Working Paper

Optimizing to the last digit: How taxes influence vehicle CO2 emission levels

In addition to vehicle CO2 emission standards imposed at the European Union level, a number of EU member states have put in place tax and other incentives to encourage consumers to buy more efficient vehicles. This working paper examines the effect those policies have had on CO2 emissions specifically, starting from the hypothesis that new vehicles would tend to cluster at the incentive points and analyzing the patterns in the distribution of CO2 emissions over time to test that hypothesis.

The results indicate a clear shift toward what might be called tax-optimized vehicles. The shift is not universal, since it would be impossible for manufacturers to optimize vehicle models for all the diverse array of taxation schemes among member states. Rather, the data suggests manufacturers seek to make vehicle CO2 emissions as beneficial as possible in as many tax schemes as possible, within the limitations imposed by engineering potential and manufacturing costs. Consumers, for their part, clearly seem to be aware of the tax implications of new vehicle emissions, and are making decisions accordingly.

Superficially, this could be regarded as a success for fiscal and environmental policy. However, looked at more closely, it is problematic it two respects. First, it highlights the disadvantage of a sharp change in vehicle tax based on CO2 emissions performance, as opposed to a more continuous rate of decline/incline: namely, that government may end up heavily subsidizing (by forgoing tax revenue) a very small decrease in vehicle CO2. Second, viewed in the context of the substantial and growing amount of evidence that real-world vehicle CO2 emissions are significantly higher than the official type-approval emissions on which taxes are based, it suggests the member states are giving significant and increasing tax subsidies to vehicles that do not actually further the public policy objectives of those subsidie—or at least do so to a lesser extent than they should.

Tracking progress