The employment double dividend of environmental tax reforms: exploring the role of agent behaviour and social interaction

ABSTRACT

It has been long debated whether environmental tax reform (ETR), i.e. a revenue-neutral shift of the tax burden from labour to carbon emissions, can have a double dividend, in terms of climate and economic goals. So far this question has been addressed in public finance and environmental economics using models with rational and representative agents. Here we examine the relevance of deviating from these standard behavioural assumptions. Our motivation is that research from other fields indicates that impacts of both environmental and income taxation on households are sensitive to behavioural biases, such as habits, imitation or status seeking. A related feature is that consumers and firms are heterogeneous with respect to many characteristics, some of which are crucial for the distributional effects of a tax reform. We combine insights from social psychology and behavioural, evolutionary and labour economics to identify behavioural cases in which the impacts of an ETR is likely to differ significantly from those in the traditional framework. Our findings show that households’ time use patterns and the distinction between extensive and intensive labour supply are relevant and deserve more attention.

KEYWORDS:

• Bounded rationality
• carbon tax
• climate policy
• heterogeneity

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 For a more general discussion of Pigouvian taxation in second-best economies see for instance Bovenberg and Goulder (2001).

2 The numbers in parentheses in this subsection all refer to arrows in Figure 1, e.g. (1) refers to arrow 1.

3 It should be pointed out that the evidence is limited: only five simulations in Freire-González (2018) include a consumer price index.

4 Energy services include air travel, electricity, gasoline, heating fuel and natural gas.

5 Indirect emissions are those not directly emitted by the household, but embodied in consumption of food, recreation or personal care, for instance.

6 Some studies of time use show that time spent on reading is declining, while household spend more time on sports and outdoor activities (see e.g. Jalas and Juntunen 2015). The material and emission intensity of these activities is highlighted for instance by Aall et al. (2011) in a study for Norway.

7 See Lipsey and Lancaster (1956) for the basic idea of the theory of second-best and Diamond and Mirrlees (1971a, 1971b) for a first comprehensive application of it to optimal income taxation.

8 These countries are France, Germany, Italy, Japan, Spain the United Kingdom and the United States.

9 Table 2 also includes different strategies for hiring low versus high-skilled labour. We only pay limited attention to these demand variations here, because we have no reliable information of strategy structures with respect to this point.

Additional information

Funding

This study was funded by an ERC Advanced Grant from the European Research Council (ERC) under the European Union’s Horizon 2020 research and innovation programme [grant agreement number 741087].