A concomitant of the rapid development of the automobile industry in China is the serious air pollution and carbon dioxide emission. There are various regulation instruments to reduce the air pollution from automobile sources. China government chooses a small-displacement oriented consumption tax as well as fuel tax to alleviate the worse air pollution. This paper evaluates the effects of both policy instruments on fuel consumption and social welfare. Our empirical results show that fuel tax decreases the total sale of new cars, which leads to a decline of total consumption of fuel from the new cars, but does not change the sale distribution over various fuel efficiency models; while consumption tax adjustment results in a skewed sale distribution toward more efficient new cars but increases the total consumption of fuel due to an enlarged sale. The effects of these two taxes on pollution depend on our assumption about the average fuel efficiency of outside goods. On the other hand, consumption tax leads to less social welfare loss; in particular, consumer surplus decreases in an order of magnitude less than that caused by fuel tax. Fuel tax actually transfers more welfare from private sector to the government.
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