Understanding Regressivity: Challenges and Opportunities of European Carbon Pricing

Abstract

We examine how a European carbon price will affect citizens by studying the carbon tax incidence in 23 countries of the EU. At the national level, the distributional impact prior to revenue recycling is largely neutral, sometimes progressive. At an aggregate EU level, however, the impact is regressive because some low-income countries would be highly impacted if subjected to a common EU carbon price. While national redistribution can do much to make EU incidence progressive, we show that European-wide redistribution is more effective for especially affected households. We offer two indicators to offset regressive distributional effects of EU climate policy such as the recently proposed Green Deal. The first renders the tax burden proportional; the second focuses on compensating the households most seriously affected. Including both indicators in European redistribution makes for a better representation of the initial burden of carbon pricing and could make the policy more salient for citizens.

Keywords: Carbon Pricing, Distributional Effect, Household Data, European Union

JEL Classification: D57, H22, H23, Q52, Q54