Recycling Carbon Tax Revenue to Maximize Welfare
Abstract: This paper explores how to recycle carbon tax revenue back to households to maximize welfare. Using a general equilibrium lifecycle model calibrated to reflect the heterogeneity in the U.S. economy, we find the optimal policy uses two thirds of carbon-tax revenue to reduce the distortionary tax on capital income while the remaining one third is used to increase the progressivity of the labor-income tax. The optimal policy attains higher welfare and more equality than the lump-sum rebate approach preferred by policymakers as well as the approach originally prescribed by economists -- which called exclusively for reductions in distortionary taxes.
File(s): File format is application/pdf https://www.federalreserve.gov/econres/feds/files/2021023pap.pdf
Part of Series: Finance and Economics Discussion Series
Publication Date: 2021-04-02