Transport taxes and subsidies in developing countries: The effect of income inequality aversion

We propose a marginal tax reform model that includes both formal and informal sectors in the economy, traffic externalities (congestion, pollution, crashes and noise) and distributional concerns. The marginal cost of public funds (MCF) is derived for fuel taxes and public transport subsidies. The model is applied to Santiago, Chile. If MCFs are computed only taking economic efficiency into account, a revenue neutral reform within the transport sector suggests increasing the car cost and reducing the bus fare in peak periods, and reducing the car cost and increasing the bus fare in off-peak periods. However, including income inequality aversion leads to suggesting lower bus fares and higher car costs in both peak and off-peak periods, significantly changing the economic assessment of current tax and subsidy instruments. The inclusion of traffic externalities has a large effect on the MCF for fuel tax and a mild effect on MCF for bus subsidy.