The drawbacks and opportunities of carbon charges in metropolitan areas -- A spatial general equilibrium approach

In cities there is a variety of economic and spatial forces that may influence to what extent a travel-related CO2 emission pricing can be an effective instrument to contribute to the achievement of CO2 reduction goals. Therefore, we examine the effectiveness and impact of CO2 emission charges using a spatial general equilibrium model of an urban economy, calibrated according to an average German city. Our analyses suggest that the imposition of a Pigouvian type CO2 emission charge on urban passenger travel may be able to reduce emissions by about 1%-11%, depending on the estimated social damage cost of carbon dioxide. Such a policy increases urban welfare mainly on account of a reduction of congestion costs. However, pricing congestion directly not only provides higher urban welfare but also higher emission reductions. Pricing congestion and CO2 emissions simultaneously allows to achieve a wide range of emission reduction goals. If, however, the reduction goal is very ambitious the emission charge must be raised to higher levels. Then, distortions in the urban markets and in spatial travel decisions lower labor supply and thus urban production, income of city residents, federal tax revenue, income of landowners outside the city, all together implying losses in welfare.