Optimal pricing of transport externalities in a federation

The purpose of this paper is to study welfare-optimal pricing of passenger and freight transport services in a federation. First a theoretical model is constructed that clearly identifies the implications of the international dimension of transport flows and the associated externalities for optimal pricing in a federation. It emphasises the role of external cost spill-overs, of tax competition and tax exporting, of differences in the shadow cost of public funds, and of potential price discrimination between domestic and international traffic in generating pricing policies at the regional level that are suboptimal from the federal viewpoint. Second, a large-scale numerical optimisation model is used to determine optimal prices in a two-region setting (Belgium and ‘other EEC members’). The model considers some fourty highly interdependent transport markets in each region. Application of the model is based on the best available estimates for all major external costs, including congestion, air pollution, accident costs and road depreciation. The model is used to determine the federally optimal pricing structure as well as the Nash equilibrium prices. Moreover, the implications of price discrimination between domestic and international transport for tax exporting are analysed.