CES - Discussion paper series, DPS14.34 pages:1-49
To what extent do car buyers undervalue future fuel costs, and what does this imply for the effectiveness of alternative tax policies? To address both questions, we show it is crucial to account for consumer heterogeneity in mileage and other dimensions. We use detailed product-level data for a long panel of European countries, and exploit variation in fuel prices by engine type. We find there is only modest undervaluation of fuel costs. As a consequence, fuel taxes are unambiguously more effective in reducing fuel usage than product taxes based on fuel economy, because fuel taxes better target high mileage consumers.