Protecting the Poor With a Carbon Tax Gilbert E. Metcalf Department of Economics Tufts University Friedrich Ebert Foundation Financing for Development Office UN-DESA June 17, 2008

Reducing Greenhouse Gas Emissions Many policy approaches to reducing GHG emissions –Carbon Tax –Cap and Trade Systems –Regulatory Approaches All raise the cost of energy use Concern about price impact on poor

Tax Burden A tax is regressive if it takes a larger share of income from the poor than from the rich A tax is progressive if it takes a larger share of income from the rich than from the poor

Concerns with a Carbon Tax Any carbon price will disproportionately impact the poor –Carbon tax is essentially an energy tax –Energy a larger share of household budget in poor households A regressive tax This is a problem with cap and trade systems as well as a tax

Advantages of a Carbon Tax Relatively easy to implement –In major GHG emitting countries, bulk of emissions from fossil fuel use Price impact is known with certainty –Impact determined by tax rate Transparent –No hidden transfers

Distributional Impacts Can Be Mitigated Carbon tax may be regressive A carbon tax reform need not be regressive –Use carbon tax revenue to offset the impact on poor households

Example From the United States $15 per ton CO 2 tax on carbon emissions Environmental Earned Income Tax Credit –A tax credit equal to 15 percent of wage income up to $560 (using 2003 data) –Credit provided to all workers in family

How the Credit Works Household A has two workers that earn $10,000 and $3,000 respectively –Workers receive credit of $560 and $450 respectively –Credit equal to 7.8 percent of income Household B has two workers that earn $45,000 and $20,000 respectively –Workers receive credit of $560 each –Credit equal to 1.7 percent of income Credit is progressive – more valuable to poor households than rich households

Who Pays the Carbon Tax? Metcalf (2007)

Who Gets the Environmental Earned Income Tax Credit? Metcalf (2007)

Net Burden Metcalf (2007)

Net Burden Explicit grant to elderly non-workers Source: Metcalf (2007)

Giving Permits to the Energy Sector Free allocation precludes the opportunity for distributional offsets Metcalf (2007)

Rebating the Tax The approach described here is designed to lower the marginal tax rate on wage income This provides some efficiency benefits A per capita rebate would be even more progressive Trade-off between efficiency and equity

Applying This Concept in Developing Countries Carbon tax can be collected at the national or sub-national level A carbon tax dividend can be provided to each household based on family size No need to verify family income or measure energy consumption

Summing Up A carbon tax may be regressive A carbon tax reform can be distributionally neutral How the carbon tax revenue gets used is crucial for distributional considerations Carbon tax revenue can offset the impacts on poor households