The Diesel Differential

Diesel and gasoline account for around 95% of energy used for road transport in the OECD and for the largest share of revenue from taxes on energy. In 33 out of 34 OECD countries, diesel fuel is taxed at lower rates than gasoline both in terms of energy and carbon content. To assess whether this difference is warranted from an environmental perspective, this paper examines the rationales for taxing both fuels, considering the externalities (including local air pollution, carbon emissions and other social costs related to road transport) associated with the use of each fuel and the fuel efficiency advantage of diesel vehicles. The revenue, distributional and competitiveness consequences of increasing tax rates on diesel are also briefly considered and the revenue effects of the tax treatment of diesel are shown to be significant. We conclude that the externalities associated with each fuel show that the lower tax rates that currently apply to diesel fuel are not justifiable from an environmental perspective. Reduction of the diesel differential is warranted. A gradual approach to removing the differential would allow the adverse distributional and competitiveness impacts to be mitigated during the transitional phase.