A well-designed carbon tax could reduce emissions and alleviate income inequality

A special article released today (6 June 2019) by researchers in the energy division of the ESRI finds that carbon taxation has an impact on both carbon emissions and on income inequality. Using data from the Household Budget Survey (HBS) and state-of-the-art methods to simulate how much people would buy once a carbon tax was applied, we estimate a reduction of carbon emissions by 3.9% for a carbon tax increase of €30 per tonne, and by 10.2% for a carbon tax increase of €80 per tonne.

Poorer households spend a greater proportion of their expenditure on energy, and therefore on carbon tax, than richer households. Carbon taxation is therefore found to be regressive. However, if the revenues raised by the tax are returned to households, the overall negative effect on income distribution can be corrected.

If every household is allocated an equal share of the revenues from the carbon tax (known as a ‘carbon cheque’), income inequality is reduced by 0.5% and 1% – when compared with the overall income inequality of a no tax scenario –  for a tax increase of €30 and €80 per tonne respectively. If the revenues are recycled in a manner that targets poorer households, inequality is reduced even more, by 1.2% and 2.8%.

The reduction in carbon emissions calculated here is based on data from the 2015-2016 HBS. Further reductions in carbon emissions could come from new policy measures, such as congestion charging or improved public transportation. Such measures would influence the degree to which consumers switch from high carbon consumption to lower carbon alternatives.

Commenting on the article, author Miguel Tovar Reaños said “This research finds that environmental and distributional policy goals are not necessarily in conflict if the policy is designed correctly. Using Irish data, we confirm that carbon taxation is an effective way of reducing carbon emissions, which has been found to be the case in other jurisdictions worldwide. The existing tax and social welfare system is the obvious way to recycle the revenues in a targeted manner. This is also likely to be cheaper to administer than a ‘carbon cheque’. Forthcoming research will discuss how to cycle the revenues through the tax and welfare system for Ireland.”