Quality-based price discrimination and tax incidence

The existing tax policies towards gasoline and diesel cars in European countries provide a unique opportunity to analyze quality-based price discrimination and the implied tax incidence. We develop an econometric framework for the demand and pricing of gasoline and diesel cars. Consumers choose the type of engine based on their annual mileage; prices are set by the manufacturers. Our empirical results show that the relative pricing of gasoline and diesel cars is consistent with price discrimination of a monopolistic type, effectively segmenting low mileage from high mileage consumers. On average, about 75 to 90 percent of the price differentials between gasoline and diesel cars can be explained by markup differences. The implied tax incidence is especially based on fuel taxes and less so on annual car taxes. Implications for the effectiveness of tax policy are drawn.status: publishe