Carbon Pricing and Household Burdens in Newly Affluent Countries – an Application to Lithuania

We assess household burdens from a carbon tax with revenue recycling, comparing them to burdens from price changes during the recent cost-of-living crisis. We focus on Lithuania, an OECD country that attained high-income status a decade ago, and that recently enacted a €60/ton CO2 carbon tax despite a challenging policy context, with high poverty rates and concerns about the affordability of energy. Households spend large parts of their budget on energy, but the impact of the carbon tax on overall cost of living is modest (3% on average), substantially smaller than the impact of inflation between 2021-24 (36%). Direct carbon-tax burdens, from higher fuel prices, fall disproportionately on lower-income households. But indirect effects, from higher prices of goods other than fuel, are sizeable and broadly “flat” across the income distribution, which dampens regressivity. We simulate seven different options for compensating households by recycling carbon-tax revenues back to them through transfers or by lowering other taxes. When carefully designed, revenue recycling allows considerable scope for cushioning burdens, and for addressing concerns about disproportionate costs for some groups of households and voters.