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The practice of excise tax setting

An analysis of fuel excise rates for the European case

Master Thesis

Frank S. Berning (310464)

Erasmus School of Economics

Erasmus University Rotterdam

19-10-2012

Supervisor: Dr. Herman Vollebergh

Abstract: Excise tax rates differ largely between countries and have increase greatly over time, and the possible explanations for this are numerous. In this study, the evolvement of the excise rates is explained from three major categories of factors: environmental externalities, tax competition and the institutional context. The analysis is performed on 17 European countries that are monitored over 34 years. Applying the Arellano-Bond first differenced estimator to this panel dataset, it shows that environmental externalities have a weakly positive effect on alterations of the excise rates, and that tax competition plays a limited role in Europe. Moreover, it is shown that the EU minimum excise rate has greatly influenced the excise rates in the EU and that excise rates are increasing in the levels of government expenditure. Finally, the notion that left-winged governments levy higher taxes did not find support.

JEL Classification: E62, E64, H21, F15, F42, H23, H24

Keywords: Energy taxation, externalities, excise rates, EU, tax competition, public finance

1. Introduction

Taxes can have many causes and objectives. Some are used to influence consumer behaviour, others are used as a viable source of government income and some even serve a more equitable distribution of income. In the real world we furthermore see that tax systems and tax rates differ largely between countries throughout the world. One example of such taxes are excise taxes on mineral oil fuels such as diesel and petrol. Where some countries levy extremely low excise taxes, in other countries the final fuel price paid by consumers consists for more than 70% of taxes (petrolprices.com, 2008). Other countries do not levy excises at all and charge consumers for their vehicle use by means of other instruments such as road taxes. Whereas the greatest differences in the excise rates are featured on a global scale, the excise rates on mineral oils also differ largely between European countries and member states of the European Union. These differences between the excise rates are depicted by the plots of the excise rates in figure 1 below.

Figure 1: Plots of the excise rates on diesel (l) and petrol (r)

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

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Especially in the earlier stages of the Union there was a lot of variation between the excise taxes on diesel and petrol. In this light, the European Union attempted to harmonise European tax rates to further the economic integration between member countries. The general idea

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was that the member countries should cooperate with each other and refrain from obtaining competitive advantages over each other by means of tax distortions. As a result, the European Commission proposed the introduction of shared Value Added Tax rates and shared excise rates applicable to all member states. Also the scope of the tax was to be harmonised throughout the Union. In 1987 the European Commission proposed the introduction of minimum excise rates on mineral oils, alcohol and tobacco, which entered into force after heavy negotiations in 1993 (the minimum excise rate is depicted by the black dotted lines in the graph). As from that date, member states were downward regulated in setting their excise taxes1, and the tax rates entered in immediate effect for new entrants to the European Union (European Commission, 2000). Nevertheless, the excise rates on mineral oils continue to differ largely between the member states, making excise rates a fascinating subject of study.

This thesis will investigate the factors underlying the vast differences between the excise rates levied on mineral oils described above. The list of potential factors contains a host of different arguments for levying excise rates and thus explaining differences between the rates levied. The first argument for levying excise rates could be to alter consumer behaviour in a country, in this case the use of mineral oils, to minimise external effects for instance. Hence, the excise tax could be used as an instrument to cause consumers to use less diesel and petrol, for instance to reduce air pollution resulting from fuel combustion. A second consideration could be the maximisation of tax revenues for the country. Whilst this is a topic which ideally relies on general equilibrium analysis, fuel taxes have often been considered to be a viable source of government revenues due to its relatively predictable income stream and its arguably small distorting effect on the economy (see for instance Goodwin et al. (2003), Knittel et al. (2006) and Brons et al. (2007)). In maximising government revenues, the tax rates levied in neighbouring countries should also be considered, especially in an open economic system as the European Union. With free movement of goods and people throughout the Union, fuelling abroad may be a very real issue,

1 Luxembourg was granted an extra two years for adjusting its excise rates to the EU minimum level. During these two years a reduced rate was imposed on Luxembourg.

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Vollebergh, 10/12/12,

Wat bedoel je hier

affecting overall government income. Finally, the fuel tax may be severely affected by political choices. Different political parties have different policy objectives and political priorities. Left winged governments generally plead for more social security instruments and green parties will adhere to greater environmental protection legislation, whereas liberal parties will aim at reducing government involvement. As a result, these parties make different political choices which can include the excise rates levied on fossil fuels. Moreover, the European Union has a strong supranational character, implying that countries’ choices are in part bound by decisions made in the European Parliament and the European Commission. Finally, the financial position of a country’s central government strongly affects its need and incentive to levy taxes.

Whereas this list of factors that may affect the excise rates that countries choose to levy is far from exhaustive, the analysis will focus on the three categories of reasons discussed above: minimisation of external effects, tax revenue maximisation and political factors. The existing literature suggests that these are the most fundamental factors (see for instance Newbery, 2005) and are thus the most interesting object of study. Other factors will of course be used in the analysis to correct the results for the existence of these influences and to prevent bias due to omission of variables, but will not be discussed at great length. The central question to be answered in the course of this thesis will be the following:

What factors drive changes in the setting of excise taxes on diesel and petrol?

The aim of the study is to generate a more complete and comprehensive understanding about the practice of tax setting on mineral oils. Much of the previous research considered has focused on one particular factor driving tax rate differences, and thus only gives a partial answer to the research question.

The most complete investigation of the practice of tax setting to date has been provided by Rietveld and van Woudenberg (2005). However, the analysis performed by Rietveld and van Woudenberg is not without flaws. Firstly, the authors estimate the effect of externalities on fuel prices rather than fuel taxes. As raw fuel prices, too, differ between countries, the

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Again: why is this an interesting question?


Vaag?

analysis may not be entirely representative. More severe is the fact that the analysis is based on a cross-section comparison, rather than a panel dataset. This implies that no corrections were made for unobserved country heterogeneity, and that the adjustments of countries’ tax rates to increases in the severity of the domestic externality problem cannot be analysed. Nevertheless, the existing body of knowledge suggests that fuel excise rates cannot solely be explained by the Pigouvian argument of internalisation of consumption externalities. Previous research has indicated that tax rates simply differ too much in relation to the externalities for them to be attributed to differences in the externalities.

The research question of this thesis will be answered by analysing the excise rates levied on diesel and petrol in 17 European Countries over a period of 34 years. The use of a panel in the analysis of excise rates is a rather novel method. Rieveld and van Woudenberg (2005) analyse fuel prices in a cross-section analysis of over 100 countries in one year. Whereas this may be very informative in finding patterns in why and how fuel prices differ, this hardly yields insights in the way countries adapt their existing excise rates. Excise rates tend to be highly path dependent, that is, current excise rates largely depend on the excise rates levied in the year before. Hence, it is better to analyse changes to the existing excise taxes rather than the differences between them across countries, as these are likely to depend on choices made many years before. This will be done by estimating a first differenced model rather than a model in levels.

Apart from Rietveld and van Woudenberg (2005), there has been very little literature delving into the matter of excise rates. Most existing literature analyses one particular aspect of tax setting such as the internalisation of externalities (see for instance Parry (2001) and Parry & Small (2005)) or on aspects of tax competition, often on a state level in the US (see for instance Devreux et al. (2007), Evers et al. (2004) for a European study, or Kanbur & Keen (1993) for a theoretical model for tax competition). As a result, the scientific relevance of this research lies in the fact that this analysis is unique in both its scope as well as its methodology. First, it focuses on a broader number of aspects of tax

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Pas op: er zijn verschillen in motivatie die je kan toeschrijven vanuit theoretische overwegingen bijv. en observaties die dat al of niet weerspiegelen; als je gaat schatten probeer je te achterhalen waar die balans dan zit in praktijk


Dit hoort hier niet, maar eerder in de inleiding of zo; heeft immers weinig met externaliteiten te maken

setting that much of the existing literature has and will thus provide a more complete insight in the factors that do and do not play a role in the practice of tax setting. Second, it is unique in its methodology as it considers countries over a long period of time, allowing for the analysis of changes of the excise rates in the countries studied. Finally, the use of nominal data is also new, and allows for an analysis of policy changes without the interference of inflation. As inflation does, however, play a very significant role in tax amendments it will be included as one of the explanatory variables.

The social relevance lies in the fact that the thesis will contribute to a better understanding of the way countries set their excise taxes on mineral oils. In doing so, a number of publicly held beliefs about the motives of political leaders throughout will be tested to their merits. Moreover, this analysis will also provide an empirical investigation of the rationale of policy makers when setting taxes.

This thesis will proceed as follows. In section 2 the theoretical framework will be drawn up and will also discuss the already existing body of knowledge in the field. Section 3 focuses on the data and methodology to be used in the analysis and also provides a justification for the choices made in this. Section 4 features the empirical analysis of the excise rates, which will be performed separately for the two different fuels that this thesis focuses upon: diesel and petrol. Section 5 discusses the limitations of the analysis and provides avenues for further research, section 6 will conclude this thesis.

2. Theoretical framework

As discussed in the introduction, the number of factors that could influence the level of excise rates on diesel and petrol is very extensive.large. The Aaim of this study is to explain tax differences from the perspective of the internalisation of externalities, government revenue maximisation and the institutional context.

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‘Large’ denk ik; maar je brengt het terug tot de belangrijkste drie redenene zou ik zeggen; zie overigens verderop bij ‘The role of’Nu hangt deze driedeling wel erg in de lucht

I )i) The internalisation of externalities relates to two (related) issues: emissions and road use. Emissions arise when fossil fuels are combusted and impose external effects by harming the environment (and thus the people living in it). On a related note, road use imposes external effects by causing damage to the transport infrastructure and by causing congestion problems.

II ii) From the perspective of government revenue maximisation, strategic interactions between countries play a role, as well as the price elasticity of the demand for fuels.

III iii) Finally, the institutional context relates to issues such as the constitution of the incumbent government, the size and the scope of the government and its activities and the imposition of legislation from the EU.

The choice for these three categories is motivated by the fact that these categories seem most fundamental to the practice of fuel tax setting. The issue of externalities is often regarded as the primary justification for levying taxes in the first place, whereas tax competition and strategic interactions between countries are often used to explain why countries may depart from the socially optimal tax rate. Moreover, the institutional context in which policy makers operate may cause the actual policies to differ from the tax level that can be explained by theoretical models alone.

Before explaining the different factors and their effects on the excise rates in detail, I will first elaborate upon the role of the price elasticity of the demand for fuel and the differences between the two fuels. In doing so I will explain the dependency of the factors on the price elasticities and how the effects may differ between petrol and diesel. I will then discuss the direct implications of the three central categories of variables.

2.1. The role of price elasticities of demand

One of the reasons to levy a tax of a good is that taxes can affect the consumption of that particular good, as it alters its price. As long as the demand for the good is not perfectly inelastic, rational consumers will thus consume less of the good. The effect of a tax is illustrated by the graph in figure 2 below.

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Ik zou denk ik met deze paragraaf beginnen; hier kun je dan fraai laten zien waar het allemaal om draait bij belastingheffen en wat daar allemaal bij komt kijken; vervolgens geef je dan aan wat kern is van de discussies over wat het zetten van tarieven beinvloedt en hoe jij daar naar gaat kijken (zie ook opmerking bij begin theoretical framework)

This figure plots the price of a good to the consumption of that particular good, in this case a fuel. The marginal private benefits from consumption are given by the curve MPB, the corresponding marginal private costs by the line MPC, equal to the unit price of the fuel. However, consumption of the fuel imposes some externalities, as discussed above. The externalities are depicted by the marginal social cost of consumption, shown by the line MSC. The privately optimal level of consumption equates the MPC to the MPB, and is given by consumption CP at price PP.

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Figure 2: The effect of a unit tax

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The social optimum equates MSC to the MPB, yielding the optimal consumption point CS at the price PP+t. To achieve the social optimum level of consumption, a government can introduce a unit tax equal to t. This tax internalises the external effects of fuel consumption, and reduces the private level of consumption to the social optimum (Perman et al., 2003). Total tax revenue is given by the product of the tax and the amount of consumption, in this case t*CS.

The price elasticities of the demand for fossil fuels affect the extent to which the excise tax will reduce fuel consumption and emissions and the efficiency of government income generation from levying fuel taxes in the first place. Also tax competition is affected by the price elasticity of demand. When the demand for petrol and diesel are inelastic, then consumption is relatively insensitive to changes in prices. This implies that an excise tax will be ineffective in reducing fuel consumption – and thus the consumption externalities – when demand is inelastic. This also makes tax competition less attractive for countries, as fewer customers from abroad can be attracted by lowering taxes. Both insights can easily be illustrated by slightly adapting figure 2. The demand curve become steeped, the less elastic the demand becomes. In the case the demand is perfectly inelastic, the demand curve is simply a vertical line. From that it easily follows that the quantity consumed is completely independent of the price of the good, and thus also unaffected by the tax, rendering the tax completely ineffective in reducing consumption. Do note, however, that the lower the elasticity of a good, the greater the tax revenue will be for a given tax rate. The

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less elastic the demand for the good is, the less its consumption is affected by the tax. As a result, the tax base remains larger after the introduction of the tax when demand is less elastic.

The price elasticity also strongly influences the efficiency of a tax on a particular good. Whenever governments levy a tax, a deadweight loss is incurred. The larger the deadweight loss of a tax, the less efficient and more distorting the tax is. As argued by Ramsey (1927), the deadweight loss is smaller when the demand for the taxed good is relatively inelastic. This is illustrated by figure 3 below.

Figure 3: The deadweight loss illustrated

D

S

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Price, P

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Q' Q

A

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In absence of a tax, the equilibrium is in point A, with equilibrium price P and quantity Q. Now assume that the government imposes a lump-sum tax t on the good. The tax drives a wedge between the price the producer receives and the buyer pays. As the price the consumer has to pay has increased, he will demand less of the good. This shifts his utility curve downwards, to D’. The new equilibrium is in point B, where the producer sells Q’ units at price P’. The consumer on the other hand has to pay P’+t. The tax wedge is equal to the difference between the price the consumer pay and the price the producer receives, equal to the tax t. In the original equilibrium, the consumer and producer surplus were equal to the surface of the areas enclosed by the demand curve and points A and P, and the supply curve and points A and P, respectively. With the tax in place, both the consumer and producer surplus decrease: the consumer surplus shrinks to the area enclosed by the demand curve and points C

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and P’+t, the producer surplus to the area enclosed by the supply curve and points B and P’. A large part of this is absorbed by the tax revenue, equal to the area P’BCP’+t. However, the area ABC is not absorbed by the tax. This area is known as the deadweight loss, the inefficiency of the tax. From the graph it can also easily be seen that the less elastic the demand for the good is (i.e. the steeper the demand curve), the smaller the deadweight loss and the more efficient the tax becomes.

Note that this feature is unique for indirect taxes (i.e. taxes that are not paid directly to the government). Direct taxes, such as road tax, do not drive a wedge between the price paid by a consumer and the revenue the supplier receives from the transaction (as there is no transaction). Thus, consumption of the good is not influenced by the direct tax, as it is independent of the amount consumed. Indirect taxes directly affect the demand for a good, and drive a wedge between the end price and the revenue to the supplied. As a result, the deadweight loss is incurred as described above.

In this thesis I will focus on the short-run effects the price elasticity of demand has on the explanatory variables. In the long run, the demand for fuel becomes more elastic as producers will start producing more fuel efficient cars and consumers will substitute away from inefficient cars in favour of car models with better fuel economy. Whereas this does play a role, the focus lies on the short-run effects which is motivated by the chosen methodology. As the estimation is based on a model of first differences, annual changes in the excise rates are measured, making it an analysis of the short-run.

In light of this argument, Sallee (2010) argues that direct fuel taxation is an efficient tool to reduce fuel consumption by nudging consumers to purchase more fuel efficient cars. In recent years, countries seek to achieve this goal by cutting other taxes or subsidising economical cars. For instance, the Netherlands introduced a cut in the car purchase tax on fuel-efficient models and consumers were also given a refund if they traded in their old, more polluting car for a newer, cleaner model (Rijksoverheid, 2010). Germany, too, introduced a similar policy known as the ‘Abwrackprämie’, to stimulate consumers to trade in their old car for a newer model by giving a governmental refund on the old car. known as the ‘Abwrackprämie’. Sallee argues, however, that even although these policies proved effective (maybe even too effective, according to some critics), a simple direct fuel tax would have had similar results at lower cost. The main reason for

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Was iets anders en wel slooppremie; belastingdifferentiatie van de BPM is iets heel anders



this is that these programmes deviate from the Pigouvian principle of directly taxing the externality (fuel in this case) and thus increase the distorting properties of the taxes. Subsidies, on the other hand, have negative revenues for governments, whereas taxes have positive revenues. Hence, from a budgetary perspective, taxes are to be preferred. Moreover, direct taxation is better at countering the problems of the rebound effect, the phenomenon describing an increase in distances travelled when mileage costs decrease. Hence, Sallee advocates the use of fuel taxes over other measures to reduce fuel consumption (Sallee, 2010).

The question now remains how large the price elasticity of demand really is? Knittel (2006) estimates the price elasticities of the demand for fuel in the USA in a number of different models for two different time periods, from 1975 until 1980 and between 2001 and 2006. He finds that the demand for fuel has become increasingly less elastic, decreasing from between -0.31 and -0.34 in the period 1975-1980 to between -0.041 and -0.043 in the period 2001-2006. He attributes this decrease to the increasing dependence on personal transportation in the US, the increasing income levels and the ever improving fuel efficiency of cars in the US. Regardless of the change in the short-run price elasticity of demand, both figures show the demand for fuel to be relatively inelastic to price changes. The estimates indicate that a 10% increase in the price of fuel leads to a decrease in the short-run fuel consumption of between 0.4%1 and 3.4%.

Goodwin et al. (2003) perform a meta-analysis of existing literature on the price elasticity of the demand for fuel, based on an analysis of 175 academic articles. The authors estimate the weighted average short term price elasticity of the demand for fuel to be around -0.25. Brons et al. (2007) also perform a meta-analysis of the short- and long-run price elasticities of the demand for petrol. The analysis is based on a review of 43 primary studies that have estimated price elasticities themselves. Using a SUR approach, Brons et al. (2007) estimate the average short-run price elasticity of fuel demand to be -0.34. While the estimates for the price elasticities of fuel demand thus differ quite largely between studies, all results indicate that fuel demand is relatively inelastic. This finding has a number of implications for the use of fuel taxes.

Firstly, as argued before, the inelastic demand for fuel makes excise rates an ineffective instrument to reduce fuel consumption, simply because consumers do not respond greatly to price changes in the short-run. Second, it does make the

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use of excise rates an efficient source of income for central governments. As the deadweight loss from the excise tax is smallest when goods are inelastic, governments can reduce the distorting effects of taxation by levying relatively high excise rates on inelastic goods such as fuel and lowering the tax burden on more elastic ‘goods’ as labour.

However, as noted by Sterner (2007), there is a large difference between the short- and long-run price elasticity of fuel demand. In the short-run, consumers cannot substitute between different fuel types and car models and cannot move to a new address to reduce their distance driven. In the long-run, however, this is very much different. People will eventually buy a new car and can thus choose for a more economical model that consumes less fuel and can also choose a model that runs on a fuel that has a lower tax rate, as argued by Sallee et al. (2010). Also, people could move to a new home which is closer to work so that they have to travel less. Producers will also generate technological developments which reduce fuel consumption by cars. Hence, in the long-run, the demand for fuel is fairly elastic. In line with other studies in the field Sterner (2007) estimates the short-run price elasticity to be in the order of -0.27, but the long-run price elasticity is much larger, between -0.71 and -0.84. Hence, fuel taxes are ineffective at reducing fuel consumption in the short-run, but may prove to be far more effective in the long-run.

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2.2. Difference between diesel and petrol

Before delving into the theoretical considerations for tax setting and the corresponding hypotheses, it is worthwhile to consider the differences between the two fuels: diesel and petrol. The first and foremost difference has to do with their use. Diesel is primarily used as a fuel for road freight transport, whereas the majority of passenger cars run on petrol in most countries (Eurostat, 2012). This difference has vast implications for the excises levied on the two fuels. First of all, the commercial use of diesel by the transport sector implies that there is organised body that exerts political power on policy makers. This can be thought of as sector organisations that lobby for lower excise rates in the political forums, both nationally and on a European stage. The profitability of the transport sector is highly dependent on the height of the fuel prices, as this is the primary input of “production” for the sector. As a result, the sector organisations will – rightly – claim that high excise rates drive down profit margins and may threaten a significant share of the transport industry. Also, it is often seen that truck drivers go on strike to protest against too high excise rates, often by blocking highways throughout the country. Hence, the political pressure on the excise rates on diesel is much higher than it is for petrol excise rates.

Moreover, given that fuel prices (and thus excise rates) are so important for the transport sector, transport companies will seek to minimise fuel costs by carefully planning their refuelling stops. With international transport services, transport companies can plan in which countries the trucks have to refuel to minimise fuel expenses. With active fuel ranges of modern trucks ranging between 1500 and 3000 kilometres, trucks can easily choose to refuel in the transit country with the lowest fuel prices. As an example, consider a Dutch transport company that delivers goods throughout all of Europe. With its large trucks (that have an active fuel range of around 3000 kilometres), the companies trucks can reach any European country on a single fuel tank. On its way to its destination country, the truck passes through a great number of countries, and can thus refuel abroad at no extra cost.

The ease of refuelling abroad implies that the domestic demand for diesel is more price elastic than the demand for petrol, not because consumption as such varies a lot with price levels, but because trucks simply refuel elsewhere when

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the prices increase unilaterally. Hence the domestic demand for diesel shifts to countries with lower fuel prices. Overall demand in Europe will hardly be affected. This effect is further exacerbated by the fact that the incentive to refuel abroad is far greater for commercial users as their profitability depends highly on the fuel prices. The greater elasticity of the demand has two major implications for the excise rates. First, it greatly increases the incentive for countries to engage in tax competition, as trucks passing through a low tax country will simply choose to refuel there. Second, it makes the taxation of diesel a less efficient source of government income than petrol, implying that from an efficiency standpoint, excise rates on diesel should be lower than for petrol. As a result, the excise rates should be lower for diesel than for petrol, and tax differences are expected to be greater.

Finally, the level of emissions differs between the two fuels, too. Whereas diesel is often considered the ‘dirtier’ fuel in terms of emissions of CO2

per litre, this finding does not hold on a per kilometre basis. A litre of diesel fuel contains more CO2 than does a litre of petrol. However, diesel cars have a better fuel economy than comparable petrol cars do because diesel has a higher energy density than petrol. As a result, a diesel powered car is capable of driving a longer distance of that one litre of fuel, implying that the higher CO2

content of a litre of diesel is offset by the better fuel economy of diesel carsGiven the better fuel economy of diesel cars, they are in fact cleaner on a kilometre basis than comparable petrol powered cars (Delucchi, 2000). Upon the introduction of particulate matter filters, the emissions of particulates and greenhouse gases have been reduced drastically, making diesel the cleaner fuel of the two (Volkswagen, 2012). Hence, the effect of emissions of air pollutants of the excise rate can be expected to be lower for diesel.If emissions do in fact play a role in explaining excise rates, then it is to be expected that the effect is weaker for diesel than it is for petrol. Moreover, the better fuel efficiency also implies that the same unit taxes will have less of an effect on the consumption of diesel as the per kilometre tax will be lower for diesel than for petrol.

[2.3.] [2.4.] Taxes to internalise externalities

Taxes are most commonly explained from an externality perspective, as the fuel price net of taxes does not fully incorporate the total external

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Requires a better discussion

effects that come from the consumption of the fuels. This is essentially the Pigouvian argument for taxation in general. The external costs of fuel consumption are diverse. Firstly, there is the obvious pollution effect of combusting fossil fuels. By burning fuel, engines emit CO2 and other Greenhouse Gases (GHG) such as NOX and SOX. Moreover, combusting fossil fuels emits CO2 and GHG that are not yet present in the atmosphere. Burning wood or charcoal does not, as the trees from which wood and charcoal are made have absorbed CO2 from the atmosphere over their lifespan. Thus fossil fuels emit new pollutants into the atmosphere. The harmful effects of this are not reflected in the fuel prices net of taxes, which only cover extraction and distribution costs and a profit margin. In absence of a fuel tax the consumption of the fuel will be above the social optimum. By levying a unit excise tax on a fuel, the price increases and consumption will decrease, limiting the harmful effects of fuel consumption (Newbery, 2005).

A second externality related to fuel consumption for road transport are congestion problems and damage to road infrastructure. Given a certain level of fuel efficiency of the stock of vehicles, more fuel consumption implies an increase in the vehicle-kilometres travelled and will thus increase congestion problems. Congestion itself causes more pollution as vehicles emit pollutants even if stationary (fuel is thus simply wasted). Also, congestion causes delays of transports and thus increases transportation costs of people and goods (Newbery, 2005). However, it is important to note that fuel taxes are an inefficient and ineffective instrument to reduce congestion problems, as congestion is not only caused by overall miles driven, but primarily dependant on where and when people drive. The fuel tax can only affect the total number of kilometres driven by a person, but do not give incentives to drive at different times of the day. Moreover, people’s routes driven are strongly dependant on where they live and work, which will hardly be affected by the unit tax on fuel (see Parry, 2001 and Parry & Small, 2005). People in cars cannot work and thus add no value. By the same token, production inputs are of no use when stuck in traffic. Also, when each car has a higher annual mileage, the transport infrastructure is used more intensively which should cause it to wear more rapidly. From a theoretical perspective, one could combat (a part) of these externalities by levying a tax on fuel. The rationale is that the higher price induces consumers to drive less and thus will reduce the external effects.

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Dit vind ik geen externaliteit en Newberry ook niet; het gaat hier om betalen naar gebruik belasting (ben even engelse naam kwijt); het zijn cost internal aan de activiteit

Figure 2 illustrates the effect of such a unit tax on consumption. The main problem of the externality approach to taxes is that the total externality cost of fuel consumption is impossible to measuredifficult to measure and hard to estimate, and relies on a number of assumptions. Thus estimations are always highlyestimations may be subjective, leading to problems in the implementation of the optimal tax rate. Nevertheless, theory suggests that larger externalities justify a higher tax rate on the respective good. As was discussed before, however, diesel is a less polluting fuel than petrol, and thus justifies a lower tax to internalise consumption externalities, as these are lower for diesel than for petrol. This leads to the first two hypotheseshypothesis.

Hypothesis 1: Governments will respond to increases in the emissions of greenhouse gases by augmenting the excise rates on petrol and diesel. This effect is expected to be smaller for diesel than for petrol. By the same token, it holds that countries with more intensive road use will charge higher fuel taxes than countries with less intensive road use.

There have been several publications that aim at determining the optimal tax rate from an externality perspective. Parry (2001), for instance, posits that the optimal tax rate on petrol covers the full environmental effects from burning fuel. However, he does note that the implementation of the correct tax level is particularly difficult as estimates of the per litre cost of pollution vary largely. Apart from the pollution externalities, fuel taxes should be used to cover the cost of congestion caused by the consumption of petrol. Parry does, however, note that congestion problems are highly dependent on the time of the day and the route, as most congestion problems are caused by people travelling to and from work. Introduction a tax rate to charge people for the cost of congestion only partly tackles the congestion problem: people now do have an incentive to drive less, but they are not incentivised to travel to work a bit earlier/later to avoid congestion. Congestion charges are more effective at tackling the congestion problem because it does provide incentives to commuters to commute outside the peak hours (Parry, 2001).

In 2005, Parry and Small estimated the optimal tax rate in the United States and the United Kingdom. In doing so, they took into account the total externality cost of fuel consumption for road use (pollution,

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Dat lijkt me wel een hele boude bewering; zie Parry and Small (2005) bijv…..

congestion and accidents) and the price elasticities of the demand for fuel. The latter is the traditional Ramseyan argument for efficient taxation. Ramsey (1927) prescribes that the goods with the most inelastic demand should be taxed as high as possible and the taxes on highly elastic goods be cut, so as to minimise the distorting effects of taxation (and thus incurring the smallest possible deadweight loss). Parry and Small estimate the optimal tax rates for the US and the UK to be 101 and 134 dollar cents per gallon, respectively. For the US the estimated optimal tax rate is about twice its 2005 federal average tax rate, for the UK it is about half the 2005 tax rate. The authors conclude that the differences in externalities are insufficient to explain the large differences in the excise rates levied by the two countries. They attribute the differences to political factors such as the lobbying power of the American oil companies and the decentralised government structure in the US. Moreover, given the size of the US and the inferiority of the American public transit system makes car ownership far more a necessity than it is in the UK. High excise rates thus face far larger resistance in the US than they do in the UK (Parry & Small, 2005).

2.3.[2.5.] Government income maximisation

The general idea of a government behind levying taxes can be the maximisation of government income, preferably at as low a cost as possible. In the European case, strategic interactions between countries play a substantial role in maximising tax revenue. This issue is more commonly known as tax competition. The basic idea is that countries undercut their neighbours’ tax rates and absorb some of the demand for fuel in the foreign country. It may be possible to offset the losses in tax income from the lower tax rate with the increase in tax revenue from the foreign consumers buying their fuel abroad.

Kanbur and Keen (1993) have developed a model of tax competition in which they allow the sizes of countries to differ. In their model they assume that there are two countries that share a common border and that there is one taxed good. The countries lie on the interval [-1, 1] and the population in each is uniformly distributed and may differ in size. Populations are given by h and H for countries home and foreign, respectively. Taxes are levied on a destination basis, i.e. each country

18


Let op: gaat dus om max T in open economie; dat is afwijkend van de Ramsey setting! Die doet max U (min verstoringen)

only levies taxes on the goods sold in that country, and cannot levy a tax on goods bought by its inhabitants in the foreign country. The countries set their own tax rate, t and T, respectively. To simplify the analysis, Kanbur and Keen assume the reservation prices v and V for the good to be the same for all consumers within a country. They may differ between the countries. As driving to the border is costly (it takes time and fuel to travel), travelling cost δ>0 is assumed. The total cost of shopping abroad is given by δs where s denotes the distance to the border. Under these assumptions, buying abroad is worthwhile if and only if:

v−T−δs>v−t (1)

t−Tδ

>s (2)

That is, as long as the surplus (the difference between the reservation price and the actual cost of buying the good) from buying the good abroad is larger than the surplus from buying it domestically, consumers will shop abroad. The critical distance is given by s. The second necessary condition is that the surplus from buying the good is positive, i.e.:

v−T−δs>0 (3)

Countries’ tax revenue is given by:

r (t , T )={t h[1−( t−Tδ )]if t ≥T

t h+tH (T−tδ ) if t ≤T

(4)

The top equation above illustrates the case in which the home country levies a higher tax rate than the foreign country. Total tax revenue of for the country is simply the tax rate multiplied by the total consumption, which is assumed to be equal to the share of the population buying the good domestically. The fraction of the population shopping domestically is equal to the share of people that live outside the feasible distance for cross border shopping, i.e. that live beyond the critical distance s from the border. As the population is uniformly

19

distributed, the number of people that live within the critical distance is proportional to the length of the interval between the border and s. As

we can see from equation 2, this amounts to t−Tδ

. Hence, the total

domestic demand for the good is equal to (the people living in) the distance from the upper bound of the interval and the point from where

domestic inhabitants start shopping abroad, equal to [1−( t−Tδ )] .

In the case where the domestic country undercuts the foreign country, the total tax revenue is equal to the bottom half of equation 4. In this case, all inhabitants of the home country will buy the good domestically, yielding tax revenue of t h. However, as the good is cheaper in the home country, inhabitants from the foreign country will choose to buy the good in the home country. The share of people for whom it is feasible to

do so is equal to (T−tδ ). As the population densities may differ between

countries, this share has to be multiplied by the total mass of people in the foreign country H and the tax rate levied in the home country t. From equation 4 it also easily follows that when both countries levy the same tax rate, no cross border shopping will occur as t−T=T−t=0.

As indicated by the model of Kanbur & Keen (1993), the degree of tax competition crucially depends on the tax differential and the travel costs. The latter implies that it is likely that tax competition is more severe for diesel than it is for petrol. As diesel cars are more fuel efficient than petrol powered cars are, the cost of travelling to the border is lower. Also, excise rates on diesel are lower, further lowering the relative cost of fuelling abroad. On a related note, the tax competition for diesel may also be more severe because trucks run almost exclusively on diesel in Europe. Trucks have large fuel tanks that give them an active range of 1500 to 3000 kilometres, enabling them to carefully plan their refuelling stops without having to take a (significant) detour. As a result, the cost of refuelling abroad is close to zero, making it an attractive option for virtually all trucks. As discussed previously, the price elasticity of the demand for fuel is also larger, again increasing the incentive for countries to engage in tax competition.

Assuming that countries aim to maximise total tax revenue from the good, this game of strategic interactions can be solved to show that

20

small countries strictly undercut the tax rate of the larger neighbouring country. The degree of the undercut is dependent on the disparity in country sizes. When the difference in country size is very large, the difference in the tax rates will be large, too. When the countries only differ slightly in size, the undercut by the smaller country will be smaller. Based on this model, it is expected that:

Hypothesis 2: Small countries levy lower fuel taxes than large countries do. These countries do so especially for diesel, but less so for petrol.

The implications of the model were tested in numerous a number of articles, for instance by Rietveld and van Woudenberg (2005) who investigated the effect of relative country size on the fuel prices in 100 countries. As predicted by the model, it were especially the countries whose ratio of the size of the neighbouring countries and to their own country size was relatively high (i.e. are small in comparison to their neighbours) engage in tax competition. Moreover, they also associated higher fuel prices in neighbouring countries to higher domestic fuel prices (Rietveld & van Woudenberg, 2005). This finding was confirmed by Slemrod (2003) in the analysis of corporate tax rates.

In a more formal analysis, Evers, de Mooij and Vollebergh (2004) found evidence for strategic interactions between the diesel tax rates of neighbouring countries. Yet again, countries respond to tax augmentations of their neighbours by raising their own tax rates. However, no evidence was found for the influence of country size on the response of the tax rates of neighbouring countries, i.e. the reactions to tax changes did not differ for large and small countries (Evers, et al., 2004). Note that this does not imply that small countries engage as vigorously in tax competition as large countries do, but rather describes the magnitude of the reaction to tax changes in neighbouring countries. Nevertheless, the finding is in contrast to the expectations formulated based on the model of Kanbur and Keen, who posit that large countries’ reactions should be larger. Devreux et al. (2007) on the other hand, find that tax competition for petrol is not particularly strong in the US. This has to do with the fact that transport costs are mostly rather large and fuel tax difference rather small. Hence, there are few consumers for

21


Nou, zoveel ken ik er nu ook weer niet…

whom cross-border shopping is actually a viable option (Devreux et al., 2007).

Of course there is more to the issue of tax competition than mere competition in tax rates. It has been common practice for many countries in the past, and still is, to enhance their international competitiveness by devaluating the domestic currency. Such a devaluation reduces the foreign price of domestically produced goods, increasing the foreign demand for them. Of course, the degree to which this adjustment has effect on domestic production depends on the openness to trade of the country in question. The devaluation of a countries’ currency also has effects in the case of tax competition. As the currency is now worth less relative to the currency in neighbouring countries, it becomes cheaper for foreign consumers to buy their fuel abroad. Given that the EU member states have complete open borders with other EU member states, cross border shopping is quite feasible in the EU. Hence changes in the exchange rates between countries affect the domestic and foreign demand for mineral oils in the home country, and more strongly so in the EU. Of course it seems farfetched that countries choose to devaluate their currency for the sole purpose of increasing sales of fuels (and thus increase tax revenues), however, exchange rate fluctuations do affect the extent of cross border shopping. As a result, the exchange rates between countries fluctuations are still expected to affect the excise rates abroad. Given certain excise rates in two countries, if one country devaluates its currency it might induce the neighbouring country to lower its nominal excise rate, to establish the original equilibrium real tax differences, leading to the next hypothesis:

Hypothesis 3: Countries respond to currency devaluations in neighbouring countries by reducing the domestic nominal excise rates. This effect is expected to be smaller for diesel than for petrol.

The second part of the hypothesis requires some explanation, as it may seem counterintuitive. After all, given the increased tax competition one would expect greater adjustments for diesel than for petrol. However, one has to consider that excise rates on diesel are lower, due to the greater effect of tax competition, the smaller external effects and the more elastic domestic demand. As stated above, countries are expected to re-establish the initial equilibrium of tax differences

22


Heeft dus ook impact op cross-border shopping!

upon a devaluation of the currency of the foreign country. Given the lower excise rates on diesel, the devaluation decreases the effective diesel excise rate by less than it does for petrol. For example, if the respective foreign excise rates on diesel and petrol are 50 and 60 Eurocents, then a 10% devaluation of the foreign currency reduces the effective foreign excise rates on diesel and petrol to domestic consumers by 5 and 6 Eurocents, respectively. The domestic country will respond proportionally, thus reducing the diesel excise rate by less than the excise rate for petrol.

2.4.[2.6.] Institutional context

The institutional context captures a number of changes in the political environment that may explain policy changes with respect to excise taxes. The institutional context includes the political orientation of the incumbent government, the level of governmental spending and changes in EU policy. The political orientation of the incumbent government refers to the political colour the government has. Aghion and Bolton (1990) analyse the policy choices of different political parties in a two-party system. With the left-wing party focusing on the poorest half of the population and the right-wing party focusing on the richest half of the population, the authors show that it is optimal for the left-wing government to increase expenditure in public services, such as public transportation and social security systems, which mostly benefit the relatively poor. Under the imposition of the restriction that the government budget must balance in every period2, the left-wing government levies higher taxes in equilibrium than the right-wing government (Aghion & Bolton, 1990). This result has two implications: first of all, left-wing governments have larger public expenditure than right-wing governments. Second, left-wing governments have higher tax rates to finance the larger expenditures. Given that the analysis focuses solely on the explanation of excise rates on diesel and petrol, only the latter claim will be tested empirically. Note that the greater price elasticity of the demand for diesel implies that diesel is a less viable ‘cash cow’ for governmental tax income generation than petrol is, as taxes on diesel create a greater deadweight loss. Hence, it is to be expected that:

2 This restriction is not entirely realistic, but holds at least in the long run

23

Hypothesis 4: The excise rates on petrol and diesel will increase when the incumbent government changes from a right-winged government to a left-winged government. This increase is larger for petrol than for diesel.

Given the assumption that the governmental revenues and expenses must match in the long run, one would expect that countries that have a larger governmental system and higher public spending compensate these levels of spending with higher taxes. For this relationship to hold, however, it must be that the country in question is facing either in a net borrowing position or has outstanding debt. A country that does not meet either two conditions has no incentive to levy higher taxes than strictly necessary as this imposes distortions in the economy. Hence, it will primarily be countries in a net borrowing position (i.e., the countries with a net governmental operating deficit) that will levy higher excise rates. Nevertheless it still holds that given a level of governmental non-tax income, a higher level of public expenditure must be associated with higher taxes. If countries with larger public spending indeed levy higher tax rates, then it is expected that the excise rates on diesel and petrol will be higher, too. As described before, diesel is a less feasible fuel for government income generation.

Hypothesis 5: Increases in countries’ government expenditure will be met by increases in the excise rates on petrol and diesel to balance government expenditure and revenues. Similarly, a worsening in the governmental operating balance will also be met by higher excise rates. Again, this effect is expected to be smaller for diesel than for petrol

The final aspect of the institutional context that is important for the analysis is the role of the European Union. As a supranational governing body, the European Union can devise legislation that is applicable to all the member states. As was discussed in the introduction, the European Commission has been working on the harmonisation of the tax systems in the EU since the 1970s. One aspect of this harmonisation process was the imposition of minimum excise rates on mineral oils, tobacco and alcohol, proposed in 1987 and formally implemented in 1993. The introduction of the minimum excise rates had two formal reasons. Firstly, it was destined to reduce the harmful effects of tax competition in the Union. Countries are supposed to be competing with each other,

24


Revenue raising argument


Deficit lijkt me relevanter; zeker ivm changes

but on the basis of comparative advantages rather than on the basis of artificial distortions to the markets via taxes (European Commission, 2000).

Kanbur and Keen (1993) have shown in their model that tax competition also leads to lower overall tax revenues, implying that countries will have to compensate this loss in tax revenue by levying higher taxes elsewhere. Hence, limiting tax competition can have great efficiency gains. Also the introduction of the shared currency, the Euro, has contributed to reduced tax competition between Euro countries, as exchange rate fluctuations between Euro countries no longer plays a role. served this purpose (amongst others). Second, the minimum excise rate forces EU member countries to control for a certain minimum level of externalities, by limiting the scope for downward adjustments of the tax rate (European Commission, 2000).

As a result, it is to be expected that the introduction of the EU minimum excise rate has led to a significant rise in the excise rates levied by the member states in order to comply with the minimum rate. Kanbur and Keen (1993) also note that when a minimum tax rate is imposed, the small country will continue to undercut the large country by setting a new excise rate close to the minimum level. The large country, in turn, will also augment its tax rate, but by less than the small country As a result, the degree of tax competition should decrease upon the introduction of the minimum excise rate. Moreover, as can be seen from the plots of the excise rates over time, the greatest effect for the minimum excise rate is to be expected to occur before its actual introduction. Countries had to comply with the minimum rates as of January 1st 1993, and thus had to respond before the tax becoming effective.

Hypothesis 6: The introduction of the minimum excise rates in diesel and petrol lead to higher overall excise rates. The increase in the excise rates is larger for small countries than it is for large countries. These adjustments have taken place before the introduction of the excise rate.

25


Why not separate anticipation and after introd


Which?

[2.7.] The role of price elasticities of demand

[2.8.] The price elasticities of the demand for fossil fuels affect the extent to which the excise tax will reduce fuel consumption and emissions and the efficiency of government income generation from levying fuel taxes in the first place. When the demand for petrol and diesel are inelastic, then consumption is relatively insensitive to changes in prices. This implies that an excise tax will be ineffective in reducing fuel consumption – and thus the consumption externalities – when demand is inelastic. This can easily be illustrated by slightly adapting figure X. If demand is, for instance, perfectly inelastic, the marginal private benefits curve (i.e. the demand curve) will be a vertical line. It then easily follows that consumption is completely unaffected by the price, implying that a tax will not alter consumption. Obviously, the demand for fuel is unlikely to be perfectly ineslastic, but this example clearly illustrates the role of price elasticities on the effect of taxes.

[2.9.] The price elasticity also strongly influences the efficiency of a tax on a particular good. Whenever governments levy a tax, a deadweight loss is incurred. The larger the deadweight loss of a tax, the less efficient and more distorting the tax is. As argued by Ramsey (1927), the deadweight loss is smaller when the demand for the taxed good is relatively inelastic. This is illustrated by figure X below.

26


Ik zou denk ik met deze paragraaf beginnen; hier kun je dan fraai laten zien waar het allemaal om draait bij belastingheffen en wat daar allemaal bij komt kijken; vervolgens geef je dan aan wat kern is van de discussies over wat het zetten van tarieven beinvloedt en hoe jij daar naar gaat kijken (zie ook opmerking bij begin theoretical framework)

[2.10.] D

S

D'Quantity, Q

Price, P

P'+t

PP'

Q' Q

A

C

B

[2.11.] In absence of a tax, the equilibrium is in point A, with equilibrium price P and quantity Q. Now assume that the government imposes a lump-sum tax t on the good. The tax drives a wedge between the price the producer receives and the buyer pays. As the price the consumer has to pay has increased, he will demand less of the good. This shifts his utility curve downwards, to D’. The new equilibrium is in point B, where the producer sells Q’ units at price P’. The consumer on the other hand has to pay P’+t. The tax wedge is equal to the difference between the price the consumer pay and the price the producer receives, equal to the tax t. In the original equilibrium, the consumer and producer surplus were equal to the surface of the areas enclosed by the demand curve and points A and P, and the supply curve and points A and P, respectively. With the tax in place, both the consumer and producer surplus decrease: the consumer surplus shrinks to the area enclosed by the demand curve and points C and P’+t, the producer surplus to the area enclosed by the supply curve and points B and P’. A large part of this is absorbed by the tax revenue, equal to the area P’BCP’+t. However, the area ABC is not absorbed by the tax. This area is known as the deadweight loss, the inefficiency of the tax. From the graph it can also easily be seen that the less elastic the demand for the good is (i.e. the steeper the demand curve), the smaller the deadweight loss and the more efficient the tax becomes.

27

[2.12.] In light of this argument, Sallee (2010) argues that direct fuel taxation is an efficient tool to reduce fuel consumption by nudging consumers to purchase more economical cars. In recent years, countries seek to achieve this goal by cutting other taxes or subsidising economical cars. For instance, the Netherlands introduced a cut in the car purchase tax on fuel-efficient models and consumers were also given a refund if they traded in their old, more polluting car for a newer, cleaner model (Rijksoverheid, 2010). Germany, too, introduced a similar policy known as the ‘Abwrackprämie’. Sallee argues, however, that even although these policies proved effective (maybe even too effective, according to some critics), a simple direct fuel tax would have had similar results at lower cost. The main reason for this is that these programmes deviate from the Pigouvian principle of directly taxing the externality (fuel in this case) and thus increase the distorting properties of the taxes. Subsidies, on the other hand, have negative revenues for governments, whereas taxes have positive revenues. Hence, from a budgetary perspective, taxes are to be preferred. Moreover, direct taxation is better at countering the problems of the rebound effect, the phenomenon describing an increase in distances travelled when mileage costs decrease. Hence, Sallee advocates the use of fuel taxes over other measures to reduce fuel consumption (Sallee, 2010).

28




Fuel efficient bedoel je?

[2.13.] The question now remains how large the price elasticity of demand really is? Knittel (2006) estimates the price elasticities of the demand for fuel in the USA in a number of different models for two different time periods, from 1975 until 1980 and between 2001 and 2006. He finds that the demand for fuel has become increasingly less elastic, decreasing from between -0.31 and -0.34 in the period 1975-1980 to between -0.041 and -0.043 in the period 2001-2006. He attributes this decrease to the increasing dependence on personal transportation in the US, the increasing income levels and the ever improving fuel efficiency of cars in the US. Regardless of the change in the short-run price elasticity of demand, both figures show the demand for fuel to be relatively inelastic to price changes. The estimates indicate that a 10% increase in the price of fuel leads to a decrease in the short-run fuel consumption of between 0.41 and 3.4%.

[2.14.] Goodwin et al. (2003) perform a meta-analysis of existing literature on the price elasticity of the demand for fuel, based on an analysis of 175 academic articles. The authors estimate the weighted average short term price elasticity of the demand for fuel to be around -0.25. Brons et al. (2007) also perform a meta-analysis of the short- and long-run price elasticities of the demand for petrol. The analysis is based on a review of 43 primary studies that have estimated price elasticities themselves. Using a SUR approach, Brons et al. (2007) estimate the average short-run price elasticity of fuel demand to be -0.34. While the estimates for the price elasticities of fuel demand thus differ quite largely between studies, all results indicate that fuel demand is relatively inelastic. This finding has a number of implications for the use of fuel taxes.

29

[2.15.] Firstly, as argued before, the inelastic demand for fuel makes excise rates an ineffective instrument to reduce fuel consumption, simply because consumers do not respond greatly to price changes in the short-run. Second, it does make the use of excise rates an efficient source of income for central governments. As the deadweight loss from the excise tax is smallest when goods are inelastic, governments can reduce the distorting effects of taxation by levying relatively high excise rates on inelastic goods such as fuel and lowering the tax burden on more elastic ‘goods’ as labour.

[2.16.] However, as noted by Sterner (2007), there is a large difference between the short- and long-run price elasticity of fuel demand. In the short-run, consumers cannot substitute between different fuel types and car models and cannot move to reduce their distance driven. In the long-run, however, this is very much different. People will eventually buy a new car and can thus choose for a more economical model that consumes less fuel and can also choose a model that runs on a fuel that has a lower tax rate, as argued by Sallee et al. (2010). Also, people could move to a new home which is closer to work so that they have to travel less. Producers will also generate technological developments which reduce fuel consumption by cars. Hence, in the long-run, the demand for fuel is fairly elastic. In line with other studies in the field Sterner (2007) estimates the short-run price elasticity to be in the order of -0.27, but the long-run price elasticity is much larger, between -0.71 and -0.84. Hence, fuel taxes are ineffective at reducing fuel consumption in the short-run, but may prove to be far more effective in the long-run.

[2.17.] Other considerations

Apart from the issues considered above, there are a number of alternative factors that can play a role on the setting of fuel excise taxes by countries. These factors include inflation, the composition of the vehicle fleet, per capita income and the importance of sectors that are sensitive to fuel prices such as the transport sector and the automotive industry.

30

Inflation plays a very significant role in the issue of setting taxes, mostly because we are looking at quantity based taxes rather than ad valorem taxes. This is best illustrated with a numerical example. Assume that a country consumes 100 units of good X, priced at 1 per unit. Thus the total tax base is 100. Now further assume that the country has an ad valorem tax rate of 19% of the price (a fairly standard VAT rate) and a specific tax rate of 0.15 per unit. In year 1, the tax receipts (nominal and real) from consumption are 19 from the ad valorem tax and 15 from the specific tax. Now assume that the country faces inflation of 10% from year 1 to year 2. The unit price now is 1.1. Assuming that the consumption remains constant at 100, the tax base in year 2 is 110. The nominal tax receipts are 20.9 for the ad valorem tax and 15 from the specific tax. Adjusting these figures for inflation, the real tax receipts of the ad valorem tax remained constant at 19, but the receipts from the specific tax have decreased to 13.64. In order to keep tax receipts constant, the country needs to adjust the specific tax rate to inflation, i.e. raise it by 10%. This simple example shows why countries with higher rates of inflation are expected to raise their specific taxes by more than countries with low inflation (Tanzi, 1977). Moreover, the analysis is based on nominal tax data, so it is necessary to adjust these data for inflation. However, given the importance of inflation in the changes to the excise rates, it will be used as an explanatory variable in the estimation procedure.

The composition of the vehicle fleet represents the share of fuel types in the total vehicle fleet of a country. There are a number of reasons why the vehicle fleet should influence the relative level of excise rates. Firstly, the larger the share of petrol powered cars, the higher the share of pollution is attributable to petrol cars, possibly inducing countries to levy higher excise rates on petrol. On the other hand, taxes can be used to alter consumer choices. Hence, if a country wanted to promote a particular fuel, it could do so via taxes. So the composition of the vehicle fleet is one of the many considerations for policy makers.

Finally, the importance of fuel price sensitive sectors such as the oil industry, the automotive sector and the especially the transport sector should not be underestimated. In the past we have seen many explicit

31


Unclear; combine with next section “difference between …”

attempts to influence excise rates by means of strikes by truck drivers. Moreover, many of the industries considered have significant lobbying power in the political chambers in Europe, and may thus have an influence on the excise rates levied. Salamon and Siegfried (1977) investigated this claim and found that oil companies have significant lobbying power in the US. Moreover, the price of the fuels net of the excise taxes also affects the extent to which governments can increase excise rates, because a rise in the net price should intensify the opposition against a possible increase of the excise rate by the abovementioned industries.

3. Data & Methodology

In this section, the data and methodology used in the analysis will be elaborated upon. As stated before, the analysis will focus on the European case. As a result, the sample includes a total of 173 European countries, tracked over 34 years, from 1978 until 2011. The choice of countries is largely driven by the availability of tax data. The excise taxes are obtained from the International Energy Agency Energy Prices and Taxes 2011 dataset. This dataset has energy tax data available for 23 countries. Six countries were excluded from this sample because they were not interesting due to their geographical location or due to incomplete data. The excluded countries were Canada and the USA, Australia and New Zealand, Japan and Turkey. The first five countries are not interesting due to the fact that they do not allow for the analysis of strategic interactions with other countries in the dataset. Moreover, none of these countries is subject to EU legislation. These two issues taken together imply that it is impossible to sensibly assess the effect of the minimum excise rate on non-EU countries that share a common border with EU countries. ,. and thus adding very little value to the analysis. Turkey was excluded on grounds of data availability. As observations were missing until 1990, the inclusion of Turkey would have significantly restricted the number of observations in the analysis.

3 The countries included in the sample are: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom

32


Hangt er maar van af; juist wel als invloed daarvan wilt meten

The excise tax data are kept in nominal terms, which is rather unusual when looking at the prior research. This choice is motivated by the focus of this research. Aim of this analysis is the investigation of the factors that contribute to changes in the excise rates levied. For this it is important to dissect actual policy changes from inflation and other disturbances. By separating inflation from the excise rates, a change in the excise rates will only be measured if policy makers actually adjust the nominal level of the excise rates. , which could trouble the analysis. If real data were to be used, the excise rates would change annually, even if the nominal excise rate had been kept unaltered. Looking at the data, it is easily concluded that this does not correspond to the reality of the excise rates. Excise rates are often not adjusted annually but once every two to four years. Hence, using real data in the analysis would measure changes that are absent in reality. Of course, inflation is a very important factor for the adjustment of the excise rates and will thus be used as a separate explanatory variable in the analysis. Table 1 below shows the total of variables that will be used in the analysis.

We have already touched upon the excise rates for diesel and petrol, which are the dependent variables. The rest of the variables can be divided into four main categories: measures for the severity of externalities, measures for the intensity of cross-border shopping, institutional variables and control variables. The measures for the severity of externalities comprise of the emissions of nitrogen oxides and road use. Nitrogen oxides are used as a measure of the severity of the pollution caused by road transport. Of course many other measures can be taken (CO2 and SOx for instance), but these cannot be used in a simultaneous regression due to collinearity of the variables4. The variable measures the totality of emissions of NOx attributable to road transport (including road freight transport). Unfortunately, this variable does not make a distinction between emissions from different fuel types., which had ideally been the case.

The intensity of tax competition is approximated by the extent of cross-border shopping and exchange rate fluctuations. The prior variable

4 CO2 is a fixed component of mineral oils which is emitted in fixed quantities per unit consumed. Hence the emissions of CO2 are proportional to fuel consumption. NOx and SOx emissions can be and have been reduced via technological advances, which makes them follow the same trend.

33


Ik zou in table tussenkopjes gebruiken die variabelen scheiden in relatie tot je 3 hoofdredenen


Niet erg duidelijk en in strijd met vervolg; why ‘trouble’?

measures the incentive for a country to engage in tax competition by size of the feasible market in the neighbouring countries of that country, as a fraction of its domestic market. The measure is constructed as follows.

First, each country is assumed to be a circle with a radius such that the total surface area of the circle equals the surface area of the respective country. However, a part of this will be captured with the composition of the vehicle fleet, measured by the variable vehicle fleet. Road use is measured by the per capita number of kilometres driven by passenger cars in a country. The idea is that more severe road use will, ceteris paribus, lead to greater externalities as congestions and damage to road infrastructure. Ideally, this variable had also included total road length, but this was not possible due to the unavailability of data.For simplicity, each country’s population is assumed to be uniformly distributed over the total surface area (as in Kanbur& Keen, 1993). Then it is assumed that each country can feasibly serve consumers in neighbouring countries up to 20 kilometres from the respective border5. Then the surface area of the total feasible market for a country is calculated as the surface area of a circle with the initial radius plus 20 kilometres. Up to this point, the measure used is the same as the one used by Rietveld and van Woudenberg (2005). However, as the relative market size is based on population size and not country size, I further calculate the number of people living in the feasible external market (i.e. the number of people living in the ring around the initial country circle). This is done by considering each country’s population density and the common border shared between the countries in question. The countries are weighted according to the share in the total border length (including coastlines), and the weights are multiplied by the size of the outer circle to get each country’s share in the surface of the external market. These shares are then multiplied by the respective population densities in the neighbouring countries to get the total number of people that could be served by the domestic country via tax competition. Dividing this figure by the total domestic population5 This figure is not arbitrarily chosen. Rather it is a result of a thought experiment. Assuming a tax differential of €0.10, an average fuel tank size of 60 litres and an average fuel consumption of 8.5 litres per 100 kilometres, a rational consumer will drive up to 40 kilometres to buy fuel abroad (at prices of €1.75 per litre). As the consumer has to drive back and forth, the feasible distance is 20 kilometres across the border.

34


?????

Table 1: Variable Description

Variable Description Measurement base SourceExcise rate Excise rate on diesel/petrol € IEA EPT 2011ExternalitiesNOx emissions Total emissions of NOx

attributable to transportKilotonnes per capita Eurostat, CEIP

Road use Distance driven by passenger cars per capita

1000 km per capita OECD

Road useRoad use Distance driven by passenger cars per capita Distance driven by passenger cars per capita

1000 km per capita OECD

Strategic InteractionsCross-border shopping Importance of foreign

market relative to domestic market

Population living within 20km over the border relative to domestic population

Own calculation

Exchange rate shocks The presence of an exchange rate shock in a neighbouring country

Dummy: 0 = No, 1 = Yes Eurostat, OECD

Institutional ContextGovernment expenditure General government

expenditureDecimal share of GDP OECD, Eurostat, CESifo, CSO

IrelandGovernment net lending/borrowing

General government net financial position

Govt_rev - Govt_exp; decimal share of GDP

OECD, Eurostat, CESifo, CSO Ireland

Left government Presence of a Left-winged government

Dummy: 0 = No, 1 = Yes The Random House Encyclopedia

Minimum excise Value of the EU minimum excise rate on diesel/petrol

€ European Commission

EU member EU membership of a country

Dummy: 0 = No, 1 = Yes European Commission

Control VariablesInflation Inflation Decimal change in CPI OECDReal GDP per capita GDP Real 1000€ per capita OECDVehicle fleet Share of Diesel Cars Share of total cars Eurostat; Technical

University of ViennaNet price Price of diesel/petrol net of

excise taxes and VATReal € IEA EPT 2011

VAT The prevalent VAT rate on mineral oil products

Decimal share IEA EPT 2011

Oil industry Domestic oil production 1000 megatonnes OECD; IEAAutomotive sector Number of Domestic Car

manufacturersnumbers Ultimatecarpage.com

Freight transport Tonnes of cargo transported via roads

1000 Megatonne-kilometres

OECD

yields the relative importance of the foreign market to the domestic market. Exchange rate shocks are measured by considering relative exchange rates between two neighbouring countries. Any upward shock6 greater than five percent is counted as a shock. The variable thus measures the presence of an upward shock in its neighbouring countries. In case there are multiple countries that devaluated their currency, the variable has a value of one, to simplify the analysis.

The institutional variables consist of government expenditure, the political colour of the incumbent government and the EU minimum

6 An upward shock implies that the currency of the neighbouring has devaluated making foreign goods cheaper relative to domestic products.

35

excise rate. Also a dummy variable for EU membership is added. Government expenditure simply measures the general government expenditure as a share of GDP. Alternatively, the general governments’ net financial position can be used in the analysis. The political colour of an incumbent government is a dummy variable that measures whether or not a countries’ government is led by social democratic or socialist party. The EU minimum excise rate simply has the overall minimum excise rate imposed by the EU. This variable is country specific in the sense that Greece and Luxembourg faced different minimum excise rates for diesel and petrol in 1993 and 1994. The EU membership variable measures whether a country is an EU member. This variable can also be used in interaction with the minimum excise rate to measure the excise rate when it became effective to that particular country7.

The composition of the vehicle fleet is part of the control variables, and is measured as the share of diesel powered cars of the total vehicle fleet of passenger cars. However, the vehicle stock may suffer from endogeneity issues as the relative shares of diesel and petrol powered cars depends on the relative height of the excise rates on the two fuels. For instance, it seems plausible that countries that have traditionally had low excise rates on diesel will have a greater share of diesel cars than countries with higher diesel excise rates. Hence, rather than the vehicle stock explaining the excise rates it may be the case that excise rates explain the composition of the vehicle fleet. To solve this issue, the vehicle stock is used as a lagged variable in the analysis.

IInflation is used as a separate variable in the analysis and is measured as the percentage change in the Consumer Price Index from one year to the next. The VAT rate on mineral oils is also included, to control for other sources of government income from fuel taxation. Real GDP per capita and the real net fuel price are also included. These two variables are measured in real terms as inflation is already included in the analysis as a separate variable. The variables for the importance of the oil industry, the automotive industry and the transport industry have three different measurement bases. The oil industry is measured by the 7 Austria and Finland, for instance, joined the EU in 1995. Hence, in 1993 and 1994, the minimum excise rate was not applicable to these two countries. Whereas the minimum excise rate variable would still read the minimum values for those years, the interaction term would read zero, reflecting the fact that it was not effective to these countries.

36


Why? Explain endogneity issue and how you solve this

overall quantity of oil produces in a country, whereas the automotive sector variable measures the number of large, active car manufacturers in a country. The freight transport sector is measured by the total tonnage of cargo transported via road. Ideally, all of these variables would measure the total value added of each of the sectors, however, this was not possible due to the unavailability of the data for the entire panel length. Data were only available for these sectors after the year 2000, so that the inclusion of these variables would have led to the omissions of more than two-thirds of the years.

3.1. Descriptive Statistics

To get a more detailed view of the core variables, the descriptive statistics are provided in this section. By means of the descriptive statistics, the relative magnitudes and the variation within the variables is better portrayed. Table 2 below shows the descriptive statistics for the variables used in the analysis.

The descriptive statistics reveal a number of interesting insights. First of all, it should be noted that excise rates on petrol are generally higher than the excise rates on diesel. This can be seen by the average rate, which is about €0.14 higher for petrol than it is for diesel, and so are the respective minima. Interestingly, however, the maximum excise rates are the same for the two fuels. This has to do with the United Kingdom, which levies virtually the same excise rates on diesel and petrol. Moreover, the differences in the excise rates across observations are larger for petrol, too, as indicated by the standard deviation and the range of the values. The same holds for the minimum excise rates imposed by the EU, which is higher for petrol than it is for diesel.

It can also be seen that there is a lot of variation in the levels of government expenditure and its net financial position. This goes to show that within the panel there are countries that have a traditionally large governmental body and countries that have relatively small governmental bodies. Also, there are numerous countries that have faced significant financial imbalances. Another striking issue is that the panel is perfectly balanced in the sense that all variables have the same

37

number of observations available. Hence the estimation should not be biased on the grounds of the available data.

Table 2: Descriptive StatisticsVariable Observations Mean Std. deviation Minimum Maximum

Excise diesel 578 0.269 0.147 0.001 0.795

Excise petrol 578 0.405 0.158 0.036 0.795

NOx emissions 578 0.017 0.013 0.003 0.107

Road use 578 8.178 2.781 1.045 12.596

Cross-border 578 26.163 54.743 0.497 260.217

Exchange rate 578 0.137 0.344 0 1

Gov’t expenditure 578 47.429 7.744 28.256 71.720

Net lending/borrowing

578 -2.347 4.872 -32.400 19.087

Left government 578 0.370 0.483 0 1

Minimum excise diesel

578 0.190 0.123 0 0.330

Minimum excise petrol

578 0.214 0.150 0 0.359

EU member 578 0.761 0.427 0 1

Inflation 578 4.727 4.955 -4.477 33.100

Real GDP/cap 578 27.285 11.001 7.915 85.683

Real net price diesel 578 0.464 0.164 0.104 0.968

Real net price petrol 578 0.496 0.181 0.211 1.196

VAT 578 16.647 7.125 0 36

Vehicle fleet 578 13.971 15.292 0.006 64.34

Oil industry 578 0.012 0.032 0 0.157

Automotive sector 578 1.433 2.329 0 7

Freight transport 578 0.059 0.073 0.000 0.343

38

3.2. The excises on diesel and petrol

Before moving on to the methodology section, I would like to dedicate some more attention to the evolution of the excise rates over the panel length. Figure 1 showed the excise rates for diesel (left panel) and petrol (right panel). In both cases, the minimum excise rate has been included, and is represented by the dotted black line. Due to the rather large number of countries in the sample, the legends have been omitted.

The graphs clearly show that the nominal excise rates have increased significantly over the past three decades. Moreover, there has been a steep increase in the excise rates in the periods before the introduction of the minimum excise rates. However, the comparison of the actual excise rates with the minimum excise rates should be done with some caution because the dummy variable includes the rates that were proposed in 1987. This variable thus also measures the discussion prior to the introduction of the minimum excises, so as to measure possible anticipation effects of the discussion. This seems plausible as countries may choose to gradually augment the excise rates to minimise the distorting effect of the augmentation of the tax. Also, the excise rate for petrol proposed in 1987 was higher than the rate that was introduced in 1993. Nevertheless, the figures show three important properties of the taxes. First, it can be seen that the excise rates are not adjusted annually, supporting the choice of using nominal data in the analysis. Second, it also shows that countries sometimes lower their excise rates. This is interesting from the point of tax competition and the pressure of lobby groups on the government tax officials. Finally, it can clearly be seen that the excise rates are strongly trending, implying that the rates are serially correlated. In other words, the excise rate levied in the current period is strongly dependent on the excise rate levied in the period before.

3.3. Methodology

The analysis will be based on panel econometric techniques and will be applied to both fuels separately. The analysis will be based on the estimation of first differenced models, because the changes in the excise rates are considered, not their absolute levels. Estimating a first

39


Had je eerder al kunnen gebruiken


Hier kan je ook een deel van je hypoetheses direct aan ophangen; zie algemene opmekringen

differenced equation ensures that only changes are measures, solidifying the results. The methodology is identical for both types of fuels. As we have seen from the plots of the excise rates, the excise rates are strongly dependent on their historical values. This has severe implications for the choice of methodology to be used in the analysis. First, the fact that the excise rates are serially correlated dictates that a lagged dependent variable has to be included in the regression. Hence, the baseline model will be of the following form.

Y ¿−Y ¿−1=β1 (Y ¿−1−Y ¿−2 )+β2 (X¿' −X ¿−1

' )+ϑ¿ (5)

Where Y is the excise rate in country i in the year t, X’ is the vector of explanatory variables in country i in year t and ϑ is the error term. However, the specification in equation 5 yields inconsistent estimates because the use of the lagged differenced dependent variable introduces an endogeneity problem. To illustrate this, consider the following derivation.

If Y ¿=β1Y ¿−1+β2 X ¿' +ε¿ (6)

And Y ¿−1=β1Y ¿−2+β2 X ¿−1' +ε ¿−1 (7)

Then Y ¿−Y ¿−1=β1 (Y ¿−1−Y ¿−2 )+β2 (X ¿' −X ¿−1

' )+(ε¿¿¿+ε¿−1)¿ (8)

As Y ¿−1 appears both on the right and the left hand side of equation 8, and Y ¿−1 is correlated with ε ¿−1 as seen from equation 7, it is also correlated with the error term in equation 8 and thus endogenous. To solve this problem, Arellano and Bond have developed an estimator that is consistent under the endogeneity caused by the first differenced autoregressive regression.

The basic idea behind the Arellano-Bond estimator is to first difference the levels equation to eliminate cross-sectional unobserved heterogeneity (the country fixed effects) and subsequently instrument the endogenous dependent variable on its past values. That is, the Arellano-Bond estimator is essentially an instrumental variable panel regression that uses past values of the dependent variable as instruments rather than a number of exogenous variables. In the

40


2x

example given in equation 8, the Arellano-Bond estimator uses Y ¿−2 as an instrument because it is correlated with Y ¿−1−Y ¿−2 but not with ε ¿+ε ¿−1. The use of the Arellano-Bond estimator does, however, reduce the number of observations used in the estimation, because the first two observations of the dependent variable are used as instruments. The Arellano-Bond estimator used in this analysis takes the formanalysis is applied to shown in equation 9.

∆ Excise¿=β1+β2∆ Excise¿−1+ β3∆ NOx¿−1+β4∆roaduse¿−1+β5∆crossborder ¿+β6∆exc hangerate¿−1+ β7∆ govt expenditure¿+β8∆ ¿¿+ β9∆minimum excise¿+β10∆ (minimumexcise∗EU member¿)+β11∆net price¿−1+ β12∆ inflation¿−1+β13∆ve hicle fleet ¿−1+β14∆VAT ¿+β15∆GDP/capita¿+β16∆oil industry¿+ β17∆car industry¿+ β18∆ transport sector¿+∆ ε¿

(9)

The model in equation 9 will be the most extensive model that will be estimated in the analysis. The data are first differenced, as depicted by the ∆s, where ∆ X¿ is equal to X ¿−X ¿−1. As can be seen from the specification in equation 9, not all observations used are from the same time period. The choice for this is based on common logic and will be elaborated upon below.

First, the model uses lagged first differences of the emissions of NOx and road use. This is done because governments are believed to be responding to emission and road use levels of the year before rather than adapting the excise rates to the levels of the current year, simply because the data on the current emissions and road use will not be available at the time at which the government decides to alter the excise rates.

Cross-border shopping is taken as a current value, because the variation between years is very small and occurs gradually (population levels change constantly, not annually). Exchange rate fluctuations, on the other hand are lagged, as well, because countries need to respond to shocks and anticipation is not feasible.

The institutional variables are all taken at their current values. Government expenditure figures are generally announced towards the end of the year, and new policies are announced simultaneously. Hence, if government spending exceeds the expectations, then policy makers will decide instantaneously whether or not the excise rates need adjustment. By the same logic, government transitions can have

41


Wordt het een sort fixed effect; gaat dat goed?


Nee; hij wordt toegepast op deze regressie

immediate effects because the variable is constructed in such a way that it measures changes only when the new government takes office (rather than the election dates). Hence, government transitions necessarily occur before the end of the year, and the new government can thus implement new policies straight away. Finally, the minimum excise rate variable already includes the period prior to the effective implementation of the minimum rate in 1993, so it measures possible anticipation effects, too. The anticipation effect will be measured explicitly by including interaction values of the minimum excise rate with dummy variables for different time periods.

From the control variables, the net fuel price, inflation, the composition of the vehicle fleet and the industry variables are lagged, GDP per capita is not. The net fuel price is lagged, because excise rate changes mostly take effect on the 1st of January, such that the current fuel price cannot have an effect. Inflation is lagged because governments generally respond to the actual inflation figures (announced in the next year), and the same goes for the composition of the vehicle fleet. The industry variables are also lagged to measure possible lobbying effects that by definition have to anticipate policy changes. GDP per capita is taken at current values, as it seems highly unlikely that policy makers actually take per capita GDP into account explicitly. It is included to control for different levels of income between countries rather than an actual factor driving tax policy changes.

42


So sepearte!

4. Analysis

The analysis in this thesis comprises of two main sections, the analysis for diesel and the analysis for petrol. As discussed in the literature review, these fuels differ strongly from each other in terms of their use and their polluting properties. The road transport industry virtually only consumes diesel, whereas the majority of passenger cars are propelled by petrol. This difference has implications for the viability of tax competition for the different fuels. Whereas cross-border shopping for petrol is only viable for people living close to the border, trucks can carefully plan their refuelling stops due to their very large range. Also, pressure on policy makers by lobby groups will be stronger for diesel than for petrol. Finally, the importance of emissions in tax setting may differ, too, due to the fact that the two fuels are not equally polluting.

The analyses are done stepwise, i.e. first the variables of interest for answering the hypotheses will be estimated separately, then estimated jointly and finally estimated jointly in a model including control variables. At first, the estimation will be based on the entire panel including seventeen countries. As a robustness check, the estimation will also be performed on a subsample of Euro countries only. The reason for this is that exchange rate fluctuations that are present for the non-Euro countries8 may measure tax policy changes that are absent in reality. Of course, exchange rate fluctuations have played a significant role in the Euro-zone before the introduction of the Euro, but to a lesser extent due to the joint pegging to the ECU in the 1980’s. Moreover, the exchange rate fluctuations are already included in the right-hand side of the equation, and should thus ideally be taken out of the excise rates. Finally, in line with hypotheses 1 and 2, a model will be estimated testing for structural differences in the intensity of tax competition and the response to the introduction of the minimum excise rates between small and large countries. Obviously, this estimation procedure will be repeated for petrol.

8 The respective values have been converted to Euros after all

43


Vind ik nog steeds niet helemaal overtuigend; aan begin van panel speelden ze ook binnen de EU landen en zelfs binnen de euorgroep!!!! Daar doe je nu niks mee; je zou dat ook apart kunnen bekijken voor robuustheidsdoele


Deze passage zou je ook eerder kunnen gebruiken; laat ook verschillen zien tussen landen; zie eerdere opmerking over endogenitiet mbt parkt

4.1. The case for Diesel

The analysis for diesel begins with the stepwise estimation of the variables of interest in the unrestricted panel. Table 3 below shows the results of this analysis.

Table3: Estimations for diesel based on the unrestricted panel9

Dependent:Excise rate

(1) (2) (3) (4) (5) (6)

Constant 0.028***(0.007)

0.037***(0.007)

0.021(0.022)

0.025***(0.004)

0.031*(0.017)

0.004(0.021)

Excise (-1) 0.936***(0.012)

0.887***(0.017)

0.857***(0.020)

0.862***(0.019)

0.839***(0.022)

0.797***(0.025)

NOx emissions(-1)

0.021(0.236)

-0.070(0.337)

0.014(0.350)

Cross-border -0.045***(0.016)

-0.025(0.042)

-0.015(0.049)

Exchange rate

0.005***(0.001)

0.004**(0.002)

0.005**(0.002)

Gov’t expenditure

0.014(0.048)


-0.065(0.043)

-0.075*(0.044)

-0.085***(0.031)

Left government

0.006(0.004)

0.006(0.004)

0.006(0.004)

0.007(0.004)


0.096***(0.019)

0.095***(0.019)

0.082***(0.017)

0.053*(0.027)

Inflation (-1) 0.009(0.007)

Real GDP/cap

0.000(0.000)

Real net price diesel (-1)

0.001(0.016)

VAT 0.027(0.030)

Vehicle fleet (-1)

-0.014(0.019)

Oil industry (-1)

0.361(0.248)

Freight transport (-1)

0.187**(0.077)

* Significant at 10%; ** Significant at 5%; *** Significant at 1%

The results from the first specification show that the lagged value of the excise rate has a very strong positive and highly significant effect on

9 Road use has been omitted due to multicollinearity, car industry has been omitted due to collinearity with freight transport

44

the excise rate levied in the subsequent period. This result is little surprising when considering the graphs in figure 3, which shows that changes are not made annually and that upward changes occur far more often than downward changes. More surprisingly, however, is the fact that the level of emissions of NOx does not have a significant effect on the height of the excise rates levied on diesel. From the perspective of theoretical argument for the internalisation of externalities and the more political argument of levying taxes to prevent air pollution, a positive effect was expected. Moreover, politicians often use the environment as a reason for levying taxes on mineral oils, but the data show no support for the use of emission levels in tax setting. Also, it does not show that countries that respond to more severe air pollution by levying higher excise rates on diesel. This finding is consistent through specifications (5) and (6), which also yield insignificant estimates10. One explanation for these findings is that the price elasticity of the demand for diesel is (perceived as) low, so that increasing the excise rates on diesel has little effect on the amount of NOx emitted.

The second specification includes the variables for tax competition. Again, the lagged excise rate is strongly positive and highly significant. Moreover, the coefficient for cross-border shopping is negative and significant at the 1% level, showing that small countries that have a large fuel market abroad in relation to their domestic market undercut their larger neighbours’ tax rates. This finding is in line with the expectations based on the theoretical model by Kanbur and Keen (1993). However, the effect vanishes in models (5) and (6), indicating that the relationship is not particularly robust to alternative specifications.

The effect of exchange rate changes in neighbouring countries is, however. All three specifications show that upon a positive currency shock abroad, countries increase their excise rates slightly. The intuition behind this finding is rather puzzling, as the opposite effect was expected. A positive exchange rate shock implies after all that the foreign currency has lost value, making foreign products cheaper for domestic consumers. Nevertheless, Kanbur and Keen show that if tax 10 Moreover, the standard errors change very little between the three specifications, increasing the reliability of the findings.

45

rate differences between two countries are sufficiently large, then it may not be worthwhile for the home country to compete with the foreign country. Rather, it will levy a higher tax rate, accept that it loses some of its domestic customers to the neighbouring countries and increase its tax receipts by levying higher tax rates on the products that are still sold domestically. Hence, the tax rate differences may be large enough to justify an increase in the domestic tax rate upon an exchange rate shock abroad. Moreover, we cannot see whether the country in question has increased its tax rate simultaneously to its currency devaluation, (partially) offsetting the exchange rate effect. Also, the effect is rather small: when a foreign country devaluates its currency, the home country increases its excise rate by half a cent.

Specifications (3) and (4) investigate the effect of the institutional context on the excise rates. Both specifications show that the introduction of the minimum excise rate has led to an overall increase in the excise rates levied by EU countries. The effect is positive and significant in specifications (3) through (6), and shows that the minimum excise rate has led to an increase of the excise rate of 5 to 10 Eurocents, on average. Model (3) shows that the level of government expenditure does not affect the excise rate levied, and specification (4) shows that the net financial position of the government does not either. However, the coefficient is significant and negative in models (5) and (6), with highly consistent standard errors. The negative coefficient indicates that a country that is in a net borrowing position11 (i.e. has a net operating deficit) levies significantly higher excise rates, as is to be expected. Interestingly, it shows that left-winged governments do not levy significantly higher excise rates than right-winged governments do. This could be due to the fact that many countries have had coalition governments in the past decades, thus weakening the power of left-winged governments to actually increase the excise rates, or simply indicate that the stereotype of left-winged governments levying excessive taxes is not true, at least in the case of diesel excise rates.

Specification (6) includes the list of control variables. All in all, these variables seem to have little effect on the level of excise rates, except for 11 When a country is in a net borrowing position, the variable has a negative value. Hence, the negative coefficient indicates a positive effect of a negative balance on the excise rates

46

the size of the transport sector. However, as the unit of measure is thousand megatonne-kilometres a year, the effect is of little economic significance. A one standard deviation change in the size of the transport sector increases the excise rate by 1.3 Eurocents. To further test the robustness of the findings above, the estimation procedure has been repeated for a subsample of Euro countries.

Table 4: Estimation for diesel in the panel restricted to Euro-zone countries


(7) (8) (9) (10) (11) (12)

Constant 0.020***(0.004)

0.030***(0.006)

-0.008(0.014)

0.021***(0.005)

-0.020(0.022)

-0.064(0.028)

Excise (-1) 0.945***(0.013)

0.928***(0.020)

0.884***(0.017)

0.894***(0.020)

0.882***(0.023)

0.845***(0.032)

NOx emissions(-1)

0.205*(0.105)

0.275(0.236)

0.544***(0.098)

Cross-border -0.024***(0.009)

-0.000(0.034)

0.048*(0.028)

Exchange rate

0.003(0.002)

0.002(0.002)

0.003(0.003)

Gov’t expenditure

0.072**(0.029)

0.084***(0.025)

0.087**(0.034)


-0.084**(0.036)

Left government

-0.000(0.003)

-0.000(0.002)

-0.000(0.003)

0.001(0.003)


0.061***(0.015)

0.052***(0.016)

0.054***(0.017)

0.060***(0.026)

Inflation (-1) 0.000(0.000)

Real GDP/cap

0.000(0.000)

Real net price diesel (-1)

0.024***(0.007)

VAT -0.028(0.021)

Vehicle fleet (-1)

-0.013(0.023)

Oil industry (-1)

0.206(0.659)


0.126**(0.064)


47

The analysis for the Euro countries shows that the level of NOx emissions now has a positive and weakly significant effect on the excise rates on diesel in specification (7). This effect is absent in model (11), but reappears upon the inclusion of the control variables in model (12). The effect is highly significant statistically, but the economic significance is limited. A one standard deviation increase in the level of NOx emissions increases the excise rate on diesel by 0.27 Eurocents in model (7) and 0.7 Eurocents in model (12). Nevertheless, there is some evidence for the inclusion of emissions in decision making processes.

Model (8) again shows that smaller countries undercut their larger neighbours, as indicated by the negative and significant coefficient for cross-border shopping. However, this finding is restricted to model (8). In model (11), the coefficient does not differ significantly from zero and in model (12) it even becomes significantly positive. However, the standard error has quadrupled between model (8) and model (12), again making the reliability of the finding in model (12) questionable. The coefficient for exchange rate fluctuations is insignificant in all models, as was to be expected. All countries that now have the Euro linked their currencies to the European Currency Unit in the 1970’s already, or upon their joining the EU in the mid 80’s for Spain and Portugal and the mid 90’s for Finland and Austria. Hence, exchange rate fluctuations between the Euro countries became increasingly rare over time, thus explaining the absence of an exchange rate effect.

Specifications (9) and (10) again investigate the effect of the institutional context on the excise rates on diesel, and largely confirm the findings from models (3) through (6). Model (9) shows that government expenditure matters for the subsample of Euro countries. The coefficient is significant and positive through all specifications, indicating a robust relationship. The positive coefficient indicates that increases in countries’ levels of government expenditure are matched by higher excise rates on diesel, most likely to cover the higher levels of governmental spending. Specification (10) also shows that the net operating balance of the government again influences the excise rates. As was the case in model (4), the negative coefficient indicates that a net operating balance is compensated for by an increase in the excise

48

rate. The political colour of the government again does not seem to affect the excise rates levied, as was already indicated by models (3) through (6). Hence, this finding is very robust. Finally, the estimates again show that the EU minimum excise rate has led to significantly higher excise rates. The effect of the introduction of the minimum tax rate has been between 5 and 6 Eurocents, on average.

Closer inspection of the control variables shows that only the diesel price net of taxes and the size of the freight transport sector have a significant effect. The positive effect of the net price is rather peculiar, because one would expect that the feasibility of excise rate changes is restricted by increases in the net price of diesel. However, the effect is of little economic significance: a one standard-deviation change in the net price of diesel increases the excise rate by 0.4 Eurocents. Also the positive effect of the size of the freight sector is quite surprising. Real GDP per capita, inflation, the VAT rate, the composition of the vehicle stock and the size of the oil industry do not have a significant effect on the excise rates levied. The absence of the effect of the oil industry can be easily explained by the fact that the subsample of Euro countries does not contain countries that produce a significant amount of oil12. However, the absence of an effect of inflation is striking, but could be explained if the countries that are not in the Euro-zone automatically correct their excise rates for inflation. This claim cannot, however, be tested on the basis of the available data.

The analysis of the diesel excise rates is concluded with a comparison of responses to the introduction of the minimum excise rate. As formulated in hypothesis 6, small countries are expected to respond more positively to the introduction of the minimum excise rate, and that most of the adjustments to the minimum excise rate have occurred between the announcement of the minimum excise rate in 1987 and its introduction in 1993. Both hypotheses will be tested using a break-test, once in cross sections by including an interaction variable of a country size dummy with the minimum excise rate, and once in time periods by including an interaction variable of the years 1987 through 1993 and the minimum excise rate. Then, the

12 In the sample, there are only two countries with a significant domestic production of crude oil, Norway and the United Kingdom. Both countries do not have the Euro and are thus not part of the subsample

49

coefficients are tested for significant differences between them. The results of the separate estimations are presented in table 5 below.

50

Table 5: Regressions underlying break-tests for dieselDependent:Excise rate

(13) (14) (15) (16)

Constant 0.025(0.040)

0.033***(0.005)

0.025***(0.006)

0.027***(0.005)

Excise (-1) 0.813***(0.019)

0.822***(0.023)

0.866***(0.022)

0.867***(0.019)


-0.065(0.044)

-0.062(0.044)

-0.089**(0.035)

-0.086**(0.040)

Left government 0.006(0.004)

0.005(0.037)

0.001(0.003)

0.002(0.003)

Minimum excise*small

-0.008(0.016)

Minimum excise 0.098***(0.021)

Minimum excise*(1987-1992)

0.058***(0.019)

0.060***(0.023)

0.065**(0.026)


0.122***(0.019)

0.081***(0.014)

0.078***(0.012)


Specification (13) performs a test for the difference in the reactions of small and large countries to the introduction of the minimum excise. In the model, the coefficient for small countries’ responses to the minimum excise rates is insignificant and smaller than zero, the coefficient for the standard minimum excise variable is positive and significant. The break-test performed tests the coefficients for significant differences from each other. Given the small standard errors the two coefficients, this difference is likely to be significant. This finding is confirmed by the break tests shown in table 6. This implies that small countries have responded less positively to the introduction of the minimum excise rate than large countries have, that is, small countries have increased their excise rates by less than large countries have in response to the introduction of the minimum excise rate. It thus follows that small countries responded less strongly to the introduction of the EU minimum excise rate than large countries. This finding stands in stark contrast to hypothesis 6.

Specifications (14) through (16) perform similar tests for the difference in the reactions to the minimum excise rate was strongest before the introduction of the minimum excise rate. The model is estimated three different times, each based on a different underlying subsample of the panel. In model (14), all

51

countries in the sample are included. The coefficient for the minimum excise rate before the introduction of the minimum rate is positive and significant, but smaller than the coefficient for the period after the introduction. This difference is significant, implying that the reactions of countries were largest after the introduction of the minimum excise rate. However, the sample includes non-EU countries, as well, which should not react to the minimum rate at all. Specification (15) excludes these countries, and shows that the two coefficients are still positive and significant, but lie much closer. Performing the break test, it shows that the difference between the two coefficients is insignificant. However, the subsample of EU-countries also includes two countries for which the minimum excise rate became effective in 1995: Luxembourg and Greece. Excluding these countries, specification (16) again shows that the coefficients are positive and significant and even closer together. As a result, the difference between the two coefficients is insignificant. This implies that there is no difference in the reactions to the introduction of the minimum excise rate between the anticipation period and the period in which the minimum rate actually took effect.

Table 6: Test for structural breaks for dieselH0: (13) (14) (15) (16)Minexcise*small

= minexcise

χ2 10.06

p-value 0.002***

Minexcise*(1987-1992)=minexcise*(1993-2011

χ2 8.01 0.78 0.28

p-value 0.046** 0.377 0.594


Looking at the plot of first differences in the excise rates on diesel in appendix 3, this finding finds support in the raw data. As can be seen, there have been two periods in which countries rapidly increased their excise rates, being the periods immediately following the announcement of and the introduction of the minimum excise rate. However, the number of countries that actually increased their excise rates is fairly limited. As a result it follows that there is no structural difference in the adjustments in the two sub-periods, explaining the results in models (15) and (16).

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4.2. The case for Petrol

For reasons discussed earlier, the analyses for the two types of fuel have been performed separately. The methodology, in terms of the econometric model employed, and the research strategy, in terms of the variables used and the estimation procedure are identical for both analyses. Hence, as was the case for diesel, the analysis for petrol begins with the stepwise testing of the hypotheses in the unrestricted panel.

Table 7 below shows the results. Specification (17) includes only the lagged dependent variable and the emissions of NOx. Again, and little surprisingly, the lagged dependent variable is highly significant and positive of sign, as was suggested by the raw data. However, the variable of interest is the NOx emissions from road transport. NOx emissions again do not generate significant coefficients in the unrestricted panel. Hence, the model confirms that the relationship between the severity of the emissions of NOx and the height of the excise rate is very weak at best. Moreover, the coefficient is insignificant in specifications (21) and (22), too. Even although the standard errors differ between the models, the results solidify the finding.

Model (18) investigates the effects of strategic interactions between the excise rates levied in different countries. The model finds a significantly negative effect of the size of the foreign market respective to the domestic market but a significantly positive effect of upward exchange rate shocks on the excise rates. The negative coefficient for the potential cross-border shopping indicates that countries whose potential fuel market abroad is larger relative to their domestic market try to serve this market by undercutting their neighbours’ excise rates by 6.5 Eurocents on average. Unfortunately, the effect is no longer significant in models (21) and (22), mostly due to the increase in the respective standard errors. Hence, the evidence for smaller countries levying lower excise rates than their neighbours is very limited. This finding, however, can be explained by the fact that several small countries in the panel levy relatively high excise rates (for instance the Netherlands, Switzerland and Ireland levy above average excise rates), and that several large countries levy relatively low excises (for instance

53

Spain and - albeit marginally – Italy levy below average excise rates). So the idea that small countries undercut their larger neighbours does not hold for the European case.

Table 7: Estimations for petrol in the unrestricted panelDependent:Excise rate

(17) (18) (19) (20) (21) (22)

Constant 0.032***(0.005)

0.056***(0.007)

0.012(0.025)

0.033***(0.005)

0.053***(0.019)

0.003(0.004)

Excise (-1) 0.947***(0.008)

0.896***(0.015)

0.918***(0.011)

0.920***(0.012)

0.880***(0.017)

0.851***(0.024)

NOx emissions (-1)

0.150(0.199)

-0.007(0.337)

0.084(0.286)

Cross-border -0.065**(0.028)

-0.061(0.056)

0.032(0.063)

Exchange rate (-1)

0.006***(0.002)

0.005***(0.002)

0.006***(0.001)

Gov’t expenditure

0.048(0.047)


-0.052(0.045)

-0.061(0.050)

-0.094**(0.048)

Left government

0.005*(0.003)

0.005*(0.003)

0.005*(0.003)

0.006*(0.003)


0.038***(0.015)

0.039**(0.014)

0.031**(0.015)

0.039(0.026)

Inflation (-1) 0.001(0.001)

Real GDP/cap

0.000(0.000)

Real net price petrol (-1)

-0.007(0.022)

VAT -0.019(0.093)

Vehicle fleet (-1)

0.052*(0.030)

Oil industry (-1)

0.311(0.194)


0.038(0.100)


Interesting, however, is that again it shows that countries actually increase their excise rates slightly upon an exchange rate shock in the neighbouring country. The fact that the coefficient is relatively small – a devaluation in the neighbouring country leads to an increase in the

54

domestic excise rate of around 0.5 Eurocents – provides more evidence that tax competition may well not be a large issue for most countries in Europe.

Models (19) and (20) investigate the effect of the institutional context on the excise rates. Government expenditure does not significantly affect the excise rate, and also the evidence for the effect of the net operating balance is limited. Only in model (22) does this variable produce a significant and negative coefficient, indicating that excise rates rises slightly when the government has faced a negative net operating balance in the previous year. In contrast to the results from the models for diesel, the estimates for petrol show a positive, yet weakly significant effect of the political colour on the incumbent government on the height of the excise rates. The coefficient shows that, on average, left governments raise the excises rates by 0.5 Eurocents. The effect is thus rather weak.

Finally, the models show that the EU minimum excise rate has had a positive effect on the excise rates levied in individual countries of 3 to 4 Eurocents. Model (22), on the other hand, finds no significant effect of the minimum excise rate on the excises on petrol. Upon closer investigation of the plot in figure 3, this could be due to the fact that excise rates for petrol in many countries in 1993 were already above the minimum rate, whereas this was not the case for diesel. As a result, countries were not forced to increase their excise rates on petrol. Model (22) also shows that apart from the vehicle stock, none control variables has an effect on the excise rate on petrol. The positive effect of the vehicle stock indicates that an increase in the share of diesel cars is associated with a higher excise rate on petrol, which makes intuitive sense. The results for the models based on the restricted panel of only Euro-zone countries are shown in table 8.

Model (23) confirms the general evidence provided thus far that the relationship between the level of NOx emissions from road transportation and the excise rates is very limited. As was the case for the unrestricted panel, the coefficient for the emissions of NOx is insignificant even at the 10% level, and this finding is consistent for model (27). In model (28), however, there seems to be a strong positive effect of the emissions of NOx on the excise rate. The evidence is thus quite mixed, indicating

55

that there may be a relatively weak relationship between the severity of the environmental externality of fuel use and the excise rates on that fuel.

Table 8: Estimation for petrol in the panel restricted to Euro-zone countries


(23) (24) (25) (26) (27) (28)

Constant 0.031***(0.005)

0.043***(0.008)

0.001(0.023)

0.026***(0.006)

0.027(0.020)

-0.021(0.028)

Excise (-1) 0.946***(0.010)

0.931***(0.016)

0.934***(0.014)

0.941***(0.017)

0.931***(0.021)

0.885***(0.028)

NOx emissions (-1)

0.171(0.147)

0.079(0.297)

0.364**(0.145)

Cross-border -0.029**(0.012)

-0.012(0.037)

0.067 (0.047)

Exchange rate (-1)

0.003*(0.002)

0.003**(0.001)

-0.001(0.005)

Gov’t expenditure

0.063(0.046)


-0.075(0.047)

-0.081(0.052)

-0.082*(0.046)

Left government

0.008***(0.002)

0.008***(0.002)

0.008***(0.003)

0.008**(0.003)


0.018(0.020)

0.016(0.021)

0.012(0.020)

0.044(0.032)

Inflation (-1) 0.000*(0.000)

Real GDP/cap

0.001(0.001)

Real net price petrol (-1)

0.034**(0.014)

VAT -0.127**(0.049)

Vehicle fleet (-1)

-0.004(0.022)

Oil industry 0.959(0.721)

Freight transport

0.037(0.082)


Specification (24) shows that smaller countries with a relatively large foreign market for fuel undercut their larger neighbours, by about 2.9 Eurocents on average. Whereas this does provide some support for the insights into tax competition developed by Kanbur and Keen (1993), the evidence is far from conclusive when considering models (27) and (28). In

56

the prior, the coefficient is negative but insignificant, in the latter it is positive and highly significant.

The conflicting evidence makes it rather difficult to properly assess hypothesis 2. The evidence for a positive effect of exchange rate fluctuations is more conclusive, even although the coefficient is no longer significant in model (28). However, the fact that the coefficient is positive and significant at either the 5% or the 10% level, or not significant at all indicates that if indeed a relationship exists, it is rather weak. Given that exchange rate fluctuations have become increasingly rare amongst the Euro-zone countries in the 1980’s and 1990’s, this evidence is not necessarily surprising.

General government expenditure does not yield a significant coefficient in model (25), and neither does the governmental net operating balance in models (26) and (27). In model (28) there is a weakly significant effect of a negative governmental balance on the height of the excise rate. As a result, the relationship between governmental spending and their excise rates on petrol is rather weak. The finding that left-winged governments levy higher excise rates on petrol persists when the analysis is performed on the subsample. The coefficients are positive and significant in all models, solidifying this finding. Nevertheless, the coefficient is relatively small: on average, left-winged governments increase excise rates by around 0.8 Eurocents. Finally, the absence of an effect of the minimum excise rate on the actual excise rates levied in the individual countries is confirmed by models (25) through (28). As explained before, this may be due to the fact that many countries in the sample already complied with the excise rate on petrol when it was implemented in 1993. This can also be explained by the fact that in the early 1990’s, a mere 11% of the total vehicle fleet ran on diesel. Hence, most governments would have focused on levying excise rates on petrol rather than diesel, explaining why countries had to adjust their diesel excises and not their petrol excises.

From the control variables, we can see that inflation, per capita income, the net price of petrol and the VAT rate on mineral oils have significant effects. Inflation has a positive and statistically significant coefficient, however, it is virtually equal to zero and thus of little economic

57

importance. The real net price of petrol, too, has a positive effect on the excise rate, as was the case for diesel. Again, this finding counters all intuition, which would prescribe an opposite effect. Finally, the VAT rate has a negative effect, as was expected. The coefficient of -0.127 indicates that a 1 percentage point increase in the VAT rate reduces the excise rate on petrol by 12.7 Eurocents, which is quite a significant effect.

The final part of the analysis again looks at the differences between small countries and large countries, with respect to their responses to changes in the relative sizes of the domestic and foreign fuel markets and the introduction of the minimum excise rate. Again, these differences are tested via a break test in cross sections.

Table 9: Regressions underlying break-tests for petrolDependent:Excise rate

(29) (30) (31) (32)

Constant 0.041***(0.006)

0.054***(0.005)

0.035***(0.006)

0.038***(0.003)

Excise (-1) 0.871***(0.013)

0.823***(0.014)

0.864***(0.012)

0.870***(0.010)


-0.044(0.046)

-0.050(0.050)

-0.162***(0.027)

-0.141***(0.029)

Left government 0.006**(0.004)

0.006**(0.003)

0.010***(0.003)

0.008***(0.003)

Minimum excise*small

0.027(0.035)

Minimum excise 0.096***(0.020)


0.048***(0.017)

0.050***(0.018)

0.054***(0.020)


0.134***(0.020)

0.113***(0.020)

0.104***(0.021)


Model (29) estimates the difference in the responses of small and large countries to the introduction of the EU minimum excise rate in 1993. The model yields a positive and significant coefficient for the minimum excise rate on the excise rates on petrol, but an insignificant coefficient for the interaction variable of country size and the minimum excise rate. The absolute values of the coefficients are relatively close, however. The break-test in table 10 shows that the two values differ insignificantly from each other. Hence, it is to be concluded that small countries did not respond more positively to the

58

introduction of the minimum excise rate than large countries. This finding stands in contrast to the expectations formulated by Kanbur and Keen (1993).

Models (31) through (33) run similar regressions for the interaction variable of the minimum excise rate and the time period dummy. Again, the models are based on different subsamples. Model (31) is based on the full sample and yields positive and significant coefficients for both the anticipation period as the period in which the minimum tax became effective. The difference between the coefficients is rather large, however, and turns out to be significant, too. This indicates that the changes in the excise rate were larger after its introduction than during the anticipation period. To test the robustness of this finding, the same analysis is performed on a subsample including only EU countries (model (32)) and on a subsample including only EU countries and excluding Greece and Luxembourg (model (33)). Whilst this does reduce the difference between the coefficients, the difference remains significant, solidifying the finding that most of the adjustment to the minimum excise rate in fact took place after its implementation.

Table 10: Tests for structural breaks for petrolH0: (29) (30) (31) (32)Minexcise*small

= minexcise

χ2 2.06

p-value

0.152

Minexcise*(1987-1992)=minexcise*(1993-2011)

χ2 50.79 33.10 37.54

p-value

0.000*** 0.000*** 0.000***


This finding is in line with the raw data, as presented in appendix 4. The figure plots the first differenced values of the excise rates over time, and shows that there have been two periods in which significant upward changes have occurred: the years following 1987 and the years following 1993. However, the plot shows that the majority of adjustments indeed occurred in the period between 1993 and 1996, as seen by the number of upward spikes in the plot. As a result, the claim

59

that most countries have adjusted their excise rates on petrol mostly at and after the introduction of the minimum excise rate.

60

4.3. Assessment of the hypotheses

In the course of the analysis, a large number of models have been estimated, which, at times, have yielded slightly conflicting evidence for the hypotheses. Hence, this subsection is dedicated to the assessment of the hypotheses in light of the evidence provided by the models. The first hypothesis stated that it was to be expected that increases in the emissions of greenhouse gases are matched by augmentations of the excise rates. In the course of the analysis, there have been four models that found a significantly positive effect of emissions on the excise rates, all other models have failed to yield significant coefficients. As, however, three of the four models including all control variables show strong and significant results, it is safe to conclude that there is indeed a positive effect of increases in the emissions of NOx on the excise rates. Interestingly, however, is that the coefficient for the emissions is more significant for diesel than it is for petrol, and has a greater coefficient. Based on the fact that diesel is the cleaner of the two fuels, it was to be expected that emissions play a smaller role in the diesel excise rates. However, this result could be explained by the fact that in the 1970s and 1980s, many countries did not yet levy (significant) excise rates on diesel as it was hardly used as a fuel for transportation. Hence, excise rates have been increasing steadily, possibly explaining the more positive coefficients for the emissions of NOx for diesel.

Hypothesis 2 was based on the theoretical model by Kanbur and Keen (1993), and read that small countries levy lower excises than large countries. The evidence for this hypothesis, too, is very limited: when estimated separately, the models showed significantly negative coefficients, confirming the hypothesis. However, the models including the other variables interest and control variables yield insignificant and sometimes positive estimates. Hence, the evidence is rather weak, leading to the rejection of the hypothesis. Moreover, the effect is smaller for diesel in the models that do yield significant coefficients, than it is for petrol, which is contrary to the expectations formulated in hypothesis 2. Note, however, that the variable for tax competition does not include cross border fuelling for the transport industry. As a result, the difference in tax competition between diesel and petrol cannot be properly assessed using the available data. The rejection of hypothesis 2 is supported by the rejection of hypothesis 3. The evidence

61

for this rejection is quite strong, as the majority of models yield significantly positive coefficients and none of the models yield negative coefficients, indicating that tax competition may not play as significant a role as argued on a theoretical basis. As was to be expected, however, the effect of exchange rate fluctuations is smaller when assessed in the subsample of Euro-zone countries, as these pegged their local currencies to the ECU in the course of the 1980’s and 1990’s. Moreover, the coefficients are less positive for diesel than for petrol, indicating that adjustments to exchange rate fluctuations are smaller for diesel than they are for petrol. Whether this difference is significant cannot be assessed, as this would require the joint estimation of the models for diesel and petrol. Finally, it should be noted that the coefficients are of little economic significance, implying that a) exchange rate shocks hardly affect excise rates at all, and thus that b) tax competition between the European countries considered here simply is not that strong. Hence, hypothesis 3 can comfortably be rejected, and also strengthens the rejection of hypothesis 2.

The analysis has also yielded some weak evidence that left-winged governments levy higher excise rates that right-winged countries do. Interestingly, this effect is restricted to the case for petrol and does not apply to diesel. This was expected from an efficiency standpoint, as the price elasticity of the demand for petrol was expected to be larger. Hence, we can confirm hypothesis 4. Governments, on the other hand, do increase their excise rates when (temporarily) facing higher levels of expenditure or have negative net operating balances, and make no clear distinction between the two fuels. The evidence is fairly strong, as most of the models give evidence in favour of hypothesis 5, and none give conclusive evidence against it. However, the coefficients are not structurally higher for petrol than they are for diesel, as formulated in hypothesis 5. A possible explanation could be that governments aim at maintaining a certain balance between the excise rates on the two fuels, thus increasing the excise rates by equal amounts. Hence, hypothesis 5 can be confirmed in part: governments in financial distress do levy higher excise rates, but in doing so, they make no distinction between the two fuels.

Hypothesis 6 can be partly confirmed. In general, the introduction of the minimum excise rate has led to higher excise rates, but has only done so for

62

diesel. Moreover, no evidence was found that smaller countries increase their excise rates by more than large countries do. In fact, there is conclusive evidence suggesting quite the opposite. Finally, it also showed that, in contrast to the expectations, the effect of the minimum excise rate was smaller in the period between the announcement and the implementation of the minimum rate than it was thereafter.

5. Limitations and further research

The findings generate a number of interesting insights into how countries set their excise rates on diesel and petrol. Nevertheless, the analysis on which the results are based does have a number of flaws. First, the panel is not quite as elaborated as would ideally have been the case. The number of countries is restricted to 17, because excise rate data on other countries is unavailable over the entire period of the analysis. For instance, it would have been very interesting to include a number of Eastern European countries into the analysis, to strengthen the analysis of the effect of the minimum excise rate and the intensity of tax competition in more detail. Moreover, a number of variables included are not ideal, again due to the unavailability of the required data. For instance, emissions of NOx do not make a distinction between the two different fuels, and the road use is not adjusted for total road length in the respective countries. Moreover, the measures for tax competition do not incorporate tax rate differences between countries due to endogeneity issues. Also an origin-destination based dataset of transport flows would improve upon the analysis of tax competition. As a result, the analysis is restricted to cross-border effects, and does not provide a proper measure for cross-border fuelling by trucks.

From an econometric perspective, the estimates from the models including the list of control variables are in part strongly affected by the control variables. While it is very important to include controls to counter biased results due to omitted variables, the standard errors sometimes change rather significantly, affecting the reliability of some estimates. Nevertheless, a fairly large number of findings are robust against different econometric specifications, strengthening the results.

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6. Conclusion

This thesis has provided an in depth analysis of the practice of excise rate setting in the European context. The analysis has led to the rejection and confirmation of a number of hypotheses. Firstly, the results have indicated that emission externalities from road use justify the levying of (higher) excise rates from a theoretical perspective, and do so, too, in practice. However, the effect is relatively small. This may be due to the difficulty of properly assessing the costs of these external effects and the large efficiency cost of levying too high an excise rate. The analysis has also shown that small countries in Europe do not significantly levy lower excise rates that do large countries, and that responses to exchange rate fluctuations are rather weak, too. All in all, this implies that the issue of fuel tax competition is of little importance in the European Union. Looking at the data, it also follows that there is one very important outlier in terms of both size and excise rates, which is Luxembourg. Hence, tax competition only seems to be an issue of one country in the sample, so that no general relationship between country size and tax rates can be found.

The analysis also showed that countries with higher levels of governmental expenditure tend to offset this by – amongst others – increasing their excise rates on mineral oils. No such convincing relationship was found between the presence of a left-winged incumbent government. The introduction of the EU minimum excise rates on diesel and petrol has only had an effect on the excise rates on diesel levied in individual countries, and not on petrol. One possible explanation for this finding is that excise rates on petrol have traditionally much higher, implying that the adjustments necessary to comply with the minimum rates were smaller. Moreover, evidence was found that large countries adjust their diesel excise rates by more than small countries do, which stands in stark contrast to the theory. Even although the analysis has some limitations, the majority of findings are quite robust, strengthening their validity.

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8. Appendix

Appendix 1: Panel Unit root Tests: Levin-Lin-Chu test; ADF lags: 1

H0: Panels contain unit roots; HA: Panels are stationary

Variable Adjusted t-statistic p-value

Excise diesel -2.589 0.048

Excise petrol -4.563 0.000

NOx emissions -4.771* 0.000

Road use -3.706 0.001

Cross-border -1.985 0.024

Exchange rate -8.226 0.000

Gov’t expenditure -4.301 0.000

Net lending/borrowing -4.888 0.000

Left government -5.074* 0.000

Minimum excise diesel -3.126 0.001

Minimum excise petrol -3.855 0.000

Inflation -8.137 0.000

Real GDP/cap -2.528 0.006

Real net price diesel -22.416 0.000

Real net price petrol -17.627 0.000

VAT -4.848 0.000

Vehicle fleet -2.971** 0.002

Oil industry -2.815* 0.002

Automotive sector -7.287* 0.000

Freight transport -16.968 0.000

* Constant omitted in test ** Deterministic trend included in test

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Appendix 2: Correlogram

Excise D Excise P Emissions Net price D Net price P VAT Road Use FreightCross-border

Exchange rate

Gov’t exp.

Excise D 1.000Excise P 0.8421 1

Emissions -0.2095 -0.2036 1Net price D -0.2134 -0.1597 -0.1002 1Net price P -0.3888 -0.4144 -0.0633 0.8733 1

VAT 0.2959 0.454 -0.1433 -0.12 -0.3898 1Road Use 0.5794 0.6684 -0.107 -0.2159 -0.3639 0.2764 1

Freight 0.3198 0.3133 -0.1804 -0.0873 -0.1582 0.0211 0.262 1Cross-border -0.1231 -0.1602 0.7229 -0.0713 -0.0412 -0.2275 -0.1231 -0.2826 1

Exchange rate -0.1005 -0.1188 -0.0327 0.1013 0.1549 -0.1257 0.0004 -0.1035 -0.091 1

Govt’ exp -0.0813 0.1958 -0.057 0.0595 -0.1449 0.4499 0.3071 -0.0378 -0.1521 0.0319 1Govt’t deficit 0.1978 0.2061 0.1876 0.0111 -0.0184 -0.0242 0.3775 -0.1896 0.1941 0.0235 -0.2482Min excise D 0.005 -0.0187 -0.0959 -0.0272 0.0016 -0.0513 -0.007 0.0507 -0.1997 0.1226 0.0842Min excise P 0.736 0.7853 -0.0702 -0.2745 -0.4913 0.4636 0.4388 0.1922 -0.027 -0.1716 0.0165

Inflation 0.6562 0.706 -0.0433 -0.379 -0.5751 0.4659 0.4041 0.1711 -0.022 -0.1857 0.0304Real GDP -0.6216 -0.6514 -0.0577 0.3886 0.5874 -0.4151 -0.6071 -0.1269 -0.1078 0.1826 -0.2589

Oil 0.2941 0.394 0.6188 0.0011 -0.1399 0.1438 0.3979 -0.0805 0.554 -0.0764 -0.0224Car 0.2431 0.2279 -0.0749 0.1023 0.0159 0.1589 0.2581 0.0831 -0.1712 0.0455 -0.0566

Left-gov’tMin. Excise

DMin. Excise

PInflation Real GDP Oil Car

Govt’t deficit 1Min excise D 0.0507 1Min excise P 0.1507 -0.0974 1

Inflation 0.1325 -0.0992 0.9631 1Real GDP -0.2342 0.0207 -0.6125 -0.594 1

Oil 0.4577 -0.1109 0.3921 0.3347 -0.4603 1Car 0.3187 0.0912 0.0686 0.0673 -0.0733 0.1706 1

Appendix 3: Plot of first differences in diesel excise rates

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

Appendix 4: Plot of first differences in petrol excise rates

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

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