India’s car market is one of the fastest-growing in the world, with annual sales having doubled from 1.4 million to more than 3 million over the past decade. At the same time, vehicles contribute a sizeable share of India’s high levels of air pollution, particularly in cities.

In recent years, India has altered its vehicle tax policy numerous times. The current policy varies vehicle tax by size, with tax decreasing by vehicle size. This project seeks to evaluate the effects of this tax structure on air pollution, social welfare, and market structure in order to understand the implications for optimal tax policy.

Why this study

The car sales in India grew from about 20,000 per month in 1992 to 200,000 per month in 2012. That is, the market grew by a factor of 10 in 20 years. Such rapid growth implies that studying India’s car market is important for addressing both local air pollution as well as greenhouse gas emissions for the global climate change.

Given the frequent changes in car tax rates, particularly in taxes for different size-segments, this project explores the effect of India’s car tax policy on air pollution, market competition, and welfare. The project addresses three major questions.

First, the policy may have induced consumers to purchase relatively smaller cars, which potentially led to reduction in air pollution. Second, the policy might have induced progressive income re-distribution given poorer households are more likely to own smaller cars. Finally, this policy might have affected market competition because it changed the incentives for car manufacturers to choose their optimal decisions on designating their cars.


For the empirical research design, this project exploits tax rules and historical tax changes in India.

First, the Indian government introduced a new car tax in 2006 that had a lower tax rate for smaller cars (car smaller than 4 meters) than larger cars. This policy created a condition that allows author to conduct a bunching analysis for cross-sectional data to examine how automakers and consumers responded to tax incentives.

Second, Indian federal government’s car tax had time-series variation that varied by car segment. Author shows some of the time­‐series variation in Figure 1 and exploits this variation over time and between segments to conduct a difference­‐in­‐differences analysis.

Figure 1: Historical Tax Rates (%) for small- and medium-sized passenger cars in India

The advantage of the research design is the ability to use these two complementary estimation methods. The bunching method gives large variation in tax and enables visually transparent analysis. The difference­‐in­‐differences method, on the other hand, provides a way to examine the policy impact for broader segments of the Indian car market and investing medium long­‐run effects of the tax policies.

Preliminary Findings

As the first step to examine the effect of the size-based car tax policy in India, the author collected automobile specification data for 1995 to 2018. Following are some preliminary findings from the analysis.

Figure 2: Number of cars sold in India before and after the policy change

In Figure 2, author shows the histogram of car sold in India before the introduction of size-based tax (between 1995 and 2006) in Panel A, and after the introduction of the size-based tax (between 2007 and 2018) in Panel B. These figures suggest that the new tax policy induced the bunching of cars at the 4-meter cutoff.

The histogram also suggests that most of the bunched cars were likely to come from the larger-length segment (i.e. the right hand side of the horizontal axis). That is, it suggests that the new tax policy had a downsizing effect on vehicles on the right hand side of the 4-meter cutoff.

In ongoing analysis, this research is examining impacts of the downsizing effect. First, this study is testing if this impact resulted in substantial reductions in fuel consumption. Second, the author is exploring if the policy compromised the safety of cars. Third, investigation continues to understand if the policy affected higher- and lower-income households differently. Finally, this study aims to know if India’s policy has affected automobile markets in other countries through multinational firms.

Project Partners