Understanding the Inequality and Welfare Impacts of Carbon Tax Policies

2024-17 | May 30, 2024

This paper develops a general equilibrium lifecycle model to explore the welfare and inequality implications of different ways to return carbon tax revenue back to households. We find that the welfare maximizing rebate uses two thirds of carbon-tax revenue to reduce the distortionary tax on capital income while using the remaining one third to increase the progressivity of the labor-income tax. This recycling approach attains higher welfare and more equality than the lump-sum rebate approach preferred by policymakers as well as the approach originally prescribed by economists __ which called exclusively for reductions in distortionary taxes.

Suggested citation:

Fried, Stephie, Kevin Novan, and William B. Peterman. 2024. “Understanding the Inequality and Welfare Impacts of Carbon Tax Policies.” Federal Reserve Bank of San Francisco Working Paper 2024-17. https://doi.org/10.24148/wp2024-17

About the Authors
Stephie Fried is a senior economist in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Stephie Fried
Kevin Novan, University of California, Davis
William B. Peterman, Federal Reserve Board of Governors