Product quality and environmental taxation

Abstract

In developed countries, car use is one of the most significant contributors to air pollution. It is also a notable fact that larger, heavier cars consume more fuel and hence contribute more to pollution. This observation has led to policy proposals to structure taxation to encourage the use of smaller, lighter cars. A model of vertical product differentiation shows that there are, however, reasons why the standard policy response may be flawed and that it may even be optimal to subsidise large cars at the expense of small ones.