Urban air pollution is a serious environmental problem in developed as well as in most developing countries. In the case of Brazil, air pollution concentrations have been rapidly increasing in the major urban areas over the last decades. As elsewhere, this expansion has been caused mainly by the increasing use of vehicles. Today, emissions from vehicles are the major source of air pollution in Brazil's largest cities. In 1997 in São Paulo, for example, private cars were responsible for approximately 75% of carbon monoxide (CO), 73% of hydrocarbons (HC), 23% of nitrogen oxides (NOx) and 10% particulate matter (PM)
Costs associated with high air pollution concentrations in large cities are known to be important. Human health costs predominate, and range from eye irritations to respiratory problems and increasing cancer rates, all of which induce direct and indirect costs to society2.
They also estimate the health costs associated with concentration levels in excess of air pollution standards, finding a loss of approximately US$ 700 million per year in the early 1990s.
Even when consumers can perceive individual emission damage, they are unable to reduce alone the aggregate social emission costs. Consequently, their preferences will usually not consider fuel and car cleanliness. In the presence of this negative externality, environmental regulation is required.
If we were able to measure emissions by individual cars, the first best incentive option for car emission control would be the imposition of a Pigovian tax on each source according to its marginal contribution to air pollution damages. This would allow flexibility for car owners in the choice of emission reduction strategies. However, such first best approaches can incur high administrative cost. As put by Innes (1996), even if tamper-resistant emissionmeasurement from tailpipes were available at reasonable costs, such devices do not detect important non-tailpipe pollution and, therefore, high costly reliable periodic car monitoring would be required. Consequently, the application of car emission control policies would have to reckon on regimes which do not require direct emission monitoring. When emission output measurements are difficult, the economic literature on MBIs proposes instead that regulators may apply first best taxes on the use of inputs and products which are related to emissions. For car emissions, fuel and automobile taxes are good candidates for this option. Fullerton and West (1999 - hereafter FW), have derived a set of fuel and car optimal taxes which are able to mimic, at least in theory, the unavailable tax on emissions. In order to derive a closed form solution, FW consider emissions per gallon (EPG) and miles per gallon (MPG) only...