Four Questions About the Distributional Effects of Climate Policy

Addressing the distributional effects of climate policy is one of the key challenges for securing a just and successful transition to carbon neutrality. Leaning on a large body of research, this paper answers four questions pertinent to understanding and counteracting the distributional effects of climate policy: 1) Why are the distributional effects of climate policy important? 2) Why do they arise? 3) What compensatory mechanisms and tools exist? 4) Which compensatory tools should be used? Our focus is on national, intragenerational distributional effects and policy. We demonstrate that, while previous research has primarily examined the distributional effects of carbon pricing, the transition to carbon neutrality, which we refer to as the “climate transition,” generates numerous other distributional effects that are largely understudied. We further highlight that what makes the climate transition different from other technological transitions is that it affects households’ costs, e.g., via carbon pricing, rather than households’ income through, e.g., job loss. This implies that welfare systems in most countries, which are geared towards handling income shocks, are not well-equipped to handle the distributional effects of climate policy. Our mapping reveals, at least tentatively, that those households and individuals who bear the highest relative costs of climate policy (rural, low-income households) are also those who reap less of its material and health benefits and care the least about mitigating global climate damage for intergenerational sustainability. This observation, along with welfare systems that fail to adjust to cost shocks, may rationalize the political backlash. We conceptually posit three desirable characteristics for compensatory measures: they should be efficient, precisely targeted, and visible. We evaluate the policy toolkit based on these characteristics and illustrate how achieving them may be mutually exclusive. While there exist potent and common tools to compensate low-income households, e.g., progressive income taxes, the tools for compensating for the geographical distributional effects are scarce and may imply inefficiencies. In summary, our review identifies several gaps in the current scientific literature and provides a mapping of available policies to help policymakers decide on when and why to use different measures.