Second-best urban tolling with distributive concerns

This paper analyzes the optimal configuration of urban congestion tolls on work-related traffic, in a second-best setting where only one road in a network can be tolled. Both heterogeneity in labor productivity and income distribution concerns are considered. The optimal toll balances two types of considerations. First, the efficiency in correcting the marginal external congestion cost on the tolled road, given the distortion on non-tolled roads. Second, the equity consideration that takes into account who uses the tolled road and how toll revenues are spent. Both separating and pooling equilibriums are analyzed for two alternative uses of the toll revenues: poll transfers or labor-tax cuts. Using numerical simulations, we show that the equity concern can lead a government to prefer recycling via poll transfers rather than via labor tax reductions.