Impacts of a Carbon Tax across US Household Income Groups: What Are the Equity- Efficiency Trade-Offs?

This paper assesses the impacts across US household income groups of carbon taxes of various designs. We consider both the source-side impacts (reflecting how policies affect nominal wage, capital, and transfer incomes) and the use-side impacts (reflecting how policies alter the real prices of goods and services purchased by households). We apply an integrated general equilibrium framework with extended measures of the source- and use-side impacts that add up to the overall welfare impact. Our results indicate that the distributional impacts depend importantly on the nature of revenue recycling and the treatment of transfer income. In the absence of targeted compensation to achieve distributional objectives, the use-side impacts tend to be regressive, while the source-side impacts are progressive. The progressive source-side impacts tend to fully offset the regressive use-side impacts. Both the source- and use-side impacts are considerably larger once one takes into account the more comprehensive welfare measures introduced in this study. The efficiency costs of targeted compensation to achieve distributional objectives depend critically on the recycling method and compensation target. These costs are an order of magnitude higher when the revenues that remain after compensation are used for corporate income tax cuts than when the remaining revenues are used in other ways. Efficiency costs also rise dramatically when targeted compensation extends beyond the lowest income quintiles.