Road to Net Zero: Carbon policy and redistributional dynamics in the green transition

Alessandro Sardone

No 16/2025, IWH Discussion Papers from Halle Institute for Economic Research (IWH)

Abstract: This paper examines the macroeconomic and distributional effects of the European Union's transition to Net Zero emissions through a gradually increasing carbon tax. I develop a New Keynesian Environmental DSGE model with two household types and distinct energy and non-energy sectors. Five alternative uses of carbon tax revenues are considered: equal transfers to households, targeted transfers to Hand-to-Mouth households, subsidies to green energy firms, and reductions in labor and capital income taxes. In the absence of technological progress, the carbon tax policy induces a persistent increase in energy prices and a reduction in GDP, investment, and consumption. Headline inflation falls below zero in the medium run, reflecting weaker aggregate demand. Distributional outcomes vary significantly depending on the implemented revenue recycling scheme: targeted transfers are the most progressive but entail larger macroeconomic costs, while subsidies and tax cuts mitigate output and investment losses but are less effective in narrowing the consumption gap. A limited foresight scenario, in which agents learn about policy targets sequentially, generates more volatile adjustment paths and temporary inflationary spikes around announcements, but long-run outcomes remain close to the baseline.

Keywords: DSGE; fiscal redistribution; green transition; inequality; macroeconomic effects; net zero; TANK (search for similar items in EconPapers)
JEL-codes: E32 H23 P28 Q43 Q52 (search for similar items in EconPapers)
Date: 2025
New Economics Papers: this item is included in nep-dge
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:iwhdps:330172

DOI: 10.18717/dpqt53-r352

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