The Distributional Effects of Carbon Taxation in Italy

Abstract

This paper studies the distributional consequences of introducing a carbon tax – modelled as an energy consumption tax paid by heterogeneous households and firms – in a sectoral general equilibrium OLG model calibrated to the Italian economy. Differences in energy intensity and in the elasticity of substitution between production factors lead to a heterogeneous vulnerability to higher energy prices across sectors. Similarly, high- and low-income households are exposed to energy price changes differently, as the latter devote a larger share of their income to purchasing energy products. We find that, depending on how the government recycles the carbon tax revenue, it is possible to achieve a reduction in energy consumption without harming any household, but only in the long run. Among the redistribution schemes considered, uniform transfers lead to the highest average welfare gains, both in the long term and during the transition. A reduction in the distortionary personal income tax (with a uniform downward shift of the entire average rate schedule) would also make most households better off, although its distributional consequences would be the opposite of those derived from uniform transfers. The former actually benefits poorer households more than richer ones, while for the latter, welfare gains increase further up the income distribution. 

Keywords: carbon tax, climate change, overlapping generations, revenue recycling

JEL Classification: H62, H23