for raising fuel taxes (Anderson & Auffhammer, 2014). A second indirect benefit of fuel taxes relates to their saliency and the signal they send to consumers. Although changes to fuel taxes and the tax-exclusive components of fuel prices affect consumer wallets the same, empirical evidence suggests that consumers respond more strongly to the former (Li et al., 2012). Specifically, a fuel tax increase yields larger reductions in fuel consumption and larger improvements to fuel economy of sold vehicles than a commensurate increase to the taxexclusive components of fuel price. The difference can possibly be attributed to fuel tax changes being more salient, e.g., due to news coverage, than changes to the tax-exclusive components of the price. Additionally, for deciding fuel economy when purchasing a vehicle, consumers might see fuel taxes as a reflection of a longer-term policy direction, whereas changes to the taxexclusive components are more likely interpreted as short-term price fluctuations. In other words, the strength of fuel taxes as a policy instrument is amplified by its saliency and signaling effects. Consequently, evaluating the impact of a fuel tax policy using the total price elasticities could actually underestimate the behavioral response but overestimate the tax revenue. Last but 13
not least, fuel taxes also affect vehicle manufacturers by encouraging them to offer more fuelefficient options in the long term (Klier et al., 2020). When fuel taxes increase, making fuel more expensive, demand for more fuel-efficient vehicles similarly grows. Consumers’ increased willingness-to-pay makes it worthwhile for automakers to invest in innovation to improve fuel economy. Furthermore, if automakers can sell a larger quantity of fuel-efficient vehicles, those vehicles benefit more from scale economies in both innovation and manufacturing. That is, automakers can spread the fixed costs of innovation and manufacturing equipment for fuelefficient vehicles over a larger number of sales, thus lowering the average cost.

Simply by increasing the upfront cost of cars, purchase taxes reduce the demand for private vehicles, and in turn reduce the negative externalities associated with their use. Additionally, cleverly designed tax structures, such as feebate programs, can incentivize substitution towards more sustainable vehicles. However, all evidence points to purchase taxes being less capable of restoring economic efficiency. In particular, the separation between the taxed activity – vehicle purchase – and the externality-creating activity – vehicle use – makes purchase taxes a crude instrument. For example, the welfare costs of reducing gasoline consumption via the CAFE standards in the US were estimated to be three times those of an equivalent direct gasoline tax (Austin and Dinan, 2005). Furthermore, price instruments on vehicle purchase do not have any direct effect on the existing stock of vehicles (Sallee, 2010). Rather, existing vehicle owners will only be reached once they choose to replace their vehicle.

The aforementioned separation between the taxed and externality-creating activities creates misaligned incentives, which can lead to unintended outcomes. Although a tax on purchase does not have a direct effect on existing stock, it can in fact have a harmful effect indirectly. An upfront tax makes vehicle replacement more costly, which extends the life of old, generally more polluting, vehicles (Gruenspecht, 1982). This so-called “Gruenspecht Effect” – named after the author who first discussed the issue – is estimated to have offset 13-16% of the fuel savings of the CAFE standards in the US (Jacobsen & van Benthem, 2015). Several different strategies can be taken to alleviate the Gruenspecht effect. Instituting a revenue-neutral feebate scheme rather than a strictly positive tax, such that replacement does not necessarily become more expensive, can go some way to lessening the impact. However, those most financially constrained, and consequently most likely to delay replacing an old vehicle due to purchase taxes, are likely the 14
same people in the market for the cheaper, usually less fuel efficient, vehicles, which are penalized by typical feebate schemes. Hence, a revenue neutral feebate scheme based on fuel economy may still prevent them from replacing their old inefficient vehicle. Alternatively, combining purchase taxes with an ownership tax scheme that penalizes ownership of older vehicles would also counteract the Gruenspecht effect (Jacobsen et al., 2022).

Fuel economy is commonly the target for feebate schemes, vehicle standards, and sometimes, indirectly, ownership fees. Over time, such policies push car buyers and manufacturers towards more efficient vehicles. However, as a byproduct, this lowers the marginal use cost of vehicles. In other words, driving becomes cheaper, which in turn encourages more driving. Additional vehicle-kilometers traveled induced by this so-called “rebound effect” negated 20%-25% of the fuel savings from fuel economy improvements between 1966-2001 in the US (Small & Van Dender, 2007). Another study puts the emissions reductions lost due to increased driving at 30%80% (Frondel et al., 2017). The extra vehicle-kilometers traveled does not just cancel out some of the fuel savings, but they also generate their own additional non-emissions-related externalities, which broadly dominate the emissions-related ones as we saw in Table 1.

Despite these drawbacks, arguments can still be made for purchase taxes to have a role to play in managing transport demand. Beyond being simple to administer, a single upfront payment can be more salient and thus effective for changing behavior. In particular, this is useful if consumers are myopic in their vehicle purchasing decision. That is, failing to fully account for the future fuel savings of driving a more efficient vehicle would lead car buyers to purchase a car with a lower fuel economy than what is rationally optimal. In such cases, introducing an upfront price instrument that depends on vehicle fuel economy can correct for the undervaluation of future savings (Sallee, 2010). Numerous studies in the literature have attempted to quantify the severity of consumer myopia in the context of vehicle purchases. However, the empirical evidence remains inconclusive (Greene, 2010; Busse et al., 2013; Allcott & Wozny, 2014; Sallee et al., 2016; Grigolon et al., 2018; Gillingham et al., 2021; Leard et al., 2023).

# 3.3. Distributional Impacts

Recognizing that taxation of vehicles and fuels creates winners and losers is fundamental to effective policy making. Until now, we have made a case for the use of price instruments to improve social welfare by restoring economic efficiency – growing the pie, so to speak.

15
However, who gets the bigger slice? And do taxes and subsidies change that? In theory, the net welfare gain can be redistributed via lump sum transfers to compensate those directly harmed by the corrective policies to prevent anyone from being worse off overall. Unfortunately, such Pareto improvements are not feasible in practice (Sallee, 2019). Identification of winners and losers is imprecise and redistribution between them is costly (Parry & Williams, 2010). This is exacerbated by the diffuse nature of the externalities associated with private vehicles and the heterogeneity of use patterns. Hence, the costs of targeting transfers with adequate precision can quickly offset the welfare gains created by the price instruments. In other words, even an ideal Pigouvian tax creates winners and losers. Effective policy making requires consideration for the distributional impacts of price instruments and their resulting political acceptability.

In our review of price instruments for restoring efficiency, theory, such as Pigouvian taxation, served as guiding principles. Unfortunately, it is not generally obvious a priori if a given formulation of a price instrument is progressive or regressive. Instead, more often than not, we are left with the rather unsatisfying answer, “it depends”. Take for example the US, where extensive research has been conducted on the distributional impacts of various instruments. As Table 3 shows, income is a strong predictor of vehicle-related consumption. Higher income households own more, newer, and more expensive vehicles. They also use their vehicles more, driving longer total distances, and consequently spending more on fuel. However, private vehicle ownership is ubiquitous in the US. Even households in the lowest income quintile own, on average, 0.9 vehicles. Despite their lower consumption, vehicle and fuel expenditure make up a larger percent of income for low-income households.

16
_Table 3: Average household-level vehicle-related consumption use by income quintile in the US, 1980-2014_

||Quintile 1<br>_(lowest 20%)_|Quintile 2|Quintile 3|Quintile 4|Quintile 5<br>_(highest 20%)_|
|---|---|---|---|---|---|
|Income, before tax|13,607|27,212|44,478|69,444|132,768|
|Vehicles|0.9|1.3|1.7|2.0|2.4|
|Vehicle age|10.2|9.4|8.4|7.7|6.8|
|Price per vehicle|8981|9927|11,750|14,115|18,930|
|VMT|7274|11,042|15,180|19,218|24,344|
|Fuel expenditure|1008|1545|2125|2673|3290|
|Vehicle price / income|0.66|0.37|0.26|0.20|0.14|
|Fuel expenditure / income|0.07|0.06|0.05|0.04|0.03|

_Adapted from Greene & Welch (2018)_ Regressivity is a common argument levied against fuel taxation – but reality is not that simple. Poorer households spend a larger share of their income on fuel. Hence, the direct distributional impact of raising fuel taxes is regressive. However, poorer households are generally also more price responsive. They are more willing to reduce vehicle-kilometers traveled and switch to alternative modes. Their larger price elasticity mitigates the regressivity of fuel taxes if adequate alternatives are provided, e.g., public transportation, non-motorized transport infrastructure, appropriate land use planning, etc. (West, 2004). Additionally, the money paid in fuel taxes do not disappear. They enter fiscal budgets, and economists increasingly recognize that how they are recycled determines the distributional impact of fuel taxes (Davis and Knittel, 2019). Due to the larger absolute expenditure of high-income households, a flat recycling scheme has been found to be progressive and welfare-enhancing for the bottom 40 percent (Bento et al., 2009). Finally, a switch to distance-based taxes allows more precise targeting while still taxing vehicle use. For example, a relatively simple urban-rural differentiated VMT tax is both more efficient and more progressive in the US context (Langer et al., 2017).

Although less apparently so, instruments on purchase are broadly regressive in the US context. The CAFE standards in the US have contributed to the improvement of fuel economy of vehicles across all market segments. In turn, this has lowered the per mile fuel consumption and total fuel expenditures. However, to satisfy the standards, manufacturers have had to develop more efficient vehicles. Concretely, a one mile-per-gallon tightening of the CAFE standards is estimated to have cost manufacturers $9-$27 per vehicle (Anderson & Sallee, 2011). The costs of 17
this innovation inevitably pass through to consumers, who ultimately fund the technological development. High-income households more frequently purchase new vehicles that are also more expensive, thus incurring a larger share of these costs. This has sometimes been used as an argument for the progressivity of instruments on purchase. Indeed, considering only the impact on the market for new cars, such the CAFE standards have been found to be progressive. However, if the analysis accounts for the propagation of price impacts to the used car market, the distributional impact becomes regressive (Jacobsen, 2013; Davis & Knittel, 2019). Additionally, instruments on purchase based on fuel economy subsidize high fuel economy vehicles, either implicitly through standards or explicitly through feebate schemes. Efficient vehicles are generally more expensive and more often purchased by high-income households. Conversely, inefficient vehicles are generally cheaper and more often purchased by low-income households. These consumption patterns tend to further exacerbate the regressivity of price instruments on purchase based around fuel economy (West, 2004).

International evidence underlines the context-dependent nature of distributional impacts. Although possibly more nuanced, the findings above may be specific to the US. Examining the international evidence underlines the dependency on local income, spatial development, and car use patterns. A study of fuel taxation across seven countries in Europe, namely France, Germany, United Kingdom, Italy, Serbia, Spain, and Sweden, found that their distributional impacts were approximately proportional, i.e., neither progressive nor regressive (Sterner, 2012). The largest outlier is Serbia, for whom fuel taxation is relatively more progressive. Notably, Serbia is the lowest income country in the sample. An evaluation of fuel taxes in Brazil also found the distributional impacts to be progressive (Proque et al., 2022). These findings align with the intuition that taxation of private vehicles and their use is progressive in lower income countries, where cars remain more of a luxury good. However, as countries become richer, cars become more ubiquitous, and taxation of private vehicles becomes increasingly regressive (Berri et al., 2014). The distributional impacts also depend on which and how externalities are accounted for. In Sweden, a study found that people in rural areas are far more adversely affected by motor taxes than in urban areas. These distributional differences were not counterbalanced by various recycling schemes (Eliasson et al, 2018). In France, a feebate scheme introduced in 2008 encouraged adoption of diesel over gasoline vehicles. Diesel engines emit fewer GHG emissions but more local air pollutants. In other words, the policy changed the distribution of externalities 18
across space. Specifically, a study found that while the policy had a net positive impact on welfare, local air pollution increases most in areas where high-income household live (Durrmeyer, 2022). Hence, the feebate scheme had a progressive distributional impact, albeit in a somewhat roundabout way.

# 3.4. Poor Saliency, Gaming, and Evasion

Even well-designed policies can sometimes yield smaller than expected behavioral responses, for example producing emissions reductions below predicted levels. Numerous practical considerations can underlie such discrepancies. In the context of vehicle and fuel taxation, the literature primarily concerns itself with three challenges. Namely, these are: poor saliency of instruments to consumers, manufacturers gaming regulations, and illicit evasion of taxes.

The saliency of a price instrument increases its behavioral response. Conversely, consumer behavior changes less when taxes are not salient. For example, posting tax-inclusive prices in grocery stores have been shown to reduce demand by 8 percent (Chetty et al., 2009); and, directly relevant to transport, electronic road toll collection has resulted in equilibrium tolls being 20 to 40 percent higher than were they collected manually (Finkelstein, 2009). A study of price instruments in France, Germany, and Sweden aimed at reducing vehicle GHG emissions adds further supporting evidence (Klier & Linn, 2015). The instruments in all three countries were tied to vehicle emissions rates. However, while France introduced an instrument on purchase with discrete tax brackets, Germany and Sweden both introduced ownership taxes that scaled linearly with vehicle emissions rates. The authors found the approach in France to be considerably more effective. They attributed the differences to the increased saliency of both paying upfront, as opposed to periodically, and the discrete brackets, as opposed to the more nebulous linear function.

Manufacturers will take advantage of loopholes to maximize profits. Improving vehicle efficiency and technology is costly for manufacturers. Hence, they will take advantage of incomplete regulation to avoid doing so to the extent legally possible. In particular, this gaming of the regulatory system typically involves taking advantage of discrete “edges” in regulation, whereby minor changes that do little to ameliorate the externalities targeted by the regulation but yield preferential tax treatment. Common gaming strategies can take the form of, for example, vehicle design tweaks to move vehicles to lower tax bracket, relabeling of vehicle categories to 19
take advantage of a more lenient regulatory classification, or temporal shifts in sales to benefit from temporary tax rebates (Sallee, 2010). Depending on instrument design, the scale and impact of gamification can be quite considerable. The 2015 EU-wide vehicle emissions standards yielded a 14% decrease to sales-weighted emissions by official calculations. However, of these, two-thirds were estimated to be attributable gaming (Reynaert, 2021). Thus, while discretized regulation may be advantageous for simplicity and saliency, such design also creates opportunities for gaming. Recognizing this trade-off is important for designing effective price instruments.

The larger the tax, the larger the incentive to evade. This follows from common economic intuition and is borne out in practice. In Finland, importing a vehicle requires paying an import tax that is a set percent of the value of the vehicle. For used cars, the value is discounted by the vehicle’ mileage. In other words, a vehicle with high mileage is liable for lower import taxes, all else equal. However, the Finnish customs authorities, who are responsible for collecting the import tax, do not regularly verify the reported mileage, creating an opportunity for tax evasion. Comparing the reported mileage with odometer readings during subsequent inspections reveals that approximately 10% of imported used cars over-reported their mileage (Harju et al., 2020). In 2012, import taxes were reformed to also depend on carbon emissions rates. The reform saw evasion become more prevalent for cars affected by the tax hike but remain unchanged for lowemissions vehicles. This supports the intuition that higher taxes result in a greater incentive to evade. Recognizing the enforcement gap, in 2013, the Finish customs authorities acquired access to odometer readings from downstream inspections. An information campaign randomized controlled trial (RCT) showed that awareness of the more stringent enforcement was effective at reducing tax evasion.

# 3.5. Interactions with Public Transportation

Sustainable mobility requires a multi-pronged approach that involves public transportation and non-motorized travel in addition to private vehicle demand management. Price instruments on private vehicles and their use push travelers towards more sustainable and efficient choices. However, pushing can be far more effective if complemented by a pull. That is, if there are viable alternatives to private vehicles, such as high-quality public transportation or built environment designed for non-motorized travel, drivers are much more likely to change their 20
behavior in response to vehicle and fuel taxes. Absent these alternatives, taxing private vehicles is simply pushing against a figurative wall. In economics terms, driving is a derived demand. Consumers make trips to access work, school, shops, leisure destinations, etc., and private vehicles are the means to that end. Inelasticity in a derived demand arises when the demand for the final “good” is inelastic and there are no viable substitutes. Although telecommuting and e- commerce have begun to change the former in certain sectors and contexts, leaving the house remains broadly necessary for the vast majority in the foreseeable future. So long as that is the case, investing in public transport will remain an essential component of any sustainable mobility strategy.

This interdependency between private vehicle use and public transportation is also evident empirically. For example, a study of the impact of a fuel tax reform across metropolitan areas in Spain found that the reform more effectively reduced carbon emissions and energy use from transportation in cities with greater public transport penetration (Danesin & Linares, 2018). Several studies in the US examine the elasticity of transit demand with respect to fuel prices (Mattson, 2008; Lane, 2010). This cross-elasticity reflects the extent to which public transportation serves as a substitute to driving in different contexts. Transit demand is relatively inelastic in small cities, where lacking service quality and coverage likely prevent more significant substitution. By comparison, transit demand is more elastic to fuel price changes in mid-size cities with population in the 100,000-500,000 range. Interestingly, the evidence is mixed for large cities. The suggestion of an S-shaped elasticity curve with respect to city size could be indicative of ridership saturation given existing capacity constraints and urban form in certain large metropolitan areas. Conversely, investments in public transportation have been shown to help reduce road congestion and improve air quality. However, the effectiveness of such investments similarly and unsurprisingly differs considerably by context (Beaudoin et al., 2015).

Several studies have examined the viability of using revenues from taxation of private vehicles, specifically fuel taxes, to cross-subsidize public transportation. This approach is particularly attractive because it improves welfare while having a clear mechanism for maintaining revenue neutrality for government budgets (Barros & Prieto-Rodriguez, 2008). Despite the conceptual appeal, the redistributive nature of such tax reforms inevitably makes them politically 21
contentious. Thus, it is crucial to consider carefully the winners and losers in designing the tax and subsidy schemes (Victor-Gallardo et al., 2022). Additionally, it is also important to understand the impacts on transit operations. At first glance, one might think that increasing transit ridership increases its revenue. However, the vast majority of transit systems operate with government subsidies and would generate considerable deficits through operations alone. In Germany, fuel taxes were found to exacerbate the operational deficit because it primarily shifted demand for commuting trips, whereas shopping and leisure trips remained relatively inelastic (Storchmann, 2001). In other words, the transit system became even more crowded during peak hours, when the system was already at capacity, forcing additional investment. Meanwhile, it did little to improve efficiency during off-peak hours, when the system is relatively empty and operating with large deficits.

# 3.6. Emergence of Electric Vehicles

The proliferation of EVs poses challenges to the conventional wisdom. In China, more than a third of new vehicles sold are EVs (Li et al., 2022; Li & Goh, 2023). Although few countries, if any, can match China’s fervor in policy making to promote EV adoption, EVs’ ascendancy appears a matter of time in most contexts. Their rise in popularity has drastic consequences for taxation of vehicles and fuels. Business-as-usual tax schemes that rely heavily of fuel taxation will inevitably leave a revenue gap as traditional fuels are increasingly replaced by electricity (Jenn et al. 2015). For example, in the US, each EV results in more than $300 of foregone fuel tax revenue per year (Davis & Sallee, 2020). Even at less than 1% of the fleet of registered vehicles, this creates a fiscal gap of $250 million annually. In places where fuel taxes are earmarked for transportation infrastructure maintenance and capital investment, such revenue gaps will have direct adverse impacts on mobility and accessibility. Furthermore, until EV technologies mature and the price of EVs becomes competitive with internal combustion engine vehicles (ICEV), EVs will mostly be affordable to high-income households. Consequently, the lack of a fuel tax equivalent for EVs will have equity implications and change the current redistribution calculus.

The technological innovation calls for policy makers to evolve their tax structures accordingly. However, optimal taxation of EVs is not straightforward. Compared to ICEVs, EVs produce fewer externalities, particularly in terms of local air pollution and GHG emissions – provided 22
that the electricity fueling the vehicles were produced in a cleaner manner. However, other externalities, such as congestion and road safety, remain largely unchanged. Hence, although electrification has rightly been brandished for its role in decarbonizing the transport sector, EVs are merely the “lesser evil” considering the full suite of external costs of private vehicle use. The first-best tax on EVs follows the Pigouvian principle of internalizing the external costs. This can be implemented through a distance-based tax – ideally one that is spatiotemporally disaggregate – but such schemes remain in their infancy, as discussed in previous section. As a more direct substitute for fuel taxes, several states in the US have introduced legislation to tax electricity at public EV charging stations (Jaros & Hoffer, 2023). However, with the availability of private home chargers, it is unclear if such policies are effective or merely an inconvenience. With all that said, the first-best tax is not relevant in most cases anyway. In practice, few countries tax the use of ICEVs adequately with fuel taxes shown to be below optimal rates in the US (Parry & Small, 2005) and many developing countries (Granger et al., 2021). If these existing distortions cannot be ironed out, the optimal tax on EVs is below the first-best level – and potentially even a subsidy – so as to encourage substitution away from the larger distortion. For example, in the US the optimal distance-based tax can be positive or negative depending on the spatiotemporal context (Davis & Sallee, 2020). On the other hand, in Germany, where fuel taxes are relatively higher, EV use should unequivocally be taxed (Hirte & Tscharaktschiew, 2013).

Numerous countries have made use of subsidies or tax credits to encourage consumers to buy EVs. For example, as early as 2008 the US introduced a federal tax credit program that subsidized EVs purchases up to $7,500 (IEA, 2017). Not to be outdone, in 2010, China announced a ¥60,000 subsidy (corresponding to around $9,000 at the time) for each EV sold paid to the manufacturer (Motavalli, 2010). While instruments on purchase are not effective at internalizing the external costs of vehicle use, they serve a different purpose in the early stages of EV adoption. In their infancy, new technologies are expensive for numerous reasons, including, chiefly, the costs of research and development. However, other car manufacturers, drivers, and society at large subsequently benefit from the technological innovation. In other words, earlystage EV adoption has positive externalities, making purchase subsidies an appropriate instrument. Importantly, as technologies mature, the subsidies will have served their purpose and should be phased out. Hence, many programs similar to the aforementioned ones have built-in sunset clauses, ending the subsidies after a target number of vehicles has been sold. It should also 23
be noted that these subsidies can quickly become expensive. Early adopters tend to be individuals who are enthusiastic about new technologies and likely would have made the switch to EVs regardless of subsidies. In economics terms, their demand tends to be relatively inelastic with respect to price. Each $1,000 subsidy between 2010-15 has been estimated to increase EV uptake by 2.6% (Jenn et al., 2018) and 7.5% (Wee et al., 2018) in the US. In other words, each additional EV sale cost the federal government $38,462 and $13,333 by the two estimates, respectively. Beyond merely the cost, it is once again important to keep in mind the equity considerations. For example, a study of a suite of policies to encourage EV adoption in Colombia showed that is the interventions largely benefit high-income households, making them regressive (Callejas et al., 2022).

Alternatively, policy makers can also opt to encourage EV adoption indirectly by subsidizing charging infrastructure. This has been shown to be an effective strategy (Li et al, 2022). For example, results of a survey conducted in China in 2017 showed consumers valued having a charging station every 5 km higher than a 50% discount off charging fees (Ma et al., 2019). Additionally, increasing the ubiquity of charging infrastructure lowers the demand on range. With batteries making up a considerable portion of the weight of EVs, lowering battery capacity can save non-negligible weight. All else equal, this lowers the severity of injuries in the event of road collisions, damage to road infrastructure, and importantly, the energy required to move the vehicle. Finally, there is a positive feedback effect between charging infrastructure investment and consumer EV adoption (Li et al., 2017). That is, more charging stations encourage more EVs, and vice versa. This feedback makes subsidizing the two sides of the market complementary. Governments can kickstart the feedback loop by upgrading the fleet of public vehicles away from traditional fuels (Corts, 2010).

# 4. Elasticities

Quantifying the response to price instruments is fundamental for designing taxation schemes for demand management. In this section, we present a compilation of response elasticities to price instruments found in the literature. Table 4 shows inverse-variance weighted average elasticities of new vehicles, fuel economy, fuel demand, and traffic volume with respect to purchase, ownership, and use taxes. Appendix B provides a description of the summarization methods and the complete list of elasticities and their geographic and temporal scopes.

24
_Table 4: Weighted average elasticities_

|**Instrument type**||**Weighted aver**<br>|**age elasticities**<sup>**4**</sup><br>||
|---|---|---|---|---|
||_New vehicles_<sup>1</sup>|_Fuel economy_|_Fuel demand_<sup>2</sup>|_Traffic volume_<sup>3</sup>|
|Purchase|-0.42<br>(0.080)|-|-0.16<br>(0.046)|0.00<br>(0.120)|
|Ownership|-0.09<br>(0.008)|-|-0.13<br>(0.033)|-0.09<br>(0.035)|
|Use<sup>4</sup>|-|0.12<br>(0.190)|-0.11<br>(0.005)|-0.04<br>(0.002)|

<mark>Standard errors in (parentheses).</mark> 1 <mark>Includes studies examining sales and new registrations.</mark>

> 2 <mark>Includes studies examining fuel demand, gasoline demand, and CO</mark> 2 <mark>emissions.</mark>

> 3 <mark>Includes studies examining traffic volume and vehicle miles travelled.</mark>

> 4 <mark>Fuel taxes only; congestion-related taxes not directly comparable.</mark>

Examining the weighted average elasticities, the empirical evidence broadly supports the hypotheses from theory with all elasticities appearing with the expected sign. However, the instruments on purchase and ownership appear to have larger elasticities than anticipated in several cases, particularly for fuel demand. It should be noted that the averages for instruments on purchase and ownership are supported by relatively few studies. Table 5 shows the number of studies used to calculate each average. While there are numerous studies examining use taxes, specifically fuel taxes, far fewer studies examine the effectiveness of purchase and ownership taxes. Notably, some cells do not have corresponding elasticities estimated. This is understandable for the elasticity of fuel economy with respect to purchase and use taxes, since these do not inherently affect fuel economy. Instead, numerous studies examine various feebate schemes, but there is not a standardized elasticity for comparison. For the elasticity of new vehicle sales with respect to use taxes, some authors estimate the impact of total spending on fuel, but this represents a combination of fuel economy and price. It is also worth pointing out, once again, that there are only a few estimates originating from developing countries with the vast majority of studies conducted in mature vehicle markets.

25
_Table 5: Number of studies used for the calculation of averages_

|**Instrument type**||**Total numb**|**er of studies**||
|---|---|---|---|---|
||_New vehicles_|_Fuel economy_|_Fuel demand_|_Traffic volume_|
|Purchase|1|0|2|1|
|Ownership|11|0|2|2|
|Use|0|1|56|11|

Finally, the average elasticities in Table 4 obscure the temporal dimension. Numerous studies distinguish between short-run and long-run elasticities. In the long-run, households can make greater behavioral adjustments, such as vehicle replacement and residential relocation. Hence, as expected, responses were generally found to be greater in the long-run. However, the definition of short-run and long-run were not always consistent across studies. Typically, one year is considered short-run, while more than five years is considered long-run. Unfortunately, the inconsistent definitions make summaries and comparisons difficult. At the same time, a robust understanding of the impact of various tax instruments over time is crucial to effective policy making considering the rapidly changing landscape of the transportation sector.

# 5. Lessons for Development Practice

As evidenced by the first four sections of this paper, the empirical work on vehicle and fuel taxation has overwhelmingly focused on high-income countries. This focus is a natural consequence of the prevalence of private vehicles in high-income countries and the stronger institutional capacity to enforce a variety of vehicle and fuel related price instruments. Several studies have recognized this gap and called for research efforts focusing on developing contexts (Anderson & Sallee, 2016; Jacobsen et al., 2022). However, more than likely, the empirical evidence specific to developing countries will only gradually become available as their vehicle markets mature – in turn changing the question from “how can we shape development?” to “how can we undo its damage?” In light of the differences in challenges faced, policy makers and development practitioners should not merely adopt existing practices from mature automotive markets and assume direct applicability. Rather, it is all the more important that they acquire an understanding of tax policies built on first principles. In this section, we examine the topic through a development lens and highlight the key areas and patterns where developing contexts 26
tend to differ from the developed ones, where much of the existing evidence originates. We discuss the policy implications of these differences and possible additional considerations that development practitioners should keep in mind. At the same time, it is important to emphasize that this discussion inevitably paints with a broad stroke, drawing attention to some of the common challenges. However, the exact circumstances in each country, city, and community are the result of their unique combination of people, culture, history, climate, geography, etc.

Households in lower income countries naturally also have smaller budgets available to address their mobility needs. This has important consequences for vehicle ownership and use patterns as well as policy making targeting these behaviors. For vehicles to be affordable, the automobile markets in many low- and middle-income countries rely on importing used vehicles from highincome countries. In particular, the vehicle fleet in Sub-Saharan Africa is largely made up of used vehicles imported from Europe, Japan, and the US (Baskin et al., 2020). At the same time, vehicle owners are more willing to contend with ageing vehicles, slowing vehicle replacement rates. Thus, the average age of vehicles in developing countries tends to be considerably higher than in developed countries. Furthermore, two- and three-wheelers are extremely popular in many low- and middle-income countries due to their relative affordability. However, these vehicles tend to be involved in road injuries and deaths at a much higher rate and emit more particulate matter than cars. The combination of older cars and widespread two- and threewheeler use have contributed to unhealthy air quality in many cities across the developing world. For policy makers, the relatively small mobility budgets can make households more responsive to price instruments (West, 2005). Due the disparity in purchasing power, monetary budgets are more often a binding constraint for travel decisions in developing countries, whereas time considerations tend to weight more heavily for such decisions in developed economies. Consequently, policy makers might observe larger response elasticities than those found in Section 4, which were largely based on empirical evidence from high-income countries. Importantly, this applies to both intended and unintended policy outcomes. That is, while welldesigned price instruments may well be more effective, poorly designed ones will accentuate the incentive misalignments. For example, a graduated purchase tax based on fuel economy will likely exacerbate the Gruenspecht and Rebound effects due to the higher price-sensitivity. Specifically, if mobility budgets are a binding constraint, the Gruenspecht effect will be more pronounced since making vehicle purchase more expensive prevents, or at least further delays, 27
replacement of old vehicles. Similarly for the Rebound effect, reducing the marginal cost of driving through fuel economy improvements leads to more induced demand if monetary rather than time constraints were binding. The volatility of price instruments in low- and middleincome countries underscores the importance of carefully considering the incentives and implications of policy designs in such contexts.

There is a remarkably robust correlation between motorization rates and GDP per capita. In other words, private vehicles are generally less common in lower income countries and often act more as luxury goods. Naturally, this has implications for the distributional impacts of tax policies. Broadly, taxation of private vehicles and their use is more progressive in low-income contexts, as discussed in Section 3.3. However, fuel taxation, in particular, can be a precarious instrument. Low-income households that do not own a private vehicle may still be reliant on motorized transport, and by extension fuel, for their mobility needs, e.g., paratransit and rideshares. Raising fuel taxes increases the costs of these services. Furthermore, petroleum products, in their various forms, are used for a variety of industrial and residential purposes, such as manufacturing and cooking. Hence, indiscriminately increasing taxes on these products may inadvertently raise prices on a broad range of consumer goods. Although high-income households will undoubtedly be affected more in absolute terms, the progressivity of fuel taxes is much less clear relative to income. That said, the collection of taxes only makes up half the distributional equation. Ultimately, equity impacts will depend as much on how the government redistributes the collected tax revenue. Recycling the revenue to benefit low-income household can help ensure progressive outcomes. However, in developing countries, the prevalence of informality and incomplete data can make policy targeting more challenging and costly, consequently, diminishing the efficiency of redistribution (Coady et al., 2004).

Although taxation of vehicles and fuels is arguably far from optimal even in mature auto markets, these distortions are far more pronounced in emerging markets. For example, commonplace in Sub-Saharan Africa, private vehicle costs are very heavily front-loaded (Granger et al., 2021). Import duties, vehicle excise taxes, and registration fees add up to exceed the value of the vehicles themselves in many places. Meanwhile, ownership taxes and registration fees are rare, and the cost of vehicle use is often undermined by fuel subsidies. Such distortions encourage import of cheaper vehicles to reduce the upfront taxes. This leads to import 28
of older vehicles, which in turn are more polluting. Once the vehicles have been acquired, their use is inadequately priced. This leads to excessive consumption, i.e., distances driven beyond the social optimum. To combat ageing and polluting vehicle fleets, many countries, particularly in Latin America, have banned the import of used vehicles (Baskin et al., 2020). By itself, such regulation is a crude instrument. Absent complementary policies, it can create an extreme case of the Gruenspecht effect, whereby large segments of the population continue to drive dilapidated vehicles because replacements have become unaffordable. As consequence of poorly designed tax structures, the transport sector in many developing countries imposes undue external costs on society at large through GHG emissions, air pollution, productivity lost in congestion, and injuries and deaths in crashes. Several factors contribute to these inefficient tax structures, including political acceptability and institutional capacity for enforcement.

Fuel taxation has a much more volatile impact on fiscal budgets in low- and middle-income countries making them even more politically contentious. Fuel prices are to a large extent determined by the price of crude oil in the global marketplace. Consequently, the same nominal fuel price change, e.g., from market fluctuations, has an outsized real impact in developing economies due to the disparity in purchasing power. To counteract price spikes, many developing country governments institute – what are intended to be – temporary subsidies to absorb the shocks. However, these subsidies can wreak havoc on fiscal budgets. Globally, energy subsidies accounted for 0.7% of GDP in 2013 (Inchauste & Victor, 2017). However, the fiscal impact can be far more significant in developing countries. For example, federal fuel taxes in the US raised $38 billion dollars in 2019 (U.S. Federal Highway Administration, 2020). This made up a not insignificant 1.1% of the total federal government revenue that year (U.S. Congressional Budget Office, 2023). By contrast, in 2022 Senegal’s fuel subsidies amounted to 15.5% of government revenue, leaving a considerable fiscal gap (Konokhova, 2023; World Bank, 2023). For comparison, Senegal’s total gasoline consumption is approximately 0.07% that of the United States’. Unfortunately, energy subsidies are also notoriously difficult to eliminate from a political perspective. Often, reforms to reduce or eliminate them lead to protests, which in fragile contexts can easily contribute to political instability and the toppling governments, e.g., the 2008 Mauritanian coup d’état (Granger et al., 2021), or the 2010 Kyrgyz revolution (McCulloch, 2023).

29
Institutional capacity for enforcement of tax polities tends to be weaker in developing contexts. Collection of distance-based taxes, congestion charges, and annual registration fees requires considerable enforcement capacity and costly technology. Both of which tend to be in short supply in developing countries. Consequently, import taxes on vehicles and fuel, which are relatively straightforward to enforce, are more often than not the instruments of choice. Especially in countries with large informal employment sectors, these upstream taxes on consumption play an outsized role, since income taxes are not collected as consistently as in developed economies. However, given the frequent politicization of fuel taxes, governments are left often with a very small set of feasible instruments in their toolbox. This in turn leads to overloading a single instrument, namely the upfront import taxes on vehicles. Not only does this create distortions, it also encourages evasion of that particular tax instrument. For example, exorbitant vehicle import taxes in Ethiopia have spurred several illegal practices, such as falsification of imported vehicle documents and smuggling from neighboring countries (Metekia, 2022). Keeping in mind the correlation between tax rates, incentive to evade, and enforcement costs is essential to effective policy making in practice.

Offering alternatives is crucial to managing demand for private vehicle ownership as incomes grow, but these alternatives remain poor in most cases (Santos et al., 2010b). The aforementioned robust correlation between per capita GDP and motorization also implies that, as incomes rise, many developing countries will experience a rapid growth in motorization rates. This underlines the challenge of managing private vehicle demand in developing contexts. Changing this trend requires high-quality alternatives to private vehicles. However, public transportation systems are in many cases underdeveloped, e.g., with poor coverage and comprising informal operators. They are often overpriced, overcrowded, and unsafe – particularly for women. Dedicated infrastructure for non-motorized transportation is also often lacking. Without sidewalks, pedestrians may be relegated to simply walk along the side of the road, making trips unsafe and stressful. Cyclists can be a rare sight with mixed traffic and poor road conditions often deemed too chaotic and dangerous. The spatial development patterns can also contribute to poor accessibility for households without a private vehicle, which are disproportionately low-income. The prevalence of informal settlements in outlying areas with inadequate infrastructure join and exacerbate all these issues. Such settlements tend to be inefficiently served by mass transit. At the same time, access to employment opportunities, 30
especially the formal job market, may be severely hindered without a use of motorized transportation. Absent a well-functioning public transportation system and built environment conducive to non-motorized travel, those who do not own a private vehicle will be severely disadvantaged. In turn, this reinforces the need to acquire a means of private motorized transport as soon as it becomes financially possible.

Although not yet widespread, EVs present important advantages specific to developing countries. Considering the state of the transportation sector in most developing countries, completely decoupling motorization from economic growth is not realistic – at least not in the foreseeable future. Rather, private vehicle ownership remains aspirational, particularly in developing contexts (Moody, 2019). In light of this, EVs offer a potential second-best solution. Specifically, EVs present an opportunity to leapfrog ICEV technology. Insofar that motorization rates are low currently, developing countries can avoid entrenchment in traditional fuel infrastructure and avoid the slow and costly process of transitioning. Substituting ICEVs for EVs can also help alleviate the fiscal impact of fuel subsidies by reducing demand for traditional fuels. Furthermore, in the developing context, EVs, including electric two- and three-wheelers, have the advantage that they contribute much less to local air pollution – a problem severely afflicting many cities in low- and middle-income countries (Briceno-Garmendia et al., 2022). Undoubtedly, leapfrogging will require proactive policy making and investments from governments. For example, Egypt and Bhutan have both banned the import of used ICEVs but allow import of used EVs. Even more stringently, several Chinese cities promote EV adoption by capping the number of ICEVs through license plate auctions and lotteries but making EVs exempt. Such aggressive instruments do naturally require corresponding enforcement capacity to implement successfully.

# 6. Conclusion

## 6.1. Summary of Lessons Learned

The literature teaches several important lessons. In policy design, the Pigouvian principle, i.e., taxing the externality-creating activity to internalize social costs, serves as a useful guide for restoring economic efficiency. This is an argument for taxing vehicle use, e.g., through distancebased taxes, fuel taxes, and congestion charges. On the other hand, price instruments on vehicle purchase can have unintended negative consequences due to a misalignment of incentives, e.g., 31
the Rebound and Gruenspecht effects. Despite this relatively simple intuition, it is clear that there is no one-size-fits-all solution in practice. Distortions in the design of taxations schemes exist for numerous reasons, be it: lacking technical expertise, equity considerations, political concerns, inadequate enforcement capacity, etc. Understanding the source of the distortions is imperative to successful diagnosis and policy making. Unfortunately, the root cause is rarely just a lack of technical expertise, and other sources of distortions generally call for second-best thinking.

This is particularly relevant in developing countries, where greater volatility and rapid growth makes understanding the local challenges all the more important. In general, households in lowand middle-income countries have smaller budgets to address mobility needs. Consequently, private vehicle ownership remains aspirational for many, meaning that vehicles tend to act as luxury goods and vehicle taxation is broadly more progressive than in mature markets. Additionally, relatively more affordable two- and three-wheelers and older, more polluting, vehicles are ubiquitous, making local air pollution and vehicle replacement higher priorities. At the same time, existing tax structures tend to be more distorted, often due to limited technology availability and weaker institutional capacity for enforcement. For example, in many countries in Sub-Saharan Africa, taxation is heavily front-loaded with exorbitant taxes on purchase but inadequate and often subsidized fuel taxation. At the same time, raising fuel taxes is often not an option due to political constraints and the technology needed to implement more sophisticated use taxes might not be available. Under such conditions, partly shifting the upfront taxes to ownership taxes is likely an advisable second-best approach, despite not being optimal absent other distortions. Importantly, this enables tax scheme designs that incentivize the retirement or replacement of dilapidated vehicles, which contribute disproportionately to the severe air pollution in many developing country cities. Alternatively, subsidizing private vehicle substitutes, e.g., public transportation or EVs, beyond first-best levels can also be a viable strategy for reducing externality costs in light of existing distortions.

# 6.2. Areas for Future Research

Previous studies had already noted the absence of academic work rooted in low- and middleincome countries. Apart from literature from the Chinese context, which in many ways has its own unique characteristics, this gap has largely persisted. Not only is there a dearth of empirical evidence, but there is also rather limited thinking about alternative solutions that account for the 32
pre-existing distortions specific to developing countries. Instead, treatments are largely constricted to the same set of tools that have been used in mature markets.

Additionally, much of the relevant existing literature originates from the energy and environmental economics fields rather than transportation. While these fields are more wellversed in tax policy, they generally consider fuel consumption and vehicle use in isolation. In other words, private vehicle use is implicitly seen as an end in itself rather than a derived demand. Consequently, potential substitution patterns and spatial considerations are generally not considered. On the other hand, while the transport literature tends to be better about recognizing these facets, it often overlooks the finer nuances and incentive structures of different taxation schemes. Undoubtedly, both emphases are important – and should be thought about in unison.

Finally, vehicles represent long-term financial commitments by households. Hence, the full effect of tax policies will not necessarily be evident immediately but gradually take form as people replace old vehicles and purchase new ones. Some studies distinguish between the short run and long run outcomes of tax policies. While this goes part of the way to examine the temporal dimension, it still implicitly considers steady state conditions, which may not exist in practice, and abstracts away the gradual transition between them. Even so, what is deemed short run versus long run often seems ad hoc. A more systematic treatment and understanding of the dynamics of the responses to vehicle and fuel taxation is important – especially given the rapidly changing landscape of mobility technology.

33