Options Magazine, Summer 2022: In the effort to combat climate change, the notion of green tax reform has become increasingly common, but how do different carbon tax designs affect people at different income levels?

Essentially, green tax reform shifts taxation from activities that are environmentally beneficial to those that are harmful.

However, green tax reform has hitherto been unpopular, largely because the less wealthy bear the brunt of higher-priced, carbon-intensive commodities. It then stands to reason that if these reforms were changed to benefit more people, support for green tax reform would increase dramatically.

In a recent study published in the European Economic Review, Armon Rezai and his coauthors used an Exact Affine Stone Index (EASI) demand system based on German household data and a labor supply schedule, using wage data, to investigate how different carbon tax designs affect people across the income distribution.

The researchers found that if revenue is recycled via lower income taxes, there is more efficiency at the expense of equity, benefitting about half of households. By combining a mix of lump-sum payments and lower income taxes, more people can benefit, increasing support for green tax reform.

“Green tax reform has the potential to lower overall costs of climate policy, but richer households often benefit the most,” explains Rezai, a researcher in the IIASA Population and Just Societies and Advancing Systems Analysis Programs. “The trick is to find ways for more people to benefit without blunting the tax’s ability to reduce emissions. Such a green tax reform will have public support and allow policymakers to enact it.”

By Jeremy Summers