Carbon pricing or taxation is a popular climate change mitigation strategy. However, the distributional effect seems to be different depending on how heavily households rely on carbon-intensive energy sources. In a latest IMF working paper, Alonso and Kilpatrick (2022) argue for a wide range of country-specific policies that could be implemented to compensate households, reduce inequality, and build support for adoption.
A carbon tax is a fee imposed on the burning of fossil fuels (e.g., natural gas, coal, oil) based on their carbon content. Carbon tax implementation is politically sensitive because of the general opposition to higher energy prices, displacement of workers, and social disturbances (price increases have led to riots in Haiti, France, Kazakhstan, Ecuador, etc). Studies show that a price of $75 per ton for advanced economies, $50 for high-income emerging market economies, and $25 for low-income emerging market economies set in place by 2030 will be needed to achieve the Paris Agreement’s target of limiting warming below 2°C.
They use household surveys and input-output (IO) tables to examine the effect of a carbon tax on households in Asia and the Pacific. The Asia and the Pacific region accounts for 27% of all emissions so far, equivalent to 452 billion tons of CO2, and the region’s global share in fossil fuel combustion emissions has risen from 30% to 49% between 2000 and 2019.
Carbon prices in the region are low based on those standards. Of the current carbon prices in place in the region, the average is around $6 per ton and only covers an average of 0.3% of yearly emissions in each country
They use IO tables to compute how higher energy prices induced by a carbon tax would lead to higher consumer prices in non-energy goods (if higher energy costs are fully passed-through). They then combine this result with household surveys to quantify the negative impact on welfare based on household consumption bundle. They also examine the extent of possible labor income loss as the carbon tax tends to lower labor demand. They study the impact of a carbon tax of $50 per ton. They use household surveys for Australia, China, Hong Kong SAR, India, Indonesia, Japan, Kiribati, Korea, Mongolia, Myanmar, New Zealand, the Philippines, Singapore, and Taiwan, Province of China.
Major findings of the paper:
Based on higher prices and lower labor income, a carbon tax of USD 50 per ton would lead to substantial losses of welfare for households amounting to around 10 percent of initial consumption in Mongolia and 7 percent in Indonesia. In China and India, the average loss would be slightly above 3 percent. It would be 2.1 percent for the Philippines and lower than 2 percent in Kiribati and Myanmar. However, the distributional impact would also be quite different. The carbon tax would be regressive in China, Indonesia, and Mongolia, but it would be progressive in India, Kiribati, the Philippines, and Myanmar. Across the region, small groups of households employed by the energy sector would be heavily exposed to labor income losses.
They argue that the household welfare loss produced by a carbon tax can be reverted and redistributed through relatively simple and cheap compensation schemes. A wide range of country-specific policies could be implemented to compensate households, reduce inequality, and build support for adoption. They find that cash transfer targeted to the poorest 40 percent of the households through realistic proxy-means testing would cost only 16 percent of the resources raised by a carbon tax to ensure that these households are on average not worse off after the reform. It would be as cheap as 8 and 11 percent for India and Kiribati, respectively. The ratio would be around 15 percent for China and Myanmar. It would reach 17 percent for the Philippines and 23 and 24 percent for Indonesia and Mongolia, respectively.
Providing a universal cash transfer or “carbon dividend” to all households to ensure that more than half of the households are better off after the reform would cost only 23 percent of the resources raised by a carbon tax in India and 33 percent in Myanmar.
In India, they find that the burden of a carbon tax due to higher prices would be mildly progressive for households. Consumers in the poorest quintile would experience a loss of around 3.2 percent compared to initial consumption, while the richest households would lose around 3.4 percent. It reflects a strongly progressive direct effect from higher energy prices, partially offset by a regressive indirect effect from higher prices on other goods. The richest households allocate relatively more of their expenditure towards electricity, gasoline, and LPG while the bottom quintile of households consume more kerosene and to a lesser degree coal. Electricity, gasoline, and LPG would see their prices rise by 20.5, 12, and 23.6 percent, respectively in response to the carbon tax. This would add up to a burden of 0.4 percent of initial consumption for the poorest quintile, but 1.5 percent for the richest quintile. This progressivity is mitigated by the effect of higher prices of kerosene and coal, which would lead to a burden of 1 percent of initial consumption for the poorest quintile and only 0.3 for the richest. In sum, the direct effect of higher energy prices would cost 1.4 percent of initial consumption for the poorest households and 1.8 percent for the richest. The implementation of a $50 carbon tax would raise fiscal revenues by about 2.5 percent of GDP.
