Can Carbon Taxes be Progressive?

by Makari Krause

Dissou et al. (2014) provide a new assessment of the incidence of carbon taxes and their impacts on inequality. Past studies on the impacts of carbon taxes have generally focused on the effects to commodity prices. This channel usually leads to the finding that carbon taxes are regressive because a carbon tax increases the price of energy-intensive goods and these goods make up the largest portion of the total goods bought by poorer households. Using only this one channel, however, overlooks a critical aspect of the tax; factor income, income generated from selling factors of production such as labor, is also affected by carbon taxes. Dissou et al. combine both the commodity price channel and the factor price channel to get a more comprehensive picture of the effects of a carbon tax on inequality and find that carbon taxes are not as regressive as previously thought.

The rich derive much of their income from capital, the poor on the other hand derive much of their income from labor. Past studies have shown that pollution control policies can harm capital income more than labor income because polluting industries are generally more capital-intensive than other industries. The outcome of a pollution control policy could, therefore, be progressive as it harms the rich more than the poor.

Dissou et al. decompose welfare metrics into three different components; initial total expenditures, contribution from commodity price changes, and contributions from changes in factor prices (i.e. wages). They then create a model and run several simulations with different carbon tax values: $15, $30, $50, $100, $150 per ton. The model produces the impact on commodity and factor prices, which are then used to measure the impact on inequality.

The first direct impact of the carbon tax is an increase in energy prices. This leads to decreased demand and lower carbon emissions. Increasing energy prices also leads to higher costs to firms and therefore higher prices in all industries. The magnitude of this price increase depends on the industry but it is this change in the price of goods that makes the tax more regressive. As the marginal cost increases, the returns to labor and capital decrease. This decrease is larger for capital and because capital is used more heavily in energy-intensive industries, output will fall in these industries more than in others. This will lead to a decrease in the demand for capital relative to labor and an increase in price for labor relative to capital. This factor price change makes the tax progressive

Results show that there are two clearly opposing effects on inequality the stem from a carbon tax. On the one hand the changes in factor prices lead to a more progressive tax in which wealthy households are impacted more heavily than poor households. On the other hand changes in commodity prices lead to a more regressive tax. The net impact depends on the strength of each of these opposing effects and is difficult to infer.

In their simulated economy, Dissou et al. did, however, observe an interesting phenomenon. At low levels, carbon taxes were found to be progressive but as the taxes increased they were found to be increasingly regressive. The distributional impact of the carbon tax might therefore be dependent on both the level of the tax and on the structure of the economy in question.

Dissou, Y., & Siddiqui, M. S., 2014. Can carbon taxes be progressive? Energy Economics 42, 88-100.



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