Does It Matter That Carbon Taxes Are Regressive?

• In Event: Beyond Pigou: Evidence on Efficiency, Equity, and Policy Instruments

Abstract

e ask how externalities should be taxed when redistribution is costly. In our model, the government raises revenue using distortionary income and commodity taxes. If more or less productive people have identical tastes for the externality-generating activity, the government optimally imposes a Pigouvian tax equal to the marginal damage from the externality. This is true regardless of whether the tax is regressive. However, if regressivity partly reflects different preferences of people with different incomes, the tax optimally deviates from the Pigouvian benchmark because this helps redistribute income efficiently. The overall tax may be higher or lower, and may even reverse sign relative to the externality. We derive sufficient statistics for optimal policy, and use them to study carbon taxation in the United States. Throughout most of the income distribution, our empirical results imply an optimal carbon tax below marginal damage, but this reverses for very high-earning households. When we allow for heterogeneity in preferences at each income level as well as across the income distribution, our optimal tax schedules are attenuated toward the Pigouvian benchmark.

Authors

• Ashley Craig, Australian National University

• Thomas Lloyd, University of Michigan

• Dylan Moore, dtmoore@hawaii.edu