This paper considers various policy measures to reduce traffic externalities in cities, including externality-reducing investments, tolls, emission standards, low emission zones, and bypass capacity to guide traffic around the city center.
Using a simple model that distinguishes local and through traffic, we study the optimal use of these instruments by an urban government that cares for the welfare of its inhabitants, and we compare the results with those preferred by a federal authority that takes into account the welfare of all road users. Our results include the following.
First, compared to the federal social optimum, we show that the city government will over-invest in externality-reducing infrastructure whenever this infrastructure increases the generalized cost of transit traffic. Second, comparing emission standards and road tolls, we find that cities with a lot of commuters will favor tolls, even though from the federal perspective standards are better.
Third, when implementing low emission zones, the urban government will set both the fee for non-compliance and the standard at a higher level than the federal government. Moreover, at sufficiently high transit levels the urban government will prefer imposing a toll instead of implementing a low emission zone. Fourth, if the city can toll the urban infrastructure, it will only invest in bypass capacity when it is allowed to earn extra toll revenues on the bypass that exceed investment costs.
Although the paper focuses on non-congestion externalities, most insights also hold in the presence of congestion.