Optimal carbon taxation and horizontal equity: A welfare-theoretic approach with application to German household data

Martin C. Hänsel, Max Franks, Matthias Kalkuhl and Ottmar Edenhofer

Journal of Environmental Economics and Management, 2022, vol. 116, issue C

Abstract: We develop a model of optimal taxation and redistribution under an ambitious climate target. We take into account vertical income differences, but also explicitly capture horizontal equity concerns by considering heterogeneous energy efficiencies. By deriving first- and second-best rules for policy instruments including carbon and labor taxes, transfers and energy subsidies, we investigate analytically how vertical and horizontal inequality is considered in the welfare maximizing tax structure. We calibrate the model to German household data and a 30 percent emission reduction goal and show that redistribution of carbon tax revenues via household-specific transfers is the first-best policy. Under plausible assumptions on inequality aversion, transfers to energy-intensive households should be about five times higher than transfers to energy-efficient households. Equal per-capita transfers do not require to observe households’ efficiency type, but increase equity-weighted mitigation costs by around 5 percent compared to the first-best. Mitigation costs increase by less, if the government can implement a uniform clean energy subsidy or household-specific tax-subsidy schemes on energy consumption and labor income that target heterogeneous energy efficiencies. Horizontal equity concerns may therefore constitute a new second-best rationale for clean energy policies or differentiated energy taxes.

Keywords: Carbon price; Optimal taxation; Horizontal equity; Redistribution; Clean energy subsidies; Climate policy; Just transition (search for similar items in EconPapers)
JEL-codes: D63 H21 H23 Q54 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Working Paper: Optimal Carbon Taxation and Horizontal Equity: A Welfare-Theoretic Approach with Application to German Household Data (2021)
Working Paper: Optimal carbon taxation and horizontal equity: A welfare-theoretic approach with application to German household data (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeeman:v:116:y:2022:i:c:s0095069622000833

DOI: 10.1016/j.jeem.2022.102730

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