Discussion Paper

Is Pay-As-You-Drive Insurance a Better Way to Reduce Gasoline than Gasoline Taxes?

Apr 20, 2005 | Ian W.H. Parry

Abstract

Gasoline taxes are widely perceived as the most efficient instrument for reducing gasolineconsumption because they exploit all behavioral responses for reducing fuel use, including reduceddriving and improved fuel economy. At present, however, higher fuel taxes are viewed as a politicalnonstarter.Pay-as-you-drive (PAYD) auto insurance, which involves replacing existing lump-sum premiumswith premiums that vary in proportion to miles driven, should be more practical, since they do not raisedriving costs for the average motorist. We show that when impacts on a broad range of motor vehicleexternalities are considered, PAYD also induces significantly higher welfare gains than comparablegasoline tax increases, for fuel reductions below 9%. The reason is that under PAYD, all of the reductionin fuel use, rather than just a fraction, comes from reduced driving; this produces a substantial additionalefficiency gain because mileage-related external costs (especially congestion and accidents) are relativelylarge in magnitude.