As greenhouse gas (GHG) emissions reach alarming levels, countries face increasing pressure to adopt more aggressive environmental policies. However, concerns regarding their economic effects and their impacts on different groups of people (distributional effects) can hinder their adoption. Reducing emissions, after all, means reallocating resources away from high-carbon sectors towards low-carbon ones, with inevitable consequences for certain sectors of the economy and society.
The turmoil around the French government’s attempts to raise taxes on diesel and petrol in 2018 to speed the transition to a green economy and the daily street demonstrations against them, known as the gilet jaunes (yellow vest) protests, is but one example of this tension. Another can be found in the United States, with the Trump administration dropping out of the climate Paris Agreement Accord only for the Biden administration to later re-join.
A Cross-Country Comparison of Carbon Taxes and Their Impacts
The question then is exactly how a carbon tax affects an economy and its associated workers. We decided to find out by doing a comparative study examining their potential impact on the United States, China and Brazil. Our conclusion is that while some workers in dirty energy sectors could be affected, carbon taxes would inflict little economic disruption overall.
Using a macroeconomic model, we estimate the carbon tax needed for the United States to achieve its original Paris Agreement pledge, or National Determined Contribution (NDCs), of a 26% reduction in emissions below 2005 levels by 2025. This, we find, would amount to an approximately 64% tax rate on the production of dirty energy and would cost the country at most a 0.8% drop in yearly GDP.
We also applied the same climate target to China and Brazil to capture cross-country differences, or heterogeneity, in the economic effect. China witnesses the largest economic loss, of up to 3.7%, because of the influence of dirty energy production in the Chinese economy, rather than its different level of development. Brazil, another emerging economy, suffers a loss comparable to that of the United States at 0.5%.
Differences on Sectors and Workers
Underneath these aggregate effects of carbon taxation lie sizable differences at the sectoral and individual levels. Dirty energy sectors directly exposed to the carbon tax (like oil or coal) witness the largest drop in production, and consequently the largest decline in the number of workers. Relatively lower skilled workers in dirty energy production and energy-intensive sectors in our model choose to relocate away to other kinds of work. By contrast, workers with a stronger comparative advantage in those sectors would tend to remain and bear the cost of the drop in wages.
Nonetheless, the welfare loss for this group in the US would be at least six times higher than for workers in non-dirty sectors, and 1.8 times that of workers who manage to relocate away from dirty energy sectors. These workers, however, make up only 2% of the US labor force. By contrast, workers in the green energy sector benefit from the carbon tax.
A Goal Worth Pursuing
Countries, in short, can use carbon taxes to achieve their climate mitigation goals with little economic turmoil, and the total negative effect on GDP would generally be small. Given the importance of curbing the emission of GHGs, it is a goal worth pursuing, with one important caveat. Workers in dirty energy sectors stand to lose out. Although constituting a relatively small fraction of the labor force, these employees need a safety net, and policymakers should anticipate it and make the appropriate policy adjustments. Finally, the effects from carbon taxation can vary considerably across countries. For this reason, governments should seek specialized analysis that considers their country’s specific circumstances.