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‘Finnish consumers would have largely bought cleaner cars regardless of domestic tax policy. The EU introduced mandatory CO2 emissions standards for car manufacturers at the same time when Finland reformed the car tax', says Robin Stitzing. He will defend his doctoral dissertation at the Aalto University School of Business on Friday, 25 November 2016.

Stitzing studied the market impact of the 2008 car tax reform and its environmental and distributional effects. The Finnish car tax, high in international comparison and an important source of government funding, is levied on the general retail price of cars at first registration. Since 2008, vehicle-specific tax rates are linked to carbon dioxide (CO2) emissions ratings to get consumers to buy cleaner cars.

CO2-based car taxation favours diesel cars

According to Stitzing’s research, the green car tax reform had little effect on the sales-weighted CO2 emissions rates, a key statistic to policymakers, given the concurrent introduction of the mandatory EU CO2 emissions standards for manufacturers. However, the CO2-based car tax increased local pollution due to its favourable treatment of diesel cars. Diesel engines emit less CO2 but more local pollutants than comparable petrol engines and are hence favoured by a CO2-based tax.

‘Israel avoided this problem of a shift towards diesel engines in their own version of the car tax by linking tax rates to a pollution index also accounting for exhaust emissions other than CO2', says Stitzing.

Large benefits to high-income households but declining government tax revenue

The car tax reform had nevertheless huge distributional implications.
‘Most consumers benefited from the CO2-differentiated car tax because cars on average became more affordable. Richer households are more likely to buy a car and are also more likely to buy expensive cars. Buyers of an expensive car model were thus the winners of the reform, unless they happened to choose a Hummer', says Stitzing.

The automobile industry also benefited from the CO2 differentiation of car tax rates. 
‘Not only did they sell more cars than they would have, price-cost margins on low-emissions car models would have been slightly lower, had car tax rates not been linked to CO2 emissions’, Stitzing continues. However, government tax revenue from purchases of new cars declined strongly because of the car tax reform. Increased vehicle sales were insufficient to keep tax revenue stable given differentiated, but on average lower tax rates. ‘Policymakers need to consider both the environmental and distributional impact of environmental policies. They also need a clear understanding of the relevant market’, Stitzing says.

Stitzing used data on vehicle registrations, car tax payments, and income records from 2004 to 2010, provided by Statistics Finland, the Finnish Transport Safety Agency TraFi, and the Finnish Customs Tulli, to examine how the Finnish market for new cars would have evolved in the absence of the 2008 car tax reform.