Ottmar Edenhofer, is Deputy Director and Chief Economist at the Potsdam Institute for Climate Impact Research (PIK), Professor of the Economics of Climate Change of the Technical University Berlin and Co-Chair of Working Group III of the Intergovernmental Panel on Climate Change (IPCC). Moreover, he is director of the Mercator Research Institute on Global Commons and Climate Change (MCC).
Empirical evidence shows that low-income households spend a high share of their income on carbon-intensive goods. This motivates a concern that carbon taxation could have strong regressive effects.
According to these empirical findings we explicitly model a subsistence level of carbon-intensive consumption in a general equilibrium model. We show that the direct incidence of carbon taxation is indeed regressive.
We then proceed within a Mirrleesian framework to identify the optimal recycling of the carbon revenue, taking into account distributional aspects.
The regressive effect of carbon taxes can be mitigated by a more progressive income tax reform, financed by the carbon tax revenue. When the level of inequality is sub-optimal, this income tax reform does not just offset the regressive effect of carbon taxation, it reduces inequality even below the sub-optimal level. We call this effect the double dividend of redistribution. It turns out that carbon taxes are higher in societies which are able to reduce the sub-optimal levels of inequality.