Estimating the Welfare Effect of Congestion Taxes: The Critical Importance of Other Distortions within the Transport System

This paper uses analytical and numerical models to illustrate how the presence of other distortions within the transport system changes the overall welfare effect of a congestion tax. These other distortions include a transit fare subsidy, congestion on competing (unpriced) routes, accident externalities, gasoline taxes, and pollution externalities. Each of these pre-existing distortions can substantially alter the welfare effect of a congestion tax that would be predicted by a first-best analysis. If congestion taxes encourage travel on other congested routes, they can produce sizeable indirect welfare losses. In addition, induced reductions in the demand for gasoline can lead to substantial welfare losses when, as appears to be the case for European countries, gasoline taxes significantly exceed marginal pollution damages. On the other hand, congestion taxes may produce significant welfare gains by offsetting accident externalities, though these gains are partially offset by increased accidents on competing roadways. To the extent that congestion taxes increase the demand for transit, they can induce significant welfare gains or losses, depending on whether transit fares are above or below marginal supply costs. The importance of other distortions varies considerably across different transport systems and across different countries. Our generic analysis illustrates the proportionate change in the welfare effect of a congestion tax due to each of these distortions over a wide range of parameter scenarios.