An assessment of carbon taxation policies: The case of Denmark

This study provides an assessment of different carbon taxation strategies, focusing on the impacts of consumption-based and production-based carbon tax policies. We use an empirical Ecological Stock-Flow Consistent Input-Output (E-SFC-IO) model for the Danish economy, which connects both the financial and real sides of the economy with an ecological sector. Our findings suggest that a production-based tax policy in itself is more effective in achieving a lower environmental sacrifice ratio – defined as the loss of income per unit of emission reduction - even when carbon leakage effects are accounted for. However, this approach significantly worsens the current account balance, resulting in a decline in the net financial wealth of the economy. In contrast, a consumption-based tax leads to a higher environmental sacrifice ratio in the long run but creates fiscal space for increased public spending on green initiatives. Our assessment suggests that, under the assumption of long-run fiscal neutrality condition – where revenue from a consumption-based tax is recycled through subsidies for low-carbon consumption - the resulting environmental sacrifice ratio is lower than that of a production-based tax, even when a Carbon-Border-Adjustment-Mechanism (CBAM) is in place. A key limitation of this setup, however, is that it results in only a modest reduction in CO2-equivelant emissions. These findings provide important insights for policymakers aiming to design effective climate policies that balance environmental and economic objectives.