The tax treatment of company cars, commuting and optimal congestion taxes

In Europe, the preferential tax treatment of company cars implies that many employees receive a company car as part of their compensation package. In this paper, we consider a model in which wages and the decision whether or not to provide a company car are the result of direct negotiation between employer and employee. Using this framework, we theoretically and numerically study first- and second-best optimal tax policies on labour and transport markets, focusing on the role of the tax treatment of company cars. We show that higher labour taxes and a more favourable tax treatment of company cars raise the fraction employees that receives a company car; congestion and congestion tolls reduce it. More importantly, we find that earlier models that ignored the preferential tax treatment of company cars may have substantially underestimated optimal congestion tolls in Europe. The numerical illustration, calibrated using Belgian data, suggests that about one third of the optimal congestion toll is due to the current tax treatment of company cars. We further find that eliminating the preferential tax treatment of company cars is an imperfect -- but easy to implement -- substitute for currently unavailable congestion tolls: it yields about half the welfare gain attainable through optimal congestion taxes. Finally, the favourable tax treatment of company cars justifies large public transport subsidies; the numerical results are consistent with zero public transport fares.