Economical driving and taxation of road use

A tax on fuel that promotes a more fuel-saving driving style leads to both fewer accidents and less noise pollution per mile driven, but also more driving due to a lower cost of driving. The present study contributes to the literature by calculating second-best optimal taxes on fuel and vehicle miles travelled within a model framework that incorporates such tax-induced impacts on externalities. The study shows that the current US tax wedge between gasoline and non-polluting goods, approximately USD 0.3 per gallon, is far below a conservative estimate of the second-best optimal tax wedge of approximately USD 2.2 per gallon, and even further below best-practice estimates of USD 3.5–4.38 per gallon. The current UK tax wedge is slightly below a conservative estimate of the optimal tax wedge of approximately USD 3 per gallon. The study also shows that the second-best optimal tax rate on fuel exceeds the marginal damage of fuel-related externalities when combined with a tax on vehicle miles travelled. The tax on vehicle miles travelled is reduced below the marginal damage of mileage-related externalities in this case to prevent excessive taxation of driving.