A combination of regulations, incentives, and fuel taxes is a good solution. To reduce emissions by renewing or improving equipment, some measures work best through regulation and others through market instruments. To reduce the use of vehicles, taxation is immensely more effective than regulation.
Regulation alone can backfire---as did banning each car from driving on a specific day of the week in Mexico City. Many drivers bought a second car to circumvent the regulation, and the added cars pushed up their costs. And with more cars in the city, many of them older, there are indications that the regulation ended up increasing pollution rather than reducing it.
This perverse outcome shows that understanding the effects of regulations and all other incentives is crucial for sound policymaking. Bank economist Gunnar Eskeland proposes an approach for moving closer to that understanding.[1]
Motor vehicles are a major source of pollution in Mexico, giving off almost half the emissions. Private cars and taxis are the big offenders---accounting for two-thirds of the sector's pollutants (weighted for toxicity) while carrying only a third of passenger-kilometers. Buses emit less than half as many pollutants per passenger-kilometer.
This pollution can be reduced by:
What is the most cost-effective combination of these three strategies?
Theory recommends a pollution tax, since it would allow consumers to choose the option that would cost them the least. But the emission monitoring needed for such a tax is costly and unwieldy. The practical solution is a mix of taxes, incentives, and regulations.
In Mexico City, some technical measures---such as retrofitting cars to use liquefied petroleum gas (LPG) and making service stations recover vapors---were found to yield net savings. Others ride up the marginal cost curve. Emission standards, applied to different groups of vehicles, are at the lower end ($200-$600 per ton of emissions reduced). Mandatory inspection and maintenance programs for vehicles are in the middle---rising as the standards and tests get tougher. Improvements in the fuel mix are at the higher end ($900-$1,200 a ton).
Beyond $1,300-$1,500 a ton, however, technical emission reductions get very expensive. Increasingly, all that remains is to keep people out of their cars.
By using various technical measures, Mexico City could reduce emissions from transport by half (by 1.2 million tons) at a cost of $580 million, an average of about $470 a ton. Combining an optimal gas tax with those measures would achieve the same reduction for about $65 million less---and generate $350 million in revenue.
Of the measures that can reduce emission coefficients, some are more cost-effective than others. In Mexico City, LPG conversion and vapor recovery for gasoline stations yielded enough fuel savings to more than cover the costs. Other measures, such as setting emission standards for high-use vehicles, have positive costs but are fairly cheap, since emission reductions are proportional to the vehicle's use.
Knowing what measures will reduce emissions is part of the task. Another part is getting vehicle owners (and operators) to accept those measures.
Many technical modifications are best induced by regulatory mechanisms, such as standards. But there are some areas where incentives can be used more efficiently. To evaluate taxes, subsidies, regulations, and other mechanisms, it is necessary to know how much the modifications can achieve at what cost---and, consequently, who should carry them out and how.
A given modification will generally be cheaper, easier to implement, and last longer if made on a new vehicle. For this and other reasons, most countries have set stricter emission standards for new vehicles.
Since 1991 Mexico has had emission standards that by implication force manufacturers to install catalytic converters. But making technical improvements on new vehicles is only one facet of a pollution-control strategy. It is also necessary to reduce emission coefficients from older vehicles. Modifications are frequently induced by setting standards for vehicles in use, to be enforced at annual mandatory tests of each vehicle.
Distinguishing between high-use and low-use vehicles is also important. Since the typical vehicle modification is an up-front investment, the ideal is to select intensively used or "young" vehicles for the most costly controls.
An example is retrofitting cars in use---worthwhile if the most inten- sively used vehicles are targeted. For retrofits with catalytic converters, it is not possible, however, to use a lower price for unleaded gasoline to encourage the owners of high-use vehicles to retrofit, since cars without converters can also use unleaded gasoline.
Installing catalytic converters is best induced by regulation, but converting vehicles to use less polluting gas---compressed natural gas (CNG) or LPG---is better induced by the price mechanism. Unlike installing catalytic converters, converting to gas gives the owner access to a fuel that can be priced independent of (and thus more cheaply than) leaded gasoline. Owners of vehicles with high annual mileage will opt for conversion to save on fuel costs. For society, too, these are the right vehicles to convert.
Some high-use groups can be selected by regulation. Taxis drive about 10 times as much as the average vehicle. A regulation requir- ing that new taxis replace old ones would reduce emission coefficients from the taxi by 80-90%. The old taxis could then be sold for private use, since their annual emissions would drop when used less intensively.
A gasoline tax raises the private costs of travel, and more so for the more fuel-intensive modes of transportation. It is appropriate to use such instruments to discourage nonessential driving, since vehicles still pollute even after emission controls are in place.
For a pollution-control program to be cost-effective, gasoline should be taxed according to the average emissions per liter, so that it exactly matches the cost per ton of the most expensive technical control option. This way, as increasingly costly emission controls are required, consumers will also forgo increasingly valuable trips, since the tax rate increases.
Managing demand by using fuel taxes and other incentive-based mechanisms has the advantage that consumers can themselves select the least essential trips to drop. Managing demand through regulation, by contrast, can force unacceptable costs on consumers because regulations do not allow such choices---as the one-day-a-week ban showed.
Mexico recently increased gasoline prices by 50%, perhaps indicating that regulation will be relied on less for demand management in the future.