Is Pay-as-You-Drive Insurance a Better Way to Reduce Gasoline than Gasoline Taxes? By Ian W.H. Parry∗

Despite concerns about US dependence on a volatile world oil market, greenhouse gases from fuel combustion, and air quality effects of mobile source emissions, substantially higher federal gasoline taxes are currently a political non-starter. Any fuel conservation measures that might be more politically palatable are generally perceived as inferior to gasoline taxes on efficiency grounds. This paper challenges the latter assertion: it shows a policy that should be far more feasible than a large increase in fuel taxes can also achieve a significant reduction in fuel demand, with a dramatically larger welfare gain. The policy is pay-as-you-drive (PAYD) insurance, which is motivated on the grounds of reducing mileage, particularly by high-risk drivers, and reducing the number of uninsured drivers by lowering premiums for low-mileage vehicles. It involves auto insurance companies switching from current, annual lump-sum premiums, to premiums levied on annual miles driven, scaled by a driver’s rating factor (which varies with age, crash record, and region). By converting some of the fixed costs of vehicle ownership into costs that vary with mileage, the policy reduces the amount vehicles are driven, and thereby reduces fuel demand. And, unlike under higher fuel taxes, driving costs (fixed plus variable) for the average motorist do not increase; hence political opposition to this policy should be more muted. To some extent, we may see a market-driven transition to PAYD over the next decade or two