Media Briefings

‘FEEBATES’: How to design tax incentives to reduce vehicle emissions without losing government revenues

  • Published Date: August 2014

Market-based schemes to encourage consumers to switch to cars with lower carbon emissions need to be carefully designed if they are to generate environmental benefits without a substantial loss of government revenue. That is the conclusion of research by Adamos Adamou, Sofronis Clerides and Theodoros Zachariadis, published in the August 2014 issue of the Economic Journal.

Their study shows that in the short run at least, so-called ‘feebates’ – which offer a rebate to purchasers of low-emission cars but levy a fee on purchasers of high-emission cars – can be a useful and effective policy tool in the effort to ‘decarbonise’ transport but only if they lead to higher tax revenues. The results underline the importance of designing environmental policies with an eye on the total costs to society.

The authors note that stabilisation of the earth’s climate may require substantial reductions in carbon emissions in the coming decades. But policies that enable such environmental improvements can have adverse economic consequences if not properly designed. This research sheds light on the implications of an increasingly popular measure, namely the imposition of emission-based taxes on new car purchases.

Vehicle taxes can be thought of as a complementary instrument to traditional policies such as emission standards and fuel taxes. The basic idea is to use carbon-dependent taxes to shift consumer purchases from high- to low-carbon vehicles. This research focuses on feebates, a specific implementation of this idea.

Feebates are a flexible, market-based scheme that pays a rebate to consumers purchasing a low-carbon vehicle and levies a fee on those buying a high-emission car. The amount of the fee or rebate depends on a car’s emission level. The fee/rebate combination changes the relative prices of low- and high-carbon vehicles in favour of the former and can be expected to boost their sales at the expense of high-carbon vehicles.

Such systems have been considered in many parts of the world (including California, Canada and China) and they have been implemented in some European countries; the French ‘bonus-malus’ system is such an example.

Despite the increased use of such schemes, there is little research on their appropriate design and impact. A usual problem is that consumers’ response to tax incentives exceeds expectations, leading to a loss of government revenue. In times of fiscal consolidation around Europe, this could turn out to be an unaffordable environmental policy.

The authors focus on the car market in Germany, Europe’s largest economy. They apply state-of-the-art economic models of demand and supply for vehicles, using several different model specifications to test the robustness of their results. They simulate the impact of a large number of alternative feebate schemes on four factors: car emissions; public revenues; profits of car manufacturers; and consumer welfare.

The impact on total social welfare depends on the combined effect on all these aspects, and each feebate variant affects each one of the four factors differently. More stringent feebates strongly reduce emissions but are costly to consumers because they force them to switch to less desirable options: the impact on public revenues depends on the trade-offs between higher tax rates and consumer response. More lenient feebates have a smaller adverse effect on consumers and firms but a minimal environmental benefit.

A delicate balance has to be found to select a feebate scheme that is environmentally meaningful without being detrimental to social welfare. The authors find that, in the short run, feebate schemes can be welfare-improving only if they lead to higher tax revenues. This underlines the importance of designing environmental policies with an eye on the total costs to society.

Co-author Sofronis Clerides concludes:

‘Important elements of this analysis require more in-depth study in the future – most notably the long-run response of consumers and car manufacturers.

‘Still, our research demonstrates that feebates can be effective in providing a credible long-term price signal that induces low-carbon car purchasing decisions among consumers and – by extension – low-carbon investments in the car industry.

‘Carefully designed feebates that avoid adverse fiscal effects can be a useful and effective policy tool in the effort to decarbonise transport.’

ENDS


Notes for editors: ‘Welfare Implications of Car Feebates: A Simulation Analysis’ by Adamos Adamou, Sofronis Clerides and Theodoros Zachariadis is published in the August 2014 issue of the Economic Journal.

Adamos Adamou and Sofronis Clerides are at the University of Cyprus. Theodoros Zachariadis is at the Cyprus University of Technology.

For further information: contact Sofronis Clerides on +357-22893709 (email: s.clerides@ucy.ac.cy); or Romesh Vaitilingam on +44-7768-661095 (email: romesh@vaitilingam.com; Twitter: @econromesh).