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Environmental tax reform for climate protection and social justice

20 Oct 2016

Environmental tax reform for climate protection and social justice

New study shows how a carbon tax can both protect the environment and advance social justice—when accompanied with a lower income tax.

In industrialised nations, an environmental tax reform could greatly reduce social inequality if properly designed. However, to have that impact, revenues from the taxation of carbon emissions would have to be used in full to lower the income tax. This is the result of a new study conducted by INET Oxford’s Linus Mattauch jointly with David Klenert, Gregor Schwerhoff and Ottmar Edenhofer from the Mercator Research Institute on Global Community and Climate Change (MCC) in Berlin. The researchers present their findings in the article “Environmental Taxation, Inequality and Engel’s Law: The Double Dividend of Redistribution” published in the journal Environmental and Resource Economics.

The researchers developed a new model to show what a carbon tax reform has to look like if it is to have a positive effect on the economy as well as on tax distribution within the population. “If the revenue from carbon taxes were to flow completely into a lowering of the income tax, this would not only increase the acceptance of these taxes by the population—but would also compensate for the negative distributional impacts which such taxes generally have on the poor,” says lead author Klenert of the MCC in Berlin. “It is crucial that the income tax be progressively reformed. In plain English: the tax on low-income households must be reduced more drastically than the tax on high-income households.”

The research team thus demonstrates how an environmental tax reform could benefit in particular the poor. By contrast, most former environmental taxes have been rejected by the majority of the population due to the additional financial burden these put on consumers. For example, the revenue from fuel taxes flows typically into the federal budget—yet is not passed back to the consumer, at least not in any visible way. At the same time, it should be mentioned, poorer households spend a greater portion of their income on carbon-intensive products than their more prosperous counterparts. As environmental taxes are levied on companies that produce and sell such products, consumer prices invariably reflect an increase in such taxes. However, as product prices are the same for all, low-income earners essentially bear the brunt of such an environmental tax reform. “This effect of inequality can be reversed by a simultaneous progressive reform of the income tax,” emphasises Klenert. “In industrialised nations, climate protection can in fact be used to make a positive difference to the poor.”

A press release about the article can be found here.

The article can be accessed here.