Research in Transportation 28 (2010) 2–45

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Research in Transportation Economics

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Part I: and economic policies in transportq

Georgina Santos a,*, Hannah Behrendt b, Laura Maconi c, Tara Shirvani c, Alexander Teytelboym b a Smith School of Enterprise and the Environment, and Studies Unit, University of Oxford, Oxford, UK b Smith School of Enterprise and the Environment, and Department of Economics, University of Oxford, Oxford, UK c Smith School of Enterprise and the Environment, University of Oxford, Oxford, UK article info abstract

Article history: Road transport imposes negative externalities on society. These externalities include environmental and Received 11 November 2009 road damage, accidents, congestion, and oil dependence. The cost of these externalities to society is in Accepted 17 November 2009 general not reflected in the current prices in the road transport sector. An efficient mobility model for the future must take into account the true costs of transport and its Keywords: regulatory framework will need to create incentives for people to make choices. Road transport externalities This paper discusses the use of economic instruments to correct road transport externalities, but gives Corrective charges relatively more weight to the problem of carbon emissions from road transport, as this is particularly Road taxes Fuel duty differentials challenging, given its global and long-term nature. Congestion charging Economics offers two types of instruments for addressing the problem of transport externalities: command-and-control and incentive-based policies. High Occupancy Toll Lanes Command-and-control policies are government regulations which force consumers and producers to Toll highways change their behaviour. They are the most widely used policy instruments. Examples include vehicle Pay-as-you-drive insurance emission and fuel standards in the US as well as driving or parking restrictions in Singapore. The Carbon tax implementation cost of these instruments to the government is small. Although from an economic Emission taxes perspective these policies often fail to achieve an efficient market outcome, the presence of political Vehicle excise duty constraints often make them the preferred option, in terms of feasibility and effectiveness. Registration taxes Equity impacts Economic theory shows how policies, which affect consumption and production incentives, can be Cap-and-trade used to achieve the optimal outcome in the presence of externalities. Incentive-based policies function Tradable permits within a new or an altered market. We first examine incentive-based policies, which cap the aggregate Scrappage schemes amount of the , such as carbon emissions, by allocating permits or rights to the emitters. The Subsidies emitters are then free to trade their permits amongst them. The permit allocation mechanism is important–although market efficiency would be satisfied by an auction, political influences usually favour a proportional allocation based on historic emissions. We discuss EU ETS as an example of a cap- and-trade system, however, no such policy for CO2 emissions in road transport has been implemented anywhere in the world to date. Fiscal instruments are, like command-and-control, widely used in road transport, because they are relatively cheap and simple to implement. They include the use of taxes and charges in order to bridge the gap between private and the social costs and, in principle, can lead to an efficient market solution. Registration, ownership, fuel, emissions, usage taxes, and parking and congestion charges have been implemented in many countries around the world. On the other side of the spectrum, subsidies can be given to those scrapping old cars and buying fuel-efficient vehicles. Some cities, such as London, have implemented congestion charges and many states in the United States have introduced high occupancy lanes. Other interesting possibilities include pay-as-you-drive insurance and other usage charges. However, the size and scope of taxes and subsidies are determined by governments, and because of their imperfect knowledge of the market the outcome is still likely to be inefficient. Governments have many effective economic instruments to create a sustainable road transport model. These instruments can be used separately or together, but their implementation will be necessary in the nearest future. Ó 2009 Elsevier Ltd. All rights reserved.

q This paper was produced under the Future of Mobility project, funded by Shell International Petroleum Co. Ltd., conducted at the Oxford University Smith School of Enterprise and the Environment, directed by Prof. Sir David King. * Corresponding author. Tel.: þ44 1865 614 917; fax: þ44 1865 614 960. E-mail addresses: [email protected], [email protected] (G. Santos).

0739-8859/$ – see front matter Ó 2009 Elsevier Ltd. All rights reserved. doi:10.1016/j.retrec.2009.11.002 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 3

List of abbreviations IB Incentive Based IEA International Energy Agency ALS Area Licensing Scheme LCCS London Congestion Charging Scheme ANPR Automatic Number Plate Recognition LEZ Low Emission Zone ARF Additional Registration Fee LTZ Limited Traffic Zone ATAC Agenzia per i Trasporti Autoferrotranviari del Comune NAP National Allocation Plan di Roma (which translates as Agency for Auto-rail-tram NOx Nitrogen Oxides transport in the Municipality of Rome) PM Particulate Matter CAC Command-and-control PARF Preferential Additional Registration Fee CAFE Corporate Average Fuel Economy PAYD Pay-as-you-drive Insurance CARS Car Allowance Rebate System insurance CBD Central Business District PQP Prevailing Quota Premium CO Carbon Monoxide RPS Road Pricing Scheme

CO2 RZ Restricted Zone CO2e Carbon Dioxide equivalent SO2 Sulphur Dioxide COE Certificate of Entitlement TfL Transport for London CZ Charging Zone UK DfT UK Department for Transport EEA European Environment Agency UNEP United Nations Environment Program ERP Electronic Road Pricing US DoT US Department of Transportation ETR Express Toll Route US EPA US Environmental Protection Agency EU ETS European Union Emission Trading Scheme US NHTSA US National Traffic Safety Administration GHG Greenhouse Gas VAT Added Tax HC Hydrocarbons VKT Vehicle-km Travelled HOT High Occupancy Toll VQS Vehicle Quota System HOV High Occupancy Vehicle VOSL Value of a Statistical Life HVF Heavy Vehicle Fee WHO World Health Organization

1. Introduction employment increases the productivity not just of the new workers but also of the workers who were employed before the project Road transport plays an essential role in today’s world economy. went ahead and who now reap the benefits of a larger urban For example, in 2004 the road share of passenger-kilometres was agglomeration. Second, higher urban productivity and associated 89 per cent for the US and 85 per cent for the EU-25 (Eurostat, 2007, higher wages ( of taxes) are, in equilibrium, matched by higher Table 5.24, p. 103). In 2003 the road share of tonne-kilometres was commuting costs and higher rents. The key point here is that this 33.4 per cent for the US and 72 per cent for the EU-25 (Eurostat, equality of higher commuting costs, higher rents and higher wages 2007, Table 5.1). is achieved with wages net of taxes. The value of the extra product An efficient equilibrium is defined as a situation in which by the new workers is higher than the costs incurred, with the marginal social costs are equal to marginal social benefits. Exter- difference going to the government, in the form of income tax nalities are a form of market failure, which means that the market is (Venables, 2007). incapable of reaching an efficient equilibrium. As fascinating as the debate on positive externalities from road Although the presence of negative externalities in the transport transport may be, with the UK Department for Transport (UK DfT) sector was never in doubt, there has recently been some debate currently revising their guidelines on how to appraise transport with respect to the presence of positive externalities. On the one projects, the focus of the present review is on negative externalities. hand, the idea of transport being associated with positive exter- As advanced above, in the presence of a negative externality the nalities seems to be mistaken. While positive externalities would market is incapable of reaching an efficient equilibrium, when the materialise in the form of increased productivity and economic total benefit of road transport is maximised (there is no way of growth made possible by transport, to the extent that increased increasing any road user’s benefit without reducing another’s). productivity and growth lead to increased individual income, these From an economic theory point of view, this problem can be benefits are not external (European Commission, 1995). On the solved by implementing corrective instruments, such as for other hand, if transport (in the form of, for example, transport example Pigouvian taxes or cap-and-trade systems, which can ) has an impact on agglomeration econ- achieve efficiency, or at least reduce the magnitude of the ineffi- omies1 then it can certainly be thought of as causing positive ciency or deadweight loss. In addition, there are a number of externalities. Venables (2007) argues that an increase in employ- complementary policies, for instance, land use and transport ment resulting from a transport project is associated with two planning, incentives to public transport and information positive externalities. First, a transport project which increases campaigns, which can act in combination with corrective instru- ments to achieve more efficient outcomes. Finally, in some cases, it is simply a question of implementing a regulation and introducing a new technology. The example of catalytic converters has become 1 Agglomeration economies refer to the benefits that economic agents obtain standard in the road transport literature. when locating near each other. For example, when firms are spatially clustered This paper concentrates on economic policies, stretching the together they tend to face lower production costs and greater access to markets to buy from and sell to. The concept applies both to firms within the same industry concept to include command-and-control measures. Although the and in different industries. idea of corrective instruments to equate marginal social costs with 4 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 marginal social benefits is attractive in theory, there are three economic output,4 and the pain, grief and suffering imposed on the problems associated with the implementation of such instruments victims, and their friends and families (Maibach et al., 2008, p. 36; in the transport sector.2 The first problem is that the marginal UK DfT, 2009a, p. 1).5 external cost imposed by vehicles is not easy to measure. Even Different countries adopt different methodologies to estimate when the marginal physical damage can be assessed, monetisation accident costs, but they all, to a greater or lesser degree include the is not always straightforward. Hence, typically, it is virtually impacts listed above. The number of accidents and the number of impossible to implement first best policies.3 The second problem casualties are therefore key quantitative indicators (UK DfT, 2009a, relates to the fact that any new instrument will usually be intro- p. 1). In developed countries, these statistics are not usually prob- duced in a system characterised by pre-existing corrective instru- lematic to collect. In developing countries, on the other hand, some ments and regulations. As a consequence, the interaction between accidents go unreported, or reported but not properly recorded new and existing instruments may lead to over-charging (thus, (Peden et al., 2004, p. 53). The main complication, however, arises at double-internalising the externality) and therefore to inefficient the time of monetising these different accident costs. Although items outcomes that reduce welfare (Zatti, 2004). The third problem is such as material damages, various administrative costs, healthcare that even in the case where marginal external costs could be costs, and lost product are relatively straightforward to value, the perfectly measured and first best policies implemented in the road pain, grief and suffering imposed on the victims, and their friends transport sector, there would be no guarantee of an efficient and families are not. Indeed, the most important and controversial outcome due to distortions in other (related) sectors in the component is the value of a life saved or the cost of a life lost. economy, which are not priced according to marginal cost For Although there could be some instinctive rejection towards the example, inefficiencies caused by adverse selection in the insurance idea of putting a value on human life, two points should be borne in sector will affect the efficiency of the road transport sector. Another mind. First, when estimating the value of a statistical life (VOSL), it important example of a related sector is the labour market, which is not the life of a specific human being in a given accident which is does not typically operate perfectly, mainly due to the presence of being valued, but rather, the value of the life of an average or distortionary labour taxes (Verhoef, 2000, p. 328). representative victim before the accident takes place. Second, even Bearing that caveat in mind, this paper consists of a survey that when no such value is explicitly estimated, individuals make concentrates on road transport economic policies in theory and in decisions and trade-offs in their daily activities, all of which involve practice. higher or lower risks, and government departments choose some There is consensus in the literature that the most important policies over others, thus, implicitly assuming a VOSL (Freeman, negative externalities from road transport include accidents, road 2003, p. 11). The question is not how much an individual would damage, environmental damage, congestion and oil dependence be willing to pay to avoid his certain death or the certain death of (Maibach et al., 2008; Newbery, 1990; Parry, Walls, & Harrington, another person (e.g., the ransom for a kidnapped relative) or how 2007; Small & Verhoef, 2007). We now turn to briefly describing much compensation that individual would require to accept that these externalities before moving on to the discussion on death, as most people would be willing to pay everything they have policies. and will ever have in order avoid certain death (Freeman, 2003, pp. 299–300, italics added by us). The VOSL is computed on the basis of 1.1. A brief summary of the main road transport externalities willingness to pay to achieve a small reduction in the probability of death or willingness to accept compensation6 to accept a small 1.1.1. Accidents increase in that probability over a certain period of time (Freeman, Accident externalities arise ‘whenever extra vehicles on the road 2003, p. 300, italics added by us). increase the probability that other road-users will be involved in an There is abundance of VOSL estimates in the literature, typi- accident’ (Newbery, 1990, p. 24). Although it is reasonable to cally relating to one geographic area and time period. Examples assume that the more vehicles there are, the higher is the proba- include estimates for (Rizzi & Ortuzar, 2003), Malaysia bility of accidents, there is evidence of compensating behaviour, as (Mohd Fauzi, Nor Ghani, Radin Umar, & Ahmad Hariza, 2004), drivers tend to drive at lower speeds and pedestrians and cyclists Thailand (Vassanadumrongdee & Matsuoka, 2005), Sweden tend to be more careful in heavier traffic (Newbery, 1990, p. 24; (Hultkrantz, Lindberg, & Andersson, 2006; Andersson, 2007), Parry et al., 2007, p. 381). The impact of one extra vehicle on the severity-adjusted accident risk is difficult to pin down (Brownfield et al., 2003). An extra vehicle increases the collision risk, but 4 Lost economic output is the output lost due to the death or injury of a person, because vehicles would drive slower due to higher congestion, each which can in principle be estimated as the discounted present value of that person’s collision would be less deadly. Although this may reduce the earnings over the reminder of his expected life. A representative victim is used for number and the severity of accidents, this compensating behaviour this calculation, as otherwise the elderly, already out of the work-force, and the is itself costly, so it should not be considered a positive externality disabled, would be less valued, and so would be young children, due to the dis- (Parry et al., 2007, p. 381). Unfortunately there is not much counting process before they enter the work-force, or women or people from ethnic minorities on lower wages. Other problems include whether that person’s produc- empirical evidence on the net effect. tivity should be measured net of or inclusive of his own consumption, whether External accident costs are the accident costs ‘not covered by risk stay-at-home spouses’ productivity (completely outside the market) should be oriented insurance premiums’ (Maibach et al., 2008,p.36).Ifinsur- assumed equal to the productivity of the domestic or to the opportunity ance premiums covered all accidents costs, the externality would cost of staying at home, which could be measured by the average earnings of workers (Freeman, 2003, pp.302-303). It should be noted that lost economic output then be fully internalised. In the US, for example, only about half of all is just one element of the value of a statistical life (VOSL), discussed below, and does accident costs are paid by private insurers (Blincoe et al., 2002). not constitute the whole VOSL, as the human capital approach would propose. Accident costs (regardless of whether they are internalised or 5 Accident costs are considerable: in the US, for example, they were estimated at 2. not) include material damage, insurance administration, legal and 3 per cent of GDP in 2000. Property damage costs for all accident types (fatal, serious court costs, police and fire services costs, medical costs, lost and slight) represented 26 per cent of all costs. Present and future medical costs due to injuries accounted for 14 per cent of the total costs (Blincoe et al., 2002). 6 In 1993, a Panel commissioned by the US National Oceanic and Atmospheric Administration with the task of assessing the reliability of contingent valuation 2 The problems are common to other areas of the economy as well. methods concluded, amongst other things, that willingness-to-pay is a more reli- 3 At most, it might be possible to impose an ex-ante expected first-best policy. able measure than willingness-to-accept compensation (Portney, 1994, p.9). G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 5

Delhi (Bhattacharya, Alberini, & Cropper, 2007), and Spain (Perez, of differing ages’ (Newbery, 1988, p. 313). The conditions for Perpinan, & Prades, 2007), to name only some recent ones. this theorem, however, are not verified in reality. In particular, Dionne and Lanoie (2004) review 85 studies and find VOSL there is evidence of road damage being caused partly by bad estimates ranging from CA$0.16–33 million at 2000 values and weather. The fraction of road damage allocated to weather varies prices or CA$0.23–47 million (£0.11 m to £22 m; V0.16 m to V32 m; from 20 to 40 per cent in hot dry climates to 40–80 per cent in very $0.22 m to $44 m) at 2007 prices and values and exchange rates.7 cold ones, with the higher figures corresponding to more stringent De Blaeij, Florax, Rietveld, and Verhoef (2003) conduct a meta- maintenance criteria and/or lower traffic volumes (Newbery, 1990, analysis of the variables that explain the variation in VOSL esti- p. 25). mates reported in the literature and find that the magnitude of VOSL estimates depends on the methodology adopted (stated preference 1.1.3. Environmental damage or revealed preference), and for contingent valuation studies, not The environmental externalities from road transport include the surprisingly, on the type of payment vehicle and elicitation format. impacts from emissions, noise and vibration, changes to landscape More importantly, they conclude that VOSL estimates cannot simply and townscape, impacts on biodiversity, heritage of historic be averaged over studies because the magnitude of VOSL is resources, and water (UK DfT, 2004). From these externalities the ‘intrinsically linked to the initial level of the risk of being caught up two which have been best quantified and monetised are noise and in a fatal traffic accident and to the risk decline implied by the emissions. The others tend to be assessed using qualitative tech- research set-up’ (De Blaeij et al., 2003, p. 973). niques. These may include a description of the problem in question Understandably, different governments, and often different (such as for example, the threatened biodiversity or heritage), an departments within the same country, have their own VOSLs. The assessment of its importance, and an overall scoring on a pre- UK DfT, for example, uses a VOSL of £1.1 million at June 2007 values determined scale. and prices (UK DfT, 2009a, p. 3), roughly equivalent to V1.6 million. Noise harms human health and interferes with people’s daily The US Department of Transportation (US DoT) uses a VOSL of $5.8 activities. According to the World Health Organization (WHO), million (£2.9 m, V4.2 m) at 2007 values and prices (US DoT, 2008a, noise from road transport affects the health of almost one third of p. 1). The Australian Government uses a VOSL of AU$3.5 million people in Europe (WHO, 2007). The main impacts from noise ($3 m; £1.5 m; V2.1 m) at 2007 values and prices. Transport Canada include ‘pain and hearing fatigue, hearing impairment, annoyance, uses a VOSL of CA$1.75 million at 2000 prices and values (Dionne & interferences with social behaviour (aggressiveness, protest and Lanoie, 2004), or CA$2.5 ($2.4 m; £1.2 m; V1.7 m) million at 2007 helplessness), interference with speech communication, sleep prices and values. disturbance and all its consequences on a long and short term basis, Governments in developing countries do not typically have cardiovascular effects, hormonal responses (stress hormones) and official VOSLs and studies are scarcer than in developed countries. their possible consequences on human metabolism (nutrition) and Attempts to approximate VOSLs for developing countries mainly immune system, performance at work and school’ (WHO, 2007). consist of regression estimates based on models originally fitted for Protection from noise pollution is costly: may have to developed countries (Bowland & Beghin, 2001; Miller, 2000). One double-glaze their windows and local governments often install obvious (and perhaps worrying) result is that VOSLs for developing noise barriers around motorways. Noise can be measured in deci- countries tend to be lower than for developed ones, implying that bels and noise costs are typically estimated with hedonic property human life is less worth in the poor world. Income or GDP per price models (Parry et al., 2007). capita is found to be an important explanatory variable (Bowland & Most of the energy consumed by road transport comes from Beghin, 2001; De Blaeij et al., 2003; Miller, 2000) with elasticities in fossil fuels. This causes emissions, not just from fossil fuel the range of 0.50 (Blaeij et al., 2003) to 0.85 and even 1 (Miller, combustion but also from the evaporation of petrol during 2000). production, storage and distribution, and evaporative emissions from the gas tank and carburettor of petrol-engined vehicles. Here, 1.1.2. Road damage however, we concentrate on emissions due to fossil fuel combus- Road damage costs include the costs of repairing the damage tion, which is the main source of road transport emissions. Emis- caused by the passage of vehicles, which is a cost borne by the sions from road transport have negative impacts at local, regional highway agency, and by other drivers, who bear extra vehicle and global level. operating costs caused by this damage (Newbery, 1990, p. 25). The At local and regional level, there are a vast range of air pollut- damage caused by a vehicle increases as the fourth power of the ants, which cause a variety of effects on the environment and axle load. Thus most of the damage is caused by heavy vehicles health. The main emissions from road transport with effects at local (such as big lorries) on thin roads (Newbery, 1990, p. 25). level are nitrogen oxides, hydrocarbons and carbon monoxide, Newbery (1988) proves an interesting result that if (a) the accounting for 58 per cent, 50 per cent and 75 per cent respectively highway agency follows a condition-responsive maintenance of all such emissions in the EU (European Parliament Fact Sheets, policy, that is, if they repair roads when these reach a pre- 2006). Other pollutants include sulphur dioxide and particulate determined state, (b) the only cause of road damage is traffic (with matter. Their impacts are summarised below. no damage attributable to weather), (c) traffic flow is constant over time (i.e., there is no traffic growth), and (d) the age distri- 1.1.3.1. Nitrogen oxides (NOx). NOx emissions are formed in the bution of the road network is uniform, then the average road combustion of fossil fuel. They include nitrogen dioxide and nitric damage externality is zero. This makes imposing efficient road oxide. Nitrogen dioxide can negatively impact the human respira- user charging very simple: the charge should equal the average tory system and reduce lung function. NOx also contribute to the cost of repair. The result holds because ‘the externality caused by formation of ozone, which is a harmful secondary pollutant in the vehicles damaging roads, which raises the operating cost of lower atmosphere. High levels of ozone increase susceptibility to subsequent vehicles, exactly cancels out when averaging over respiratory disease and irritate the eyes, nose throat and respira- tory system, particularly in urban areas (UK DfT, 2007a, p. 51).

7 The average exchange rate in the period Jan-Dec 2007 was £1 ¼ $2 ¼ AU$2.4 ¼ 1.1.3.2. Hydrocarbons (HC). HC are the result of incomplete CA$2.1 ¼ V1.5 (IMF Exchange Rate Query Tool). combustion of fossil fuels and cause eye and throat irritation and 6 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 coughing (Banister, 1998, p. 4). They also cause damage to crops and trees, and this may lead to crop losses. MSC 1.1.3.3. Carbon monoxide (CO). CO is also produced by the incom- plete combustion of fossil fuels and interferes with the absorption of M oxygen. After being inhaled, CO molecules can enter the bloodstream, D = MPB = MSB where they inhibit the delivery of oxygen throughout the body. This in turn leads to dizziness, headaches, and fatigue, and can affect fertility and general levels of health. CO interferes with respiratory bio-chemistry and can affect the central nervous and cardiovascular F H systems (UK DfT, 2007a, p. 50). Other pollutants can exacerbate its effects (Banister, 1998, p. 4). The fitting of catalytic converters to all ASC = MPC new vehicles virtually around the world in the late 1980s and A B C throughout the 1990s has substantially reduced emissions of CO. Average andMarginal Costs G E

1.1.3.4. Sulphur dioxide (SO2). SO2 affects the lining of the nose, throat and airways of the lung, in particular, among those who suffer from asthma and chronic lung disease (UK DfT, 2007a, p. 51). e qm It causes respiratory illness, in particular bronchitis, and it also q contributes to acid rain (Banister, 1998, 4). Traffic flow (PCU/lane hour)

Fig. 1. The economics of congestion. 1.1.3.5. Particulate matter (PM). PM is a generic term used to describe a complex group of air pollutants that vary in size and coming from oil-based fuels and only small differences in the composition. The two main types of here are PM10 and carbon content of the different fuels, CO2 emissions from the PM2.5, which are particles with aerodynamic diameters of up to 10 different transport sub-sectors are roughly proportional to their 8 microns and 2.5 microns, respectively. PM has been linked to energy use (Kahn Ribeiro et al., 2007, p. 328). Indeed CO2 emissions numerous adverse health effects including increased hospital are closely related to the quantity of fuel consumed, and this, as we admissions and emergency room visits, respiratory symptoms, shall see in the sections that follow, has important implications for exacerbation of chronic respiratory and cardiovascular diseases, policy instrument design. decreased lung function, and premature mortality (Bell, Samet, & Valuing the impact of global warming is undoubtedly a chal- Dominici, 2003, p. 8). lenging task. A number of models have been developed10 with Particulates are the main pollutants causing deaths in Europe estimates varying according to the impacts (and some times today, with an estimate of 348,000 premature deaths in Europe due adaptation) taken into account, the assumptions made, and the to exposure to anthropogenic PM2.5 for the year 2000 (European discount rate used. Environment Agency, EEA, 2005a, p. 98) or loss of statistical life expectancy of approximately 9 months (EEA, 2005b, p. 47). In some 1.1.4. Congestion areas of Europe, such as the Benelux area, in northern Italy and in Traffic congestion is a road condition characterised by slow parts of Poland and Hungary, the average loss of life expectancy speeds. It takes place when the demand for road space is greater than from particulates is up to two years (EEA, 2005a, p. 98). road capacity. The impacts are well-known: longer and unreliable Impacts on health, crops, buildings, etc from local and regional travel times and ultimately, negative economic effects as a result of an pollutants can be physically measured and monetised.9 Once the inefficient distribution and delivery of , services and resources. link between emissions and concentration of a pollutant has been In his seminal paper on the economics of congestion, Walters established, the next step involves the estimation of a dose- (1961) established the isomorphism between travel time on response function, which relates pollutant concentration to the a given length of highway as a function of traffic flow (speed-flow physical impact on the receptor (for example, population in relationship), on one hand, and as a function of flow, a town). Finally, the impact resulting from exposure can be valued on the other hand. That was Walters’ fundamental original using stated and/or revealed preference methods and/or combi- contribution. An adequate conversion from time into cost, nations of both. combined with a demand curve, makes the analysis of the whole It should be noted however, that emission rates per km of air picture from an economic point of view possible. Fig. 1 presents the pollutants with local and regional impacts has been decreasing in standard diagram of the economics of traffic congestion on a link. virtually all countries, due to the introduction of ever more strin- Higher traffic flows lead to lower average speeds and higher gent regulations on new vehicle models. travel times and costs per km. Additional traffic imposes an At global level, the main pollutant is carbon dioxide (CO2), the external cost on all other road users. Under congested conditions, anthropogenic greenhouse gas (GHG) which most contributes to particularly in urban areas, and in the absence of efficient road global warming, and the unavoidable product of fuel combustion. pricing, traffic will be undercharged and hence, excessive. In the period 1990–2002 the growth rate of energy consumption in In Fig. 1, road users are assumed identical apart from their the transport sector was the highest among all the end-use sectors, marginal willingness to pay for a trip, given by the inverse demand and road vehicles account for 77 per cent of that energy use (Kahn curve D, which represents marginal private and social benefits. Ribeiro et al., 2007, p. 328). With 95 per cent of transport energy Marginal private (MPB) and marginal social benefit (MSB) are assumed identical (i.e., distributional considerations are ignored). The efficient equilibrium is at point H, where the marginal social

8 One micron is one micrometer or one millionth of a meter (1 mm ¼ 1000 mm, where mm: microns). 9 Spadaro and Rabl (2001), for example, argue that the impacts on health account 10 These models are reviewed in Schneider and Lane (2005), Hope (2005) and for more than 90 per cent of the cost of automotive air pollution. Stern (2006). G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 7 cost (MSC) is equal to the MSB. The market equilibrium however is The question of how to measure the costs of oil dependence has at point C, where the average (ASC) is equal to the MSB. attracted some attention, especially in the US (Greene & Ahmad, At this point drivers are paying for their ASC but not for their MSC, 2005; Leiby, 2007; Parry & Darmstadter, 2003). These costs leaving thus a congestion externality or marginal congestion cost include the transfer of wealth from the importing country to the oil (MCC), which can be measured by the segment MC. The inefficiency producing country, a decrease in the maximum product the of incorrect pricing of scarce road resources or deadweight loss is importing country would be capable of if oil prices were compet- then measured by the area HMC. itive (as opposed to monopolistic or oligopolistic) and any macro- It should be noted that the MCC at the efficient level of traffic qe is economic adjustment costs driven by price shocks, which impact positive and equal to the segment HE. In other words, zero conges- prices and wages and as a consequence, employment of resources, tion would not be an optimal situation, but rather, would reflect such as capital and labour (Leiby, 2007). Some consequences of oil a waste of resources. Estimates of congestion costs are mainly based dependence, such as its effect on foreign policy and national on assumptions on the value of time and value of reliability.11 These security, are much more difficult to quantify (Leiby, 2007). have been subject to extensive empirical and theoretical research. Some important recent contributions include Brownstone and Small 1.2. Command-and-control vs. incentive based policies (2005), Calfee and Winston (1998), De Borger and Fosgerau (2008), Fosgerau (2006), Hensher (2006), Hensher (2008), Hensher and Having summarised the most important road transport exter- Goodwin (2004), Lam and Small (2001), Mackie et al. (2003), nalities the next question is whether anything ought to be done Ramjerdi and Dillen (2007), Steimetz and Brownstone (2005), about them and why. As explained above, the market is incapable of Tseng and Verhoef (2008), and, Wardman (2001). reaching an efficient equilibrium in the presence of externalities. There is substantial heterogeneity in values of time and reli- This calls for some action from the government in order to correct ability across the population and these depend on a number of the market failure, at least in part, and achieve, or at least get close factors. Some widely agreed upon determinants include income to, an efficient equilibrium. and trip purpose. Although the correlations are far from perfect, in From an economic point of view, policies to reduce negative general we expect that a higher income leads to a higher value of externalities can be divided in two groups: command-and-control both working and non-working time; and the more important the (CAC) and incentive based (IB). IB mechanisms can be further cat- trip purpose (work as opposed to shopping, and their corre- egorised into price controls and quantity controls. sponding delay penalties) the higher the value of time . The A CAC policy is essentially a regulation, or a ‘‘command’’, which value of reliability also varies with income and trip purpose, needs to be ‘‘controlled’’ or enforced. When there is an externality, although gender differences, reflecting childcare commitments, the regulator (or government) can impose a maximum level of the also have an influence. activity causing it, or a restriction over the behaviour of economic Elasticities of the value of time with respect to income are also agents, or characteristics of products. CAC measures give rise to important. Mackie at al. (2003) conduct a meta-analysis of value of predictable outcomes and are relatively easy to implement, enforce, time studies and conclude that reasonable assumptions would be 1 and understand (Button, 1990). However, they are inflexible and for the working time and 0.8 for the non-working time elasticities, they do not provide incentives to go beyond the mandatory standard respectively (p. 11) and the UK DfT has adopted these values (UK (Button,1990). Every time a change is envisaged, the measure needs DfT, 2009b, p. 5). to be revised, thus leading to an additional bureaucratic burden. IB policies, on the other hand, provide economic incentives to 1.1.5. Oil dependence the targeted agents and act to directly alter private or private Oil dependence is a problem for oil importing countries. These benefit from a given behavioural response. Consequently, they are countries are vulnerable to volatile oil prices and oil price shocks. crucial instruments to induce behavioural change. This has the potential of threatening national security and the Price control IB policies put a price on a good or an activity, such economy of a country, especially if this country does not have as emissions or congestion. These can take the form of taxes (or fees enough market power to influence world prices. or charges) or subsidies, both providing incentives to reduce the Roughly 42 per cent of world oil is produced by OPEC countries, level of the externality. A foregone subsidy can have a similar and from this, 68 per cent comes from Iran, Iraq, Kuwait, Saudi impact to that of a tax. A tax to internalise an externality, also known as a Pigouvian or Arabia and United Arab Emirates (Parry & Darmstadter, 2003, p. 3). 12 These countries, together with Venezuela, and two non-OPEC corrective tax (or fee or charge) is a tax set equal to the marginal countries, Mexico and Norway, are willing to produce well below external cost of the activity at the efficient equilibrium. Thus, the their capacity in order to keep their influence over world prices corrective tax brings the marginal private cost up to the level of (Parry & Darmstadter, 2003, p. 5). OPEC is an organization that marginal social cost. influences production and ultimately prices (Kaufmann, Bradford, A subsidy, on the other hand, encourages the agent to reduce the Belanger, McLaughlin, & Miki, 2008) via capacity utilisation, level of activity by compensating him for his loss. Thus, a car manu- production quotas, and the degree to which OPEC production facturer may be given a subsidy to produce cleaner cars or a road user may be given a subsidy as long as he stops travelling by car during the exceeds these quotas (Kaufmann, 2004, p. 81). 13 Virtually every activity in developed countries relies on oil rush-hour. However, it may be difficult to measure baseline emis- directly and/or indirectly, and as a consequence, world oil prices sions to estimate emissions reductions under a subsidy. impact GDP, other ’ prices, and employment, to More importantly, Baumol and Oates (1988, chap. 14, pp. 211– name just a few economic indicators (Cleveland & Kaufmann, 2003, 234) highlight a number of differences between the impacts from p. 488), as well national security. Reducing vulnerability to oil price taxes and subsidies at firm and industry level: volatility requires a reduction in oil use, regardless of where it is produced (Cleveland & Kaufmann, 2003, p. 488). 12 These taxes are called Pigouvian in honour of Arthur Pigou, a Cambridge Neo- classical economist, who also developed the concept of externalities. They are also called corrective because they are aimed at correcting a market distortion. 11 The cost curves in Fig. 1, if expressed in monetary units, are obtained by 13 In practice this could translate, for example, into a subsidy to public transport assuming a value of time. fares. 8 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45

It may be profitable for the firm to start off by emitting more than by regulated consumers or producers; and they exploit the mar- it would have otherwise in order to qualify for larger subsidies. ket’s capability of private information aggregation (Hepburn, 2006, There is less of an incentive to introduce new technologies p. 228). This makes IB instruments more efficient to CAC measures under subsidies than under taxes. when the information basis is not complete and cannot be inferred An unprofitable firm under taxes may become profitable under by the regulator. The advantage of IB instruments over CAC is subsidies. particularly marked when the regulated entities are not homoge- While taxes will typically drive firms out of a competitive neous16 and their optimal response is not uniform (Hepburn, 2006, industry and this will usually result in a decrease in its pp. 228–229), or when there are time and spatial variations in production, a subsidy may attract new entrants, thus increasing problems (European Commission, 1995). the level of production of that industry. However, IB mechanisms can lead to market failures and blunt Under perfect , a subsidy will yield a reduction in miss of objectives. This can happen, as explained above, when emissions at firm level, but an increase in emissions at industry incentives are not correctly calibrated due to difficulties in deter- level, even beyond the level of emissions there would have mining the marginal external cost (and therefore of efficient level of been without any intervention. activity), the system already having corrective instruments and regulations in place (whose effects will be added to the new IB Quantity control IB policies usually assume the form of cap-and- instrument’s), and the presence of distortions in other (related) trade systems. They target a certain level of activity (for example, sectors in the economy. In these cases, the effectiveness of the emissions), assign property rights (permits) to match the targeted instruments in meeting the targets may be impaired. Transaction and total quantity and let consumers, firms and other entities trade these implementation costs may also be higher for IB mechanisms than for permits at an endogenously determined price. To the extent that CAC, due to the need of advanced monitoring systems (European quantity control instruments involve a trading mechanism, they also Commission, 1995). However, costs are likely to decrease as tech- provide price incentives to the regulated parties (Hepburn, 2006). nology progresses. Cap-and-trade systems were theoretically articulated by Dales Finally, CAC may be preferable to IB instruments when there are (1968), who built his ideas on the basis of work by Coase (1960). no informational asymmetries, there is little risk of government The rights or permits initial allocation method is a decision failure, and the regulated entities are required to respond in the same which needs to be made early in the process. There are mainly two way. An instance when CAC would be advisable is when the optimal possible initial allocation methods: grandfathering and auctioning. level of an externality, for example a certain polluting activity, is zero. With grandfathering, permits are allocated by the regulator for free The activity in this case should simply be banned (Hepburn, 2006,p. to each polluter, according to their past (historic) emissions. With 229). This happens when after reducing emissions by 100 per cent auctioning, polluters pay for the permits they wish to buy, the marginal social benefit is higher than the marginal social cost. according to the price that emerges from the auction. Obvious cases of this are bans on the use of dichlorodiphenyltri- Auctioning reduces barriers to entry in the case of industry, chloroethane (DDT) as a pesticide and asbestos in construction, increases regulation stringency, prevents the possibility of wind- which were implemented by many countries in the 1980s. The lead fall profits, and generates revenues that can be recycled for envi- phase-out from petrol, discussed in Section 2, is another example. ronmental purposes and/or cutting distortionary taxes. Grand- fathering, on the other hand, is a more widely accepted option, as essentially trading parties are allocated permits for free, but does 1.3. Incentive based: quantity vs. price control under asymmetric not apply the ‘‘polluter pays’’ principle in full.14 information The main advantage of IB (both price and quantity control) instruments over CAC ones is their cost effectiveness. Economic A cap-and-trade system guarantees a quantity of externality or agents (producers or consumers) with low costs of abatement will activity producing the externality, regardless of the abatement find it relatively easier to reduce their level of externality than to costs. A tax, on the assumption that polluters (either consumers or buy permits or pay taxes, while those with high costs of abatement producers) are cost minimisers, guarantees that the marginal will prefer to buy permits or pay taxes. The cost of reducing the abatement cost will be equated to the tax, regardless of the externality is thus minimised compared to the more direct regu- resulting quantity of the externality or activity producing the latory approach of setting standards (Baumol & Oates, 1988, externality (Baumol & Oates, Chapter 5). Chapters 6 and 8). Having said that, the magnitude of these cost Under perfect information a system of Pigouvian taxes and savings varies greatly across specific cases (Newell & Stavins, 2003, a system of marketable permits are equivalent and yield the same p. 46). Tietenberg (1985,inNewell & Stavins, 2003) compares the efficient outcome. In general ‘it is neither easier nor harder to name costs of air pollution control across ten different examples and finds the right prices than the right quantities because in principle exactly ratios ranging from 1.1 to 22.15 the same information is needed to correctlyspecifyeither’(Weitzman, 17 Another advantage of IB instruments over CAC is that they lead 1974,p.478). If the optimal number of permits is issued by the to self-revelation of private information through the choice made regulator, their price will be bid up on the free market to precisely the level of the Pigouvian tax. At that point, it makes no difference to the polluter whether he pays a tax equal to his marginal external cost to 14 At first sight, an initial free allocation of permits might lead to the conclusion the authorities, or whether he pays that same amount to buy permits that the ‘‘polluter pays’’ principle is not applied at all. However, one must consider that will allow him to produce the same level of externality and the opportunity costs that come with the use of permits: by using a permit, the marginal external cost (Baumol & Oates, 1988, chap. 5). permit holder is giving up the earning he would make by selling it at the market price. The incentive, however, is smaller than in the case of auctions, where polluters must pay upfront for the permits. 15 Newell and Stavins (2003) attempt to fill the niche in research on the relation- 16 Permit trading provisions may, however, solve the cost heterogeneity problem. ship between the nature and magnitude of the heterogeneity in abatement costs 17 It should be noted, however, that in the case of road transport most pollutants with and the potential cost savings from IB instruments. They develop an analytical local or regional impacts, exhibit a marginal damage curve which is approximately flat. framework linking cost savings from IB instruments relative to CAC and different In such cases, the optimal tax will be the same, regardless of the shape of the demand sources of heterogeneity in abatement costs, including the slope of the marginal (or marginal social benefit) curve. Under these assumptions estimating the efficient tax cost curve, baseline emissions and firm size. requires less information than estimating the efficient quantity. G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 9

In an imperfect information setting, the conclusions are very lower monitoring and enforcement expenditures (Gallagher et al., different. Lack of enough relevant information on the part of the 2007). In general, policy is not designed to follow economic princi- regulator is a crucial factor that can lead to regulatory failure under ples but rather to maximise votes (Helm, 2005,p.213). price as well as under quantity control mechanisms. Hybrid instruments also constitute an alternative. These The source of uncertainty can lie in the marginal abatement cost combine price and quantity instruments. An example is a cap-and- curve or in the marginal social benefit curve. When there is perfect trade scheme with a price ceiling or price floor. The government information regarding marginal abatement costs but lack of infor- commits to selling or buying permits at a certain price when the mation regarding marginal social benefits, the policy, either taxes market price hits the ceiling or the floor (Hepburn, 2006, p. 230). or permits, will not be optimal. The cost of the error, however, will Finally, a multiple instrument package can also be implemented be the same under either policy (Weitzman, 1974,inBaumol & (Hepburn, 2006, p. 231). Such a package can include permits, taxes, Oates, 1988) and so in the presence of uncertainty with respect to subsidies and regulations. The danger in this case, in terms of marginal social benefits it makes no difference to choose one or the efficiency, is the double-charging or double-penalising of an other. The reason for this is that the resulting permit price, after the externality, as its reduction in that case would be excessive. regulator has determined what he thinks is the optimal quantity, Aldy, Ley, and Parry (2008) discuss the design of CO2 taxes at the and the resulting quantity, after the regulator has determined what domestic and international level and the choice of taxes versus he thinks is the optimal tax, depend exclusively on marginal permits. They find a strong case for taxes on uncertainty, fiscal, and abatement costs and are independent from marginal social distributional grounds, especially if permits are grandfathered. First, benefits. taxes provide certainty with respect to the price for emissions, and When there is imperfect information regarding marginal therefore the marginal abatement costs, while permits fix quantity abatement costs, the outcome will be inefficient. In this case, the but not price, which fluctuates with market conditions, and hence, cost of the error under a permit or tax system may be different. the uncertainty is larger. Second, unlike permits distributed for free, In general, both permits and taxes will yield inefficient taxes offer revenues to the government, helping a healthier fiscal outcomes. When the assumed marginal abatement costs are lower balance. These revenues can then be used to reduce distortionary than the actual ones, the reduction of the externality under a cap- taxes in the economy, thus increasing efficiency. Third, governments and-trade system will not be enough, and the reduction of the can use revenues from CO2 taxes or auctioned permits to benefit externality under a tax will be excessive. The opposite holds when lower income groups, thus reducing any initial regressive effects. the assumed marginal abatement costs are higher than the actual They pointout that the main disadvantage of taxes is that if they were ones (Baumol & Oates, Chapter 5). implemented at an international level, individual countries could The inefficiency arising from lack of information on marginal reduce other taxes, even taxes on sources of other GHGs, to offset the abatements costs under permits and taxes depends on the relative burden. To solve this problem they propose a CO2 tax which takes into slopes of the marginal abatement cost and marginal social benefit account pre-existing energy taxes or subsidies. functions. An important result from Weitzman (1974), digested in Baumol and Oates (Chapter 5) is that: 1.4. Concluding remarks

When the marginal social benefit and the marginal abatement The most important externalities caused by road transport are cost curves are linear and the absolute values of their slopes are accidents, road damage, environmental damage, congestion and oil equal, the magnitude of the distortion caused by cap-and-trade dependence. In the presence of externalities the market is inca- and a tax will be identical (p. 67). pable of achieving an efficient equilibrium. This problem can in The steeper the slope of the marginal social benefit curve, the theory be solved by implementing corrective taxes or introducing less severe the magnitude of the distortion caused by a cap- cap-and-trade systems. These are equivalent instruments under and-trade system will be, compared to that of a tax (p. 64). perfect information but errors can be made under imperfect The steeper the slope of the marginal abatement cost curve, the information. The cost of the error is identical if there is lack of more severe the magnitude of the distortion caused by a cap- information regarding marginal social benefits or if there is lack of and-trade system will be, compared to that of a tax (p. 66). information regarding marginal abatement costs and the marginal social benefit and the marginal abatement cost curves are linear Finally, when the slope of the marginal benefit and marginal with equal slopes in absolute value. If there is lack of information cost curves are both uncertain, quantity control will in general be regarding the marginal abatement cost and the slopes of the cost preferred, since ‘prices can be a disastrous choice of instrument far and benefit curves are different, the cost of the error varies more often than quantities can’ (Weitzman, 1974, p. 486). depending on which curve is steeper. There are also a number of Taxation leads to price stability, while permits may lead to price complementary policies, such as for example, land use and trans- fluctuations. The volatility associated with permits will add up to port planning, which can act in combination with corrective the intrinsic uncertainty over returns in technology development, instruments to reduce the level of externalities. Command-and- and may reduce investment incentives by risk-averse firms control measures and new technologies also have a very impor- (Gallagher, Collantes, Holdren, Lee, & Frosch, 2007, p. 18). Risk- tant role to play. aversion therefore may play a role in instrument selection. All else being equal, when the regulated entities are risk-averse, price 2. Command-and-control policies control tends to be preferred to quantity control. In fact, the vola- tility of cap-and-trade systems may be avoided through taxation As explained in Section 1.2, CAC policies are not efficient from an (Baldursson & von der Fehr, 2004,inHepburn, 2006). economic point of view: even in a context of perfect information Other considerations that go beyond pure economic theory are when the regulation or standard is set at the optimal level, the also relevant in instrument selection. For example, regardless of any target is not achieved at minimum cost, and, worse yet, the social efficiency criteria, permits tend to be more costly in regulatory terms, costs could exceed the potential benefits (thus replacing market in the sense that they require an institutional setting, definition of failure with government failure). Despite being inefficient policy property rights and initial allocation, and enforcement procedures instruments, they are the most widely used ones to regulate envi- (Helm, 2005, p. 212). Taxes, on the other hand, require relatively ronmental and other externalities. In many cases, however, the 10 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 choice of instrument is justified by the severity of the problem, state of California in 2007. The Low Carbon Fuel Standard requires with the extreme case of lethal fumes being the prototype example. fuel providers to reduce GHG emissions of the fuel they sell. The The transport sector is no exception, and throughout the world programme intends to achieve a 10 per cent reduction in the carbon there is a plethora of examples of CAC policies targeting different intensity of transport fuels by 2020 (Farrell & Sperling, 2007). transport externalities. In this section, some of these examples are briefly described and discussed, mainly to illustrate how the regulations were set and to give an idea of their success or failure. 2.2. Vehicle standards

2.1. Fuel standards Vehicle standards are CAC policies which typically regulate vehicle safety, tailpipe emissions and fuel efficiency. In general, These are standards that countries impose on motor-vehicle different countries set their own vehicle standards, although the EU fuels. The most notable example is the ban on lead in petrol, which sets standards for all its members. has been implemented virtually all over the world as of 2009. Lead Typically, safety standards set front and side impact tests which had been used as an additive since the 1920s. It was a pollutant of vehicles have to pass before they are introduced into the market. great concern, mainly due to its effects on children’s brains and was There are also regulations regarding compulsory fitting of head- therefore phased out and finally banned in most countries. restraints and seat-belts, and on the minimum depth of tyre In the US, for example, the Environmental Protection Agency treads, brakes, and annual safety checks (Acutt & Dodgson, 1997, (US EPA) started a lead phase-down program in 1973,18 with the p.19). In general, safety standards have become more stringent over objective of reducing the lead content in petrol from 1.7 grams per time and newer vehicles tend to be safer than older ones. gallon (0.45 grams per litre) down to 0.5 grams per gallon (0.13 One prominent example of a CAC policy relating to tailpipe grams per litre) by 1980 in large refineries and by 1982 in small emissions is that of catalytic converters. These were first intro- refineries. The standard allowed refineries to average their total duced in new cars in the US in 1975 in order to reduce the toxicity of (both leaded and unleaded) output to reach the 0.5 standard. In emissions from internal combustion engines. The converters also 1982, the US EPA loosened the standard to 1.1 grams per gallon facilitated the compliance with the Clean Air Act of 1970, according (0.29 grams per litre) but eliminated the provision that allowed to which all new vehicles sold in the US from 1975 onwards had to averaging between unleaded and leaded petrol. In July 1985 the meet US EPA standards on HC, NOx and CO emissions (US EPA standard was tightened again to 0.5 grams per gallon (0.13 grams website b). per litre) and finally, in January 1986, to 0.10 grams per gallon (0.03 The EU made catalytic converters mandatory in new cars with grams per litre) (US EPA, 1985). Although this was mainly a CAC the Council Directive 91/441/EEC of 26 June 1991, on measures to be policy, it was also complemented with a form of credit trading, an taken against air pollution by emissions from motor vehicles 21 early ancestor of cap-and-trade.19 By 1995, unleaded petrol sales (Council of the European Communities, 1991). The main systems accounted for 99 per cent of the petrol market in the US (US DoT, of vehicle emission standards are those from the US and the EU. 2008b). Having said that, most developed countries (and some developing Meanwhile, in the UK the maximum amount of lead allowed in ones), including Australia, China, Japan, Switzerland, South Korea petrol was reduced from 0.45 grams per litre to 0.40 in 1981 and and Taiwan have implemented some type of fuel economy or CO2 then again to 0.15 grams per litre in December 1985. In 1986 standard (Clerides & Zachariadis, 2008, p. 2658), although in many unleaded petrol was first sold in the UK and a final ban was instances they closely follow (or import) the standards in place in imposed on leaded petrol at the end of 1999 (UK DfT, 2007a, p. 51). the US or Europe (Faiz, Weaver, & Walsh, 1996). Most developed countries followed similar paths in the 1980s In general, when a country or group of countries adopts a stan- and 1990s. On top of that, the United Nations Environment dard, this standard applies to new vehicles sold, rather than to Program (UNEP) led a campaign to eliminate leaded petrol those already on the road. The US was the first country in the world 22 completely everywhere in the world and as of 2009 very few to set standards for vehicle emissions. Under the North American countries still use it.20 Free Trade Agreement these standards were later also adopted by Fuel standards are widely used in many (mainly developed) Canada and Mexico (Faiz et al., 1996, p. 1). countries and thanks to them, the emissions of benzene, sulphur There are a number of landmarks that have shaped the devel- dioxide, and other harmful pollutants have been reduced. opment of vehicle emission standards and fuel economy around the Much less common are regulations on CO2 emissions from fuel. world. One important such landmark was the introduction of the One exception is the Low Carbon Fuel Standard, introduced by the Corporate Average Fuel Economy (CAFE) in the US, enacted by Congress in 1975 and still in place as of 2009. The purpose of CAFE is to reduce energy consumption by increasing the fuel economy of 18 During the early 1970s catalytic converters, discussed below, were being devel- cars and vans. Regulating CAFE is the responsibility of the US oped for mass production in the US. These were (and still are) incompatible with National Highway Traffic Safety Administration (US NHTSA) and leaded petrol, as the lead coats the working surfaces of the catalyst, encapsulating the US EPA. The US NHTSA sets fuel economy standards for cars and it and preventing it from treating the exhaust. Unleaded petrol therefore ended up vans sold in the US, and the US EPA calculates the average fuel serving two objectives: the objective of reducing lead emissions and the objective of not jeopardising the function of catalytic converters. economy for each manufacturer (US NHTSA website a). Typically, 19 To facilitate the phase-down, the US EPA allowed two forms of trading: inter- a manufacturer can meet the standard by producing fewer large refinery averaging during each quarter and banking for future use or sale (US vehicles and more small vehicles or by improving the mileage of all EPA website a). These are briefly discussed in Section 3, as they constitute an IB of the vehicles it produces. policy. 20 Apart from Bosnia and Herzegovina, which plan to phase-out leaded petrol by January 2010 and Serbia, which will probably do it around 2015–2020, no phase- out date is yet known for any of the following countries: Macedonia, Kazakhstan, 21 It should be noted that although catalytic converters remove HC, NOx and CO Tajikistan, Turkmenistan, Afghanistan, Fiji, Micronesia, Myanmar, North Korea, harmful to human health and the local air, the exhaust gases leaving the engine Solomon Islands and Tonga (UNEP, 2007). Uzbekistan had plans to phase it out in through the catalytic converter are two important GHGs: carbon dioxide, which 2008 but Taylor (2008) lists the country as not having done so. The rest of the world remains in the atmosphere for a long time, and nitrous oxide. has completely phased leaded petrol out thanks to standards, regulations and bans, 22 California was the first US state to develop vehicle emission standards. Often, implemented on a country-by-country basis. Californian standards were later adopted at federal level (Faiz et al., 1996, p.2). G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 11

CAFE standards in the US have typically been ‘‘technology- driving, they argue, could be as large as the benefits from CAFE. forcing’’ as opposed to ‘‘technology-following’’ (Faiz et al., 1996,p. Small and Van Dender (2007), on the other hand, point out that the 1). Technology-forcing standards are standards set at a level which, rebound effect has recently halved in the US due to rising incomes although feasible, remains to be demonstrated in practice, and in and diminished significance of fuel costs. the case of the US, have pushed technological advances forward. Until the mid-80s, vehicle emission regulations in Europe were Although consumers may regard CAFE as a good policy (all else designed by the Economic Commission for Europe, to be later being equal, they spend less on fuel to drive the same distance, or adopted and enforced by individual countries, and were typically they spend the same and drive more), CAFE has been seen as an much less stringent than US standards, as they had to be agreed by inefficient CAC policy for two reasons: (a) it encourages excess so many countries (Faiz et al., 1996, p. 8). The turning point in investment in fuel efficiency and distorts the mix of large and small Europe came with the Consolidated Emissions Directive 91/441/ vehicles (Godek, 1997, p. 495); and (b) it is less cost effective than EEC, which was adopted by the Ministers of the European fuel taxes at reducing petrol consumption because by lowering fuel Community in June 1991, made effective from 1 July 1992 for new costs per km driven it increases (rather than reduces) vehicle use models and from 31 December 1992 for all production (Faiz et al., (Austin & Dinan, 2005; Kleit, 2004; West & Williams, 2005; Parry, 1996, p. 8). Since then emission standards have been adopted at 2007,inFischer, Harrington, & Parry, 2007). Referring to standards a European level without the need for unanimous agreement from in general, although not necessarily to CAFE standards in particular, all countries. Gruenspecht (1982) shows that more stringent standards for new Like in the US, EU standards increase their stringency with time. vehicles prolongs the retention of old, high emission ones and as As of 2009, emissions of NOx, HC, CO and PM are regulated for cars, a result aggregate emissions may increase in the short run (p. 328). vans and lorries and for other vehicle types. While CAFE standards CAFE standards could have been tightened periodically since in the US regulate fuel economy and in doing so, CO2 emissions, the they were implemented. In practice, however, CAFE standards for EU still lacked similar legislation until recently.25 Naively, Europe cars have remained the same since 1990, and are, as of 2009, still relied on voluntary changes and information campaigns to reduce 27.5 miles per gallon (11.7 km per litre). CAFE standards for vans CO2 emissions from the road transport sector. have indeed been tightened, albeit in very small increments. They In 1995, the EU heads of state and government set them- are 23.1 miles per gallon (9.8 km per litre) and 23.5 miles per gallon selves the goal of reducing emissions of CO2 from new cars to (10 km per litre) for the years 2009 and 2010 respectively. 120 grams per kilometre by 2012. This is roughly equivalent to Portney, Parry, Gruenspecht, and Harrington (2003, p. 204) a fuel efficiency of 22 km per litre for diesel cars and 20 km per show that higher real petrol prices together with new standards in litre for petrol cars (EurActiv website). The strategy relied mainly the US had a substantial combined impact on fuel economy. They on voluntary commitments from car manufacturers, improve- point out that new car and new van fuel economy rose by over 30 ments in consumer information and the option of individual and 35 per cent respectively between 1978 and 1982. At that point countries implementing fiscal measures. In 1998, the European fuel prices decreased and yet fuel economy continued to increase, Automobile Manufacturers Association committed to reducing very likely as a result of the CAFE program. However, the increase in average emissions from new cars sold to 140 grams of CO2 per the share of vans,23 subject to less stringent standards, meant that km by 2008 and, in 1999, the Japanese and Korean Automobile the combined new vehicle average fuel economy declined 6 per Manufacturers Associations also committed to reaching the cent between 1987 and 2002. This increase in the share of vans is same target by 2009 (European Commission, 2007). However, by a direct impact from CAFE (Fischer et al., 2007,p.2;Godek, 1997,p. the beginning of the year 2007, it became clear that while some 496). As of 2007, vans accounted for half of new passenger vehicle progress had been made towards the target of 140 grams of CO2 sales in the US (Fischer et al., 2007, p. 2).24 per km by 2008/9, the Community objective of average emis- On 19 May 2009 President Barack Obama announced new sions from the new car fleet of 120 grams of CO2 per km would tighter CAFE standards, covering models for the period 2012–2016 not be met by 2012 in the absence of additional measures and reaching an average of 35.5 miles per gallon (15 km per litre) by (European Commission, 2007). 2016 (The White House Office of the Press Secretary, 2009). Portney Later that year, the European Commission proposed mandatory et al. (2003, p. 216) warn that, although tightening CAFE standards reductions of emissions of CO2 to reach the objective of 130 grams may reduce fuel consumption and CO2 emissions, they will also of CO2 per km for the average new car fleet, through improve- reduce the cost of driving and thus create a stronger incentive to ments in vehicle motor technology, and a further reduction of 10 drive. The external cost of the ‘‘rebound effect’’ of additional grams of CO2 per km by other technological improvements (fuel- efficient tyres and air conditioning, traffic management and eco- driving26) and by an increased use of biofuels (European 23 Vans, or light trucks, in US terminology, include sport utility vehicles, minivans Commission, 2007). and pickups (Fischer et al., 2007, p.1). More specifically, they are defined as: ‘a 4- In December 2008 the European Parliament voted to adopt the wheel vehicle which is designed for off-road operation (has 4-wheel drive or is regulation (European Commission, 2008). The fleet average to be more than 6000 pounds of gross vehicle weight and has physical features consis- achieved by all cars registered in the EU is 130 grams per kilometre. tent with those of a truck); or which is designed to perform at least one of the following functions: (1) transport more than 10 people; (2) provide temporary Heavier cars are allowed higher emissions than lighter cars while living quarters; (3) transport property in an open bed; (4) permit greater cargo- preserving the overall fleet average and the requirements will be carrying capacity than passenger-carrying volume; or (5) can be converted to an phased in, starting with 65 per cent of each manufacturer’s newly open bed vehicle by removal of rear seats to form a flat continuous floor with registered cars having to comply on average with the limit, the use of simple tools’ (NHTSA website b). 24 This change in vehicle share may have had an impact on accident rates and their severity in the US. There are studies (Gayer, 2004; White, 2004 in Brozovic & Whritenour Ando, 2009) showing that in multi-vehicle collisions drivers of 25 Interestingly, this did not result in higher fuel economy in the US than in vans are less likely to die than drivers of cars. Thus, consumers may have an incen- Europe. For the year 2006, the average fuel economy for all cars in the US was tive to buy vans instead of cars not just because they feel better protected in case of 22.4 miles per gallon (9.52 km per litre) (US DoT, 2008b, Table 4.23). The average an accident but also because other consumers have already chosen vans and there fuel economy for all cars in the UK, also for 2006, was 26.7 miles per gallon (11.3 are more vans around. Brozovic and Whritenour Ando (2009) estimate that with km per litre) (UK DfT, 2008, Table 3.4). Note that the fuel economy listed in UK current accident rates and levels of van aggressivity in the US, damage from acci- DfT (2008) is 32 miles per UK gallon, and 1 UK gallon ¼ 1.2 US gallons. dents would be minimised if the fleet contained no vans at all. 26 Eco-driving is discussed in Part II of this volume. 12 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 increasing to 100 per cent from 2015 onwards (European 2.3.2. Restrictions on vehicle circulation Commission, 2008). In order to maintain the diversity of the car Restrictions to circulation have been widely implemented in market the CO2 emission targets are defined according to their towns and cities throughout the world. It is very common to see mass, so different vehicle sizes are subject to different targets. Also, pedestrianisation of streets, which are closed to traffic at all or manufacturers are allowed to form pools so that the average some times of the day. It is also common to see streets where only emissions of the pool as a whole do not exceed the target emissions public transport and taxis can circulate. This type of CAC policy is for the pool (European Commission, 2007). As of August 2009, the equitable, in the sense that it affects all drivers and does not European Commission is developing a new legislative proposal to differentiate by their willingness to pay for using the road (i.e. by reduce CO2 emissions from light commercial vehicles (vans and their ability to pay). minibuses). Many (historic) towns in Europe have such types of areas. In Clerides and Zachariadis (2008) explore the impacts of fuel general they do not harm the local economy, but rather, create standards (and also of fuel taxes) on new car fuel economy in a better environment for shoppers in the area. Parkhurst (2003) Australia, Canada, the EU, Japan and the US, in the period 1975–2003. evaluates evidence from a pedestrianisation scheme in Oxford, They find that fuel standards have contributed to fuel economy UK, which was implemented in 1999 and is still in place today. He improvements in the US, Europe and Japan. They also find that new finds that as a result of the program there was a reduction of 17 per car fuel economy becomes less sensitive to fuel prices after the cent in the number of car trips to the centre but such reduction did implementation of standards (p. 2671) and show that in Europe and not affect overall visitor numbers. Japan the impact of a fuel economy standard on new car fuel Another type of road space has been to restrict certain consumption has usually been more pronounced than that of an licence plates from circulating. Such a policy can be found in cities increase in fuel prices (p. 2671). like Athens, where cars with even (odd) number plates are allowed Although fuel economy standards have had impacts on fuel to drive on even (odd) days only. The problem with this type of economy, Aldy et al. (2008, p. 496) argue that standards for the policy is that even if the final number of vehicles using the road as average fuel economy of vehicles in a manufacturer’s sales fleet do not a result of this type of policy was optimal from an economic point of encourage mitigation outside the automobile industry, or down- view, there is no guarantee that the most efficient trips, with the stream sequestration activities, or reduction in road user mileage. highest marginal benefit (made by those drivers with the highest Portney et al. (2003) conclude that fuel taxes (or carbon taxes) and willingness to pay) would be the ones taking place (Verhoef, tradeable permits would make more efficient tools for reducing fuel Nijkamp, & Rietveld, 1995,p.141). consumption and GHG emissions. One way of making fuel standards A similar scheme was implemented in Mexico City in 1989 to slightly more efficient, they suggest, would be to provide some flex- control air pollution from cars. The Hoy No Circula27 program bans ibility by making fuel economy credits transferable between car and most drivers from using their vehicles one weekday per week on van fleets and between different manufacturers (p. 216). the basis of the last digit of the vehicle’s licence plate. The restric- tions apply Monday to Friday, from 5:00 a.m. to 10:00 p. m. and 2.3. Other CAC policies in the road transport sector affect most residential and commercial vehicles. Taxis, buses, and emergency vehicles (police cars, ambulances, and fire engines), as Other CAC policies include restrictions on vehicle circulation, well as commercial vehicles operating with liquid propane gas, and vehicle ownership, parking, and emissions in certain areas or on commercial vehicles transporting perishable goods are all exempt. certain days. In this section we give some examples. Davis (2008) measures the effect of the driving restrictions on air quality and finds no evidence of the restrictions having improved 2.3.1. The low emission zone in London air quality. He does find evidence, however, of the restrictions The Low Emission Zone (LEZ) in London was implemented in having led to an increase in the total number of vehicles in circu- February 2008. The zone covers most of Greater London, which can lation as well as a change in composition towards high-emissions broadly be defined as the area inside the M25 motorway. Vehicles vehicles. Eskeland and Feyzioglu (1997) find that many house- driving on the M25 without entering Greater London are not holds bought an additional car to be able to drive on any day of the subject to the emission limits. The main objective of the scheme is week and the amount of driving increased. The use of old cars also to deter the most polluting diesel vehicles from driving inside increased as well as weekend driving. Greater London. Another type of restriction on vehicle circulation is the Italian The regulation includes diesel lorries, buses, coaches, large vans limited traffic zones, which have been implemented in a number of and minibuses. It also includes a number of other specialist vehi- historic centres of medieval cities in Italy, such as for example, cles, such as for example, breakdown and recovery vehicles, gritters Rome. The Limited Traffic Zone (LTZ) in the historic centre of Rome and road sweepers. Cars, motorcycles and small vans are not is an area with restricted traffic. There are different permit types included in the LEZ. The scheme operates 24 h a day, seven days that allow different driving and parking arrangements. There are a week, every day of the year (Transport for London website). seven sectors inside the LTZ and different types of permits allow There are number of exemptions and discounts. Exempt vehicles circulation with and without parking in different sectors at include historic vehicles (built before 1973), military vehicles and different times. Permits are restricted to a limited number of vehicles which are mainly for off-road use, but which may be used essential users. Those qualifying for permits include residents, on the road for limited purposes, such as tractors, cranes and farm some types of workers (such as doctors, nurses and teachers who machinery. work inside the LTZ), workers who have parking in the premises If a vehicle subject to the regulation neither meets the LEZ where they work, automobile mechanics, journalists, cars carrying standards nor qualifies for an exemption or discount, it is subject to children to school, school buses, goods vehicles, and disabled a daily charge. This is £100 for large vans and mini-buses and £200 for lorries. The implementation is being phased. Although LEZ started in February 2008, there are different phases through to January 2012. Different vehicles will be affected over time as increasingly tougher emission standards apply. 27 Hoy No Circula translates as ‘Today it does not circulate’. G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 13

Table 1 Since there are bids this policy can be seen as an incentive based Results for May 2009 second COE open bidding exercise. rather than a command-and-control one. However, the COEs are Category Quota QP (S$) PQP (S$) not tradeable, so the policy cannot be classified under the cap-and- A – Car (1600cc & below) &Taxi 1402 9889 7178 trade umbrella. It falls into a grey area. B – Car (Above 1600 cc) 774 9180 6971 C – Goods Vehicle & Bus 238 7600 6586 2.3.4. Parking restrictions D – Motorcycle 393 810 921 Parking restrictions can indirectly reduce traffic levels, and in E – Open (any type of vehicle) 725 10,046 doing so reduce most traffic externalities. Parking as an activity Category Received Successful Unsuccessful Unused entails costs because parked vehicles use public space, which has A – Car (1600cc & below) &Taxi 1999 1383 616 19 an opportunity cost, as the land used for parking could be used for B – Car (Above 1600 cc) 1051 774 277 0 something else (Verhoef et al., 1995). C – Goods Vehicle & Bus 320 228 92 10 D – Motorcycle 535 378 157 15 Verhoef et al. (1995) show that under strict assumptions (each E – Open (any type of vehicle) 1285 724 561 1 individual drives the same distance, congestion is equally spread

Note: QP: Quota Premium, PQP: Prevailing Quota Premium. over the urban road network, the regulator has full control over all S$: Singapore dollar. The average exchange rate in the period Jan-May 2009 was parking space available, every car is parked in a publicly managed S$1 ¼ £0.46 ¼ V0.51 ¼ $0.67 (IMF Exchange Rate Query Tool). parking space, and all cars are parked for the same length of time) quantitative restrictions on parking (in other words, a CAC policy) can achieve the optimal volume of traffic in terms of marginal people amongst others (ATAC website).28 Permits are valid for congestion costs and marginal parking costs,29 just as they would a year and there is a fee for each type of permit according to the with an IB policy. However, they point out that there would be no sectors and the user, but this fee is fixed by the city council in guarantee that the most valuable trips would be the ones that are advance, rather than determined at auction. realised. They also note that under quantity restrictions on park- The scheme operates in the historic centre only, which has an ing, a market for parking permits could develop spontaneously, as area of 4.6 km2 (1.8 mi2), representing only 0.36 per cent of the area drivers would try to secure parking for the most valuable trips. of Rome, which is 1290 km2 (500 mi2). The area is considerably Finally, reducing the number of parking spaces available, could smaller than the Charging Zone in London, which is discussed on result in more congestion, as more drivers would spend time Section 5. The hours of operation of the LTZ are Monday to Friday looking for an available parking slot (Arnott & Inci, 2006; Arnott & from 6:30 a.m. to 6:00 p. m., except public holidays, and on Rowse, 1999). Saturdays from 2:00 p.m. to 6:00 p.m. (ATAC website). The LTZ in Rome is a CAC policy for two reasons: (a) the permits 2.4. Concluding remarks are not tradeable and (b) not everyone can qualify for a permit, which means that drivers who are willing to pay may not be CAC is not efficient from an economic point of view because even allowed into the LTZ. when the standard is set at the optimal level, it is not achieved at minimum cost. Despite that, CAC is the most widely used type of 2.3.3. Restrictions on vehicle ownership instrument in the road transport sector. Fuel and vehicle standards, Another way of controlling vehicle use is through restrictions on which are used in virtually every country in the world, are the most vehicle ownership. The only example of a direct quantity control of prominent example. There are also some less spread regulations, this sort is the Vehicle Quota System (VQS), a policy implemented which include parking restrictions, the Low Emission Zone in Lon- in Singapore in 1990 and still in place today. don, restrictions on vehicle circulation (pedestrianisation of streets, Prospective vehicle owners are required to purchase a Certifi- odd and even number plates allowed to circulate on alternate days, cate of Entitlement (COE), which is a licence that lasts ten years, etc) and the restrictions on vehicle ownership in Singapore. The except for taxis, for which it lasts seven. The government sets success of these measures varies, but in general they are all a quota on COEs for different vehicle categories a year in advance, in perceived as equitable by the motoring public, only because they do May each year. not involve payments, which tend to hit harder on the poorer. The allocation of COEs is done through open auction. When a person submits a bid (something which is done electronically) the current successful price is known and the person can adjust his bid. 3. Incentive based policies: quantity control As the number of bids usually exceeds the set quota, there are usually unsuccessful bidders. An IB policy based on quantity control is a system of market- There are two COE Open Bidding exercises every month. The able (transferable or tradeable) permits, credits, allowances or bidding exercises usually start on the first Monday and third rights in which the regulator determines a cap or aggregate Monday of the month and last for three working days. The exercise quantity of emissions, pollution or waste and leaves their alloca- that finished on 20 May 2009, for example, yielded the results tion amongst polluters to be determined by the market (Baumol & shown in Table 1. Oates, 1988,p.59). The Prevailing Quota Premium (PQP) applies to those who wish There are three steps involved in implementing and maintaining to extend the COE of their vehicles. Vehicle owners do not need to a system of this sort. First, the regulator sets the quantity or bid for a COE as the PQP payable will be based on the moving aggregate quota. Under a perfect information scenario, the regu- average of the last three months Quota Premium results. For lator sets the quantity at the point at which marginal abatement example, the PQP in May 2009 is the average COE prices of March, costs are equal to marginal social damage. In reality, however, the April and May 2009. Thus, the PQP payable for each month will be regulator hardly has enough information to determine the efficient different. aggregate quantity of emissions, and sets a limit based on incom- plete information. He is also often influenced by political factors,

28 ATAC stands for Agenzia per i Trasporti Autoferrotranviari del Comune di Roma, which translates as Agency for Auto-rail-tram transport in the Municipality of Rome. 29 This result can probably be extended to other externalities. 14 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 such as lobby groups. Second, the regulator allocates the permits, system implemented at European level to help achieve the Kyoto which together do not exceed the cap. As already mentioned in target of an 8 per cent emission reduction of GHG in the EU by 2012. Section 1, there are mainly two allocation methods: grandfathering The EU ETS only covers emissions of CO2. For the first two trading and auctioning. These can be used in their pure form or they can be periods, 2005–2007 and 2008–2012, aggregated emission caps combined. With grandfathering, permits are allocated for free to were imposed on the most energy-intensive sectors (cement, glass, each polluter, according to their past (historic) emissions. With ceramics, paper, steel and iron, and power) (European Commission, auctioning, polluters pay for the permits they wish to buy, according 2003, Annex I), which were responsible for more than half of EU to the price that emerges from the auction. An example of combi- CO2 emissions from 2005 to 2007 (European Commission, 2005,p. nation of both methods could be one in which 90 per cent of permits 5). Permit allocation is made through grandfathering and combined are distributed for free, according to past emissions, and 10 per cent with a very small percentage of auctioning (5 per cent and 10 per are allocated through auctioning. Third, emitters trade their cent at most, for the first and second periods respectively). Allo- permits. Usually, those with lower marginal abatement costs sell cation decisions are made at EU level, based on each country’s permits and those with higher abatement costs buy permits. Permit National Allocation Plan (NAP) (European Commission, 2000, p. 18). trading amongst sources establishes the market-clearing price. NAPs determine the total quantity of CO2 emissions that Member There are other allocation methods, although these have not States grant to their companies, which can then be sold or bought been discussed very much in the literature. These include free by the companies themselves. This means each Member State must distribution of permits, updating and benchmarking. Free distri- ex-ante decide how many allowances to allocate in total for bution differs from grandfathering only insofar as the permits are a trading period and how many each plant covered by the Emis- not distributed on the basis of past (nor future) emissions or usage sions Trading Scheme will receive. (Watters & Tight, 2007, p. 7), but on the basis of other criteria (e.g. Aviation will be included in the EU ETS from 2012 and as of 2009 equal per capita allocation). Updating also allocates permits for there are already some discussions about the prospects of including free, but on the basis of information (e.g. over level of activity) road transport as well (UK DfT, 2007b). However, a cap-and-trade which is updated over time (Watters & Tight, 2007, p. 6). According system to deal with the external costs briefly described in Section to this method, higher usage today will lead to more permits 1 has not been implemented for road transport anywhere yet. tomorrow. Benchmarking allocates permits for free to each There have been proposals and studies of marketable permits in polluter, according to each polluter’s emissions’ efficiency against road transport regarding different transport externalities (Verhoef, a sector average. Nijkamp, & Rietveld, 1997), including air pollution (Raux, 2004) and It is important to emphasise that a cap-and-trade system is very CO2 (Albrecht, 2001; Raux & Marlot, 2005; Wadud, Noland, & different from the CAC approach discussed in Section 2. Under Graham, 2008; Watters, Tight, & Bristow, 2006). If a cap-and- a CAC system, the regulator specifies a level of emissions or waste trade system were to be implemented in the road transport for each source and no trading is allowed afterwards. sector, there would be a number of issues to consider. The Albrecht Due to the novelty of the concept, penetration of cap-and-trade (2001), Grubb and Neuhoff (2006) and UK DfT (2007b) highlight systems as a policy measure has been slow. In the 1970s a number a number of points that need to be assessed and decided upon the of credit-based emission trading schemes, a very embryonic introduction of a cap-and-trade system for CO2 emissions (in the version of modern marketable permits, evolved in the US to deal road transport sector). These are: with air quality. In the 1980s the US EPA instituted two forms of trading: inter- Allocation of permits: refinery averaging during each quarter and banking for future use o How to allocate (auctioning vs. grandfathering) or sale (US EPA website a). The objective was to facilitate the phase- o Whom to allocate (individual motorists, vehicle manufac- down of lead in petrol. turers, fuel producers) Inter-refinery averaging operated from November 1982 to o How many permits to allocate (cap on emissions) December 1985, and allowed refineries to trade rights to add lead to Area of applicability of the policy (regional, national, petrol (Hahn & Hester, 1989, p. 381). If a refinery added less lead to international) petrol than was permitted, it could then sell lead rights to another Duration of the permit (time scale) refinery in an amount equal to the difference between the actual and Decision over whether the emission trading scheme is a stand- allowed quantity (Hahn & Hester, 1989, p. 382). The other refinery alone scheme, or part of a broader emission trading scheme was then allowed to add more lead than the standard allowed. across sectors Banking for future use or sale was introduced in 1985 (Hahn & Interaction of the road transport emission trading scheme with Hester, 1989, p. 382). Essentially refineries were allowed to bank other schemes, such as the EU ETS, and other policies, such as credits for use until the end of 1987, in effect extending the life of fuel taxation lead credits to that date (US EPA website a). Credibility of the scheme continuation Hansju¨ rgens (2005, pp. 5–6) summarises the history of cap-and- Costs and benefits for firms, road users and government trade systems in the US, following the US Clean Air Act of 1990. Long-term marginal abatement costs (which in transport These included the Regional Clean Air Incentives Market in depend on intermodal shifts, penetration of highly fuel effi- Southern California, trading sulphur oxides and nitrogen oxides cient vehicles, and behavioural change, amongst others) (1994), the Acid Rain Program, trading sulphur dioxide (1995), the Northeast NOX Budget Trading Program, a multi-jurisdictional Ellerman, Jacoby, and Zimmerman (2006) point out that the partnership between the federal and nine state governments, main challenges in the introduction of emission trading schemes in trading nitrogen oxides (1999), later expanded to include nineteen the transport sector come from the fact that emission sources are states and the District of Columbia (2004). small, dispersed and mobile, hence difficult and costly to monitor, The biggest scheme to have ever been implemented, however, is and from the fact that the transport sector is already highly regu- the EU Emission Trading Scheme (EU ETS). Before the EU ETS, some lated. This means that cap-and-trade systems need to be carefully governments, such as the UK in 2002 and the Australian state of coordinated with existing policies if they are to achieve the desired New South Wales in 2003, had already implemented carbon effects at the minimum cost, without imposing excessive burdens trading (Hepburn, 2007, p. 377). The EU ETS is a permit-trading on the targeted agents. G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 15

A baseline-and-credit system could also be envisaged instead of greater financial power are in a better position to buy as many a cap-and-trade system (Watters & Tight 2007, p. 8). In a baseline- permits as they require during the auctioning phase, thus threat- and-credit system, a baseline consumption of the resource is ening equity (although upper regulatory limits could be imposed to established for each user. A period of time is then established for prevent this effect) (Watters & Tight, p. 6). Finally, auctioning compliance with the baseline. If actual emissions are lower than the provides more transparency and clearer long-term price signals baseline, users are given credits. If they are higher, they must compared to grandfathering. Periodic auctions could improve price purchase credits. The problem is that the emission limit is user- stability and the management of uncertainty (Hepburn, Grubb, specific rather than universal. Hence, total emissions could Neuhoff, Matthes, & Tse, 2006, p. 147). increase if new users entered the market (i.e. started using road An important element to consider when evaluating emission transport). On the other hand, under a cap-and-trade system a limit trading proposals is the impact of the scheme on the competi- of emissions for the whole sector (or for the whole country) is tiveness of the industry it regulates. In the long term, the chosen established. Permits are allocated and participants are allowed to allocation method does not normally affect competitiveness.32 trade these permits in a secondary market. Grandfathering acts as a temporary subsidy to participants in the scheme. It does not normally affect marginal costs, and marginal costs determine competitiveness. Furthermore, evaluating 3.1. Grandfathering versus auctioning different proposals on the basis of competitiveness is only possible in industries which are exposed to competition from countries The way in which permits are allocated to the relevant parties is outside the scheme (which might not apply to road transport, important. The two ends of the spectrum are grandfathering and depending on whom the permits are allocated to), and which face auctioning. As we explained above, grandfathering is an allocation significant cost increases. The final point regarding competitiveness method based on historic emissions or indicators: the number of is that auctioning has the advantage of making some border-tax permits allocated to an agent (a firm or a group of firms, a consumer adjustments feasible. These can only be based on real cost or a group of consumers, etc) has some degree of proportionality to incurred as a result of the regulation under World Trade Organi- its historic emissions. Grandfathering is the method most zation rules. Auctioning helps align total costs (inclusive of commonly used in practice, due to its greater political acceptability, opportunity costs) with real costs (Hepburn et al., 2006). when compared to auctioning. Auctioning involves polluters bid- Auctioning is to be preferred to grandfathering also from ding for emission permits, and is, from an economic point of view, a dynamic perspective in relation to the incentives it creates. the most efficient as well as the most equitable allocation system, Theoretically, auctioning enhances incentives for innovation. This is as we will discuss below. due to the fact that innovation ultimately leads to a decrease in Any system of emission permits raises the prices of the goods demand for permits, and consequently a decrease in prices of and services affected directly or indirectly by the scheme. Firms permits. This reduces the rents which belong to the needing emission permits will typically pass on their costs to industry under a grandfathering scheme, but do not under 30 consumers. Consumers needing permits themselves will also end auctioning (Cramton & Kerr, 2002). Hence, only the beneficial price- 31 up paying a higher final price for the good or service in question. reduction effect is internalised by the industry under auctioning.33 However, the market price of permits is independent from the In addition, grandfathering may lead to perverse dynamic allocation method (grandfathering versus auctioning). incentives in emissions reduction. This occurs when future rights Grandfathering however allows companies to make windfall are a function of current emissions (which always occurs under profits. This raises equity as well as implementation issues. To the updating). In this case, regulation induces a higher amount of extent that shareholders of the profiting firms are richer than average, current emissions than optimal. Also, when allocation of permits to this amounts to a transfer to the relatively rich. Equity considerations new plants is subject to more restrictive criteria than allocation of also concern the treatment of new entrants versus incumbents. permits to the incumbent, incentives to invest in new plants will be Grandfathering discourages entry if new entrants, unlike the reduced, and incentives for plant life-time extension will be incumbents, have to buy all the permits they need and are not allo- enhanced in a distortionary manner (Hepburn et al., 2006). cated a share of permits for free (Watters & Tight, 2007). Imple- The case for free allocation of permits is mainly due to the fact mentation problems under grandfathering relate to the difficulty in that it minimises problems of social and political acceptability establishing historic emission levels, especially if the trading parties (Raux & Marlot, 2005). Also, in some instances, free allocation may are individuals (Watters & Tight, p. 6), such as for example, drivers. be administratively less costly. If an emission trading scheme were Auctioning creates revenues for the government, which can be to be implemented amongst motorists, free allocation would redistributed in the form of, for example, tax cuts (Cramton & Kerr, allow at least a certain amount of fuel to be consumed at no 1999, p. 256). Hence, the use of auctioning has the potential to additional cost (Raux & Marlot, 2005). Even taking into account correct distributional impacts. Revenues from auctioning permits to the opportunity cost for a motorist of not selling the permit, this fuel producers could also be channelled into in trans- opportunity cost would be the lost revenue but would not be an port infrastructure, public transport, R&D of cleaner technologies, ‘‘additional’’ cost on top of what he paid for fuel previously. etc. However, it has been argued that individuals or entities with Auctioning permits to such a large number of individuals would not be practically feasible. Grandfathering has already been shown to involve lobbying activities to get the preferred allocation 30 Obvious examples include an electricity company charging higher utility bills or (Hepburn, 2007), and this would cause a loss of resources. Also, a car manufacturer raising the sale price of the cars he produces. On the other hand, a grandfathering allocation of permits among drivers would in the US, the power generation market in many states remains under cost-of- service regulation. This prevents the electricity from passing on the oppor- tunity cost of free permits to consumers, reduces the price impacts of allocation policies and causes suboptimal electricity conservation (Beamon, Leckey, & Martin, 2001; Burtraw, Palmer, Bharvirkar, & Paul, 2001). 32 This is so unless grandfathering allows an unprofitable firm to survive. 31 For example, if petrol consumption were included in an emission trading 33 This is true unless permits are auctioned many years in advance, in which case scheme drivers would pay for petrol and for the permit to consume that petrol. grandfathering and auctioning provide the same incentives (Kerr, 2000,inCramton Drivers would perceive no change only in the case that permits replaced fuel duties & Kerr, 2002). Also, empirically, there is little difference between R&D efficiency and the final average amounts paid were roughly similar. gains under auctioning and under grandfathering (Fisher et al., 2003). 16 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 involve administrative costs to collect the historic data necessary emissions, indirectly produce emission increases elsewhere in the for the allocation. These administrative costs would be even transport sector or in other sectors. This occurs through the price higher under updating. channel. As emissions are reduced through some measure that is Finally, Parry (2003) analyses both carbon taxes and tradeable not covered by the scheme, the permit price falls, and an increase in carbon permits in a setting where there are pre-existing tax emissions will be observed elsewhere in the economy. The impli- distortions in the labour market (which is very likely to be the case cation is that the benefits from programs that could further reduce in virtually any economy) and finds that although both policies can emissions below the cap level are economic (reducing compliance cause substantial efficiency losses in the labour market (relative to costs elsewhere) rather than environmental (reducing aggregate abatement costs), these can be offset, or even more than offset, if emissions) (Millard-Ball, 2009). revenues from carbon taxes or auctioned permits are used to Another emission trading scheme option in the road transport reduce distortionary taxes. Thus, he concludes that there is a case sector would target vehicle manufacturers. Under such an for using carbon taxes or auctioned permits rather than grand- arrangement, manufacturers would be required to purchase fathered permits. permits for emissions imputed to their vehicles (UK DfT, 2007b; Millard-Ball, 2008). It would be difficult to retroactively cover all 3.2. Target group vehicles in circulation but it would certainly be possible to cover all new vehicles sold. The disadvantage of this approach is that it could The question of whom the permits should be allocated to - fuel potentially boost the second-hand market, increase second-hand producers, vehicle manufacturers, or individual motorists - is not car prices, prolong the life of fuel inefficient vehicles, and hit the easy to answer, and we shall evaluate each option separately. new vehicle market. Trading among fuel producers or car manufacturers is called If car manufacturers were to trade emission permits, these could ‘‘upstream’’ trading, while trading among individual motorists is be required to cover all expected future life-time emissions of the called ‘‘downstream’’ trading. fleet (total carbon approach), or emissions in grams of CO2 per km. If the target group were fuel producers, they would be required Since there are few car manufacturers, the ‘administrative costs to hold permits to cover the total amount of emissions resulting would be low’ (German, 2007, p. 95). from the fuel they sell (UK DfT, 2007b). Oil refineries in the EU are On the other hand, if the cap were based on expected life-time currently included in the EU ETS on the basis of their direct emissions of the fleet and the estimates were not precise, the combustion emissions, i.e. CO2 emitted during the fuel production desired carbon reduction objective could be missed. Furthermore, if process. They are therefore already familiar with the EU ETS. In the transport emissions were to be covered in the EU ETS, the adoption UK, regulating twenty fuel producers would cover 99 per cent of of future emissions as a standard would risk undermining its fuel sales (UK DfT, 2007b). This means that the administrative costs integrity because the EU ETS is based on current emissions. of this option would be relatively low. However, fuel producers A solution could be the setting up of a separate regulation for car have few tools at their disposal for reducing emissions, mainly manufacturers, so that they would only be allowed to buy but not efficiency increases in the production process and the alteration of sell emission permits in the EU ETS (UK DfT, 2007b). carbon composition of petrol. The main effect of emission trading in Tradeable certificates would increase the involvement of the car the short run will be an increase in fuel prices, as refineries are industry in the development of fuel-efficient vehicles (Millard-Ball, likely to pass on at least part of the cost of emission trading permits 2008) and create incentives to innovate. They would provide to consumers. The likely short-term effect of the policy is a non- a direct financial reward to the reduction of emissions from vehicles equitable regressive effect, similar to that of an additional tax on (both in terms of type of car and type of fuel the car uses) and give fuel (Watters & Tight, 2007).34 A tax would have the advantage of car manufacturers that have invested in fuel-efficient cars being less volatile, more easily adjustable, and requiring less a (Millard-Ball, 2008). The total carbon monitoring. The exact burden share between refineries and final approach would create incentives to reduce emissions at all consumers of fuel would depend on supply constraints and the possible levels (German, 2007, p. 97). Beside the development of level of competition, amongst other factors (Millard-Ball, 2009). new low-emission technologies, and the reduction in average By and large, the main short-term impact on emissions of vehicle size, car manufacturers could respond with an increase in upstream trading would be a reduction in fuel consumption due to marketing efforts to sell low emission vehicles (Watters & Tight, an increase in fuel prices (UK DfT, 2007b). Short-term responses by 2007). At the same time, if the permit price were high, highly motorists would be a reduction in the amount of travel and adop- efficient cars would be made relatively cheaper and this would tion of a more responsible travel behaviour (such as for example, stimulate their market penetration. eco-driving, using public transport, walking or cycling, which are Not only would regulation at the manufacturers’ level have low discussed in Part II of this volume). In the long run, demand may administration costs from an administrative point of view, as lean more towards more fuel-efficient vehicles (UK DfT, 2007b). already pointed out above, but it would also have the advantage of Demand for vehicle travel is relatively inelastic, especially in the avoiding politically-sensitive increases in fuel prices. However, it short term. Consequently, if the trading system was part of a multi- has been argued that fuel-economy standards and feebates may be sector system (like the EU ETS), the transport sector would tend to equally effective in targeting the optimal fuel-efficiency of the purchase credits rather than reduce emissions itself. Hence, vehicle fleet (Millard-Ball, 2008). One of the major weaknesses of upstream trading would miss out on the potential for numerous a cap-and-trade scheme designed to target car manufacturers is low-cost transport abatement measures (Millard-Ball, 2008). that it has a negligible influence on vehicle usage. This happens Another weakness of an upstream emission trading scheme in because the number of permits and the consequent market price the transport sector is that it would undermine the effectiveness of are determined prior to the car-use decision made by consumers. alternative measures to reduce emissions below the cap level. In Double-counting is yet another potential problem if upstream fact, investment in public transport improvement and demand producers in another sector (e.g. fuel producers) are also included management policies, which lead directly to a reduction in in the emission trading scheme (Millard-Ball, 2008). An option suggested by Gallagher et al. (2007) would be to establish a market of permits that includes both vehicles manu- 34 Regressivity of fuel taxes has been widely debated, as summarised in Section 4. facturers and fuel producers. This would increase the flexibility of G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 17 the system, but has greater implementation challenges and shares As already mentioned above, any of these downstream schemes most of the downsides of an upstream trading scheme discussed would entail substantial administrative and transaction costs, from above. implementation to monitoring and enforcement (Watters & Tight, Downstream trading refers to the inclusion of individual 2007), since the scheme would include a large number of emit- motorists into the cap-and-trade scheme. The inclusion could occur ters, each accounting only for a relatively small volume of emissions under different formats: (UK DfT, 2007b). The intermediation of retailers such as fuel stations would certainly act to contain these costs and simplify Motorists could be required to use permits against the monitoring and enforcement (Verhoef et al., 1997). purchase of fuel. Permits could be allocated for free by the regulator or auctioned. Individuals could then trade their 3.3. Other considerations permits. Bank operators or petrol stations could act as intermediaries in the purchase and sale of permits (Raux & Amongst other important considerations in the design of Marlot, 2005). This would make this option similar to alloca- trading schemes there are: the definition of the area of applicability tion to fuel producers (UK DfT, 2007b). A problem with this of a trading scheme, the possibility of integration of a (road) option could be cross-border refuelling, unless and entire transport trading scheme within other broader trading schemes, region adopted such a system. and the choice of time validity of the permit. For example, it may be Motorists could be required to use permits against the advantageous to have a wider area covered by a trading scheme due purchase of a vehicle. The number of automobiles would be to the added liquidity in the permits market. In fact, a wider area capped and vehicle ownership permits would be traded would mean a larger number of players, which would facilitate (Millard-Ball, 2008). finding a trading partner. With regards to the length of the validity Motorists could be required to use and trade parking permits or of the permit, there are potential trade-offs. The shorter is the vehicle kilometres travelled allowances, or tradeable driving permit duration, the lower is its tradability, and the higher are the day rights. transaction costs. However, the longer is the validity of a permit, Motorists could be endowed with personal carbon quotas or the greater is the uncertainty about future prices. Uncertainty, in domestic tradeable quotas to cover their entire carbon footprints, turn, undermines the efficiency of the trading system. including personal transport emissions (Millard-Ball, 2008). If the road transport sector were included in the EU ETS drivers would probably become net buyers of permits, at least in the short- Although downstream trading at individual motorist level could run. This would be likely to happen unless permit prices were so be extremely costly to implement and monitor it would also have high that alternative technologies became attractive, or unless a number of advantages.35 First of all, the maximum efficiency of an additional requirements were imposed. It should be stressed that economic incentive instrument is achieved when it operates at the motorists, fuel producers or car manufacturers becoming net most decentralised level (Raux & Marlot, 2005). Second, a large buyers is a desirable characteristic of economic instruments and not number of consumers would yield a large and liquid market for an imperfection. Reductions would be made where the marginal permits (Watters & Tight, 2007). Third, a free allocation of permits to abatement costs are lower, which would be in other sectors of the individuals would create strong incentives for emission reduction, economy,36 rather than the road transport sector. If the regulator’s due to the opportunity cost of using them, i.e. the clear monetary objective were to guarantee a certain level of emission reduction benefit they would gain by selling excess permits on the market. In from road transport, then a separate scheme (perhaps linked in the short run the system would probably act as a disincentive on car some way) to the EU ETS would need to be designed. usage. In the long run, it would act as an incentive to purchase low- emission vehicles. Finally, if permits were freely allocated in equal amount to motorists, the system would be perceived as equitable 3.4. Concluding remarks and politically acceptable (Watters & Tight, 2007). Having said all that, the introduction of a downstream A cap-and-trade system is one in which the regulator deter- scheme would not be free from weaknesses. In particular, if mines a cap on emissions, pollution or waste and leaves their permits were allocated for free in proportion to the number of allocation amongst polluters to be determined by the market. cars held by the individual, individuals would buy too many cars, Polluters can trade permits: those with lower marginal abatement and would have no incentive to buy fuel efficient ones (Watters costs sell permits and those with higher abatement costs buy &Tight,2007). permits. There are mainly two initial allocation methods: grand- If motorists were required to use permits against the purchase of fathering and auctioning. With grandfathering, permits are allo- a vehicle, the link between car ownership and emissions would be cated to each polluter for free, according to their past (historic) weak. Only parking externalities and emissions from construction emissions. With auctioning, polluters pay for the permits they wish and scrapping of vehicles are directly related to car ownership to buy, according to the price that emerges from the auction. (Verhoef et al., 1997). Unless the number of permits were made Although there have been and there continue to be proposals to proportional to the emissions of the car, there would be no incentive introduce cap-and-trade to deal with different externalities (lately to shift towards more fuel-efficient cars. If that happened, the scheme with CO2 emissions), no such system has been implemented in the would miss the important connection between car usage and emis- road transport sector anywhere in the world yet. sions, which matters more than the choice of vehicle type. Further- Implementing tradeable permits in road transport would entail more, the sale of permits through a bidding procedure (as in a number of decisions, including how to allocate (auctioning vs. Singapore, discussed in Section 2) in such a setting would dispro- portionately penalise individuals with lower income (Verhoef et al., 1997). 36 However, Parry (2007) argues that the benefits from auctioned (rather than grandfathered) permits (and also taxes) to reduce road transport emissions are larger than the costs when account is taken of (a) their impact on reducing other road transport externalities such as accidents, congestion, local air pollution and 35 An upstream system for fuel refiners with a number of permits proportional to oil dependence and (b) interactions with the broader fiscal system such as the the carbon content of refined fuel would have similar advantages. use of revenues to reduce distortionary labour taxes. 18 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 grandfathering), whom to allocate (individual motorists, vehicle externalities. Although Parry and Small (2005, p. 1277) recognise manufacturers, fuel producers), how many permits to allocate that global warming is ‘the only component for which the is (actual cap on emissions), area of applicability of the policy (approximately) the right instrument’, they still estimate what the (regional, national, international) and duration of the permits, to fuel tax should be if it were to internalise most road transport name just a few. externalities, and assuming no other tax or charge were imple- Although fuel and vehicle taxation is already in place, and mented simultaneously. adjusting it would be administratively less costly than introducing There are many types of taxes and charges in road transport. an entirely new system, such as cap-and-trade, there seems to be Several factors determine the ideal policy instrument to be selected a trend around the world to favour or welcome the novelty of the (Timilsina & Dulal, 2008). These are the type of externality that the concept of tradeable permits, and just because of that reason, cap- government wants to target, e.g. emissions versus congestion, and-trade may have a role to play in the road transport sector in the global emissions versus local emissions; the flexibility the short, medium and long-run. government has to meet the targets; the nature of information asymmetries; the specific characteristics of the location; and ulti- 4. Incentive based policies: fiscal policy instruments mately the (administrative and monitoring) costs and benefits associated with each instrument. For example, fuel consumption is Governments use taxes for two reasons: either to generate closely related to the global warming impact of a vehicle. However, revenues and to redistribute part of the revenues to achieve PM emissions and noise also strongly depend on location, weather a ‘‘fairer’’ distribution of resources in society and provide goods or conditions and congestion levels prevailing at the time the vehicle services that the market by itself would not provide (such as for is driven. Hence, even though fuel taxes may be good instruments example, defence) or to correct market failures. The first type of to target global warming, they may be less effective for targeting taxes are distortive taxes, the second type are corrective taxes. local air pollution (Crawford & Smith, 1995, p. 34). Proost, Delhaye, What the two types of taxation have in common is that they act as Nijs, and Van Regemorter (2009) argue that (high) fuel taxes are incentives (or disincentives) on behaviour, by increasing the imperfect instruments to internalise all transport externalities marginal cost of certain activities. What they differ on is that the simultaneously. first type of taxes is introduced in an otherwise efficient economy. Another important consideration concerns the distinction Their introduction generates a deadweight loss, by ‘inserting between first best and second best policies. While in a first best a wedge between marginal cost and price’ (Cramton & Kerr, 2002,p. context one instrument can suffice to reach the optimal allocation, 339). The second type of taxes, on the other hand, is introduced in in a second best context,38 many instruments may need to be an otherwise inefficient economy, in order to correct the distortions combined to obtain the best feasible allocation. This may involve and change behaviour so as to restore efficiency. the taxation of activities that are complementary to the taxation The road transport externalities discussed in Section 1 are of fuel and vehicles, when these cannot account for the full social examples of the type of inefficiency that can arise in an economy. As costs, and subsidisation of substitute activities. Hence, additional it was already advanced in that section, one possible instrument parking charges or subsidisation of public transport may be that can be used to correct the distortion is a corrective or Pigou- advisable (Crawford & Smith, 1995,p.44).Secondbestsituations vian tax, charge or fee. Such a corrective tax can help align marginal are likely to be the rule rather than the exception in a context of private costs with marginal social costs. transport externalities and corrective taxes (Verhoef, 2000,p. In practice, any economy will have inefficiencies, and any 308). government will try to provide at least some of the services which are not typically provided by the market and pursue some equitygoals. As 4.1. Taxes on purchase and ownership of a vehicle a consequence, both distortive and corrective taxes will typically be present. Corrective taxes, besides tackling the market failure, Many countries impose taxes on the purchase of vehicles, and/or generate revenues that the government can use to finance expendi- a periodic (e.g. annual) licence fee on the ownership of a vehicle. 37 tures or (at least partially) to substitute for distorting taxes. Purchase taxes are direct tools to address CO2 emissions generated Taxes have been widely implemented in the road transport during the manufacturing and disposal of vehicles. However, CO2 sector around the world, both in developed and developing coun- emissions generated during purchase and disposal account for only tries. These have been introduced as either IB instruments to a small share of life-time vehicle emissions, which purchase and influence travellers’ behaviour in such a way as to induce a given ownership taxes do not directly tackle (Hayashi et al., 2001) in their response that reduces or corrects market failures, or as revenue basic undifferentiated form. In fact, as such, the primary impact of raising instruments. For example, the taxation of cars can be a purchase tax is a reduction in the number of vehicles in circula- structured so as to limit ownership, promote adoption of cleaner tion (Chia Tsui, & Whalley, 2001), and a longer tenure. A longer vehicles, change age and class car structure within a market, and tenure implies increase in the usage rate of vehicles (De Jong, 1990, improve car maintenance (Hayashi, Kato, & Teodoro, 2001, p. 124), in Barter, 2005). This is a perverse incentive that induces over- at the same time as generating revenues. The effectiveness of taxes consumption of older and more polluting models. In addition, as corrective instruments depends on the strength of the link Pritchard and DeBoer (1995,inTimilsina & Dulal, 2008) point out between the externality they are targeting and the tax itself. If this that if higher taxes on new vehicles are not matched by higher link is weak, then drivers, polluters, or road users may respond in taxes on second-hand ones the policy may fail to bring about an inefficient way (Crawford & Smith, 1995, p. 40). a reduction in car ownership. Higher taxes on new vehicles only can Parry and Small (2005) attempt to compute the optimal petrol otherwise result in a perverse effect, shifting purchase behaviour tax in the US, if this were to internalise congestion, accidents and towards older and more polluting vehicles. In general, purchase and local and global air pollution. Parry (2008) conducts a similar ownership taxes also increase business costs of a country and harm exercise for diesel tax in the US, accounting for accidents, road its competitiveness (Barter, 2005). However, more sophisticated damage, noise, energy security, and local and global pollution

38 Second best refers to the optimal policy when the true optimum (the first best) 37 This is the double dividend hypothesis, which is discussed in Section 4.5. is unavailable due to constraints on policy choice. G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 19 forms of purchase and ownership taxes can be envisaged that readings could lead to efficient internalisation of usage choices, better target vehicle usage emissions and internalise (at least since intensity of car use could be taxed. However, individuals partly) environmental externalities. These are differentiated taxes, would have incentives to roll back their odometers (Fullerton & on the basis of fuel economy characteristics of vehicles, or other West, 2003, p. 53). This, however, is becoming increasingly vehicle characteristics. harder, as electronic odometers are being introduced. In the case of purchase taxes, these can be differentiated on the Whether the tax is levied on purchase or on an annual basis has basis of fuel consumption per mile, type of fuel supported, horse- consequences on incentives. If purchase of both used and new power, size of engine, vehicle weight, and retail price. Jonhstone vehicles is taxed, then, as previously argued, the turnover of the and Karousakis (1999, p. 101) identify model year, mileage and vehicle stock is reduced, as the price of new vehicles increases. This the presence of fuel injection as the most significant factors that slows down emissions reduction, as new vehicles are typically contribute to emissions of HC, NOx and CO. In the case of ownership cleaner than older ones (Jonhstone & Karousakis, 1999). A tax taxes, relevant characteristics also include vehicle age. Such proportional to age of the vehicle bought (or a subsidy on new a differentiation provides price signals to consumers that act as vehicles) could counteract these perverse incentives and play incentives or disincentives on their purchase decisions (Evans, a significant role in reducing emissions, by discouraging the 2008) and can, for example, encourage a shift towards smaller purchase of older vehicles (Fullerton & West, 2003). A periodic tax cars (Acutt & Dodgson, 1997, p. 23). However, there is often a trade- makes consumers bear the costs of continued operations of off between the precision of the characteristics as a basis for a polluting vehicle, and can potentially foster maintenance activi- emissions correction, and the easiness in adoption of such a basis. ties that reduce emissions. In addition, a periodic tax allows the For example, engine size is straight-forward to tax. However, its adjustment of the tax on the basis of time-variant characteristics correlation with emissions of conventional pollutants might be that are linked to pollution, e.g. age. Age is highly correlated with weak compared to a tax on emissions-per-km. Emissions-per-km emissions, and is easier to observe and tax than emissions per km. are, however, less easily measured, since they depend on engine However, Fullerton and Gan (2005, pp. 303–304) find that a tax on size, vehicle age, fuel cleanliness and pollution control equipment, age is not very effective in reducing emissions, compared to a tax on as well as driving style (Fullerton & West, 2003 p. 5; Fullerton & fuel or on emissions-per-km. Gan, 2005, p. 300). The distributional effect of differentiated tax policies on Differentiated taxes are potentially effective tools and adminis- purchase and ownership depends on the characteristics taxed, and tratively relatively simple, since a tax system is already in place. on the characteristics of the households in the location where the Moderate costs can arise from modifications to the tax collection policy is implemented. For example, Fullerton and West (2003) system that may be required if the tax structure is changed (Acutt & show that in California, a tax on vehicle size would be progres- Dodgson, 1997). Although purchase and ownership taxes are low sive, as wealth is positively correlated with vehicle size. relative to the total cost of purchase, ownership and usage of a car, However, West (2004) shows that overall in the US a tax on size they can have a significant impact by influencing choice of car would be regressive, since higher income households’ preferences ownership at the margin (Knight, Vanden Branden, Potter, Enoch, & for size are non-homogeneous across vehicle age: ‘households with Ubbels, 2000). Differentiated vehicle tax systems have an impact higher incomes that own 1980s-vintage vehicles prefer smaller both on the supply and on the demand of vehicles. They incentivise engine sizes, while those with 1990s vehicles prefer larger engine manufacturers to improve the fuel efficiency of vehicles, so as to sizes’ (p. 738). Thus, expenditure on the size-tax would account for reduce consumers’ tax burden and they provide incentives for a smaller share of household income in high income compared to consumers to privilege fuel economy in their purchase choice (Evans, low income households. A subsidy to encourage the purchase of 2008). However, a danger exists that imposing a tax on a certain new vehicles would also be regressive, since higher income characteristic will elicit a manufacturer’s response in vehicle’s design households prefer newer vehicles (West, 2004, p. 738). Similarly, that eludes the tax and breaks down the observed relationship a tax based on vehicle age would also typically have a higher impact between characteristic and emissions. As a consequence, these on lower income families (Fullerton & West, 2003). policies are more effective in countries that do not have significant manufacturing capacity (Jonhstone & Karousakis, 1999). 4.1.1. Subsidies to efficient vehicles and feebates An ideal differentiated tax to internalise emissions would be set Subsidies for the purchase of fuel efficient or alternative fuel equal to the present value of the social costs of emissions, the vehicles are an important economic instrument to encourage the vehicle’s emissions per mile or km, and the life-time mileage choice purchase of low (or zero) emission vehicles. Consumers may choose (Jonhstone & Karousakis, 1999). However, this is difficult to not to buy a cleaner (but more expensive) vehicle, especially if the implement in practice for several reasons. Firstly, assessing the annual distances driven provide no opportunity to capture the social costs of emissions is a complex and costly task. Secondly, if benefits from fuel savings over the life of the vehicle (McKinsey & the tax is calculated at the time of purchase, the life-time mileage Company, 2009, p. 19). In these cases, subsidies may be effective in choice is an ex-post decision, and the fixed tax remains an initial tilting consumers’ preferences. However, they may also lead to an sunk cost. As a consequence, the tax does not present the driver increase in the number of car ownership, offsetting the subsidies’ with the correct subsequent incentives for mileage choice, pollu- beneficial effect. The choice of subsidy policies needs to be carefully tion control equipment maintenance, and length of vehicle life- matched to technological information and information about the time. For this reason, it might be advisable to combine a purchase specific local characteristics. For example, if electric cars were to be tax with a fuel tax and/or a congestion charge, measures which act subsidised, the way in which the electricity they consume is directly on usage decisions (Jonhstone & Karousakis, 1999; Sterner, produced (e.g. coal vs. nuclear power stations) would need to be 2003,inEvans, 2008). taken into account. Similarly, from a fuel consumption and CO2 When taxes are combined, one classic problem if the combi- emissions point of view, hybrid cars are a good choice in towns and nation is not carefully designed is that of double charging. For cities, where speeds are low and congestion is a problem. On trunk example, a tax based on the size of engine is superfluous when a tax roads, on the other hand, the advantage of hybrids over conven- on fuel is already in place, since larger engines are associated with tional petrol cars is much smaller. greater fuel consumption (Fullerton & West, 2003). If the vehicle An alternative to subsidies would be deductions from taxable tax was determined on a periodic basis, then periodic odometer income to make up for part or all of the vehicle cost, or tax credits 20 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 for the purchase of cleaner vehicles. In designing tax credit 4.1.2. Scrappage incentives schemes, care must be taken not to inadvertently create perverse Scrappage incentives, also known as voluntary accelerated incentives. In the US, for instance, the CAFE credits given to hybrid vehicle retirement programs, are rebates granted to owners of old vehicles are discounted so as to reduce the extent by which vehicles upon scrappage (Evans, 2008).39 These incentives directly manufacturers can cross-subsidise fuel inefficient vehicles by act on the fleet of old vehicles in circulation, which are responsible producing some extremely efficient ones (US NHTSA website b). for a (relatively) disproportionately higher share of emissions than Another crucial observation is that the distributional impact of newer vehicles (Evans, 2008). The immediate benefit that this a subsidy is not the same as the distributional impact of a tax policy aims at is an earlier scrappage of some vehicles and deduction or tax credit. In fact, the primary and (perhaps the only) a consequent reduction in fuel consumption due both to the higher beneficiaries of tax deductions and tax credits are those individuals fuel efficiency of newer vehicles, and to a reduction in the number who earn taxable income, i.e. the relatively rich in the population. of vehicles if the old ones are not replaced (Acutt & Dodgson, 1997). In addition, if the chosen format is deductions from taxable income, However, Alberini, Edelstein, and McConnell (1994) point out that the benefits will be higher the higher the income when taxation scrappage incentives may lead some individuals to keep their systems are progressive, hence the system would be regressive, and vehicles longer so as to reach the age at which they become eligible for this reason, not desirable from an equity point of view. for the scrappage scheme. Similarly, De Palma and Kilani (2008) A particularly attractive form of subsidisation is that of feebates, show that scrapping premia may perversely delay the replace- a term used to describe a scheme which combines fees and rebates. ment of vehicles due to the fact that an old car will be more This could take the form of for example, purchase taxes on fuel valuable with the scrapping scheme than without. The costs inefficient vehicles, and rebates on the price of fuel efficient ones. imposed by scrappage schemes on the government consist of the Feebates reduce the burden on the government’s finances subsidies and administration costs. The schemes are generally compared to simple subsidies. By financing the subsidisation of fuel considered relatively easy to implement (Hsu & Sperling, 1994, pp. efficient vehicles through taxation of less efficient ones, feebates 90–98). However, many scrappage programs have been financed by have the potential to be budget neutral instruments (BenDor & private companies as a way to achieve imposed regulatory stan- Ford, 2006; Koopman, 1995). dards or to obtain emissions offsets (Alberini, Harrington, & Feebates can shift both demand and supply of vehicles. In fact, McConnell, 1998). not only do they alter the purchase price of a vehicle, but they also Assessing the benefits of a scrappage scheme is not an easy task, encourage manufacturers to develop and adopt low emission since there are a number of uncertainties over car use and emissions technologies on the vehicles offered, in order to best exploit the (Hsu & Sperling, 1994). Another problem associated with the eval- feebate system in place, and get a head start over competitors. The uation of the cost effectiveness of scrappage schemes is that of moral supply response to the feebates incentive occurs also when feebates hazard (only the worst cars get scrapped, which are hardly used are offered directly to consumers. Consumers’ demand, however, anyway),40 which makes it difficult to adequately ‘reward actual does not shift when feebates target manufacturers on the basis of emissions reduced by scrapping a vehicle’ (Hahn, 1995, p. 239). The their sales mix within a model year. This suggests that consumers problem can be worse if it is difficult to estimate the remaining life- should be the privileged target for the application of such schemes. time of a particular vehicle (Hahn, 1995, p. 239).41 Vehicles that are Feebates can provide an incentive to meet vehicle standards in scrapped under a scrappage scheme are likely to be those in worst a more efficient way than through the internal pricing strategy each condition and almost at the end of their life (Alberini et al.,1994). Old vehicle manufacturer would undertake under normal competitive vehicles that are not replaced upon scrappage are likely not to have conditions. They can also work alongside congestion charges and been in active use prior to being scrapped. Hence, their contribution fuel taxes as additional price signals (Greene, Patterson, Singh, & Li, to emissions and consequent social costs would have probably been 2005), by strengthening the life-time fuel linkage to the lower than the scrappage bonus. purchase decision (Evans, 2008), which may be weak due to This may explain why the literature is not unanimous in its ‘imperfections in the market for fuel economy’ (Kunert & Kuhfeld, assessment of the benefits of scrappage schemes on emissions. 2007, p. 315). The shortcoming of feebates is that they target only BenDor and Ford (2006) predict that, even if all vehicles scrapped the new vehicle fleet. Hence, the emissions reduction that they are immediately replaced, the scheme leads to large and immediate achieve is gradual, and their full potential can only be achieved (HC) emissions reductions (BenDor & Ford, 2006). Sandstro¨m within the span of one or two decades as the whole fleet renews (2003), on the other hand, points out that the effect of scrappage (BenDor & Ford, 2006). For this reason they are considered long- policies on emissions is ambiguous. Alberini et al. (1998) show that term measures. The effect of feebates on emission reduction will the reduction in emissions is small unless a substantial scrappage also be mitigated by the rebound effect (Evans, 2008). This effect premium is offered, which reduces the cost effectiveness of the arises whenever consumers buy more fuel efficient cars, thus face scheme. Van Wee, Moll, and Dirks (2000) go further and claim that a lower cost per km and travel longer distances in response. scrapping programs may lead to an increase in CO2 emissions over One of the appealing features of feebates is their potential the life-cycle of vehicles. This is due to the fact that an increase in neutrality on government finances. This is a theoretical possibility that stems from the fact that there always exists a zero-point level (where no taxes or subsidies are imposed) and a feebate structure 39 Sometimes the rebate is conditional on the purchase of a new car (on which such that the expected revenues equal the expected costs of the a purchase tax is levied). 40 policy. In practice, however, calculating the optimal structure Moral hazard is related to the problem of asymmetric information, a situation presents an important challenge, due to the uncertainty regarding in which one party in a transaction (such as for example the car owner) has more information than the other (the regulator). Moral hazard occurs when the party consumers’ response to feebates and the elasticity of substitution with more information (e.g., about the vehicle being very old and not even in use between different car models. This uncertainty makes it difficult to or about to be scrapped anyway) has an incentive to hide the information from determine the optimal feebate rate (Gallagher et al., 2007). the other party (e.g., the regulator, who is about to pay the owner of the vehicle However, Ford (1995,inBenDor & Ford, 2006, p. 1200) demon- an amount for scrapping the vehicle). 41 A common assumption in policies is that scrappage vehicles are similar to the strates that despite the uncertainties over market shares, it is average vehicle in a given model year cohort in terms of remaining life, distance possible to maintain a reasonable balance and control the finances, driven and emission levels. But the self-selection bias makes this assumption wrong provided that the subsidisation plan is flexible enough. (Alberini, Harrington, & McConnell, 1995). G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 21 car production leads to increased emissions in assembly and new restrictions on program eligibility (Hahn, 1995). Careful design of cars are faster and bigger than the old cars they replace. Retrofitting the scrappage program is thus essential, in particular, in order to high-pollutant vehicles may thus be more cost effective than avoid creating demand for old vehicles (Gorham, 2002, p. 116). scrapping. Scrappage subsidies could theoretically lead to an increase in the Careful design of eligibility requirements for scrappage schemes price of used vehicles due to an increase in their demand (Alberini is a fundamental issue. Some scrappage schemes require that the et al., 1994). This price increase would weaken the scrappage vehicle be driven to the scrappage site so as to prevent appropri- incentive (Gorham, 2002) and have regressive distributional ation of bounties for vehicles that would not have produced effects, since people on lower incomes are more likely to purchase emissions because they were not operational. When the scrappage used cars. This problem can be avoided by implementing strict system is local, and aimed at reducing local air pollution, another eligibility requirements for scrappage, for instance, requiring that, important requirement is that the vehicle be registered in the local prior to scrappage, a car must have been registered for a certain area, so as to prevent an inflow of vehicles from other areas with amount of time in the area with the scrappage policy in place. the sole purpose of scrapping them (Hahn, 1995). The effectiveness Regarding the distributional effects, it should also be noted that of a scrappage program in reducing emissions is greater if low- people on low incomes are generally also more likely to own old quality cars are the largest emitters, which may not always be vehicles and hence benefit from the scrappage premium (Acutt & the case. If a large portion of high-quality used cars contributes Dodgson, 1997). to pollution, and their value is higher than the scrappage The appeal of scrappage schemes weakens over time. As the premium, the achieved emissions reduction from the scheme will vehicle fleet approaches a zero emissions level,44 the gains to be be relatively low (Mazumder & Wu, 2008). This is due to the fact made by scrapping old vehicles decreases. Hence, a scrappage that the value of cars is not necessarily negatively correlated with scheme is best suited to be a transitional strategy (Hahn, 1995). The the emissions produced, since for example a larger car (of higher effectiveness of a scrappage program is also a function of location. quality), may have the same market value as a smaller newer car In fact, local schemes do not affect the supply of used cars and are which produces less emissions. Hence the subsidy will not be therefore less costly, as they do not need to respond to increases in enough to induce scrappage of these high-quality high-emitters. the value of used cars by offering higher premia (Alberini et al., Scrappage schemes can be either permanent measures, or 1994). Furthermore, the emissions-reducing potential of scrap- temporary measures introduced, for example, to boost car demand page schemes is stronger in highly polluted metropolitan areas at a specific moment. A permanent scrappage scheme will accel- with a large share of old vehicles (Hahn, 1995). erate the vehicle fleet turnover as it is equivalent to a negative Scrappage schemes need not be stand-alone measures and purchase tax. If a purchase tax is levied, and refunded with indeed are unlikely to be effective instruments for emissions at the time of scrappage, the system is revenue neutral (i.e., it has reduction, if adopted alone (Alberini et al., 1998, p. 20). It is possible no impact on the government’s finances), and the life-length of to combine scrappage incentives with a system of feebates, or to vehicles is reduced, although the size of the vehicle fleet is not graduate incentives on the basis of the fuel economy of the affected. Sandstro¨m (2003) argues that a scrappage scheme will purchased car. This combination would have the additional benefit lead to an increase in the size of the vehicle fleet, which increases of creating incentives regarding both old and new vehicles, emissions. As a consequence, emissions may not be reduced, and promoting adoption of the cleanest new vehicles (Evans, 2008). The may even increase. system would lead to both a short-term and a long-term decrease A temporary scrappage scheme, on the other hand, will not have in vehicle emissions, and fees on high-emitting new cars could a long-term impact on the life-length of vehicles (Sandstro¨m, 2003). finance subsidies on clean new vehicles and scrappage (BenDor & Temporary scrappage schemes have the potential to reduce emis- Ford, 2006). sions and burst sales in the short-term. The temporary burst of sales The existence of inspection and maintenance programs can also will also depend on the fact that people will typically delay their affect the effectiveness of scrappage incentives. More stringency in scrapping decision between the time the policy is announced and inspection and maintenance leads to more scrappage for a given the time the policy becomes effective.42 The medium-term effect bonus, but could reduce cost effectiveness (Hahn, 1995, p. 222). will be a reduced level of activity, since the age distribution of the Alberini et al. (1998) show that the introduction of a scrappage vehicle fleet will have changed (Adda & Cooper, 2000). The scrap- program under an existing inspection and maintenance program page scheme might even lead to an increase in emissions relative to can be welfare-increasing. Gorham (2002) discusses the possibility the no-scrappage incentive scenario, if some technological break- of tying a scrappage program to the grant of a free public transport through appears when cars have just been replaced as a conse- pass. Other alternative policies to scrappage incentives include quence of the scheme (Sandstro¨m, 2003). Finally, it should be noted a reduction of purchase taxes relative to usage taxes, or a differen- that there is no market failure rationale for scrappage policies and tiation of usage taxes on the basis of age (Sandstro¨m, 2003). they can even be efficiency-reducing if petrol is priced according to marginal social cost.43 The introduction of scrappage incentives has an impact on the 4.2. Taxes on usage of a vehicle second-hand car market. Used cars will be imported either to be scrapped so as to take advantage of the bonus, or to replace vehicles Usage taxes are imposed on the basis of a vehicle’s usage. If the which have been scrapped (Hahn, 1995). This may partially off-set vehicle is left idle, there are no usage taxes to be paid. Examples of the emissions reduction, depending on the age of migrating vehi- these charges include fuel taxes, tolls, congestion charges and cles (Dixon & Garber, 2001 in Evans, 2008). Policy-makers can avoid parking charges. Together with ownership taxes, usage charges this effect through the introduction of taxes on imports, or through constitute an important policy, which affects demand and supply

44 This statement depends on the type of emissions and fuel in question. While 42 Sales tend to over-react, hence they are not a good benchmark when analysing local air pollutants may be reduced and even approach zero, as long as vehicles car markets (Sandstro¨m, 2003). run on oil-based fuels carbon dioxide emissions may go down in time but they 43 If petrol is priced according to marginal social cost, all the externalities have will never approach the zero level. Carbon emissions are an inevitable product of been internalised already and there is no need for any further measures. oil-based fuel combustion. 22 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 and reduces road transport externalities, in particular environ- varies by its carbon content), as well as the income and price 47 mental externalities, such as global warming resulting from CO2 elasticities. Second, a carbon tax is potentially regressive, since emissions. lower income households may spend more on carbon intensive activities. Third, the tax may impact competitiveness of the country 4.2.1. Emission taxes where the tax is imposed relative to other countries (Pearce, 1991). Emission taxes are in theory direct Pigouvian taxes, which Lastly, a tax based only on CO2 may distort incentives in emission- should be set equal to the marginal cost of the actual level of reducing activities towards activities that increase local air pollut- emissions generated by each vehicle. Emission taxes are the first ants, since CO2 emissions and other emissions may be negatively best instrument to correct emission externalities and induce the correlated. optimal driving behaviour and vehicle’s purchase and usage choice (Acutt & Dodgson, 1997, p. 23; Jonhstone & Karousakis, 1999,p. 4.2.2. Fuel taxes 100). However, under current technology, direct charging for Fuel taxes are applied in virtually every developed and devel- emissions is not feasible due to the lack of cost effectiveness and oping country in the world, as they constitute a low cost effective impracticability of monitoring techniques (Fullerton & Gan, 2005,p. revenue generating instrument. However, they are typically 300; Fullerton & West, 2000,p.1;Plaut, 1998, p. 194). defended by politicians on environmental grounds (Newbery, The level of emissions generated by a vehicle does not only 2005a, p. 24) and indeed they have a potential role as emissions depend on fuel usage, but also on contingencies that are less easy to reducing instruments. The most striking advantage of fuel taxes pin down. These include vehicle characteristics such as size, age, over other policy instruments is their administrative simplicity, due and maintenance, driving behaviour such as frequency of cold-start to the fact that a tax collection system is already in place. Collection ups and speed, location and time-dependent characteristics such as of fuel taxes can occur at the level of fuel wholesalers or refineries, air temperature (Fullerton & West, 2000, p. 3). Hence, imple- of which there are relatively few, thus reducing collection costs and mentation of an emission tax would require monitoring of actual the likelihood of fraud or evasion (Wachs, 2003), or it can occur at pollution generated by each vehicle on circulation (Jonhstone & the level of retailers, e.g. at the petrol station. The tax burden will Karousakis, 1999). Remote sensing of emissions with infrared ultimately fall on consumers, regardless of where they are beams has been suggested as a possibility for effective monitoring. collected, as the cost is likely to be passed on to them. Although fuel However, this system has many weaknesses. Complexity, lack of taxes generate revenues for the government which can be rein- detection of non-tailpipe emissions and of some types of tailpipe vested profitably, the burden on drivers, and spill-over effects on pollutants reduces its appeal (Johnston and Karousakis, 1999, p. the economy contribute to making fuel taxes unpopular, and reduce 100; Fullerton & Gan, 2005, p. 300). the political viability of a tax increase. Given the practical obstacles to the implementation of an Fuel taxes can serve as price signals (Wachs, 2003) to drivers on emissions tax, Fullerton and West (2002) demonstrate that the the social cost of the externalities they produce. In order for this to same efficiency can be achieved with a petrol tax that depends on occur, it is crucial that the structure of the taxes be transparent and fuel type, engine size and pollution control equipment or with a tax the composition of the tax well understood by motorists. If that depends on distance. Having said that, given that emissions of motorists are not aware of the changes in behaviour that will air pollutants per km (which have mainly local and regional reduce their tax payments, the tax will not have the desired effects impacts rather than global impacts) have declined substantially (Gorham, 2002). CO2 emissions are closely correlated to fuel with the introduction of tighter standards in different countries consumption, and thus they can be easily internalised through around the world, a tax to control these emissions may not be a fuel tax. Congestion, accidents, and local air pollution are exter- necessary after all.45 nalities which are only indirectly targeted by fuel taxes. The total One type of emission tax that focuses on a specific type of costs of these externalities, however, have been estimated as being emission, namely carbon, is a carbon tax. This instrument would be 14 times the cost of GHG emissions (Evans, 2008). Hence a tax almost ideal in the fight against global warming. Almost refers to the based on local emissions, distance driven, or peak-time congestion fact that other GHG such as methane are emitted from vehicles and would be better suited than a fuel tax to internalise these other contribute to global warming (Harrington & McConnell, 2003). externalities (Newbery, 2005a; Parry & Small, 2005). A carbon tax would be implemented as a tax on the carbon content An optimal fuel tax requires a fair amount of information on of fuel,46 and could be paid at the moment of fuel purchase, as it is private and social costs and benefits for its calculation. If ad valorem, currently the case with fuel duties. A carbon tax has an impact both the optimal tax would ideally need to be readjusted as oil prices on the choice of fuel type and on the aggregate fuel demand, as change (Watters et al., 2006, p. 2). Fuel prices, however vary on determined by vehicle fuel economy and vehicle usage (Gorham, a daily basis and there is typically going to be an implementation 2002). It could lead to dynamically efficient choices of ‘ever lag that prevents the adoption of the correct tax. Adjustment of cleaner technology and energy conservation’ (Pearce, 1991, p. 942). taxes to match the oil price would also create uncertainties in The tax could be accompanied by reductions in incentive distorting government’s revenues (Leicester, 2005). taxes such as income taxes (double dividend feature), so as to be Nonetheless, fuel taxes have been cited as an extremely effective revenue neutral on the government’s budget. climate policy instrument. Sterner (2007) for example, stresses An ‘‘optimal’’ carbon tax would be one designed to meet their importance as instruments to reduce environmental exter- a specific target of CO2 emissions reductions. However, there are nalities and keep emissions under control. He argues that had several drawbacks, which must be considered. First, in order to Europe followed the US pattern of low fuel taxes, it would have had design such a tax, it would be necessary to know with precision the twice as much fuel consumption as it has now. Hence any attempt inter-fuel substitution elasticities (since the carbon tax on a fuel to abandon fuel taxation light-heartedly, e.g. as part of integration of transport into the EU ETS, could be dangerous.

45 This does not apply to CO2 emissions, which have not been subject to the same type of standards. 46 In its application a carbon tax would effectively be a specific type of fuel tax. Fuel taxes are discussed in more depth in Section 4.2.2. 47 Note that this information can be learned and the tax adjusted iteratively. G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 23

The immediate effect of an increase in fuel taxes is on demand, fuels are associated with different types and intensities of emis- in the form of a reduction in km driven, through the impact of taxes sions, fuel duty differentials typically affect the mix of emissions on the marginal cost of driving. More long-term effects include (Acutt & Dodgson, 1997). Tax differentials can thus become incentives to scrapping old vehicles,48 reducing car ownership, and important and cost effective instruments to discourage the use of favouring vehicles with higher fuel economy at the time of the more environmental damaging fuels (Knight et al., 2000). purchase. Cobb (1999) finds that the predominant effect of an Taxation of certain components of fuel, such as lead, sulphur, increase in petrol tax in the US would be a shift towards more fuel oxygen content or octane rating may also create strong incentives efficient vehicles; this would be accompanied by a modest modal to change the fuel content (Gorham, 2002). It may not always be shift in the direction of public transport, and a minor shift to car- easy to find the efficient tax, i.e., the tax which covers the marginal pooling. A supply effect is also triggered by the fuel tax, by external costs caused by a specific pollutant. providing price-incentives to invest in cleaner technology and 4.2.2.1.1. Diesel vs. petrol taxation. In the Pre-Euro I phase (pre- produce vehicles with higher fuel economy to gain a competitive 1993) when petrol cars were not equipped with a three-way cata- advantage. Surveying the literature, Graham and Glaister (2004, pp. lyst, diesel was superior to petrol in terms of emissions (CO, HC, 270–271) and Goodwin, Dargay, and Hanly (2004, p. 282) report NOx,CO2) per vehicle kilometre in urban conditions, with the only the short-run price elasticity of fuel demand to average around exception of PM emissions, where petrol was far superior. However, 49 0.2 to 0.3, and the long-run elasticity to average around 0.6 to under Euro IV (post-2006), diesel cars emit less CO and less CO2 0.8. Small and Van Dender (2007), on the other hand, report than petrol cars with three-way catalysts, but their emissions of HC, a more moderate long run elasticity of 0.43 (p. 26). The immediate NOx and PM particulates are greater (UK DfT, 2008, Table 3.6, p. 55). reduction in driving will be low; hence the environmental condi- However, the difference between diesel- and petrol-fuelled cars in tions will not improve in the short-term (Sipes & Mendelsohn, terms of their emissions of HC, NOx and PM gradually decreased 2001). Fuel taxes thus have greater potential to reduce emissions over the period 1993–2006, as cleaner fuels and vehicles were in the long-term than in the short-term, although in the long-term introduced in Europe (UK DfT, 2008, Table 3.6, p. 55). Although a rebound effect may be observed. This occurs if a higher fuel these conclusions are drawn on the basis of European data, similar economy of vehicles is accompanied by an increase in distance conclusions would be reached for countries which adopted similar travelled, due to the reduced cost per km. standards. For countries that have not regulated emissions in this The distributional impacts of fuel taxes have been subject to way, the case of Europe proves that it is (technologically) possible to considerable debate in the literature. In determining the distribu- achieve such emission differentials. tional impact of fuel taxes it is important to keep in mind whether To compare the external costs of diesel and petrol, or in other the measure of income considered is based on annual income, or words, to decide whether diesel or petrol should be favoured, either the less variable life-time income. Poterba (1989) thus shows that shadow prices need to be determined for each pollutant (a practical fuel taxes may be much less regressive if calculated on the basis of difficulty which is common to all Pigouvian taxes) or at least, some life-time, rather than annual income. (subjective) weighting needs to be assigned. Crawford and Smith There is general agreement that when all households are (1995, p. 46) suggest the use of relative weights but emissions considered, fuel taxes are progressive, but if only car-owning from petrol and diesel have changed drastically since they wrote households are considered fuel taxes are regressive (Acutt & their paper. It is now clear from the data on emissions that, unless Dodgson, 1997; Blow & Crawford, 1997; Leicester, 2005; Johnson, carbon monoxide and CO2 have a much higher social cost than all McKay, & Smith, 1990; Santos & Catchesides, 2005; West, 2004). the other emissions, the use of diesel should now be discouraged Apart from car-ownership, other factors that play a role in the esti- and one way of doing this is through higher taxes. mation of distributional impacts are the extent to and the way in Along these lines, Mayeres and Proost (2001a) argue that diesel which revenues are recycled. Bento, Goulder, Henry, Jacobsen, and has much higher environmental costs than petrol, since the social von Haefen (2005) find that if revenues are recycled to households costs of PM emissions are high. Having said that, the difference in in proportion to their fuel-tax payments, the impact of the fuel tax is emissions of PM between petrol and diesel cars has declined close to proportional. On the other hand, if revenues are recycled in between 2001 (when they wrote their paper) and 2009. If climate proportion to households’ income, the impact of the fuel tax is highly change and CO2 emissions were to be given the highest weight, regressive. Wachs (2003) argues that fuel taxes are less regressive there could be an argument for lower taxes on diesel than on than sales taxes as instruments to finance public transport expen- petrol. Whatever the reason, EU countries have not increased ditures, whose primary beneficiaries are lower income people. diesel taxes relative to petrol taxes over time. Graham and Glaister (2004, p. 270) find that the income elasticity of Mayeres and Proost (2001a) further argue that when there are fuel demand is between 0.3 and 0.5 in the short-run and between 0.5 constraints on the choice of tax instruments, a change in ownership and 1.5 in the long-run. Goodwin et al. (2004, p. 284) report the mean taxes to discourage the use of diesel cars is an important instru- income elasticity of fuel consumption to be 0.39 in the short-run and ment. Constraints could arise, for example, from a difficulty in 1.08 in the long run. This is equivalent to saying that a household that differentiating fuel taxes between private and commercial use, and doubles its income in the short-run will increase fuel demand by between cars and lorries. Giblin and McNabola (2009) find that roughly 30–50 per cent. In other words, fuel taxes will hit harder on ownership taxes have a higher impact on new vehicle purchases lower income groups, unless they are redistributed. than any fuel duty differentials.50

4.2.2.1. Fuel duty differentials. Different levels of taxes can be applied to fuels that differ in composition. Since different types of 49 Although it may be argued that outdoor concentrations of CO are too small to harm human health, CO has been linked to a number of problems, briefly described in Section 1. McCubbin and Delucchi (1999, Table 3, p.270) estimate the health costs of a number of pollutants from road transport in the US for 1990. Although PM is by 48 On the other hand, de Palma and Kilani (2008) argue that the higher the price far the most costly, CO is not zero. of petrol, the later a vehicle will be replaced, and hence the older the cars in circu- 50 They model the potential impacts of the new carbon based tax system for new lation will be. This result differs from previous results (Fullerton & Gan, 2005; vehicles purchased from 1 July 2008 by the Irish government and find that CO2 Fullerton & West, 2002) because it accounts for the fact that less usage leads to emissions from private transport will be reduced by 3 per cent with respect to a lower replacement rate. 2007 levels. 24 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45

In practice, many countries tax diesel less than petrol, and any shift in demand for more fuel efficient vehicles. Hence its produce an artificial price differential that is much higher than that benefit is more limited. This drawback could be reduced by warranted by international prices. The rationale behind these differentiating the VKT charge on the basis of the vehicle’s fuel differentials is often political, to protect the competitiveness of economy (European Commission, 1995). sectors such as agriculture, that rely on diesel (Gorham, 2002). An economic rationale for the observed duty differential lies in the 4.2.4. Congestion charges increased efficiency of taxation when applied to consumers, The simple idea behind a congestion charge that reflects the combined with the fact that diesel is used as an input in production additional social costs of congestion is to confront the trip maker by lorries and industries more than petrol. Diesel enjoys an intrinsic with the true social cost of his journey. In theory, a congestion fuel economy advantage over petrol, since kilometres per litre of charge is a corrective, or Pigouvian, tax, set equal to the marginal diesel are higher, all else being equal. The tax incentives add to that cost of congestion. A congestion charge ensures that only cost- intrinsic advantage and constitute an added incentive for the use of justified journeys are made and the scarce road space is allocated diesel, which may not be warranted from a welfare perspective. The to those who value it most. The effect of charging is to reduce travel lower usage cost of diesel cars is also responsible for a rebound demand and congestion, and to increase speeds and the total net effect, i.e. an increase in distances travelled, triggered by a lower benefits of travel. cost per km, which partially offsets the fuel savings (Gorham, An efficient equilibrium is one in which the only journeys made 2002).51 are those whose value exceed their marginal social cost. Thus, Finally, let us return to a point mentioned above, which could journeys are made until the least valuable trip yields a benefit equal serve as an argument for having lower taxes on diesel than on to the marginal social cost, which is equal to the private cost plus 52 petrol. Since CO2 emissions per vehicle km from diesel are lower the congestion externality. The efficient congestion charge can be than those from petrol, increasing the share of diesel vehicles measured by the segment DE in Fig. 1 (in Section 1). The charge is e would reduce CO2 emissions. If the key objective of the tax were to equal to the MCC at the efficient level of traffic, q ,inFig. 1. The address the issue of , putting a greater weight on government revenue from this charge is FDEG and the social gain is CO2 relative to other emissions could then be justified. DMC. The disbenefit to those who are priced off is given by area 4.2.2.1.2. Cleaner fuels. In order to promote the adoption of DCB, which can be approximated by (qmqe * FA)/2. The total loss of cleaner fuels (unleaded instead of leaded petrol or low-sulphur consumer surplus can be measured by FADC and the loss for instead of high-sulphur diesel, etc) governments can, and indeed existing users who continue to drive is FADB. The benefit to existing have, set duty differentials or subsidies, so that cleaner fuels users (in the form of higher speeds) is given by area AGBE. become more attractive. These subsidies or duty differentials can This description gives a very simplified representation of the help curb emissions in transport, although their effect on conges- problem. Nonetheless it is useful and conclusions do not change that tion need not be beneficial (Timilsina & Dulal, 2008), as longer much when the model is made more complex. This simple model of distances may be driven. Some specific successful examples are congestion charging has been extended in several directions. discussed in Section 5. Vickrey (1969) proposed a bottleneck model, where congestion When alternative fuels can be utilised in existing vehicles is assumed to arise when vehicles queue behind a bottleneck. If without any adaptation, then theory prescribes that relative taxa- commuters need to arrive at work at a certain time and there is tion should reflect the relative environmental damage produced by a bottleneck on the way, they will bear costs associated with early different fuels. When major adaptations on existing vehicles or and late arrival, which together with the congestion charge, are their replacement is needed to adopt cleaner fuels, then both fuel added to the cost of the trip. This bottleneck model was further and vehicle taxation matter. In particular, if cleaner fuels are sub- extended, mainly by Arnott, De Palma, and Lindsay (1988, 1990a, sidised, the risk is that subsidies will benefit users who drive long 1990b, 1992, 1993, 1994, 1998) to include heterogeneous distances and would have found it profitable to buy the cleaner commuters, route choice, stochasticity in capacity, elastic demand, vehicles even without any fiscal incentives. Such a policy may thus and time-varying congestion charges. imply a higher deadweight loss than a policy that subsidises cleaner Congestion charges in the static model and in the bottleneck vehicles rather than cleaner fuels (Crawford & Smith, 1995). model are first best solutions, as the underlying assumptions are that there are no constraints of any sort (i.e. the regulator can price 4.2.3. Vehicle km travelled taxation any link at any time) and no imperfections in the rest of the A type of usage tax that can be used as an alternative or economy. However, in real world situations, due to constraints, complement to fuel taxation in order to reduce emissions from road congestion charges are likely to be second best solutions. transport is a tax on distance driven. Such a tax could be levied once Constraints could include a situation where only part of the road a year, as part of the annual ownership tax, on the basis of km network or only some road users are priced (Liu & McDonald, 1999; travelled as registered on the odometer. Kilometres could be Small & Yan, 2001; Verhoef, 2000, 2002a, 2002b; Verhoef, Nijkamp, checked during regular mandatory safety inspections so as to reduce & Rietveld, 1996). Ignoring these constraints and naively imple- the administrative cost. Vehicle-km travelled (VKT) taxes are asso- menting first best congestion charges (equal to marginal conges- ciated with a high incentive to cheat by rolling back old odometers. tion costs) can lead to lower welfare gains from pricing than the New electronic odometers will be more cheat-proof in this respect. gains from second best pricing, which by definition achieves the The advantage of a VKT tax is that it avoids the rebound effect highest gains given the constraints that apply (Small & Verhoef, previously discussed for fuel taxes, and acts directly to reduce 2007). Second best scenarios may also include complements to, distance travelled. Indirectly, a VKT tax will reduce congestion (Ubbels, Rietveld, & Peeters, 2002). However, such a tax is unlikely to trigger any technological emission abatement improvement, or 52 In this simple model other externalities (such as accidents, air pollution, climate change, etc) are initially ignored. However, marginal social cost includes a number of externalities, each of which should be internalised in order to achieve an efficient 51 A different tax on diesel could in theory be applied to cars and lorries (or equilibrium. In this section we focus our attention on the congestion externality private and commercial vehicles) but this could in practice prove administratively and the use of a congestion charge to internalise it. Further below we discuss the expensive. possibility of a congestion and environmental charge. G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 25 and substitutes for, a priced link or area. Parking charges, for traffic. Rather than having just a congestion charge, he proposes example, have frequently been suggested as an alternative to that vehicles should also be charged for the damage they cause on congestion charges (Verhoef et al., 1995). the road. A road user charge would then include a congestion Another problem that would interfere with first best pricing is charge element and a road damage charge element. that of distortions in other sectors of the economy. One classic example is that of pre-existing distortionary taxation on labour. The 4.2.5. Parking charges interaction between congestion charges and distortionary labour/ Much of the literature on pricing relates to parking as a common income taxes has been analysed by Mayeres and Proost (2001b) and property resource, which is over-exploited if under-priced Parry and Bento (2001). An important result in this respect is that (Anderson & de Palma, 2007). The provision and use of the parking the overall welfare gains from congestion charging not only depend slot entails a marginal cost (Verhoef et al., 1995). The search for on the initial impacts of the charge, but also on the use of the parking space in congested urban areas is also one of the factors revenues, which could be allocated, as already discussed for the contributing to travel congestion itself (Arnott & Rowse,1999, Arnott case of fuel taxes, to reducing distortionary taxes in the economy, &Inci,2006). Nonetheless, it is not uncommon in urban areas for such as for example, labour/income taxes. drivers to park for free, at least at the workplace. The problem of Parry and Bento (2001) thus find that congestion taxes tend to parking being under-priced when considering its social costs has increase the total cost of commuting (although this is partly offset a simple efficient solution: appropriate pricing of parking slots. The by lower travel time costs), discouraging labour force participation, administrative complexity of the system is likely to be low, requiring leading to a welfare loss that can be greater than the Pigouvian little investment costs and being easy to introduce. Political welfare gain resulting from the internalisation of the congestion acceptability for parking fees is likely to be higher than for conges- externality. A positive net impact on labour supply, on the other tion charging (Zatti, 2004). Revenues raised through parking fees can hand, can be achieved by using the congestion charge revenues to be reinvested. However, there is the need for monitoring and for reduce income taxes, raising ‘the overall welfare gain from the setting penalties to mitigate the risk of avoidance of parking charges congestion tax by around 100 percent’ (Parry & Bento, 2001, p. 645). (Acutt & Dodgson, 1997). Furthermore, the congestion charge could be set so as to also Parking charges have also been suggested in the literature as internalise the environmental externalities from driving, thus a second best instrument to deal with road transport externalities, becoming a combined congestion and environmental charge. As such as for example, congestion (Verhoef et al., 1995) and emis- already explained in Section 1, the environmental externality sions. Parking charges increase the total cost of a trip (Timilsina & includes a variety of elements, ranging from local, regional and Dulal, 2008). This could reduce the attractiveness of a given global pollutants, to noise, water contamination, and visual intru- urban area altogether, or discourage vehicle usage, resulting in sion. A corrective charge could then be designed to include both the a decrease in the inflow of vehicles (Eisenkopf, 2008).53 In addition, congestion and the environmental externality (Button, 2004, p. 14). the introduction of parking fees could help matching demand with As discussed above, however, fuel taxes can approximate optimal supply, thus reducing parking search time, and improving mobility environmental charges because most environmental externalities (Zatti, 2004). However, parking policies are not optimal instru- are closely dependent on fuel consumption. ments (in a first best sense) to regulate costs that are largely Finally, an important link to congestion charges is that of dependent on length and route of the trips. They may even be capacity choice. Keeler and Small (1977) build on previous work by counterproductive, as they charge the average, rather than the Mohring and Harwitz (1962), Vickrey (1963), Strotz (1964,inKeeler marginal, external cost, thus cross-subsidising longer trips through & Small, 1977), and Mohring (1970,inKeeler & Small, 1977) and shorter trips (Verhoef et al., 1995). show that revenues from an efficient congestion charge (equal to The possible effects of a parking charge on drivers include, the marginal congestion cost) are equal to the rental cost of the according to Feeney (1989,inTimilsina & Dulal, 2008,p.27) highway under the assumptions of constant returns to scale, indi- a change in parking location and/or trip destination, a change in visibility of road construction, and independence of demand in journey-time, a modal change, or the cancellation of the trip alto- each period from prices in other periods. They define rental cost of gether. The long-term effect could also be a reduction in car- the highway as the sum of construction costs (on which interest ownership level, although the impact is likely to be marginal and amortisation are computed), maintenance costs, and land (Acutt & Dodgson, 1997, p. 27). acquisition costs. Although at first sight there may seem to be no Efficient or inefficient parking fees, however, both allocate link between efficient congestion charges and the rental cost of the scarce parking spaces without necessarily reducing peak traffic road there is one, and this is given by a function of net benefits that congestion and emissions. These charges affect drivers whose includes both benefits and costs to the users and the costs of the destinations are in the area where the parking charges apply, and highway. By maximising the net benefits of all trips on that road fail to differentiate according to trip lengths or routes followed over the life of the road, computed as the difference between the (Verhoef et al., 1995) and emission levels. Thus, parking fees are not net benefits to road users and the rental cost of the road they arrive effective in reducing through traffic. In fact, the number of drivers at fairly standard results: (a) the price paid by the road user should passing through the area and the length of their trips may increase equal the average rental cost plus the congestion externality, and in response to the parking charges, as they extend their trips to take (b) lane capacity (or width) should be expanded to the point where advantage of free parking slots outside the area where the charges the marginal cost of an extra unit of capacity is equal to the apply. One way to counteract this would be to avoid discontinuities marginal value of user cost savings (typically vehicle operating and in the charges applied, and to have uniform charges in wide areas to time cost savings) brought about by that expansion. Combining increase effectiveness (Zatti, 2004). these results, simple algebraic manipulation shows that the Although information and enforcement intensive, parking revenue from the efficient congestion charge is exactly equal to the charges could be designed to vary according to time of day, location rental cost of the road, under the assumptions already listed above. The main problem with the model above is that it assumes the rental cost of the highway to be exclusively dependent on its width, 53 This comes at a cost in terms of competitiveness of the city, if they are applied and not on traffic. Newbery (1989) improves the model by on a large scale (Eisenkopf, 2008). On the other hand, effective, fast and reliable assuming that maintenance to repair road damage does depend on public transport provision may counteract this effect. 26 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 of the parking place, and according to the vehicle’s fuel economy. The Parking charges discriminate on the basis of willingness to pay, first option is an important element both as a first best instrument to while parking restrictions do not. regulate time-dependent parking externalities, and as a second best instrument to regulate time-dependent driving externalities. The 4.2.6. Pay-as-you-drive insurance second option is important because external costs vary with the Pay-as-you-drive (PAYD) insurance differs from standard congestion of the area. For example, external costs tend to be higher insurance in that the premium is dependent on the annual distance in the city centre, and generally lower for off-street parking places travelled. Thus, insurance becomes a variable cost (Litman, 2008). (e.g. underground) than for on-street ones (Zatti, 2004). As in standard insurance, the premium can be conditioned on the Glazer and Niskanen (1992) show that when road usage charges driver’s rating factor (Parry et al., 2007, p. 394), which is a function are sub-optimal, parking charges can increase welfare if they are of age, crash record, and region (Parry, 2005, p. 288). The advantage lump-sum fees, but not if they are increasing in parking time. In fact, of PAYD insurance over conventional insurance is that it price- if charges vary with length of stay, people park for a shorter time, discriminates more successfully between travellers on the basis of and more people use the parking slots, thus increasing traffic. the distance they drive, which is correlated to their willingness to Verhoef et al. (1995) show that efficient parking charges can only pay for insurance. As PAYD insurance reduces premia for short reduce traffic congestion (by mimicking congestion charges) under distances driven, implementing such insurance schemes can be very restrictive assumptions. These assumptions were already expected to reduce the number of uninsured drivers (Parry, 2005,p. summarised in Section 2, and include: (a) each individual drives the 288). Insurance schemes such as PAYD are also more accurate, as same distance, (b) congestion is equally spread over the road they increase the correlation between premia and expected claims network, (c) the government (regulator or local authority) has full to the insurance company (Litman, 2008). Under PAYD, travellers control over all parking spaces, (d) every car is parked in a public do not ‘‘over-consume’’, or ‘‘over-drive’’, as the amount they pay parking space, and (e) all cars are parked for the same length of time. increases with distance, very different from a scenario where they Arnott, De Palma, and Lindsay (1991) and Calthrop, Proost, and pay a fixed sunk-cost at the beginning (Evans, 2008). van Dender (2000) show that congestion and parking charges Parry (2005) argues that although fuel taxes are more cost need to be set simultaneously. Using the bottleneck model, originally effective in reducing emissions and improving fuel economy, PAYD developed by Vickrey (1969), Arnott et al. (1991) demonstrate that insurance, which is politically more acceptable, reduces distance- the joint implementation of an optimal congestion charge and related externalities, such as congestion, accidents and local emis- a location-dependent parking fee yield an efficient equilibrium. sions, ‘far more than fuel taxes’ (p. 288). He also shows that PAYD is Using a numerical simulation model and assuming a cordon slightly more efficient than a VKT tax for a given reduction in charging system, Calthrop et al. (2000) find that as parking charges demand for petrol. Evans (2008) also argues that the extra-premium approach their efficient level, the level of optimal cordon charges paid by drivers who drive longer distances will net-out with the falls. Similarly, with a cordon charge, the level of efficient parking lower premium paid by drivers who drive shorter distances. charges falls. In this sense, parking charges can be seen as a substitute The distributional impacts of PAYD insurance have been sug- for congestion charges. However, Button (2006) argues that the gested to be progressive, since there is a positive correlation effectiveness of parking fees as a road pricing surrogate are highly between income and km travelled. Bordoff and Noel (2008) thus context specific, which brings us back to the restrictive assumptions note that on average families on low incomes will benefit from PAYD made by Verhoef et al. (1995). insurance schemes, as they ‘make up a disproportionately large Arnott and Inci (2006) develop a model which integrates traffic fraction of the low-mileage drivers within any risk class’ (p. 39). congestion and saturated on-street parking, with cars causing However, Wenzel (1995) argues that PAYD insurance could be congestion when looking for a parking space. They find that the effi- regressive, as the burden of the scheme relative to a standard cient on-street parking charge is a charge that eliminates the activity insurance scheme could be higher for lower and middle-income of driving to find a parking space, regardless of whether the quantity households. It should also be noted that if the elasticity of distance of on-street parking spaces is optimal or not. Arnott and Rowse (2009) driven with respect to income is lower than 1, PAYD insurance is extend that model to include on-street parking, off-street privately likely to be regressive. provided parking,54 and traffic congestion, and conclude that Considering the issue of political feasibility, PAYD insurance increasing on-street parking charges generates efficiency gains that schemes may compare favourably to other policy measures such as may be several times as large as the increased revenue raised. fuel taxes. Unlike fuel taxes, implementing PAYD insurance Arnott (2006) and Calthrop and Proost (2006) arrive to similar schemes does not transfer large tax payments from motorists to the conclusions using different models which integrate both on-street government. For the average driver, PAYD schemes do not increase and off-street privately provided parking. Arnott (2006) finds that driving costs, leading Parry (2005) to conclude that ‘hence political the number of cars looking for a parking space adjusts to equalise the opposition to this policy should be more muted’ (p. 288). full prices of on-street and off-street privately provided parking Implementation of PAYD at a large scale may be difficult because spaces. Calthrop and Proost (2006) show that the optimal on-street insurance companies would have to incur costs of monitoring that parking charge equals the marginal cost of providing off-street would outweigh their direct benefits. A socially inefficient choice parking spaces at the optimal quantity. If off-street parking is by insurers (i.e. failure to implement PAYD insurance schemes) is supplied under constant returns to scale, they prove that the efficient likely, as the benefits to society from such a scheme would be large, on-street parking charge should be equal to the off-street one. but these benefits would not be internalised by insurance compa- An alternative to parking charges would be a mandated nies. Edlin (2003, pp. 56–57) lists the positive externalities or social restriction on parking supply. Verhoef et al. (1995) show that benefits from PAYD. These include: reduction in accident costs mandated restrictions are inferior on the basis of information and (which benefits insured vehicles, with or without PAYD, uninsured efficiency arguments, as discussed in Section 2. In fact, individuals and underinsured ones), reduction in congestion, reduction in may not know that there are parking restrictions, hence undertake pollution and reduction in road maintenance costs. the trips anyhow, and then drive around to find a parking place. The main concern with PAYD insurance implemented at a large scale is related to monitoring costs. Odometer reading would be needed to determine the appropriate charges, and fraud would be 54 They call it ‘‘parking garages’’. an obstacle as it is quite possible to roll odometers back (Bordoff & G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 27

Noel, 2008; Edlin, 2003). Electronic odometers, more difficult to higher usage. Feebate schemes are increasingly more costly relative tamper with, may be the solution. to CO2 taxes as CO2 reduction targets tighten, as the costs of Other implementation costs include the calculation of new achieving a given fuel efficiency ‘increase more than proportionally’ premia and development of new procedures for the insurance in the fuel efficiency target. Finally, a feebate scheme may be companies (Litman, 2008).There exist patents for PAYD schemes needed in combination with a CO2 tax if consumers underestimate that may discourage adoption of the system by other insurers the total vehicle life-time fuel consumption at the time of purchase (Bordoff & Noel, 2008). In addition, first-movers will face adverse- (Koopman, 1995, p. 67). selection in consumers’ choice, reducing the benefits of PAYD.55 In De Borger and Mayeres (2007) construct a numerical optimi- order to counteract this effect, an increase in the average premium sation model to study optimal fixed and variable taxes on petrol of the fixed insurance schemes could be introduced at the same and diesel cars in Belgium. They find that shifting the balance of time in order for the insurance companies not to make losses. taxes towards variable taxes does not necessarily improve welfare. Insurers also have concerns that the distance foregone (not driven) They also show that the combination of peak road pricing with after the introduction of a PAYD scheme will be less risky than the revenue recycling in the form of higher transport subsidies or lower average driven distance or average number of km. Hence, the petrol taxes is the policy with the highest marginal effect.56 reduction in the premium will be more than the reduction in claim Fullerton and West (2003) show on the basis of Californian data costs, leading to losses for the insurers. Litman (2008) argues that that a fuel tax alone can achieve 62 per cent of the welfare gain empirical evidence suggests that the opposite holds: the reduction obtained in a first best scenario with a tax on emissions. The intro- in cost claims is more than one to one with the reduction in km duction of a two-part schedule consisting of a fuel tax and a subsidy travelled. Along the same lines, Bordoff and Noel (2008) argue that to new cars is an improvement upon this, achieving a welfare gain the number of accidents increases less than one to one with that is 71 per cent of that obtainable in the first best scenario. vehicle-km travelled. In any case, if the adoption of a PAYD scheme However, distributional effects and administrative costs are not is successful and leads to a reduction in km travelled, the total considered in the analysis, and may lead to different conclusions. premia will be reduced. This, even if matched by a corresponding Chia et al. (2001) compare ownership and usage taxes on the reduction in claim costs, will lead to a lower investment income for basis of Singapore’s data in the mid 1990s. They assume that insurance companies, and hence to lower profits (Litman, 2008). travellers can choose whether to travel by car or by bus. Trips by car entail fixed costs, but lower variable costs. Usage taxes are found to be superior to ownership taxes for internalising congestion exter- 4.3. Ownership vs. usage taxes nalities, but are less revenue-efficient. They argue that when combining ownership and usage taxes, one should first optimise The transport economics literature is very critical of ownership over ownership taxes, and then introduce usage taxes. taxes, because they are blunt and indirect tools to address transport Newbery (2005a, p. 29) argues that petrol and diesel taxes can externalities. However, ownership taxes are easier to implement be set at equal rates, as long as the difference in the damage caused and may face less political opposition (Barter, 2005). The choice of by emissions from diesel and petrol vehicles is collected through tax weights applied to the different stages of ownership, purchase, the annual vehicle excise duty. usage and scrappage of a vehicle is a key determinant of purchasing and travel behaviour, and consequently of the life-time CO emis- 2 4.4. Company cars and other incentives sions of a vehicle from production to usage, maintenance and disposal (Hayashi et al., 2001). In principle, variable taxes such as The tax treatment of commuting expenses and employer provided fuel duties, distance based taxes and congestion charges are transport-related fringe benefits plays an important role not only in superior to fixed taxes (on purchase and/or ownership) at tackling transport policy but also in environmental policy (Potter, Enoch, Rye, externalities. &Black,2002). Company cars are cars provided by employers to However, when the government is constrained in its capability employees and can typically be used for both business and private to impose the efficient variable taxes, fixed taxes can be important trips (Cohen-Blankshtain, 2008, pp. 66–67). The provision of second best instruments (De Borger & Mayeres, 2007, pp. 1178– company cars acts as a disincentive to the use of public transport or 1179). Ownership and purchase taxes may be better tools for other modes such as car-pools. Hence, from an environmental point directing purchase behaviour towards vehicles associated with less of view, company cars should be limited (Cohen-Blankshtain, 2008). negative externalities (Barter, 2005, p. 526), since consumers’ Taxation can help integrate employers’ behaviour with employees’ choice of vehicle class and their decisions regarding vehicle behaviour towards a low carbon transport economy. Commuting disposal and repurchase are less directly targeted by usage taxes expenses can be seen as personal expenses, subject to income taxa- (Hayashi et al., 2001). tion, or as tax deductible expenses (Potter et al., 2002). Whether Koopman (1995) compares the CO emissions reducing poten- 2 commuting expenses are taxed or not can make a big difference to tial of a range of fixed and variable taxes through simulations with commuters’ incentives regarding their travel behaviour. a partial equilibrium model of European passenger transport. He If travel is classified as an intermediate good, the Diamond– finds that carbon taxes are superior to feebate schemes; these in Mirrlees productive efficiency result applies - intermediate goods turn perform better than annual ownership taxes, while purchase in production should not be subject to distortionary taxes taxes are the least cost effective instrument. Different policies (Diamond & Mirrlees, 1971).57 Related to that is the idea that induce different behavioural responses. Feebates induce vehicle expenses incurred in earning income should not be part of taxable fleet compositional change, towards more fuel efficient vehicles. The purchase of more fuel efficient vehicles leads to a moderate rebound effect, since the lower marginal cost of driving leads to 56 Their analysis is based on a logit model and takes a partial equilibrium approach which ignores international competition issues. 57 It should be noted, however, that this sub-section, dealing only with 55 Adverse selection refers to a situation where an individual’s demand for insur- commuting and work-related trips, ignores a large proportion of trips that people ance is positively correlated with the individual’s risk and the insurance company make. According to the 2001 US National Household Travel Survey, for example, cannot introduce that correlation in the premium. PAYD would probably be chosen only 14.8 per cent of trips made were commuting trips, with an additional 2.9 by those who already drive less. per cent of trips for other work-related purposes (US DoT, 2003, p. 10). 28 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 income (Richter, 2006). According to this principle, commercial Canada through another distortion, namely non-taxed transport vehicles (and the fuel they consume) that are used as inputs in passes is not the direction to take. The best approach is to appro- production should only be taxed to correct for externalities, but not priately tax the benefit derived from free parking provision. for the sole purpose of raising revenue for the government. Tax concessions for commuting expenses58 are found to induce Whether a commuting trip is considered an intermediate good or distortions in residential land use (Wrede, 2003), stimulate not can be subject to debate. In the UK commuting trips are not commuting by car and longer trips (due to distorted location choice considered working trips and therefore taxes on commuting trips of residence and or/working place), with negative effects on the are not refundable. Furthermore, the UK DfT (2009b) places very environment (Potter et al., 2002). Non-deductibility could be different values on working and commuting time. justified by a lack of other instruments to internalise congestion One approach towards company cars is to differentiate taxation and environmental externalities (Wrede, 2003). The literature is at the purchase and ownership level, by making excise duties not unanimous on the optimal treatment of commuting expenses. refundable for commercial vehicles, even if they are going to be Even if concessions are only targeted to public transport used for private trips as well. Fuel taxes, on the other hand, can be commuting expenses, they need not be advisable. In fact, they made refundable for working trips only (and commuting trips, contribute to trip lengthening, and they impose a heavy burden on depending on the individual government’s view). finances (Potter et al., 2002). This lower tax while in the course of production is also one of the rationales behind the lower taxation of diesel versus petrol. However, this may distort incentives of private individuals 4.5. Revenue allocation towards purchase and usage patterns that create more damage to the environment. Economic theory suggests that the optimal tax The use of revenues generated through road transport policies on a company car should be based on the total net cost for the that correct externalities has important welfare and distributional company of providing the car to the employee. This is the case in consequences, and is ultimately one of the determinants of the the US but not in many other countries (Gutie´rrez-i-Puigarnau & political acceptability of these policies. Revenues can be redis- van Ommeren, 2007). The tax treatment of employer provided tributed as lump-sum subsidies, to counteract the regressive transport benefits in kind (such as company cars, reimbursement impacts of the policy itself. They can thus be used to cut labour/ of commuting business related travel expenses) is an important income taxes or other distortionary taxes, or be earmarked for factor directly affecting modal choice and travel behaviour at large investment in specific sectors, in particular, the transport sector. (Knight et al., 2000). This has significant impacts on road trans- Earmarking revenues means that the revenues generated port emissions control, especially in countries where company through a tax program will be used towards specific pre-defined cars have a high share (e.g. the UK) and in urban centres where projects. Earmarking can increase the political acceptability of travellers commute long-distances. In some countries, commuting certain policies; it can establish a link between tax and use of expenses can be deducted from taxable income. a resource if, for example, road taxes are spent on roads projects; it The tax on a company car can be based on the fuel economy, is also a way to ensure a stable revenue flow to government needed engine size or on the vehicle’s CO2 emissions, the latter being for undertaking desirable governmental functions. However, ear- currently the case in the UK (UK Inland Revenue website, Gross marking revenues hampers flexibility for the government, since it Heptonstall, Anable, Greenacre, & E4tech, 2009, Evidence Table: may prevent adaptation to changing conditions or to a greater Company Car Tax). Another key issue is the tax treatment of car amount of available information. Earmarking may also allocate purchase by companies, because it directly affects the incentives of revenues in an inefficient way, or to projects that have lower the company to provide the car in the first place. The extent to priority (Santos, 2005). Funds may be misallocated among func- which the purchase price can be treated as a capital allowance and tions, and a lack of periodic review may leave systems in place the amount of yearly allowable writing-down against corporation beyond the necessary time (Knight et al., 2000). However, tax is also important, as is the treatment of value added tax (VAT) Bracewell-Milnes (1991) argues that in an imperfect world, ear- on purchase and VAT on fuel as a recoverable or not-recoverable marking can serve as an instrument for better decision-marking, for input tax. instance, earmarking can solve policymakers’ time inconsistency Some employers provide company cars, free parking spaces, or problems to some extent (Marsiliani & Renstrom 2000). public transport passes to the workplace (Knight et al., 2000). The When a government does not have any need for raising addi- tax treatment of these benefits in kind is important in strength- tional revenue or when it can use lump-sum taxes, economic theory ening or weakening these incentives on the basis of environmental suggests that taxation for environmental damage should equal considerations. Taxation of employer provided parking as a benefit marginal external costs. When the government needs additional would be an important tool to reduce employers’ subsidies to revenues, environmental taxes may be raised above the marginal automobiles. However, there could be valuation issues, since some damage (Fullerton, 1997). Along these lines, West and Williams employers may provide parking on private premises that could not (2007) show that since petrol is a complement to leisure, the be profitably used for other purposes. An alternative to taxation optimal petrol tax is much higher than the marginal external cost. would be the requirement of employers to provide monetary Early research suggested that environmental taxes can generate benefits (parking ‘‘cash-outs’’) for employees who decide not to a ‘‘double dividend’’. This refers to the idea that not only do envi- take advantage of the free parking places (DeCorla-Souza, 2004; ronmental taxes correct a market failure, but they also generate Toder, 2007). Making employer provided public transport passes revenues which can be used to reduce distortionary taxes. Pearce a non-taxable benefit could be an option to encourage modal shift (1991) emphasises the role of the double dividend argument in towards public transport. However, this policy need not be the most carbon taxation policy, as ‘the corporate and public acceptability of cost efficient, and may raise equity issues (Di Domenico, 2006), as it such a tax is greatly enhanced if the tax is introduced as part of targets only a (relatively wealthy) share of the population. a ‘‘package’’ of fiscally neutral measures’ (Pearce, 1991, p. 940). Furthermore, under-taxation of one benefit to compensate for under-taxation of a substitute benefit need not be the right approach. Di Domenico (2006), for example, argues that correcting 58 For more on the tax treatment of commuting and work-related expenses, see the under-taxation of employers’ provided parking spaces in Baldry (1998), Richter (2006) and Wrede (2001, 2003). G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 29

However, later analyses have refined the notion of the ‘‘double credits instituted by the US EPA in the 1980s to facilitate the phase- dividend’’ (Goulder, 1995). In particular, we can differentiate down of lead in petrol, cap-and-trade has not been implemented in between ‘‘weak’’ and ‘‘strong’’ versions of the concept. The ‘‘weak’’ the road transport sector in any country or region to date. Its version, broadly supported by empirical literature, refers to the idea application has been and still is contemplated and debated, to deal that reducing distortionary taxation using carbon tax revenues leads mainly with congestion and emissions, and in particular with CO2 to greater welfare gains than would be achieved through lump-sum emissions. In this section we concentrate on IB policies that have redistribution (Parry, 1994; Goulder, 1995). The ‘‘stronger’’ version been implemented, and thus, we focus on fiscal measures and omit contends ‘that revenue neutral swaps of environmental taxes for permits. ordinary distortionary taxes involve zero or negative gross costs’ Taxes and charges on road transport are used extensively (Goulder, 1995, p. 157). Numerical evidence for the strong form, throughout the developing and developed world. From an economic however, is mixed at best (Goulder, 1995). Parry and Bento (2000) point of view, Pigouvian fiscal measures can correct externalities show that, under certain circumstances, a revenue-neutral emis- and achieve efficient levels of traffic (and therefore congestion and sions tax, whose revenues are recycled to reduce income taxes, emissions).61 This, however, has not historically been the reason for could produce a double dividend.59 The reasons for the failure of the the introduction of taxes and charges, which existed even before any ‘‘strong’’ version of the double dividend arise from general equi- concerns regarding externalities in general, and climate change in librium analysis. Environmental taxes applied to inputs60 exacer- particular, were raised. Governments need funds, not just to build bate the distortions created by labour taxes, thus imposing costs that and maintain roads, but also to provide other public goods and more than offset the benefits of tax substitution (Parry,1994). This is services, such as defense, education and health care. Road transport due to the fact that taxing a polluting input through environmental increasingly became an excellent source of revenues, regardless of taxes will distort the production mix (Bovenberg & Goulder, 1997). any consideration of negative externalities. As a consequence, the double dividend feature of corrective taxes Nevertheless, road taxes and charges have helped (perhaps does not completely hold, if interpreted to mean that the taxes on unintentionally) to reduce excessive levels of negative externalities. dirty goods should be increased more on top of the environmental This is not to say that they have been designed to reduce them or externality than the taxes on clean goods to generate revenues that they have reduced them to their efficient levels. (Fullerton, 1997). The interdependency effect between corrective In what follows, we collate evidence of different types of road and distortive taxes works to reduce welfare (Parry,1994). It follows transport taxes and charges applied in different countries, their that the difference between the optimal tax on a dirty good and the relative differences and, to the extent which is possible within optimal tax on a clean good in a world characterised by distortionary a review, their impact. taxes is below the Pigouvian tax, i.e. below the marginal environ- mental cost (Bovenberg & de Mooij, 1994; Fullerton, 1997). An environmental tax will be less desirable as a way to finance public 5.1. Taxes on purchase and ownership of a vehicle spending the larger the efficiency cost on the economy of existing taxation (Bovenberg & Goulder, 1996). An alternative taxation 5.1.1. Purchase and registration taxes schedule consists of a combination of higher taxes on labour with All European countries levy a value added tax (VAT) on the a subsidy to clean goods (Fullerton, 1997). purchase of new motor vehicles, just as they do on purchases of most goods and services. VAT rates vary between 15 per cent and 25 per cent, with Denmark, Hungary and Sweden at the higher end. 4.6. Concluding remarks Many countries also levy a registration tax, based on the pre-tax price, fuel consumption, cylinder capacity, CO emissions and/or Taxes act as incentives (or disincentives) on behaviour by 2 other emissions, and vehicle length (European Automobile increasing the marginal cost of certain activities. Corrective or Manufacturers’ Association, 2009a, p. 1).62 Pigouvian taxes close the difference between marginal private and Registration taxes are typically charged when the vehicle is marginal social cost. Their effectiveness depends on the strength of registered for the first time. The exceptions are Belgium and Italy, the link between the externality they are aimed at correcting and where the registration tax is levied every time the vehicle changes the tax itself. ownership (Knight et al., 2000, p. 37). Kunert and Kuhfeld (2007,p. There are many types of taxes and charges in the road transport 309) show that registration taxes exhibit great variations across sector. These include taxes on purchase and ownership of a vehicle countries, with Denmark, Ireland, Malta and Norway imposing the and taxes on usage of a vehicle, such as emission taxes, fuel duties, highest registration taxes in Europe. distance travelled taxes, congestion and parking charges, and pay- Ryan, Ferreira, and Convery (2009) conduct a study for the EU- as-you-drive insurance. Also, subsidies to efficient vehicles can be 15 and find that registration taxes are significant in purchasing used in combination with feebates and/or scrappage incentives, to decisions (especially regarding the decision of whether to buy help consumers decide towards cleaner vehicles, even when these a petrol or diesel car) when the specificities of each country are more expensive than more polluting ones. (country fixed effects) are ignored, but they stop being significant The use of revenues generated through these taxes has impor- when country fixed effects are included in the model (pp. 372–373). tant welfare and distributional consequences, and may help They also find that registration taxes are not significant in changing increase public and political acceptability. average vehicle CO2 emissions (p. 372) and highlight the fact that registration taxes in the EU are levied mainly on cars and that such 5. Taxes and charges in the road transport sector taxes apply at reduced rates, if at all, to commercial vehicles like buses, vans or lorries (p. 36). Except for the very early attempts of credit and permit systems in the US, including the inter-refinery averaging and banking of

61 Note that, as explained in Section 1, the efficient level is not zero, but that at which marginal social costs and marginal social benefits are equal. 59 It must be noted, however, that this result is particular to the US, and need not 62 Bulgaria, the Czech Republic, Estonia, Germany, Lithuania, Luxemburg, Slovakia, apply to other countries, such as the UK. Sweden and the UK do not have any registration tax (European Automobile 60 Fuelisalsoaninputtoproductiontotheextentthatitisusedbycommercialvehicles. Manufacturers’ Association, 2009a, p. 1). 30 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45

The case of Singapore is worth highlighting, as it has very high 5.1.3. Subsidies to efficient vehicles and feebates ownership taxes. On top of the COE described in Section 2, A showcase example of this type of subsidies is the ‘ecoauto motorists need to pay the Additional Registration Fee (ARF). The Rebate Program’, which was run in Canada between March 2007 ARF is an ad valorem duty on a vehicle’s open market value63 and March 2009. The idea behind it was to encourage Canadians to payable by buyers of new motor vehicles, in addition to an buy new fuel efficient vehicles. administrative fee, referred to as the Basic Registration Fee. The ARF Eligible vehicles included cars with fuel efficiency of 6.5 litres rate was raised through the 1970s, reaching 125 per cent in 1978 per 100 km or better, vans with fuel efficiency of 8.3 litres per and 150 per cent in 1980 (Santos, Li, & Koh, 2004). However, as the 100 km or better, and flex-fuel vehicles, running on a combination ARF rate rose, it also discouraged existing vehicle owners from of petrol and ethanol, with a combined fuel consumption rating of replacing their cars and encouraged new car buyers to buy used 13 litres per km or better (Banerjee, 2007, p. 2).66 cars. Concerned with a stock of aging vehicles, when the applicable During the two years that the program operated, applicants who ARF rate was raised to 100 per cent in 1975, the government purchased or leased (12 months or more) eligible 2006, 2007 and introduced a Preferential Additional Registration Fee (PARF) to 2008 model-year, fuel efficient vehicles, could apply for and receive counterbalance the disincentives on vehicle renewal. The purchaser rebates ranging from CA$1000 to CA$2000 (£502–£1004 or V655– of a new vehicle paid a substantially lower PARF rate if he V1310 or $925–$1850).67 By the time the program finished it had de-registered an old vehicle (i.e. by exporting or scrapping it) of issued over 167,000 rebates, amounting to CA$187.7 million the same engine category at the time of his new purchase. (Transport Canada website). Since 1997, the PARF has been amended to a system where the The rebate was combined with a tax on fuel inefficient vehicles, applicable discount is a function of the age of the vehicle to be the Green Levy, which started at CA$1000 for vehicles with fuel de-registered.64 Vehicles older than ten years no longer qualify for (in)efficiency of between 13 and 14 litres per 100 km and increased in PARF treatment. CA$1000 steps for every litre in consumption up to 16 litres per 100 km, at which point the tax was capped and all vehicles using 5.1.2. Ownership taxes 16 litres per 100 km or more paid a maximum tax of CA$4000 Annual ownership taxes, sometimes also called annual circu- (Banerjee, 2007,p.2). lation taxes or vehicle excise duties, are levied in most countries, The impact of the program on new vehicle purchases and usually on private and commercial vehicles. In Europe, the criteria emissions has not been published by the Canadian Government yet, to set these taxes vary across countries. For cars these include and therefore it is difficult to assess its success. cylinder capacity, fuel efficiency, vehicle age, gross weight, CO2 and/or other emissions; and for commercial vehicles, which tend to 5.1.4. Scrappage incentives be heavier and damage roads more, these depend mainly on A number of European countries have scrappage schemes in weight and axles, although also on noise and CO2 and/or other place. In December 2007 France introduced a system of bonuses emissions (European Automobile Manufacturers’ Association, and penalties on the purchase of new vehicles with a bonus 2009a, p. 2). between V200 and V5000 on vehicles emitting less than 130 In the UK, for example, vehicle excise duties levied on cars grams of CO2 per km and penalties between V200 and V2600 for registered on or after 1 March 2001 depend on the amount of CO2 vehicles emitting more than 160 grams of CO2 per km. The system emitted by the automobile (Driver and Vehicle Licensing Agency, also included a ‘‘super-bonus’’ - a scrappage scheme offering an 2009). Excise duties have varied over the years. The levels additional incentive of V300 for scrapping a car more than fifteen applying from 1 May 2009 are as follows. If the car emits less than years old. In December 2008, as part of an economic stimulus 100 grams per km the vehicle is exempt from vehicle excise duty. program, the policy was reviewed, increasing the ‘‘super-bonus’’ Cars emitting between 101 and 120 grams per km are charged £35 to V1000, and extending it to include the scrapping of cars more (V40, $56)65 per year, cars emitting between 121 and 140 grams per than ten years old and the purchase of new vehicles emitting less km are charged £120 (V138, $193) per year, cars emitting 141–150 than 160 grams of CO2 per km. The maximum total bonus under grams per km are charged £125 (V144, $200) per year, and cars the revised scheme is V2000, which would be attained by emitting 151–165 grams per km are charged £150 (V173, $241) per replacing an old vehicle by one emitting less than 100 grams of year. The charge continues to increase with the CO2 emitted per km CO2 per km (French Ministry for the Environment, Energy, and reaches a maximum of £400 (V461, $642) per year when CO2 Sustainable Development and the Sea website). In Germany the emissions exceed 226 grams per km (Driver and Vehicle Licensing incentive is V2500 for scrapping cars older than nine years and Agency, 2009). buying new fuel efficient cars, which are required to satisfy the Some European countries, however, do not levy any annual tax. Euro 4 criteria on emissions (German Federal Ministry of These include the Czech Republic, Estonia, France, Lithuania, Poland, Economics and Technology, 2009). Slovenia and Slovakia (European Automobile Manufacturers’ The scrappage scheme in the UK was launched on 18 May 2009 Association, 2009a, p. 2). and will last until the end of February 2010, or until the £300 Ryan et al. (2009, p. 373) find that annual ownership taxes, in million (V346 m; $482 m) funding is exhausted (if this occurs first), contrast with registration taxes, show a strong impact on total new offers an incentive of £2000 (V2307; $3212) to scrap a car over ten car sales in Europe. Consumers seem to be more sensitive to taxes years old and buy a new one, where £1000 of this incentive is they will pay every year for as long as they own the vehicle than to provided by the government and £1000 from the vehicle manu- one-off registration taxes. facturer. The scheme, not specifying any restrictions on the new

63 The open market value is essentially similar to Cost plus Insurance and Freight 66 These numbers are equivalent to 15.4 km per litre for cars, 12 km per litre for (CIF). It includes purchase price, freight, insurance and all other charges incidental vans, and 7.7 km per litre for flex-fuel vehicles. The only eligible vehicles for the to the sale and delivery of the car to Singapore. rebate in Canada, however, were essentially either hybrid or compact, or running 64 This is a common feature with scrappage incentives, discussed in Section 5.1.4. on a combination of petrol and ethanol. 65 The average exchange rate in the period May-July 2009 was £1 ¼ V1.15 ¼ $1.6 67 The average exchange rate in the period Mar 2007 - Mar 2009 was CA$1 ¼ £0.5 (IMF Exchange Rate Query Tool). ¼ V0.65 ¼ $0.93 (IMF Exchange Rate Query Tool). G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 31 car’s CO2 emissions, is mainly intended to provide a short-term 1999, p. 344). These, however, failed due to strong opposition from boost to the demand for cars (UK Department for Business, industry and several member states (Richardson, 2002, p. 194). Innovation and Skills website). There are some countries in Europe that have implemented Other European countries, including Austria, Cyprus, Italy, Lux- a carbon tax, but the efforts have never been coordinated or agreed emburg, Portugal, Romania, Slovakia, Spain and The Netherlands at EU level. These countries are Finland, which introduced a carbon have also introduced scrappage schemes (European Automobile tax in 1990, Sweden and Norway, in 1991, the Netherlands in 1992, Manufacturers’ Association, 2009b, website). Although many Denmark in 1993 (Richardson, 2002, p. 194), and Italy, in 1999. of the scrappage schemes in Europe specify conditions regarding Although most countries argue that these carbon taxes have CO2 emissions, the main reason for the proliferation of these decreased CO2 emissions to some extent (Vehmas, 2005, p. 2180), incentives is the economic and its impact on the car looking at Fig. 3 it is evident that the carbon tax component of the industry. petrol and diesel duties have not made them significantly different While many countries in Europe have been keen to adopt from those applied in other countries. scrappage schemes, these schemes have not been limited to Europe. In July 2008 British Columbia in Canada implemented a carbon In the US a scrappage scheme was introduced with the signing into tax (British Columbia Ministry of Small Business and Revenue, law of the Consumer Assistance to Recycle and Save Act of 2009, by 2008). It started at CA$10 (£5, V6.4, $9.4)72 per tonne of carbon 73 President Barack Obama in June 2009 (US NHTSAwebsite c). The Car dioxide equivalent (CO2e) and will rise by CA$5 per year reaching Allowance Rebate System (CARS),68 is an incentive scheme which CA$30 in 2012. The petrol tax will then reach 7.24 Canadian cents aims to both stimulate car and lorry sales while also removing older per litre (British Columbia Government website), equivalent to 4.6 and less fuel efficient vehicles from the roads. The scheme offers an Euro-cents, which represent a very small increase relative to the incentive of either $3500 (£2141; V2491) or $4500 (£2753; current tax component of 22 Euro-cents shown on Fig. 2. V3203)69 for the purchase or long-term lease (minimum 5 years) of a new vehicle, when they trade in their old vehicle. The incentive 5.2.2. Fuel taxes depends on the type of vehicle and the difference in fuel economy Although fuel taxes are in place in most countries, they vary between the new vehicle and the one traded in. The car or van widely from one to another. In fact, no other product seems to be traded in must be 25 years old or newer and have a combined city/ subject to such divergent treatment (Gupta & Mahler, 1995, p. 101). trunk road fuel economy of 18 miles per gallon (7.7 litres per km) or Fig. 2 shows unleaded petrol taxes and prices for OECD countries less.70 The scheme will run until 1 November 2009, or until the $1 during the third quarter of 2008 in V per litre. billion allocated to it by the federal government runs out (US NHTSA As it can be easily seen from Fig. 2, Mexico and the US have website c). remarkably low petrol taxes, when compared to the rest of the The Japanese government’s stimulus package approved by the OECD countries. Unsurprisingly there is not that much difference in Japanese Cabinet in April 2009 includes a scrappage scheme as well the pre-tax price across countries, except, as expected, for Mexico. as incentives for the purchase of environmentally friendly vehicles There is, however, considerable variation regarding taxes. without scrapping requirements. The vehicle replacement incen- Fig. 3 shows fuel duties for the same countries, expressed as tive scheme applies to cars and mini-vehicles as well as lorries, percentage of pre-tax price. It should be noted that these shares requiring the scrapped vehicles to be at least 13 years old. For cars change with the pre-tax price, increasing when oil prices decrease in the standard and small categories the subsidy upon replacement and decreasing when oil prices increase (Newbery, 2005a, p. 6). of an old car by one meeting the 2010 fuel efficiency standards is Most countries have fixed petrol and diesel taxes, rather than ad U250,000 (£1647; V1884; $2588)71 per vehicle (Japan Automobile valorem. The advantage of this practice is that stable revenues are Manufacturers’ Association website). guaranteed regardless of world oil prices. In order to keep a constant revenue flow, governments would need to adjust ad valorem taxes 5.2. Taxes on usage of a vehicle every time there was an important change in oil prices. Gupta and Mahler (1995, p. 103) point out that ‘if the international price of 5.2.1. Emission taxes the product is subject to wide variations, the quantities of petroleum As discussed in Section 4.2.1, although these would be the first products consumed may be more stable than the value of the best instrument to internalise CO2 emissions from road transport, petroleum product consumed’ and in that case revenues from direct charging for emissions is not feasible under current tech- a specific tax would be more predictable and stable, while revenues nology due to a lack of cost effectiveness and impracticability of from ad valorem taxes would be more elastic. On the other hand, ad monitoring techniques. valorem taxes are automatically adjusted with inflation whereas There is a very good proxy for emission taxes, however, that fixed rates need to be adjusted to keep up with changes in domestic would be virtually as effective: a carbon tax. This would be a tax on prices and exchange rates, if the real value of taxes is not to be eroded the carbon content of the fuel in question or on the estimated CO2 through inflation (Smith, 2006). In the EU inflation and exchange emitted in the fuel combustion process. The idea of a carbon tax, rates are not volatile, and hence the preferred practice of fixed fuel however, has frequently encountered public and political opposi- duty rates does not pose the inconveniences it may pose in devel- tion, even more so than the idea of a cap-and-trade system. In 1992, oping countries. 1995 and 1997 the European Commission advanced proposals for Issues related to inflation and exchange rate volatility, however, a European carbon tax (Vehmas, Kaivo-Oja, Luukkanen, & Malaska, can be a problem in African countries, for instance. Metschies (2001,inSmith, 2006) argues that in countries where the domestic is substantially devalued, regulated fuel prices 68 In the US this type of scheme is usually referred to as Cash for Clunkers. 69 The average exchange rate in the period June-July 2009 was $1 ¼ £0.6 ¼ V0.7 (IMF Exchange Rate Query Tool). 70 The requirements for work lorries are different and the CARS Act limits the amount of funds that can be used to provide credits for purchases or leases of 72 The average exchange rate in the period Jan-Dec 2008 was CA$1 ¼ £0.51 ¼ V0. work lorries to 7.5 per cent of the funds available for the program. 64 ¼ $0.94 (IMF Exchange Rate Query Tool). 71 The average exchange rate in the period April-July 2009 was £1 ¼ U152 ¼ V1.14 73 Using a stoichiometric conversion factor of 44/12 ¼ 3.6667, this is equivalent to ¼ $1.57 (IMF Exchange Rate Query Tool). CA$ 2.23 per tonne of carbon. 32 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45

Turkey Norway Netherlands Belgium United Kingdom France Germany Portugal Denmark Italy Finland Sweden Austria Pre-tax price Tax component Korea Poland Slovak Rep. Ireland Hungary Luxembourg Czech Rep. Spain Switzerland Japan Greece New Zealand Australia Canada United States Mexico 0 0.25 0.5 0.75 1 1.25 1.5 1.75 2

Fig. 2. Unleaded petrol taxes and prices for OECD, V per litre (3rd quarter 2008 or latest available). Note: Tax includes both fuel duty and VAT (or equivalent sales tax). In some countries, like in the US, both federal and state taxes apply. In these cases, the graph shows state and federal taxes as weighted averages, based on petrol sold in all states (International Energy Agency, IEA, 2008, p. 296) (An average fuel tax in the US of 8.6 Euro-cents per litre of unleaded petrol for the third quarter of 2008 is equivalent to 50 cents per gallon). Source: IEA (2008), Fig. 8, p.xxxiv.

(and taxes) fall relative to world prices, and the government loses the VAT, the fuel duty is left to cover the external costs from road real revenues, effectively providing a subsidy to drivers. transport that may be deemed worth internalising through fuel Fig. 4 shows fuel duty as a percentage of pre-tax fuel prices for duties. some selected Sub-Saharan countries. 1991 is the last year for Parry and Small (2005) develop a model that estimates the which data was available. For poor and/or developing countries, it is optimal fuel tax and theycalibrate such a model for the US and the UK. not unusual to find contradictory information in different sources The externalities they include are damage from CO2 emissions and air regarding fuel tax rates. pollution, congestion and accidents. They conclude that for the year From Figs. 3 and 4, it is puzzling that countries so close to each 2000 the optimal petrol tax in the US would have been $1.01 per US other geographically and some times members of the same gallon (26 cents, 28 Euro-cents,17 pence per litre),74 more than twice economic community, have such variations in fuel duty rates across the actual rate for that year, and the optimal petrol tax in the UK them. would have been $1.34 per US gallon (35 cents, 38 Euro-cents, 23 Newbery (2005a, p. 6) points out that the European Commission pence per litre), slightly less than half the rate for that year (p. 1283). aims at harmonising energy taxes within the EU and that a Euro- Newbery (2005b, Table 7.3, p. 217) finds that the external costs pean approach to reducing emissions requires that each country of road damage,75 air pollution, global warming, water pollution and GHG source face the same charge per tonne of carbon. The and noise in the UK in 2000 amounted to 36 pence per litre of argument is perfectly reasonable from an economic point of view, since, as explained in Section 1, marginal abatement costs need to be equalised across polluters to achieve efficiency. The EU therefore faces the challenge of getting all its member states to agree on 74 a uniform rate of petrol and diesel taxes. The average exchange rate in the period Jan-Dec 2000 was $1 ¼ V1.08 ¼ £0.66 (IMF Exchange Rate Query Tool). The next question is what this uniform rate ought to be. Should it 75 Newbery (2005b) points out that the damage per litre of fuel varies across be at the lower end, like the one applied in Greece, or at the higher vehicle types and ages, and although the vehicle excise duty can be fine-tuned to end, as in the UK? If the revenue raising component of fuel taxes is allow for those differences, fuel duties cannot. G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 33

Germany United Kingdom Finland Netherlands France Sweden Turkey Norway Italy Belgium Portugal

Denmark Slovak Rep. Ireland Poland Hungary Switzerland Czech Rep. Petrol Diesel Luxembourg Korea Austria Spain Greece Japan New Zealand Australia Canada United States

0 20 40 60 80 100 120

Fig. 3. Fuel duties as percentage of pre-tax price for OECD countries (3rd quarter 2008)*. Note: Canada does not have any duty on diesel and New Zealand’s duty on diesel is only 0.3 per cent of the pre-tax price. Source: Own calculations using IEA, (2008)*or latest available.

petrol.76 Since the fuel duty in the UK for the year 2000 was 48.8 warming externality seems to have already been internalised, pence per litre (UK DfT, 2008, Table 3.3, p. 53) it can be concluded which would make substantial increases in tax rates inefficient that the fuel duty more than covered those externalities. from an economic point of view. CO2 emissions from road trans- Both Newbery (2005b) and Parry and Small (2005) conclude port in these countries are probably lower than they would have that the UK had a fuel duty that more than covered the environ- been had no such high taxes been in place (Sterner, 2007), but mental costs of petrol. The numbers could be easily updated to they still seem to be too high to meet the various commitments 2009 and the same conclusions would be reached. that different governments have adhered to. The only way to This is the kind of analysis that would need to be done when defend higher fuel tax rates would be to use a much higher trying to agree on a harmonised European rate of fuel duties. shadow price of carbon, and this in turn would need to be justi- Smith (2006) highlights an additional problem resulting from fied by the type of models mentioned in Section 1. The effects such large differences in fuel duties across African countries. He from climate change can only be modelled (not predicted with explains that if neighbouring countries in Africa have very different certainty) and this modelling process involves making a large fuel taxes, this can lead to problems of smuggling and some number of assumptions regarding possible impacts and adapta- diversion of activity. Harmonisation even in poor countries makes tion, discount rates and other parameters. sense, if only to address the problems of smuggling, reduced fuel It is also worth bearing in mind that there are countries with tax revenues, and diversion of transport routes and economic significant scope to increase fuel taxes, especially when the idea of activity to regions where taxes are lower. harmonisation is brought into the discussion. It is worth keeping in mind that in the UK, and probably in other countries with comparable fuel tax rates, the global 5.2.2.1. Fuel duty differentials 5.2.2.1.1. Diesel vs. petrol taxation. It is evident from Figs. 3 and 4 that diesel is often favoured by governments relative to petrol. The 76 Note that Newbery (2005b) excludes accidents and congestion from these reasons for and against this were discussed in Section 4.2.2.1. calculations. 34 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45

Senegal

Angola

Ivory Coast

Cameroon

Uganda

Mauritius

Burkina Faso Petrol Diesel Rwanda

Namibia

South Africa

Ethiopia

Mozambique

Malawi

Madagascar

Botswana

Tanzania

Lesotho

Zimbabwe

Swaziland

Zambia

Nigeria

0 50 100 150 200 250 300

Fig. 4. Fuel duties as percentage of pre-tax prices for selected Sub-Saharan countries for 1991. Source: Smith (2006, Table 5.2).

Newbery (2005a, p. 29) points out that similar tax rates on A few years later, the differential duty on unleaded petrol and petrol and diesel can be compensated with differentiated vehicle ultra-low sulphur petrol followed in the UK. In October 2000 the excise duties, by charging higher duties to heavy goods vehicles, fuel duty on ultra-low sulphur petrol, which at the time was diffi- which cause more road damage and run on diesel. cult to find at petrol stations, was cut down by 1 penny per litre. In Ryan et al. (2009) find that when diesel fuel prices and diesel March 2001 it was further cut down by two pence. The pump- vehicle taxes are high, the share of petrol vehicles increases, prices were 78.2 and 75.9 pence per litre (UK DfT, 2008, Table 3.3, although these impacts disappear when the specificities of each p. 53). At that point most drivers switched from unleaded petrol to country are controlled for. The reason for this, they argue, might be unleaded ultra-low sulphur petrol, and by 2006 unleaded petrol that fuel and vehicle taxation are political decisions and, as a result, was eventually phased out. the favouring or not of diesel cars and fuels is determined by country and is a fixed country effect (p. 371, p. 373). 5.2.3. Vehicle km travelled taxation Whatever the reason for governments to favour diesel in their Switzerland introduced a Heavy Vehicle Fee (HVF) in January tax policy, diesel passenger car market penetration in the EU was 2001, which applies to lorries over 3.5 tonnes. The HVF varies with 40 per cent in 2003, with Austria and France reaching 60 per cent their gross weight, kilometres driven within Switzerland, and (Zervas, Poulopoulos, & Philippopoulos, 2006, p. 2848). The emission category of the model (Suter & Walter, 2001, p. 383). percentage penetration for that year was at least 30 per cent in The fee is collected with the help of on-board units, which every EU-15 country, with the exception of Ireland, Finland, record distances driven and routes taken. At the end of each month Sweden and Greece where it was 17 per cent, 13.6 per cent, 7 per the data are transmitted to the Swiss Customs Agency either by cent and 1 per cent, respectively (Zervas et al., 2006, p. 2850). mail or over the Internet. This information is used to generate a bill 5.2.2.1.2. Cleaner fuels. Governments can use taxes to incentivise that is sent to the vehicle owner. motorists to switch to cleaner petrol, when this becomes available in As a result, the total volume of goods transported by road the market. The main economic advantage of this type of taxes is that through the Alps increased by 3 per cent but lorry trips declined 14 they leave the user to decide how best to respond, rather than per cent between 2000 and 2005, indicating that pricing encour- forcing him to choose one fuel. In the UK for example, the higher tax ages more efficient use of lorry capacity. on leaded than on unleaded petrol, raised the proportion of motor- ists buying unleaded petrol from five per cent in 1988 to 63 per cent 5.2.4. Congestion charges by 1993 (Newbery & Santos, 1999, p. 117). Similarly, in Sweden the Although congestion charging has been advocated by transport tax differential between leaded and unleaded petrol decreased the economists for many decades its implementation has been limited. share of leaded petrol from 70 per cent in 1986 to practically zero in The main barriers are typically public and political opposition, 1994 (Ekins & Speck, 1999,p.384). linked to equity concerns. As a result, there are only a few examples G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 35 of congestion charging as of 2009. These are briefly described The State Route 91 (SR-91) Express Lanes, which opened in below. December 1995, were the first practical example of in the US (Sullivan & El Harake, 1998). 5.2.4.1. Norwegian toll rings. The Norwegian toll rings, very often Although they were originally privately operated, in January cited in the road pricing literature as examples of congestion 2003 their operation was taken over by the Orange County Trans- charging, were designed to generate revenues to finance infra- portation Authority. The SR-91 Express Lanes, which extend 10 structure. The aim was not to manage traffic demand. Nonetheless, miles (16 km) operate between the Orange/Riverside county line since it has become common practice to bring them into any and the Costa Mesa Freeway (SR-55) interchange in eastern discussion on congestion charging, they deserve a mention. Anaheim. Since the late 1980s - early 1990s a number of towns in Norway, Tolls apply 24 h a day, 7 days a week, with the lowest one being including Oslo and Bergen amongst others, have tolls, usually $1.25 and the highest one, $9.50 (Orange County Transportation surrounding the whole town rather than the city centre, with daily Authority, 2008). charges which never exceed NOK 20 (roughly £2 or V2.2)77 for cars As of 2009 there are an additional seven HOT lane projects in and light vehicles. All schemes in Norway have flat rates 24 h a day operation in the US, which have been partly funded by the Value every day, except for Namsos, where the scheme only operates Pricing Pilot program or by its predecessor, the Congestion Pricing Monday to Friday, from 6:00 a.m. to 6:00 p.m. Pilot Program. Projects include segments of the I-15 in San Diego, Since the original aim of these toll rings was not to reduce traffic California (implemented in 1996), the I-25 in Denver, Colorado levels and congestion, the decrease in demand for car travel has (implemented in 2006), the I-394 in Minneapolis, Minnesota been low, with estimates varying from zero to 10 per cent reduction (implemented in 2005), the Katy Freeway (I-10) and the US 290 in at most. Similarly there have been no significant changes in private Houston, Texas (implemented in 1998 and 2000 respectively), the I- car occupancy rates or demand for public transport (Ramjerdi, 15 in Salt Lake City, in Utah (implemented in 2006), and the SR 167 Minken, & Østmoe, 2004). in King County, Seattle, Washington (implemented in 2008). The individual designs vary, and tolls range from 50 cents to $9. In some 5.2.4.2. Toll highways. There are a number of toll highways cases tolls apply in the morning peak, in others in the afternoon around the world. Although the only objective of many of these peak, and in others they change in real time with traffic demand. In schemes is to generate revenue, some also aim at relieving this case, drivers are informed of the toll rate changes through congestion. Examples include the M6 Toll in England, the 407 variable message signs located in advance of the entry points. Express Toll Route (ETR) in Toronto and a number of roads in An advantage of HOT lanes over other congestion charging major Australian cities, such as for example, City Link in Mel- systems is that with HOT lanes drivers ‘can choose between bourne and the Westlink M7 Toll Road in Sydney. In all these meeting the vehicle occupancy requirement or paying the toll in cases the toll highways are in privately owned or managed. order to use the HOV lane’ (DeCorla-Souza, 2004, p. 288). Drivers have the option of choosing between the toll road with lower journey times and the publicly provided alternative with 5.2.4.4. Singapore. In 1975, congestion pricing was implemented in higher journey times. Singapore. The system was a paper-based area licensing scheme The M6 Toll in England is a parallel78 segment to the M6 (ALS). Vehicles had to purchase a licence and display it on their motorway, which extends 27 miles (43 km). Drivers have the windscreen before entering the restricted zone (RZ). The charge option of using the publicly provided alternative for free or using was per day, not per entry, meaning that they could enter and leave the toll road. The M6 toll runs from junction 3a on the M6 and the RZ an unlimited number of times during the day. Exemptions rejoins it at junction 11a. Charging is done at toll plazas along the included police cars, ambulances, fire engines and public transport road or at the exit and is not electronic. buses. Motorcycles, goods vehicles and carpools were initially The Highway 407 ETR in Toronto extends 67 miles (108 km) exempt, but from 1989 onwards they were also required to buy from Brock Road in Pickering in the east to the QEW/403 inter- a licence (Chin, 2002). No discounts or exemptions were given for change near Hamilton in the west. The 407 ETR charges tolls residents living inside the RZ, although driving inside the zone electronically, based on distance driven. without crossing the boundary could be done for free. The hours of The City Link in Melbourne is a toll road in the centre of Mel- charging and the levels of the charges varied throughout the years. bourne in Australia, which extends 14 miles (22 km), from Tulla- They started with the morning peak Monday to Saturday, but later marine Freeway to the West gate Freeway and the West Gate included the inter-peak period, from mid-morning till middle Freeway to the Monash Freeway. The system operates electronically afternoon, and the evening peak. Drivers could purchase a whole- and charges per trip made along the toll segment. day licence, which allowed them to drive inside the RZ at any The Westlink M7 Toll Road in Sydney extends 35 miles (40 km), time during the hours of operation of ALS, or a part-day licence, connecting the M2, M4 and M5 motorways. It operates electroni- which only allowed them to drive during the inter-peak hours on cally and charges per distance driven. weekdays and the post-peak period on Saturdays. The system was manually enforced by enforcement officers 5.2.4.3. High occupancy toll lanes in the US. High Occupancy Toll standing at the boundaries of the RZ, and was thus prone to error. (HOT) lanes in the US are lanes where tolls are applied on low The impacts on traffic were drastic. Phang and Toh (1997, p. 99) occupancy vehicles wanting to use lanes which are free to use for report that the introduction of ALS increased average speeds from high occupancy vehicles (HOV). High occupancy is usually defined 11.8 to 22.4 miles (19–36 km) per hour, exceeding the government as vehicles with two or more occupants. target of 12.4–18.6 miles (20–30 km) per hour. According to Willoughby (2000, p. 10), traffic volumes during the morning peak hours fell by 45 per cent, well above the expected reduction of 25– 30 per cent. Car entries were reduced by 70 per cent. This project was for many years the only congestion charging 77 The average exchange rate in the period Jan-May 2009 was NOK 1 ¼ £0.10 ¼ V0.11 (IMF Exchange Rate Query Tool). project in the world. It has to be borne in mind that Singapore is 78 It is not parallel in the strict sense, as it arcs around the north-east of the West a very special case, and as such, replication of the ALS elsewhere Midlands conurbation before re-joining the M6. would not have been straightforward. Geographically, it is an island 36 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 city-state, which measures 26.1 miles (42 km) East to West and 14.3 The CZ is relatively small. It covers roughly 15 mi2 (39 km2), miles (23 km) North to South. It has 1955 miles (3149 km) of roads representing 2.4 per cent of the total 617 mi2 (1579 km2) of Greater for a population of about 4.2 million people and 707,000 registered London. No charge is made for driving on the roads that limit the CZ motor vehicles in the year 2002 (Santos et al., 2004). Politically, and there are two free corridors: one north to south, crossing there is a dominating political party, the People’s Action Party, roughly in the middle of the CZ, and another one north-west of the which has won all the elections since 1959. zone, east to west, as the diversion route would have been too long In June 1995, a paper-based Road Pricing Scheme (RPS), oper- for drivers just wanting to cross a short segment of an A-road81 that ating in the same way as the ALS, was implemented on an falls inside the CZ. expressway (East Coast Parkway). This was later extended to other The charging zone is set to shrink. The new Mayor of London, Boris expressways. The aim of the RPS was to reduce congestion on the Johnson, who took post in May 2008, conducted a public consultation expressways during morning peak times, and to familiarise Singa- on the Western Extension between September and October 2008, poreans with both linear passage tolls and road charging outside giving the public and stakeholders the options of keeping it, the CBD (Goh, 2002). removing it or altering it. Following this consultation, in November In September 1998 Electronic Road Pricing (ERP) replaced the that same year, he announced that the Western Extension would be ALS. Rather than a licence to use the RZ, charges apply per-passage. removed, although not earlier than 2010 (Transport for London, TfL, The charging area is divided into central business districts 2008b). When this eventually happens, the new CZ will be the (including the areas previously covered by ALS), where charging original one, only 8 mi2 (21 km2), or 1.3 per cent of Greater London. applies from 7:30 a.m. to 8:00 p.m., and expressways/outer ring There are a number of exemptions and discounts, which apply roads, where charging applies from 7:30 to 9:30 a.m., Mondays to to two-wheelers, emergency vehicles, vehicles used by or for Saturdays, except public holidays. Vehicles are charged automati- disabled people, buses, taxis and mini-cabs, some military vehicles, cally on an electronic card, which is inserted in an In-vehicle Unit, alternative fuel vehicles (with stringent emission savings), roadside each time the vehicle crosses a gantry. If the charge cannot be assistance and recovery vehicles. Finally, vehicles registered to deducted from the card, either because it is not properly inserted or residents of the CZ are entitled to a 90 per cent discount when because it does not have sufficient credit, a fine is issued to the buying at least a week worth of congestion charge. Enforcement is vehicle owner. undertaken with Automatic Number Plate Recognition (ANPR), and The only exemptions include emergency vehicles, such as violators (vehicles with number plates using the CZ without having ambulances, fire engines and police cars. ERP rates vary with paid the charge) are fined. vehicle type, time of day and location of the gantry. Charges for Both the number of vehicles with four or more wheels entering passenger cars, taxis and light goods vehicles for example vary the original CZ as well as the number of vehicle-kilometres driven between S$0.50 and S$3.50,79 charges for motorcycles vary by vehicles with four or more wheels inside the original CZ during between S$0.25 and S$2, charges for heavy goods vehicles and light charging hours decreased by around 20 per cent, with most of this buses vary between S$0.75 and S$6, and charges for very heavy reduction having taken place in the first year of the LCCS and goods vehicles and big buses vary between S$1 and S$8. maintained throughout (TfL, 2007, p. 17 and Table 2.4, p. 26, TfL, In February 2003 a graduated ERP rate was introduced in the 2008a, p. 41). first five minutes of the time slot with a higher charge in order to Congestion, defined as ‘the difference between the average discourage motorists from speeding up or slowing down to avoid network travel rate and the uncongested (free-flow) network travel higher charges ( Authority website). Since the rate in minutes per vehicle-kilometre’ (TfL, 2003, Table 3.1, p. 46), graduated rate is introduced in the more expensive band, drivers decreased by 30 per cent in the first year of the LCCS. This reduction save some . For example, where the charge for passenger in congestion deteriorated over the period 2005–2007, when cars would be S$2 between 8:00 and 8:30 a.m. and S$3 between average delays eventually went back to pre-charging levels, despite 8:30 and 9:00 a.m., it is now S$2 between 8:05 and 8:30 a.m., the decrease both in the number of vehicles entering the original CZ S$2.50 between 8:30 and 8:35 a.m., and S$3 between 8:35 and 8:55 and in the number of vehicle-kilometres driven by vehicles with a.m., when it changes to S$2. four or more wheels having stayed constant between 2003 and The Singaporean ERP is the most fine-tuned road pricing system 2007. TfL gives a number of reasons explaining the increase in in the world to date. Since charges vary with vehicle type, time of congestion, including a high number of road works, particularly in day and location of the gantry and are only debited per passage, the second half of 2006, as well as during 2007 and into 2008 (TfL, they incorporate a fair degree of differentiation. 2007, point 3.2, p. 35 and point 3.10, p. 45), traffic management programs to reduce the number of road traffic accidents, improved 5.2.4.5. London. The introduction of congestion charging was bus services, and a better environment for pedestrians and cyclists a central part of Ken Livingstone’s manifesto for the mayoral elec- (TfL, 2007, p. 2). In other words, part of the newly recovered tion in May 2000. After a number of public consultations, the network space was allocated to users other than private car drivers. London Congestion Charging Scheme (LCCS) was implemented in The two main modes of public transport in London are buses February 2003. All vehicles entering, leaving, driving or parking on and the underground. The LCCS had impacts on bus use but not on a public road inside the Charging Zone (CZ) between 7:00 a.m. and underground use. The number of bus passengers entering central 6:00 p.m.80 Monday to Friday, excluding public holidays, must pay London increased by 18 per cent and 12 per cent respectively the congestion charge. This was initially £5, but in July 2005 it was during the first and second years of the LCCS, and have since settled increased to £8 per day. Payment of this charge allows road users to (TfL, 2007, p. 58, TfL, 2008a, p. 86). By the time congestion charging enter and exit the CZ as many times as they wish to and drive inside started, bus services had been improved by a combination of more the CZ as much as they want on that day. frequent services, new and altered routes, and bigger buses. The LCCS is an unsophisticated flat charge, which does not differentiate by vehicle type or time of day. However, it achieved its

79 The average exchange rate in the period Jan-May 2009 was S$1 ¼ £0.46 ¼ V0.51 (IMF Exchange Rate Query Tool). 80 The end time was originally 6:30 p.m. but it was brought forward to 6:00 p.m. when the zone was expanded to the West in February 2007. 81 An A-road in the UK is a main road. G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 37 objective of reducing car use. Although speeds increased in the first majority of the burden falls disproportionately on occasional two years, they then started to deteriorate and by 2007 delays were visitors to the city. back at pre-charging levels. The decrease in average speeds The Transport Act 2000 (Acts of Parliament, 2000) gave local however, is not linked in any way to an increase in traffic but rather, authorities in England and Wales powers to introduce workplace to a reallocation of network space to buses, cyclists and pedestrians, parking levies. However, as of August 2009, Nottingham City plus the unfortunate timing of road works in central London. Council is the only local authority to have concrete proposals for a workplace parking levy, and the scheme will not start until 5.2.4.6. . The congestion tax in Stockholm was imple- specific regulations regarding workplace parking charges have mented in August 2007 with the objectives of reducing traffic been detailed (Nottingham City Council website). All employers congestion and emissions. It is a cordon toll system, with a cordon with more than ten parking spaces would be liable and the Council that surrounds the entire Stockholm City, which has a total area of hopes that the policy will reduce peak-time congestion and roughly 13.7 mi2 (35.5 km2). Like in London, enforcement is encourage the use of an improved public transport system. undertaken with ANPR, with cameras located at each of the 18 entry and exit points. 5.2.6. Pay-as-you-drive insurance Each passage into or out of the area surrounded by the cordon Parry et al. (2007) report that PAYD schemes are slowly costs SEK 10, 15 or 20 (roughly between £0.8 and £1.7 or V0.9 and emerging at state level in the US. Oregon has offered insurance V1.8)82 depending on the time of day. The accumulated passages companies a state tax credit of $100 per motorist for the first 10,000 made by any vehicle during a particular day are aggregated and the motorists who take up a PAYD policy and Texas has passed legis- vehicle owner is liable for either the sum of the charges or SEK 60, lation which allows insurance companies to offer PAYD (p. 394). whichever is lower. In May 2009 the New America Foundation Climate Policy Exemptions include emergency vehicles, buses, diplomatic Program published a survey of 33 US states climate change emis- cars,83 motorcycles, foreign registered vehicles, military vehicles, sion reduction plans (New America Foundation website). Twelve disabled parking permit holders, and vehicles that according to the include PAYD as a transport emission reduction strategy.84 These Swedish Road Administration’s vehicle registry, are equipped with states include Arizona, California, Colorado, Maryland, Maine, technology for running (a) completely or partially on electricity or Minnesota, New Hampshire, New Mexico, North Carolina, Rhode a gas other than LPG or (b) on a fuel blend that predominantly Island, Vermont and Virginia. The degree of emphasis and support comprises alcohol (Swedish Road Administration, 2007). In addi- for PAYD varies. For example, the Rhode Island plan, while tion, vehicles driving on the motorway which goes through the endorsing the importance of the strategy, explicitly says that the charging zone are also exempts, as there are no alternative routes. state will likely wait for other states to figure out how to promote Finally, traffic to and from Lidingo¨ island, with its only access to the PAYD insurance before it does so. The California Department of mainland through the charging zone, is also exempt. Insurance is now in the process of rule making to support PAYD The congestion tax is paid retroactively. The payment must (California Department of Insurance website). reach the Swedish Road Administration within 14 days of crossing There are some limited examples in other countries, with some the cordon. Regular users can set up a direct debit. Other ways of companies offering PAYD in Australia, Israel, the Netherlands and paying include cash or credit card at convenience stores, credit or South Africa. It is not a widely spread practice yet, and so there are debit cards on the congestion tax website, or directly to the Road not many implementation examples to report on or assess. Administration’s account (Swedish Road Administration, 2007). Drivers not paying the tax within 14 days are issued a fine. 5.3. Revenue allocation Eventually, if the vehicle owner continues to refuse to pay, his name is entered in the Enforcement Register (Swedish Road As already explained in Section 4.5, revenues from taxes can be Administration, 2007). earmarked for specific uses, such as for example, the road trans- port sector. Thus, road infrastructure and public transport and/or 5.2.5. Parking charges other environmentally friendly transport projects can be financed Parking charges can be divided into three groups: parking with a stable flow of revenues from ring-fenced taxes or from the charges for using a space on a public road, parking charges for using general government funds. Many governments depend on fuel a space in a privately provided parking lot, and parking charges for and other road taxes for general revenues. Fuel taxes are relatively parking at the workplace. easy to administer and collect and so it is difficult for governments Except for the charges paid in privately provided spaces, which to let go. typically cover all costs of parking and even yield some profit to the The US, however, allocates most of the fuel tax revenues to owner, the other charges tend to be low or non-existent. expenditure on building and maintaining the national highway Zatti (2004) discusses the effectiveness of the parking charges system. Although this used to be enough in the past, it only covers in the city of Pavia (Italy). In Pavia, the parking charges are about one third of total expenses now, and the gap is financed limited to a small area, the charges are modest, and many cate- with real estate and other taxes (Scha¨fer et al., Chapter 7, p. 224). gories of drivers are exempt from payment. He argues that these Fuel taxes in the US are lower than in other developed countries, factors, together with the vast use of illegal parking contribute to as was shown in Section 5.2.2. About three-quarters of the make parking fees in the city of Pavia a revenue instrument revenue goes to the highway account, a small portion is allocated rather than an instrument to internalise externalities. In fact, the to public transport and only the residual goes to the general budget. In the UK, fuel duties and vehicle excise duties, exclusive of VAT 82 The average exchange rate in the period Jan-May 2009 was SEK 1 ¼ 8 pence ¼ 9 receipts, amounted to almost £26 (V28.6) billion in 2002–2003, or Euro-cents (IMF Exchange Rate Query Tool). 6.7 per cent of total tax revenue, around 2 per cent of GDP. Only £5.5 83 Under the 1961 Vienna Convention, diplomats are exempt from paying taxes. Staff at the US and German embassies refuse to pay the congestion charge in Lon- don, arguing that under the 1961 Vienna Convention, they are exempt from paying taxes. However, the is not a tax but a charge. The Stock- 84 The excel sheet summarising the plans is available on www.newamerica.net/ holm congestion tax on the other hand is a tax. files/State%20Climate%20Policy%20Tracker%205-4-09.xls 38 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 billion of this revenue was spent on roads85 (National Statistics While the Stockholm congestion tax has been classified as a tax, Online, 2004, Table 7.13). Newbery and Santos (1999) report the London and Singapore congestion charges have been classified similar gaps since the 1950s. Interestingly, the allocation of road tax as charges, not taxes. All three schemes, however, generate reve- revenues to other sectors in the economy is not taking place nues which are allocated to the road transport sector. In the case of because there is no need for investment in roads. In fact, invest- Stockholm, these have been earmarked for new road construction ment in the road network in the UK is failing to keep up with the in and around Stockholm and for improvement of public transport. growth in traffic levels. Between 1991 and 2001, road traffic in the In the case of London, the London Greater Authority Act (Acts of UK increased by 15 per cent, yet road length only grew by 9 per cent Parliament, 1999), which gives the Mayor power to introduce (RAC, 2003). congestion charges, requires that net revenues are used for the local Most countries in Europe also depend on motor fuel excises, transport plan. Most have and continue to be allocated to the bus which typically represent 4–6 per cent of total tax revenues. If these network. A smaller percentage is allocated to improvement of roads taxes were earmarked for road transport only, other sectors in need and bridges, road safety, walking and cycling facilities and facili- of funding would suffer. tation of distribution of freight (TfL, 2007, Table 6.3, p. 114). In the Gupta and Mahler (1995) show that the taxation of domestic case of Singapore, which has the longest history of congestion consumption of oil products is an important source of revenue in charging, revenues are also used to finance projects in road most countries. In developing countries, they argue, these revenues transport. represent between 7 and 30 per cent of total tax revenues, or The fact that net revenues from the urban congestion charging between 1 and 3.5 per cent of GDP (p. 101). schemes have been earmarked to road transport has helped polit- In other words, tax revenues from fuel are significant enough for ical acceptability. Surveys carried out in London between March governments to be reluctant to earmark them. It is worth fast- and August 1999 found that people changed their attitude towards forwarding a couple or so decades in time, and trying to imagine the idea of congestion charging when they were told that revenues what would happen if oil-based fuels were completely or at least would be earmarked to transport. 67 per cent of the general public mostly replaced by alternative fuels (be it biofuels, electricity, etc). thought that road user charges in central London would be a good For these alternative fuels to achieve such a market penetration, idea if net revenues were spent on transport improvements, and governments would probably need to offer tax reductions on these the proportion increased to 73 per cent when the respondents’ types of energy (as well as subsidies to buy the vehicles that would spending preferences were introduced (ROCOL Working Group, support them).86 Consequently, the tax revenues from petrol and 2000, p. 57). diesel would be seriously compromised, leaving most govern- ments, developing and developed, in need of finding new ways of 5.4. Concluding remarks raising such sums. Having said that, there are some exceptions, as not all govern- Taxes and charges in the road transport sector are used exten- ments rely heavily on revenues from fuel taxes. Such countries sively throughout the world. Most countries levy a registration tax include mainly those where fuel prices are regulated, or where oil on new vehicles and annual vehicle excise duties. More recently importing, refining and distribution activities are publicly-owned many have also introduced subsidies to efficient vehicles, feebates (Smith, 2006) and oil-exporting countries (Gupta & Mahler, 1995). and/or scrappage incentives. In these countries, pump-prices tend to be lower, and taxes, either Most countries also have fuel duties, some taking the form of non-existent or just about sufficient to subsidise the losses from carbon taxes. Fuel taxes vary substantially from one country to publicly-owned companies. another. Mexico and the US, for example, have very low petrol Up to this point, revenue allocation from fuel and vehicle taxes taxes, when compared to other OECD countries. Great differences has been briefly discussed. Revenues from congestion charges pose can also be observed across African countries. different challenges and opportunities. It is now also worth high- Many European countries depend on motor fuel excises, which lighting the difference between a charge and a tax. According to the typically represent 4–6 per cent of total tax revenues. If these taxes System of 1993 (OECD, 1993): were earmarked for road transport only, other sectors in need of funding would suffer. If the road transport sector were deca- ‘Taxes are compulsory, unrequited payments . to government rbonised and alternative forms of energy were exempt from taxes, units. They are described as unrequited because the government governments would need to introduce taxes in other sectors of the provides nothing in return to the individual unit making the economy to make up for the loss of revenues they would suffer. payment, although governments may use the funds raised in taxes to provide goods or services to other units, either indi- 6. Conclusions and policy recommendations vidually or collectively, or to the community as a whole’ (OECD, 1993, p. 46). 6.1. Conclusions In other words, the revenues from a tax can go to the general fund, as the government does not need to provide anything ‘in In this paper we have summarised the main road transport return to the individual unit making the payment’, or they can be externalities and economic policies proposed and implemented to specifically earmarked for some use. The revenues from a charge, deal with them. on the other hand, do not need to be specifically earmarked, as they The most important negative externalities from road transport already are, ipso facto. include accidents, road damage, environmental damage, conges- tion and oil dependence. Since the market is incapable of reaching an efficient equilib- rium in the presence of externalities, a number of government 85 This expenditure included new construction, improvement, structural mainte- interventions have been suggested in the literature. From an nance, bridge maintenance and strengthening, safety and public lighting. economic point of view, these interventions fall under two head- 86 The UK government, for example, announced in April 2009 that they would ings: command-and-control (CAC) and incentive-based (IB) poli- provide subsidies of between £2000 and £5000 to help consumers buy their first electric and plug in hybrid cars, when these become widely available, from 2011 cies. CAC policies are essentially regulations, which force (UK DfT Press Release, 2009). consumers and producers to change their behaviour. IB policies are G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 39 designed to mimic in some way the functioning of the market, by The use of revenues generated through IB road transport providing financial incentives to consumers and producers to policies that correct externalities has impacts on social welfare change their behaviour. These can be further categorised into price and equity and is an important determinant of the political controls and quantity controls. Price controls tend to be either acceptability of these policies. In general, using these revenues to taxes, charges or fees. They can also take the form of subsidies, as reduce distortionary taxes increases the efficiency of the system, a foregone subsidy can have a similar impact to that of a tax. and investing them in the transport sector (on roads, public Quantity controls are systems of tradeable permits, where a cap is transport, R&D) increases equity. imposed by the regulator and permits can be traded among Except for the inter-refinery averaging and banking of credits economic agents. instituted by the US EPA in the 1980s to facilitate the phase-out of The main advantage of IB policies (both price and quantity leaded petrol in the US, cap-and-trade schemes have not been control) over CAC ones is their cost effectiveness. Producers or implemented in the road transport sector in any country or region consumers with low costs of abatement tend to reduce the amount to date. of externalities generated by themselves, rather than buying The main candidate for a permit system in the road transport permits or paying taxes, while those with high costs of abatement sector is CO2 emissions. One important difficulty is that emission choose to buy permits or pay taxes. The cost of reducing the sources in road transport are small, dispersed, and mobile, which externality is thus minimised compared to the more direct regu- makes enforcement difficult. This obstacle could, however, be latory approach of setting standards, which obliges everyone to overcome by implementing a system that would work at the pump reduce their generation of externalities to the level fixed by the (and in that case it would essentially be similar to a fuel tax) or one regulator, regardless of how costly abatement for each firm or at upstream level, designed either for fuel producers or car individual is. manufacturers. A number of CAC and IB policies have been reviewed. Although tradeable permits would in principle incentivise the CAC policies are not efficient from an economic point of development of fuel-efficient and alternative fuel vehicles, there view: even in a context of perfect information when the regulation are a number of potential problems relating to their implementa- or standard is set at the optimal level, the target is not achieved at tion: (a) auctioned permits would awake public and political the minimum cost, and worse yet, the social costs could exceed the opposition, whereas grandfathered permits would deprive potential benefits (thus replacing market failure with government governments of revenues, which could be allocated to reducing failure). Despite all this, they are the type of instrument most fav- distortionary taxes or for investment in R&D of new technologies; oured by policy makers. (b) permits with shorter life would have higher tradeability, but Regulations, however, seem to be adequate for regulating also transaction costs, and permits with longer life would have fuel quality, perhaps complemented with a duty differential or greater uncertainty about future prices; (c) including road trans- a facility for trading credits. This approach was successful, in port in a much larger scheme, such as the EU ETS, would achieve phasing out leaded petrol in many countries, including the US and reductions in emissions, although not necessarily in road transport. those in Europe, as well as in reducing the sulphur content of petrol Designing a separate system, would guarantee emission reductions and other harmful emissions. in road transport, but not necessarily in other sectors with lower Standards also seem to be adequate for regulating tailpipe abatement costs. emissions: standards can become increasingly stringent over Taxes and charges have been widely implemented in the road time, and they can regulate emissions of nitrogen oxide, transport sector around the world, both in developed and devel- hydrocarbons, carbon monoxide and particulate matter. They oping countries. Their effectiveness as corrective instruments, could also serve for regulating CO2 emissions, although this is however, depends on the link between the externality they are a much more problematic area, where the inefficiency of CAC targeting and the tax or charge itself. becomes evident. A carbon tax, or, at least, a fuel tax would be Vehicle purchase and ownership taxes can be designed to take better suited as an instrument for reducing CO2 emissions. We into account the road damage they cause, so that heavier vehicles return to this point below. Fuel economy standards for vehicles, not pay higher taxes. However, these taxes are unlikely to influence too dissimilar from CO2 caps per km, reduce fuel consumption but travel behaviour. Travel behaviour can be altered with congestion also cause a rebound effect. charges, PAYD insurance, and fuel duties. The Low Emission Zone (LEZ) in London is a CAC policy. Congestion, which varies with vehicle type, road and time However, its cost effectiveness may not be as poor as that of other of day, is best targeted with a congestion charge than with CAC instruments, mainly because it is being phased-in. In reality, afueltax.A fuel tax may reduce demand for travel, but may not the vehicles affected by the regulation are few, as the increasing reduce it (enough) during congested periods. Examples of standards, required for circulation inside the LEZ, kick in years after congestion charging are limited, with only three urban schemes, the EU-standards, on which they are based, come into effect. the ones in Singapore, London and Stockholm, and a few High Bans on vehicle circulation, especially of the types imposed in Occupancy Toll lanes in the US. The most fine-tuned system is the Athens and Mexico City, do not ensure that the most valuable Electronic Road Pricing scheme in Singapore, which charges trips will be made. Worse yet, they may result in more, rather different rates to different vehicle types, at different locations and than less, driving. This is because motorists may acquire second times of the day. hand cars, or forge licence plates to be able to drive every day of Congestion charging is an IB policy which has and continues to the week. face fierce public and political opposition. Concerns are usually Parking restrictions pose a similar problem to a ban on vehicle linked to pervasive distributional impacts. In reality, however, car circulation: the trips that are made may not be the most valuable users are not willing to pay for something they have always had for ones. Thus, an inefficiency will occur. Also, drivers may free. As anecdotal evidence, implementation of the Manchester contribute more to congestion while looking for an available congestion charge was halted after the results of a public refer- parking space. endum. The scheme did take into account a number of potential IB policies do not impose any choices, but rather leave negative effects and proposed solutions. These included exemp- consumers and producers to make decisions according to their tions for low-paid workers, additional school buses, and significant costs and benefits, preferences and constraints. improvements in public transport and Park & Ride facilities. None of 40 G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 these compromises were enough to make the scheme more based one - are not designed to achieve the same reduction in acceptable. activity (because otherwise the reduction would be beyond Pay-as-you-drive (PAYD) insurance could reduce the number optimal). of trips made, which would also have a welcome impact on congestion and emissions. This would also increase the efficiency In general, regulations on fuel composition and vehicle emis- of insurance systems because the link between distance driven per sions have worked well, and are both feasible and effective year and the premium would be strengthened. instruments. The variation in fuel duties across countries is large. Although Given that incentive based policies are efficient from an these were originally introduced as revenue-raising instruments, economic point of view, but in reality, do not always fulfill their cost they are now also increasingly being regarded as corrective taxes to minimisation potential, we do not recommend widespread adop- internalise road transport externalities. tion of this type of instrument blindly. However, taxes, charges and Bearing in mind that these are excellent instruments (only permits are excellent instruments in the following cases: second to carbon taxes) to internalise the global warming exter- nality the very fact that fuel duties are so different indicates the when the revenue generated from taxes or permit auctions by presence of an inefficiency. This inefficiency is of particular the government can be used to reduce distortionary taxes in concern, given that the externality is global, regardless of where the the economy, such as income taxes, and/or be returned to the emissions originate. road transport sector in the form of investment in public Harmonisation of fuel duties across countries in a region transport or R&D of cleaner technologies; would support coordinated policies to reduce CO2 emissions, as a driver to change economic agents’ behaviour, such as with just one (implicit) shadow price of carbon. One important driving fewer km or increasing the use of public transport; problem regarding fuel tax harmonisation is that countries would need to agree on the tax rate. When faced with the choice between permits and taxes, Virtually all countries have mechanisms in place for col- governments may find that taxes are more practical and admin- lecting fuel duties. Thus, in addition to being fairly effective and istratively easier to implement in the case of road transport. internalising the global warming externality, a carbon tax on However, given the general current trend throughout the world to motor fuels, or at least blunter fuel duties, have the advantage of consider permits a refreshing alternative to taxes, the time may be already being place. In addition, they are easy to monitor and optimal to move towards tradeable permits to internalise the enforce, inexpensive to collect, and guarantee some level of price external costs of CO2 emissions, if only because they seem to be stability. Permits are more costly in regulatory terms, in the more acceptable. It should also be highlighted that, if a global sense that they require an institutional setting, definition of carbon market emerged, with the participation of most countries property rights and initial allocation, as well as enforcement and economic sectors, the price signals would make decisions procedures. However, there seems to be some preference, both easier at all levels (production and consumption, as well as from politicians and from consumers and producers, for tradeable investment) , as well as targeting them towards lower carbon permits. This is evident in the trends regarding initiatives to tackle choices. climate change. Taxes and charges, on the other hand, should be used when The EU ETS was designed and implemented after proposals for there is a strong link between the tax or charge and the externality a European carbon tax failed in the 1990s. In the US there are in question. Congestion charging and PAYD insurance, for instance, currently proposals for cap-and-trade systems, rather than carbon are good examples. taxes, let alone substantial increases in fuel taxes. Governments can choose from a variety of excellent policy Since cap-and-trade systems seem to be better accepted, instruments, which reduce carbon emissions from road transport perhaps in the hope that they will be grandfathered following and address the problem of climate change – ‘the greatest and insistent lobbying from affected parties, the time may have come to widest-ranging market failure ever seen’ (Stern, 2006, p. i). Imple- start thinking globally on how to design and implement new menting these will require political will and commitment. But systems that will be compatible with each other. Better yet, would given the high costs of postponing these decisions, the best policy is be a unified carbon market. This would entail international agree- to act now. ments on country-level quotas and long and costly negotiations, but may finally result in the world-wide institution of a truly global Acknowledgements carbon market. We are grateful to Jack Jacometti, Stewart Kempsell and Sylvia 6.2. Policy recommendations Williams, from Shell International, as well as Stephen Skippon, from Shell Global Solutions, for fruitful discussions about the work On the basis of our survey, which considers economic presented in this paper. theory and policy implementation of instruments to ameliorate We are also thankful to all our colleagues at the Smith School road transport externalities, we offer the following policy of Enterprise and the Environment, and especially to Oliver recommendations. Inderwildi, Xiaoyu Yan, Aaron Holdway, Chris Carey and Nick Regulations and standards are not efficient from an economic Owen, who also worked on the Future of Mobility, and to Stephen perspective, but they are excellent instruments under the following Smith, from University College London and Todd Litman, from the circumstances: Victoria Transport Policy Institute, for helpful pointers. Finally, we are indebted to our external reviewer, Ian Parry, from if the level of an activity, such as emitting a lethal substance, Resources for the Future, for helpful comments and suggestions needs to be drastically reduced or altogether eliminated; that improved this paper. when the constraints faced by the regulator, such as public and Any remaining errors or shortcomings are our own. Any views political acceptability of incentive based measures, are severe; or conclusions expressed in this paper do not represent those of as complements to incentive based policies, as long as the two Shell, the Smith School of Enterprise and the Environment or instruments - the command-and-control and the incentive Oxford University. G. Santos et al. / Research in Transportation Economics 28 (2010) 2–45 41

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