How do households spend carbon tax rebates?

Abstract

Carbon taxes are viewed by most economists as a cost-effective approach to reducing greenhouse gas emissions. Concerns over adverse impacts to disposable income, and corresponding political acceptability, have led many to propose a "fee-and-dividend" approach, whereby revenue from carbon taxes is rebated back to consumers. Standard economic theory suggests that so long as the rebate is independent of a households consumption of emitting goods, it should act solely as an income effect, without affecting the incentive to shift towards lower-emitting goods and activities as intended by the carbon tax. Behavioural models of "mental accounting", however, suggest consumers may earmark their rebates for particular purposes. For example, they may disproportionately spend their rebates on fuel purchases, deeming the rebates as relief from the tax; or, they may associate the rebates with the underlying climate policy and spend them on emission-reduction opportunities. We examine this question empirically using the introduction of British Columbia's carbon tax and rebate in 2008 using a triple-difference approach. We find consumers do not spend rebate income in the same way as "normal'' income. In particular, we find consumers allocate more of their rebate income towards public transport, and less towards gasoline, than would be predicted under a rational consumer model.

Keywords: Climate change, carbon tax, fee and dividend, climate action rebate, tax credit, consumer spending

JEL Classification: Q58, D12