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Urban transport has serious problems that are symptoms of the general process of rapid urbanization and environmental degradation. Policymakers in general and urban economists in particular have paid little attention to public transport system pricing leading to the absence of a financially viable, self-supporting urban transport system. In this paper, we report a partial equilibrium model developed by us, which captures transport tax reforms in the presence of certain transport externalities. Our theoretical model shows that the question of public transport subsidies to reduce congestion and provide quality transport services depends on three factors: (a) the extent to which such subsidies induce people to switch from private transport to public transport; (b) if the price elasticity of current users of public transport is higher, there may be a sharp rise in public transport ridership as a reaction to increased subsidies, which will have an undesirable effect; and (c) there is the danger that subsidies will cause a loss in productive efficiency. The numerical model of our paper for Delhi shows that the cross price elasticity of public transport demand with respect to the price of private transport is significant (0.63) in the off-peak period whereas the same in the peak period is somewhat low (0.16) and the combined effect of these elasticities will result in a considerable modal shift in favour of bus transport demand (19%) if the price of public transport were to be subsidized and private transport were to be priced optimally. Even without subsidy, the modal shift will be significant (18%), if the under-priced private transport modes are optimally priced keeping the current bus prices constant. This paper shows that there will be significant welfare gains in both these scenarios. [ABSTRACT FROM AUTHOR]