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Carbon Taxes - Their Macroeconomic Effects and Prospects for Global Adoption - A Survey of the Literature

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Javier Cuervo
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Many industrial countries have agreed to binding reductions of greenhouse gases under the Kyoto Protocol. A carbon tax is one of the most efficient instruments available to achieve this objective. While such a tax could generate substantial revenue, it could also reduce the rate of economic growth, worsen the distribution of income, and erode the competitiveness of a country.s exports. This paper reviews the literature for empirical evidence on the seriousness of the carbon tax's macroeconomic impacts. The effect of a carbon tax on economic growth depends on the choice of model, the assumptions underlying the model, and the use to which carbon tax revenues are put. When the model contained .optimistic. assumptions, such as a strong response of economic agents to the tax, ready availability of cheap alternative fuels and technologies, and efficient recycling of available revenues, the tax was shown to have little to no negative effect on growth. Most studies show the distributional impact of a carbon tax to be generally regressive but its degree varies by country, by type of model used, and by how the tax burden is measured. The studies establish that the regressivity of the tax can be greatly offset by proper mitigation, such as exemption or relief, or by compensatory measures, such as wage subsidies or earned income tax relief. The effect of carbon taxes on exports could be substantial, but studies show that increased costs of production can be offset by reductions of payroll and income taxes that carbon tax revenues could make possible. An international agreement to adopt carbon taxes in a coordinated fashion would greatly reduce the fears of a loss of export competitiveness. If the Kyoto Protocol on global warming is ever implemented, carbon taxes could be central to the development of an efficient policy mix. [author]