Charging higher tax on cars that pollute more has prompted consumers to buy greener cars, the Bank of Israel says.

Environmental reforms in tax rates on vehicle purchases have revealed that “economic incentives have a significant effect in the desired direction on consumer behavior,” according to an excerpt from Bank of Israel 2013 Annual Report, released on Tuesday. This impact is enhanced by technological advances that support this change in attitude, the report said.

“The success of the reform may therefore serve as an argument for also implementing economic policy tools to reduce congestion on the roads, such as differential taxes on travel during peak hours vis-à-vis other hours,” the bank said.

The government decided to implement a “green reform” in the taxation of private vehicles in 2009, determining purchase tax rates based on 15 pollution ratings and raising the base tax rate up to 90 percent, the report explained. After taking the green benefit program into account, the actual tax rates on vehicle purchases ranged between 30% and 83%.

The central bank rejects claims that the reduction in pollution levels of imported vehicles could be linked to increasing fuel prices rather than to the tax reform. While between the years 2000 and 2008 average engine sizes purchased increased despite increasing fuel prices, after 2008 the average engine sizes decreased as fuel prices continued to increase, the report explained.

By July 2013, the Environmental Protection Ministry needed to update the green taxation rates because most of the vehicles being imported then fell into the lower pollution rating categories, the report said. The declining differentiation between pollution levels weakened the power of tax rates to enforce green policy, and therefore warranted a green tax “re-calibration” for private vehicles.

In addition, a significant loss in tax revenue necessitated a fiscal response, the report said.

With the introduction of the re-calibrated system, the government expects to see a taxation distribution similar to that of 2009, when the green reform was introduced, the bank said.

The Finance and Transportation ministries launched a three-year examination process that will assess how financial incentives affected travel habits at the beginning of 2013. The findings will help a professional committee appointed by the two ministries that is to propose a new tax policy regarding travel habits with the aim of reducing congestion on roads, the report concluded.

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