Working Paper

Unequal Climate Policy in an Unequal World

Abstract: We study climate policy in an economy with heterogeneous households, two types of goods (clean and dirty), and a climate externality from the dirty good. Using household expenditure and emissions data, we document that low-income households have higher emissions per dollar spent than high-income households, making a carbon tax regressive. We build a model that captures this fact and study climate policies that are neutral with respect to the income distribution. A central feature of these policies is that resource transfers across consumers are ruled out. We show that the constrained optimal carbon tax in a heterogeneous economy is heterogeneous: Higher-income households face a higher rate. Our main result shows that when the planner is limited to a uniform carbon tax, the tax follows the Pigouvian rule but is lower than the unconstrained carbon tax. Finally, we embed this model into a standard incomplete markets framework to quantify the policy effects on the economy, climate and welfare, and we find a Pareto-improving result. The climate policy is welfare-improving for every consumer.

Keywords: carbon tax; inequality; consumption; welfare; climate change;

JEL Classification: D62; H23; Q54;

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Globalization Institute Working Papers

Publication Date: 2024-07-16

Number: 427