Are environmental taxes a free lunch? Issues in modelling the macroeconomic effects of carbon taxes

Applied analysis of output and employment effects from revenue neutral environmental taxation depends critically on how the supply side of the economy is modelled. Despite the long history of theoretical and computable general equilibrium, supply-side models, the empirical basis of much of this work has been quite weak until recently. However, most econometric attempts to capture factor substitution effects have not been based on theoretically consistent structures. This paper examines the methodological issues that underlie these problems and compares the results of imposing environmental taxes in two different econometric modelling structures. The implications of theories of endogenous technical progress on the simulation properties of such models are discussed, and a simple empirically based model that embodies some of these features is presented.