One of the biggest challenges of our time is how to combat the ever-increasing threat of climate change. Policy makers around the world are dealing with the issue on a daily basis and there is always a lot of discussion around the effectiveness of the different policies. The introduction of a carbon tax, which belongs to the category of carbon pricing policies, is certainly one of the most cited ways to efficiently address CO2 emissions in a given economy. Yet, there is also increased concern about both the efficiency and equity of such a tax. The question thus remains: Can a carbon tax help solving a social issue without creating another one?
It is argued that one of the main concerns about a carbon tax is that, like other consumption taxes, it is a regressive tax and therefore affects people with low incomes more severely than people with high incomes. As a response, academics have argued that when a certain percentage of the carbon tax revenue will be spend on society’s poorest, e.g. by increasing social safety net programs, then those households would, in fact, not be worse off with such a tax. This shows that, to be able to effectively assess the impact of such a tax, one will need to carefully consider both the expenditure as well as the revenue side of the tax because only that can deliver a holistic picture.
Besides looking at these two sides of a tax, it is also important to understand the impact on different stakeholders. Research has shown that households are affected differently given their demographic characteristics and that this extends beyond the income level. It also differs depending on whether the household members take on the role of, for example, a consumer, a worker, or a business owner. While the direct price of a consumption tax places the largest burden on low-income households, as explained above, other types of households can also be heavily affected when, for instance, a worker’s income is decreased because his employer needs to pay more taxes and cannot afford to pay the same salary any longer. As a result, one should be aware that a tax can have both direct and indirect impacts. This applies, however, equally to the benefits of a tax. It has been argued, for example, that a carbon tax can also yield employment creation due to the development of a new economic sector.
What we can learn from this is that the effects of a carbon tax are multifaceted, but that environmental tax reforms and social progress are not necessarily contradicting factors. If short run negative impacts can be neutralized, the long run impact of carbon taxes is more often than not a positive one for society as a whole.