Aviation tax and railway subsidy: An integrated policy

Highlights

• The first paper to analyze the traffic impacts of an integrated tax-subsidy policy in the context of air and rail transportation.

• Different rules of high-speed rail (HSR) subsidy are investigated, particularly the air-HSR integrated tax-subsidy policy.

• Transport network and the complementarity between air and rail are also considered.

• We show that the integrated tax-subsidy policy is not able to reduce air traffic on all routes.

• The comparison between aviation tax rates on different routes also plays a role.

Abstract

In this paper, we build a simple model to investigate the impacts of using aviation tax to subsidize high-speed rail (HSR). We find that when the HSR subsidy is not directly linked to the aviation tax, introducing this subsidy will decrease the air traffic and increase the rail traffic on the route where air transport and HSR compete. However, if part of the aviation tax revenue is earmarked for the HSR subsidy (i.e., the integrated tax-subsidy policy), the traffic implications of the HSR subsidy will be the opposite. To extend the analysis to a transportation network, when the integrated tax-subsidy policy only involves aviation tax revenue from routes with HSR presence, it will decrease air traffic on routes without HSR. When the integrated tax-subsidy scheme involves tax revenue from the whole network, the traffic implications depend on the comparison between aviation tax rate on routes with and without HSR.

Introduction

Aviation has a major impact on the climate system and accounts for 2 to 3 percent of the total greenhouse gas (GHG) emissions of human activity. Although aviation has been hit hard by the Covid-19 global pandemic, the reduction of GHG emissions from this sector is expected to be temporary. The long-term trend is still upward, as the aviation industry had been expanding rapidly for a very long period of time before the pandemic. In particular, up until the pandemic, GHG emissions from international aviation had increased by 83% since 1990. In recent years, the role of aviation in climate change has drawn more and more attention. Growing pressures from investors, environmental groups and passengers in the form of public movements such as ‘flygskam’ (flight shaming), whereby people are pledging to give up flying, have demanded a radical transformation of the industry.

Against such background, more and more countries have levied tax on airfares in order to reduce pollution. For example, tax is already included in the German air ticket prices, and the government will further increase the amounts from 2020.¹ Nevertheless, how to utilize this tax income is less of a consensus across countries. Some countries, including France and Germany, plan to utilize the money to subsidize their high-speed railways (HSR), so as to boost the competitiveness of aviation's main substitutive transport mode, further diverting traffic away from the air. As using tax revenue to fund subsidy is a relatively new idea in the transportation sector, many details regarding how to implement the integrated tax-subsidy policy for air transport and HSR remain unclear and in need of careful analytical evaluation.²

The first question to answer is how to allocate the aviation tax revenue to subsidize HSR. Traditionally, the aviation tax revenue will first go to the national treasury, from which different sources of taxation will be pooled together and then distributed to support various fiscal policies including subsidies to HSR. The challenge of this mechanism is to convince the general public that the aviation tax revenue will be properly utilized, especially in the stage when the tax is newly introduced. As pointed out by IATA (2019), only a very small percentage of people trust that governments would spend environmental taxes on environmental action. Alternatively, the tax can be fully or partially earmarked for the HSR subsidy, i.e., a certain percentage of the tax revenue can only be used to subsidize HSR. The framework that adopts a holistic view for the two is called integrated tax-subsidy policy (e.g., Galinato and Yoder, 2010; Skolrud and Galinato, 2017) or feebate (fee + rebate) system (e.g., Greene et al., 2005; Martin et al., 2014). This is a popular self-financing system of taxes (fees) and subsidies (rebates) to shift purchase from a polluting product to a cleaner alternative (e.g., Lu et al., 2010; Meng et al., 2013). For example, there is much discussion in the energy literature to allocate carbon tax imposed on fossil fuel to fund the subsidy given to renewable energy (Timilsina et al., 2011; Abolhosseini and Heshmati, 2014). In the transportation sector, California once proposed a “Clean Car Discount” program, where a fee needs to be paid when purchasing a high carbon emitting vehicle, while this fee would be given to a customer who purchases a low emission vehicle (Martin et al., 2014). This mechanism can help to mitigate the suspicion of the general public, as earmarking the aviation tax revenue for HSR subsidy is a simple and strong message of assurance to ease the public's mind. However, we also need to consider the possible impacts of such principle on the competitive dynamics between air transport and HSR. In particular, when a part of the railway income depends on how much traffic airlines generate, the rail sector may be less incentivized to fiercely compete with the airlines. In other words, a tacit collusion may be formed and the consumer surplus and the environment might be hurt.

Another factor to look into is the network of the transport modes. One defining feature of air transport is its extensive network. HSR can indeed substitute air transport, but only in certain markets. It is generally believed that air transport still has incomparable competitiveness in long-haul markets over 1000 kilometers (Janic, 1993; Rothengatter, 2011). Due to this substantial substitutability in the short-haul routes and the fact that air transport is still the only realistic mode for long-haul travel, there exists a natural complementarity between the two modes (Tsekeris, 2011). In particular, HSR service can replace short-haul flights to feed traffic into major airports so as to sustain the hub-and-spoke network system of the airlines (Jiang and Zhang, 2014). With such potential complementarity, the traffic impacts of the integrated tax-subsidy policy framework should be different across different routes of the transport network and should be carefully examined.

In this paper, we build a simple theoretical model to analyze the traffic impacts of utilizing aviation tax revenue to subsidize HSR, considering different rules of tax revenue allocation as well as the transport network effect. The contribution of the paper is multi-fold. From a theoretical perspective, this is the first paper to build an analytical framework to investigate the integrated tax-subsidy scheme in the air-HSR context, incorporating features that are specific to the transportation sector and can potentially affect the effectiveness of the policy. From a practical perspective, this paper helps our understanding towards the impacts of the air-HSR integrated tax-subsidy policy, pointing out some factors of concern. The model is also able to generate some policy suggestions, which can potentially raise the awareness of the policy makers on a few areas of contention before the implementation of the policy.

The paper is organized as follows. Section 2 provides literature review while Section 3 sets up the model. Section 4 focuses on analytical results and Section 5 presents further discussion and concluding remarks.