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Optimal Carbon Taxation and Horizontal Equity: A Welfare-Theoretic Approach with Application to German Household Data

Authors
/persons/resource/Martin.Haensel

Hänsel,  Martin C.
Potsdam Institute for Climate Impact Research;

/persons/resource/franks

Franks,  R. Maximilian
Potsdam Institute for Climate Impact Research;

Kalkuhl,  Matthias
External Organizations;

/persons/resource/Ottmar.Edenhofer

Edenhofer,  Ottmar
Potsdam Institute for Climate Impact Research;

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Citation

Hänsel, M. C., Franks, R. M., Kalkuhl, M., Edenhofer, O. (2021): Optimal Carbon Taxation and Horizontal Equity: A Welfare-Theoretic Approach with Application to German Household Data, (CESifo Working Paper ; 8931), Munich : CESifo, 51 p.


Cite as: https://publications.pik-potsdam.de/pubman/item/item_25438
Abstract
We develop a model of optimal carbon taxation and redistribution taking into account horizontal equity concerns by considering heterogeneous energy efficiencies. By deriving first- and second-best rules for policy instruments including carbon taxes, transfers and energy subsidies, we then investigate analytically how horizontal equity is considered in the social welfare maximizing tax structure. We calibrate the model to German household data and a 30 percent emission reduction goal. Our results show that energy-intensive households should receive more redistributive resources than energy-efficient households if and only if social inequality aversion is sufficiently high. We further find that redistribution of carbon tax revenue via household-specific transfers is the first-best policy. Equal per-capita transfers do not suffer from informational problems, but increase mitigation costs by around 15 percent compared to the first-best for unity inequality aversion. Adding renewable energy subsidies or non-linear energy subsidies, reduces mitigation costs further without relying on observability of households’ energy efficiency.