De-Fueling Externalities: Causal Effects of Fuel Taxation and Mediating Mechanisms for Reducing Climate and Pollution Costs

This paper provides the most comprehensive assessment of how fuel taxation reduces climate and pollution externalities with a quasi-experimental evaluation of the world’s largest environmental tax reform. Leveraging multiple causal inference methods, we compare carbon and air pollutant emissions of the actual and counterfactual German transport sector following the 1999 eco-tax reform and demonstrate sizable reductions in carbon, particulate matter, and nitrogen dioxide emissions. Using official cost estimates, the eco-tax saved around 80 billion Euros of external costs, predominantly relating to pollution reduction benefits. We further show that environmental taxation contributed substantially to fostering low-carbon innovation. In complementary analyses, we document much stronger demand responses to increases in environmentally-motivated taxes than to market price movements, which we relate primarily to increased tax salience in newspapers. Our findings highlight the roles of salience and fuel substitution in mediating the effectiveness of fuel taxes to deliver climate and pollution reduction benefits.