ESRI Comments On Implications Of Carbon Tax

by Jason Gorringe, Tax-News.com, London

17 July 2008

Ireland's Economic and Social Research Institute (ESRI) recently published a working paper, entitled 'The Distributional Implications of a Carbon Tax in Ireland'.

The paper, co-authored by Tim Callan, Seán Lyons, Susan Scott, Richard S.J. Tol, and Stefano Verde, studied the effects of carbon tax and revenue recycling across the income distribution in the Republic of Ireland.

The report suggested that:

"Climate policy necessarily increases the price of energy, either explicitly through taxes or tradable permits or implicitly by mandating the use of different fuels from those that a free market would choose. As energy is a necessary good, climate policy is regressive: it will disproportionally harm poorer households. Therefore, there should be additional policy reform to offset the negative effects of climate policy on the distribution of income."

And observed:

"The Programme for Government 2007-2012 states that “[a]ppropriate fiscal instruments, including a carbon levy, will be phased in on a revenue-neutral basis over the lifetime of this Government.” Details of the carbon tax will not be decided before late 2009, but it seems likely that the carbon tax would be levied on carbon dioxide emissions that are not already regulated by the European Union Emissions Trading Scheme (EU ETS), and that the tax would be roughly equal to the expected permit price in the EU ETS."

The ESRI analysis further suggested that:

"In contrast to other policy instruments, a carbon tax has the distinct advantage that it generates tax revenue that can be used to even out undesired side-effects of greenhouse gas emission reduction. The purchasing power of households can be targeted through income taxes and, as the negative effects of a carbon tax are concentrated in the lower income groups, social welfare payments. This is essential for the political acceptability of a carbon tax. The previous attempt to introduce such a tax in Ireland was abandoned (in 2004) at least partly due to distributional concerns."

The authors argued that:

"In absolute terms, a carbon tax of EUR20/tCO2 would cost the poorest households less than EUR3/week and the richest households more than EUR4/week. A carbon tax is regressive, therefore. However, if the tax revenue is used to increase social benefits and tax credits, households across the income distribution can be made better off without exhausting the total carbon tax revenue."

And concluded:

"The impact of a carbon tax of €20/tCO2 is small compared to pre-existing taxes and benefits. A modest increase in welfare payments would offset the negative impacts of a carbon tax in the lower half of the income distribution. It is important that benefits for dependent children of welfare recipients are increased too."

"People in the top half of the income distribution can be compensated by a small increase in the tax credit or a small decrease in the base rate of the income tax. Higher tax credits are slightly progressive, while lower tax rates are slightly regressive. These compensation schemes use between 65% and 80% of the expected revenue of the carbon tax. Therefore, in a country like Ireland, distributional concerns need not deter the introduction of a carbon tax."

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