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Could a carbon tax have prevented the Volkswagen scandal?

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(Read caption) Volkswagen ornaments sit in a box in a scrap yard in Berlin, Germany (Sept. 2015).

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If anyone needed another example of why a carbon tax is a good idea, look no further than Volkswagen’s diesel scandal. The automaker’s efforts to game the current system are a case study in what’s wrong with government attempts to reduce pollution with regulation and tax subsidies, rather than through a relatively straight-forward tax on carbon-based fuels.

The current system is complex mix of environmental carrots and sticks. The sticks include regulation such as fuel economy standards. The carrots include tax subsidies. One was the (now-expired) alternative motor vehicle tax credit that was available to specific models that met detailed fuel economy requirements. Two models of VW Jettas qualified for credits of $1,300 and the LA Times reported in September that the government paid as much as $51 million in credits to buyers of VW diesel cars.

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Unable to limit emissions, give consumers the high performance they want, and meet fuel economy standards, VW cheated. As you know by now, the firm installed software in its diesel cars designed to fool routine emissions tests—which made the cars appear “cleaner” than they really were. In all, VW reportedly sold 500,000 cars in the US from 2009-2015 with the rogue software. Here is a helpful description from Vox explaining the whole sad story.

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VW eventually got caught, of course. It faces penalties from EPA and potential criminal charges for violating the False Claims Act, as well as an investigation by the Senate Finance Committee. CEO Martin Winterkorn has resigned and the firm has stopped selling diesel cars in the US.

Still, a lot of this mess could have been avoided with a carbon tax. Such a levy could replace many—though not all-- of these complex rules and eliminate most incentives for gaming. A carbon tax would not help reduce local air pollutants such as NOx so it would not replace all auto pollution regulations. But it could supplant those that aim to reduce carbon emissions from vehicles.

For drivers, the choice would be relative simply: You buy a carbon-based fuel, you pay a tax. The more carbon in the fuel, the more tax you pay. The manufacturer wouldn’t need to hit a mandated fuel economy standard. No-one would need to worry about conflicting regulations.

Instead, consumers would likely respond to higher taxes by demanding cars that, one way or another, use less carbon-based fuel. We have lots of evidence that consumers are extremely responsive to changes in gasoline prices—the price goes up, they buy Priuses; it goes down, they switch to less fuel-efficient vehicles.

And with a big carbon tax, manufacturers will probably respond to consumer demands by producing low-carbon vehicles. The proof will be at the pump. If an automaker lies about its fuel efficiency, it will be immediately obvious: Consumers will be filling up their tanks more often than they expected. And government won’t have to test carbon emissions from tens of millions of cars. It will just need to calculate the carbon content of their fuel.

There is one other classic argument for corrective taxes such as a carbon tax. Such a levy provides ongoing incentives for firms to enhance technology and continue to drive down emissions. But with regulation or subsidies, even honest producers are more likely to hit the mandated target—and stop.

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This is not to suggest that carbon taxes are not without their own complex issues. My Tax Policy Center colleagues Donald Marron and Eric Toder have described some of the technical challenges. But overall, market mechanisms such as carbon taxes (or a cap-and-trade system) are far more efficient, and much less prone to cheating, than a system based on regulations and subsidies.

This article first appeared on TaxVox.