Green tax reform for a just climate transition (GRETA)

The European Unions ambitious climate policies will have wide-ranging distributional impacts in societies.

Yet, it is poorly understood how to mitigate the adverse impacts and how compensation mechanisms can be designed to allocate funds to those most in need.

GRETA introduces an integrated approach for climate policies and inequality, and will increase our understanding on how to reach climate targets equitably.

In the theoretical part, we characterize a green tax reform that creates sufficient incentives to cut emissions, generates public revenue for the green transition, and ensures that costs are fairly distributed across the society. Individuals hold private information about their productivity and abatement costs.

In this setting, income taxation and carbon pricing are not separable and, strikingly, effective carbon prices should vary by income-level.

The theory shows that the optimal tax design depends on a limited set of sufficient statistics, including: (1) carbon price incidence per income group, (2) emission semi-elasticity per income group and (3) individuals perception of within- and across-income inequality.In the empirical part, we quantify these sufficient statistics (1)-(3) using price variation created by the Energy Crisis of 2022 and a rich administrative data covering all Finnish firms and individuals.

First, we estimate the within- and across-income inequalities created by the sudden rise in electricity prices and, using plausibly exogenous ending dates of fixed-term contract, estimate the individual-level emission semi-elasticities.

Second, we study how the energy price spikes contribute to inequality though their different impacts on firm owners and workers, where our identification is based on a shift-share instrument approach. Third, we study the fairness perception by a large-scale survey where responses are linked to the administrative data.

These empirical findings allow us to quantify the optimal tax design numerically.