Abstract Transportation, energy and environmental tax reforms represent an ongoing debate in contemporary policy. The main aim of this paper is to shed some light on this debate using micro-simulation tools to analyse consumer response and welfare effects of environmental policy consisting of an increment of the indirect taxes on fuels to finance the elimination of VAT on the public means of transport. In order to do so, we first estimate an Almost Ideal Demand System for 16 different groups of goods in the Spanish economy, for the purpose of evaluating expenditure and price elasticities. Using this information, we then micro-simulate the abolition of VAT on public transport services and a simultaneous increment on fuel taxes, so that total revenue remains unchanged. The welfare effects of this revenue-neutral tax reform are evaluated. The aim of this simulation is to define a public policy that increases public transportation availability and use in order to bring about decreases in pollution and congestion.