Carbon Tax Aversion and Macroeconomic Effects

Abstract

This paper investigates how carbon tax aversion impacts the macroeconomy. Through an analysis of carbon tax announcements in Alberta, we first provide empirical evidence that carbon taxes result in the formation of pessimistic macroeconomic beliefs, characterised by higher inflation expectations and lower expected real income. We term these beliefs as carbon tax aversion in the macroeconomy and incorporate them into a two-sector New Keynesian model that departs from the standard assumption of rational expectations. From our benchmark model, we find that carbon tax aversion exacerbates output losses but stabilizes aggregate prices after carbon tax announcements. With carbon tax aversion, the announcement of a 1% increase in carbon taxes results in larger output losses by 0.3% but smaller decrease in aggregate prices by 0.02%, relative to the rational expectations model. Furthermore, earlier announcements result in lower output losses. Our findings highlight the importance of managing pessimistic beliefs against carbon taxes and the role of central banks in supporting the green transition.

Keywords: Behavioral Macroeconomics, Climate Policy, Carbon Tax, Inflation Expectations, Tax Aversion

JEL Classification: D83, E71, H23, H31, Q58