The Efficiency of Taxation: Save The Environment, Tax Petrol

Part of the new budget proposals was a tax break for “hybrid” cars, which use both petrol and electrical-driven engines to achieve heretofore unheard of fuel economy. But is this a good idea? Not so much in terms of encouraging the adoption of “green” vehicles, but rather in terms of whether this is actually the best deployment of the government’s financial resources.

In any case, others are talking about further measures along the same vein:

Researcher: Cut interest on green cars

PETALING JAYA: While buyers of the Toyota Prius hybrid will be given a discount of RM35,000, financial institutions have been asked to offer lower interest rates for environmentally-friendly vehicles.

“They should lead the way to help consumers buy more “green cars” with competitive loan schemes over those for conventional passenger cars,” said environmental research engineer S. Piarapakaran.

He said banks and financial institutions were crucial in encouraging the growth of environmentally-friendly technology...

…Meanwhile, WWF-Malaysia executive director Datuk Dr Dionysius Sharma lauded the Government’s move to encourage hybrid cars.

“This is the sort of thing that we have been looking for. Consumers, businesses and the environment will also benefit.”

However, he said lower interest rates for green cars could be counter-productive to efforts to get people to use more public transportation and get private vehicles off the roads.

That last point is critical and absolutely right. The idea is not just to improve the proximate cause (cars cause pollution) but to address the underlying problem (Malaysians have too many cars on the road), and reducing costs of hybrids does not achieve that aim.

By sheer coincidence, or maybe divine providence, this research paper arrived in my inbox last week (abstract, emphasis added):

The Taxation of Fuel Economy
James Sallee

Policy-makers have instituted a variety of fuel economy tax policies -- polices that tax or subsidize new vehicle purchases on the basis of fuel economy performance -- in the hopes of improving fleet fuel economy and reducing gasoline consumption. This article reviews existing policies and concludes that while they do work to improve vehicle fuel economy, the same goals could be achieved at a lower cost to society if policy-makers instead directly taxed fuel. Fuel economy taxation, as it is currently practiced, invites several forms of gaming that could be eliminated by policy changes. Thus, even if policy-makers prefer fuel economy taxation over fuel taxes for reasons other than efficiency, there are still potential efficiency gains from reform.

I believe there’re only two hybrids on the Malaysian market from Toyota and Honda, and Proton has been talking about coming out with a hybrid model next year. But beyond the limited consumer choice, the new policy is essentially a subsidy for these limited players against those that don’t have a hybrid model. And it does nothing for encouraging a move from private transportation to public transportation, which is an essential ingredient for the success of the proposed MRT.

To me the best option is still to remove the existing subsidies on petrol and gas…and start taxing fuel instead.

Technical Notes:

James Sallee, "The Taxation of Fuel Economy", NBER Working Paper No. 16466, October 2010