Climate policy design, competitiveness and income distribution: A macro-micro assessment for 11 EU countries

Abstract

Concerns about industry competitiveness and distributional impacts can deter ambitious climate policies. Typically, these issues are studied separately, without giving much attention to the interaction between the two. Here, we explore how carbon leakage reduction measures affect distributional outcomes across households within 11 European countries by combining an economy-wide computable general equilibrium model with a household-level microsimulation model. Quantitative simulations indicate that a free allocation of emission permits to safeguard the competitive position of energy-intensive trade-exposed industries leads to impacts that are slightly more regressive than under full auctioning. We identify three channels that contribute to this effect: higher capital and labour income; lower tax revenue for compensating low-income households; and stronger consumption price increases following from higher carbon prices needed to reach the same emissions target. While these findings suggest a competitiveness-equity trade-off, the results also show that redistributing the revenues from partial permit auctioning on an equal-per-household basis still ensures that climate policy is progressive, indicating that there is room for policy to reconcile competitiveness and equity concerns. Finally, we illustrate that indexing social benefits to consumer price changes mitigates pre-revenue-recycling impact regressivity, but is insufficient to compensate vulnerable households in the absence of other complementary measures.

Distributional effects of carbon pricing by transport fuel taxation

“…Barker and Köhler (1998) identify a slightly regressive effect of carbon taxes for most of the eleven examined EU countries, including Germany, but also a slightly progressive effect when only taking transport fuels into account. Similar patterns are found by Vandyck et al (2021) in a more recent study of eleven EU countries. Focusing on Austria, Eisner et al (2021) find a regressive effect for electricity and heating, but an disproportionate tax burden on middle-income households for transport fuels.…”

Who pays for higher carbon prices?

“…Hynes and O'Donoghue (2014 [24]) provide a broad review of the use of microsimulation models to inform environmental policy. The distributional implications of carbon taxes have been analysed by Casler and Rafiqui (1993[61]) and Mathur and Morris (2014 [62]) in the USA, Hamilton and Cameron (1994[63]) in Canada, Pearson and Smith (1991[49]), Symons et al (1994[64]) and Symons et al (2002[65]) in the United Kingdom, Cornwell and Creedy (1997 [66]) and Creedy and van de Ven (1997 [67]) in Australia, Callan et al (2009[46]) and O'Donoghue (1997 [68]) in Ireland, Bach et al (2002[69]) and Bork (2006[70]) in Germany, Kerkhof et al (2009[71]) in the Netherlands, Poltimäe and Võrk (2009[72]) in Estonia, Labandeira and Labeaga (1999 [73]), Labandeira et al (2009[74]) and Garcia-Muros et al (2017 [75]) in Spain, Bureau (2011[76]) and Berry (2019 [43]) in France, Vandyck and Van Regemorter (2014 [77]) in Belgium, Yusuf & Resosudarmo (2015 [78]) in Indonesia, and Rosas-Flores (2017 [79]) in Mexico.…”

A Multi-Model Assessment of Inequality and Climate Change

“…The recent advancements in estimating impact functions of climate change with improved data sets and empirical methods ( Despite the relevance of the relation between climate and inequality, the literature involving coupled climate-economy models has not made it a priority yet. Though individual modeling studies have explored policy incidence (Rausch, Metcalf and Reilly, 2011;Vandyck et al, 2021), model ensembles have prioritized other topics such as technology and international climate policy. For example, none of the model comparison reported in the IPCC 6th assessment report scenario database has a focus or data about economic inequality and its links with climate change.…”