12 Increased fuel and carbon tax for road vehicles

12.0.1 Description

The goal of carbon pricing is to reduce the amount of CO2 emissions within a specific sector by imposing a fee or cap on CO2 emissions. Within the transport sector a carbon tax usually applies to the combustion of transport fuels, essentially raising the price of travel for vehicles that use an internal combustion engine. This will incentivise the use of cleaner vehicles (alternative fuel cell vehicles) or public transport and therefore should decrease the amount of vehicle kilometres travelled by combustion engine vehicles (Leard et al, 2020).

There are multiple ways to implement a carbon tax for road vehicles, most of which take a variation of one of two main approaches, a carbon tax (normally through a fuel tax) or an emissions trading scheme (ETS). An ETS puts a price on emissions by charging on a quantity basis for greenhouse gases emitted. An ETS-based approach is more complex to implement and is normally applied upstream where the fuel is first commercialized as this allows for greater coverage of the tax across the economy as it only needs to be applied to a few up-stream entities (World Bank Group, 2021). California has a ‘Cap and Trade’ programme that uses this ETS-based approach, and it is one of their key tools for reducing greenhouse gas emissions within the state. They have a state-wide cap on the quantity of greenhouse gas emissions from major sources (including transport) that has been decreasing ever since its implementation in 2013. Companies that fall within the ‘Cap and Trade’ programme are then allocated allowances of greenhouse gas emissions and can purchase additional allowances at auctions, with the floor price rising simultaneously with the decreasing emissions cap (California Air Resources Board, 2012).

The second more common approach to a carbon tax on road vehicles is by adding a ‘tailpipe’ tax, with the simplest form being the addition of a tax on to the price of fossil fuels paid by the consumer at the pump. In 2021, 47% of New Zealand’s CO2 emissions came from the transport sector, with a large portion of this being in Auckland (Wood & Shaw, 2021). This approach to carbon taxes is very common globally, often applying a tax based on the carbon content of the fuel, this is because some fuels like diesel contain higher quantities of carbon per gallon than other fuels. Whilst Auckland’s Regional Fuel Tax was introduced in July 2018 as a way to increase transport funding for the region, a similar approach could be adopted with carbon emission reductions as the objective.

12.0.2 Type of travel affected

A carbon tax on road vehicles can affect all travel undertaken by road vehicles with an internal combustion engine. The amount that a user is taxed can depend on the type and amount of fuel they are using, the fuel efficiency of the vehicle and the way in which the tax is implemented.

12.0.3 How travel and emission effects, including long-run, can be measured and modelled

All forms of a carbon tax on road vehicles essentially increase the cost of travel for certain vehicle types, with the aim of decreasing the negative externality on the environment of these vehicle types, whilst also raising revenue for national and local governments. This tax can be fixed for all internal combustion engine vehicles or can vary depending on the emissions level of each vehicle, either measured through the fuel type or the quantity of fuel consumed. Travel impacts, and emissions can be predicted based on price elasticity models, noting these models would need to separate out each vehicle class as only a subset of vehicles are affected by the tax.

In light of climate change, Sweden became one of the first countries in the world to implement a carbon tax in 1991 and the year prior it added a tax of 25% to the price of gasoline and diesel. The carbon tax was introduced at €24 per ton of CO2 and in 2021 had risen to €114 per ton of CO2, this being one of the highest carbon taxes in the world (International Energy Authority, 2022). This carbon tax was implemented broadly across many sectors, some of which receive a lower rate such as the agriculture sector. The transport sector, Sweden’s largest emitter of CO2 is fully covered by the carbon tax. It is estimated that since the introduction of the carbon tax in 1991 there has been an average annual reduction in CO2 emissions of 6.3% (or 1.5 million metric tons of CO2) per year up until the time of the study in 2017 (Andersson, 2017).

General fuel taxes make up most of the cost of fuel for European Union countries, eg, in France, 2018, it made up 64% of the cost of unleaded petrol and 59% for diesel. In New Zealand regular 91 petrol had an overall tax of roughly $1.15 in January of 2022, which at the time made up about 41% of the total cost. This tax consists of a petrol excise duty, an ETS levy and other levies. A 2019 study by Benjamin and Hurtado looked at the rebound effect caused by fuel taxes. Since travel is an essential part of life for most people the initial effect of a fuel tax may seem large but over time private road users shift back to pre-tax ways of travel and just accept the tax as a cost of living, therefore the tax becomes less effective over time. Benjamin and Hurtado (2019) found that in the medium run after the implementation of a fuel tax, 30% to 35% of the original traffic reduction gains released by the fuel tax were lost due to an increase in demand for driving. They find this is primarily caused by private road users in rural areas who do not have the same access to public transport as those in metropolitan areas (Benjamin and Hurtado, 2019).

12.0.4 Secondary impacts

As with any form of tax there are going to be negative and positive externalities outside of the scope of the tax. The main goal of a carbon tax for road vehicles is to reduce vehicle kilometres travelled by vehicles with internal combustion engines and therefore reduce the amount of CO2 emissions. A positive externality of this tax is it incentivises new technology. By raising the price of gasoline and diesel, demand for more fuel-efficient vehicles and vehicles that are run by alternative fuel sources such as electricity and hydrogen increases. This helps increase innovation within the transport sector which decreases emissions in the long run. In the context of NZ, this might help to accelerate the refresh of the vehicle fleet with low- and zero-emission vehicles.

A negative externality associated with a carbon tax on road vehicles is it has the potential to increase inequality due its equity impacts. This is because one of the key reasons for implementing a carbon tax on vehicles is to incentivise road users to drive cars that do not use fossil fuels. Cars with alternative full cells have a higher cost barrier and are therefore significantly more expensive than vehicles with internal combustion engines. This means financially vulnerable households may not be able to afford an alternative fuel cell vehicle due to these cost barriers (Ministry of Transport, 2020). Although, it has been suggested that issues can be addressed with intelligent mechanism design that provides the right incentives to travelers and uses the raised revenues in a way to achieve desired equitable ends eg, by cutting other taxes and investing in infrastructure and services (Levinson, 2010).

Fuel prices also tend to have limited impact on consumers decisions due to its relatively inelastic demand therefore for a fuel tax to have significant impact on emissions the fuel tax would need to be very large as for each increase in fuel tax there is limited change in vehicle kilometres travelled. This effect is also compounded in places with a weak public transport system where it is more difficult for private road users to change their mode of transport.

12.0.5 Key Information sources

Andersson, J. (2017). Cars, carbon taxes and CO2. Centre for Climate Change Economics and Policy, 33.

One of the first empirical analyses of the effectiveness of a carbon tax to reduce emissions and the first to find a significant causal effect on emissions, using a quasi-experimental study of the implementation of a carbon tax and a value added tax on transport fuel in Sweden.

Benjamin Leard, J. L. (2020, September 10). Carbon Pricing 202: Pricing Carbon in the Transportation Sector. Retrieved from Resources for the Future: https://www.rff.org/publications/explainers/carbon-pricing-202-pricing-carbon-transportation-sector/

Benjamin, C., & Hurtado, A. G. (2019). HOW DO FUEL TAXES IMPACT REBOUND EFFECT? EMPIRICAL. Direction générale du Trésor.

California Air Resources Board. (2012, September). Cap and Trade Program. Retrieved from California Air Resources Board: https://ww2.arb.ca.gov/our-work/programs/cap-and-trade-program/about

International Energy Authority. (2022, February 23). Sweden Carbon Tax. Retrieved from IEA: https://www.iea.org/policies/12725-sweden-carbon-tax

Levinson, D. (2010). Equity Effects of Road Pricing: A Review. Transport Reviews, 30(1), 33–57. https://doi.org/10.1080/01441640903189304

This paper provides a synthesis of the literature to date on both the theory of equity, as applied to road pricing, and the findings of empirical and simulation studies of the effects of particular implementations of road pricing, and suggested remedies for real or perceived inequities.

Ministry of Transport. (2020). The Congestion Question. Retrieved from https://www.transport.govt.nz/area-of-interest/auckland/the-congestion-question/

Wood, M., & Shaw, J. (2021, May 14). Govt to rev up reductions in transport emissions. Retrieved from Beehive: https://www.beehive.govt.nz/release/govt-rev-reductions-transport-emissions

Press release seeking public comment on Transport Emissions Pathways report.