Protecting the Poor With a Carbon Tax

Gilbert E. MetcalfDepartment of Economics

Tufts University

Friedrich Ebert FoundationFinancing for Development Office

UN-DESAJune 17, 2008

Reducing Greenhouse Gas Emissions

• Many policy approaches to reducing GHG emissions– Carbon Tax– Cap and Trade Systems– Regulatory Approaches

• All raise the cost of energy use

• Concern about price impact on poor

Tax Burden

• A tax is regressive if it takes a larger share of income from the poor than from the rich

• A tax is progressive if it takes a larger share of income from the rich than from the poor

Concerns with a Carbon Tax

• Any carbon price will disproportionately impact the poor– Carbon tax is essentially an energy tax– Energy a larger share of household budget in

poor households

• A regressive tax

• This is a problem with cap and trade systems as well as a tax

Advantages of a Carbon Tax

• Relatively easy to implement– In major GHG emitting countries, bulk of

emissions from fossil fuel use

• Price impact is known with certainty– Impact determined by tax rate

• Transparent– No hidden transfers

Distributional Impacts Can Be Mitigated

• Carbon tax may be regressive

• A carbon tax reform need not be regressive– Use carbon tax revenue to offset the impact

on poor households

Example From the United States

• $15 per ton CO2 tax on carbon emissions

• Environmental Earned Income Tax Credit– A tax credit equal to 15 percent of wage

income up to $560 (using 2003 data)– Credit provided to all workers in family

How the Credit Works

• Household A has two workers that earn $10,000 and $3,000 respectively– Workers receive credit of $560 and $450 respectively– Credit equal to 7.8 percent of income

• Household B has two workers that earn $45,000 and $20,000 respectively– Workers receive credit of $560 each– Credit equal to 1.7 percent of income

• Credit is progressive – more valuable to poor households than rich households

Who Pays the Carbon Tax?

3.6

3.1

2.4

2.01.8

1.51.4 1.2

1.00.8

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1 2 3 4 5 6 7 8 9 10

Decile

Per

cent

age

of I

ncom

e

Metcalf (2007)

Who Gets the Environmental Earned Income Tax Credit?

2.7

2.1 2.2 2.11.9 1.8

1.61.4

1.10.8

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1 2 3 4 5 6 7 8 9 10

Decile

Per

cent

age

of I

ncom

e

Metcalf (2007)

Net Burden

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

1 2 3 4 5 6 7 8 9 10

Decile

Per

cent

age

of I

ncom

e

Metcalf (2007)

Net Burden

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

1 2 3 4 5 6 7 8 9 10

Decile

Per

cent

age

of I

ncom

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Explicit grant to elderly non-workers

Source: Metcalf (2007)

Giving Permits to the Energy Sector

2.0

0.7 0.60.4 0.5 0.4

0.3 0.2

-0.2-0.5

-1.0

-0.5

0.0

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1.0

1.5

2.0

2.5

3.0

3.5

4.0

1 2 3 4 5 6 7 8 9 10

Decile

Per

cent

age

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Free allocation precludes the

opportunity for distributional offsets

Metcalf (2007)

Rebating the Tax

• The approach described here is designed to lower the marginal tax rate on wage income

• This provides some efficiency benefits

• A per capita rebate would be even more progressive

• Trade-off between efficiency and equity

Applying This Concept in Developing Countries

• Carbon tax can be collected at the national or sub-national level

• A carbon tax dividend can be provided to each household based on family size

• No need to verify family income or measure energy consumption

Summing Up

• A carbon tax may be regressive

• A carbon tax reform can be distributionally neutral

• How the carbon tax revenue gets used is crucial for distributional considerations

• Carbon tax revenue can offset the impacts on poor households