Carbon taxes, poverty and compensation options

Today the ESRI publishes ‘Carbon Taxes, Poverty and Compensation Options’ as part of the ESRI Survey and Statistical Report Series. The paper examines how the Irish carbon tax can be raised without increasing poverty and disproportionately affecting low-income households. It shows that poverty can in fact be reduced and the lowest-income fifth of households left better-off using a third of revenues from a carbon tax rise on targeted increases in welfare payments, as proposed in the recent Programme for Government. This reverses the regressive impact of an uncompensated carbon tax rise, which arises because goods subject to the carbon tax make up a larger share of spending for lower- than higher-income households. 

The lowest-income fifth of households is heavily comprised of working-age adults in receipt of social welfare payments and their dependents. These can be compensated for a rise in the carbon tax through increases in the maximum rates of the main working-age welfare payments or raising Increases for Qualified Children (IQCs) paid alongside these benefits to those with dependent children. We show that doing so using a third of the €159 million Revenue estimate that a €7.50 per tonne carbon tax increase raises would reduce the overall poverty rate by 0.2 percentage points (ppts) and leave the lowest-income fifth of households on average better-off. Using the revenue to increase IQCs would reduce the child poverty rate by twice that (0.4ppts): a substantial reduction, given Regan and Maître (2020) estimate child poverty could rise by 1.4ppts this year because of pandemic related job losses, even with some recovery.

Policymakers may also be concerned about the impact an uncompensated carbon tax rise will have on single adults living alone. Using a third of revenues to raise the Fuel Allowance or Living Alone Increase is well targeted at compensating such households, though would not on its own reverse the regressive impact of a carbon tax rise. This is because much of the gain from such benefits goes to households around the middle rather than the bottom of the income distribution, reflected in lower rates of poverty among retired adults than working-age adults or children. However, using one-third of the revenue to fund a combined increase in IQCs and these benefits would be both progressive and poverty reducing.

The Programme for Government also commits to allocating around half of the additional revenue raised from planned carbon tax increases over the next decade to a national housing retrofit programme. The paper provides an overview of the evidence from research on existing housing retrofit programmes administered by the Sustainable Energy Authority of Ireland (SEAI), which finds significant variation in the level of grant aid provided relative to the energy efficiency gain. It also suggests that it would be prudent to incorporate funding for the evaluation of grant effectiveness into any new retrofit programme.