Fiscal Costs of Climate Policies: Role of Tax, Political, and Behavioural Distortions

Here I review the fiscal costs of carbon pricing and climate policies, paying due attention to second-best as well as first-best polies. This starts with a discussion of when the double dividend hypothesis, i.e. when recycling carbon taxes via lower income taxes boosts employment and lowers the marginal cost of public funds. I propose that recycling carbon tax revenue benefits from considering the income on the whole distribution of households, since this allows one to get a better understanding of the political feasibility of carbon tax reforms. Political feasibility also requires intergenerational and international transfers to ensure all generations and countries benefit from carbon tax reform. The politics of carbon tax reform also requires one to take account of business cycle aspects, heightened salience of carbon taxes, and the propensity of policymakers to procrastinate and prefer subsidies to taxes.