Second-best Urban Tolls in a Monocentric City with Housing Market Regulations

This paper investigates second-best congestion pricing in a monocentric city characterized by distortionary, rigid regulatory mechanisms in the housing market (building height restrictions, zoning and property taxation). The Pigouvian toll is shown to retain its optimality under any setting with quantity restrictions in the housing market. However, the extent of the quantity restriction determines the volume of the welfare gains in a non-monotonic fashion. This finding introduces a warning to cost-benefit analyses: our numerical results suggest that the actual gains of a road tax might be 40% lower than the gains predicted by a model that disregards maximum building height restrictions, and 80% higher than the gains suggested by a model that disregards zoning. In general, this implies that decision making on urban road pricing can ignore quantitative restrictions in the related markets of land, housing and labor insofar as the determination of optimal marginal tax rules is concerned; the tax levels stemming from those rules will be affected by the restrictions. However, this is not the case in the presence of a tax-induced distortion. Introducing an ad- valorem property tax on housing, we show that adjustments of the Pigouvian toll can lead to small, but not negligible welfare gains.