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Travel in a private vehicle has negative external effects, chiefly air pollution and its attendant damage to health, and increased congestion on the roads with its attendant waste of time.[1] These effects are market failures, and one of the ways to correct these failures involves the taxation mechanism.

Since the effects are mainly connected with the use of vehicles and not with ownership of them, it would make sense to impose a differential tax on the use of vehicles by the level of pollution they cause (per liter of fuel). For example, different tax rates could be imposed on fuel by the amount of pollution caused by each model of vehicle. However, since it is difficult to apply differential tax rates on fuel for vehicles, there is logic in differential taxation on the purchase of the vehicles themselves, according to the amount of pollution they cause.

In recent years, Israel has thus changed the tax rates imposed on the purchase of vehicles in order to reflect the air pollution emissions. In 2009, the recommendations of an interministerial committee (with the participation of the Ministries of Finance, Transport and Road Safety, National Infrastructures, and Environmental Protection,) to implement a “green” reform in the taxation of private vehicles came into effect.[2] In accordance with the recommendations, the average tax rate remained as it was, but a scale of purchase tax rates was created based on 15 pollution ratings.[3] Within this framework, the base purchase-tax rate was raised from 72–75 percent to up to 90 percent, before a tax benefit appropriate to the level of pollution of each model.[4] The actual tax rates—after the benefit—ranged between 30 and 83 percent. As a result, the prices of less polluting vehicles were significantly lowered, while vehicles that pollute more became more expensive.[5]


Figure 1 indicates the change as a result of the reform: The average green grade of vehicles has improved consistently.[6]


[1] Traffic accidents, meaning a driver colliding with other individuals or their property, also have external effects. Compulsory vehicle insurance partially incorporates these external effects.
[2] “The Report of the Interministerial Committee on ‘Green’ Taxation—Ministries of Finance, Transport and Road Safety, National Infrastructures, Environmental Protection,” January 2008. In order to estimate the quantitative volume of the external effects, the committee used estimates made in 2001 in Europe concerning the costs of damage caused by vehicular emissions.
[3] The scale was basically created by way of a monetary purchase tax credit, which increases with a decline in pollution levels.
[4] Around 130 models—about 1/10 of total gasoline fueled private models imported in 2012—do not belong to the pollution grade that is appropriate for their engine size. More than 2/3 of them pollute less than expected, with the remaining 1/3 polluting more than expected. See:
[5] Pursuant to the Clean Air Law, 5768–2008, the pollution level of each vehicle appears in all advertisements for that vehicle.
[6] Technically, the “green” grade declines with a decline in the pollution level of the vehicle.