Finance and Economics Discussion Series (FEDS)
Recycling Carbon Tax Revenue to Maximize Welfare
Stephie Fried, Kevin Novan, William B. Peterman
This paper explores how to recycle carbon tax revenue back to households to maximize welfare. Using a general equilibrium lifecycle model calibrated to reflect the heterogeneity in the U.S. economy, we find the optimal policy uses two thirds of carbon-tax revenue to reduce the distortionary tax on capital income while the remaining one third is used to increase the progressivity of the labor-income tax. The optimal policy attains higher welfare and more equality than the lump-sum rebate approach preferred by policymakers as well as the approach originally prescribed by economists--which called exclusively for reductions in distortionary taxes.
Keywords: Carbon tax; overlapping generations; revenue recycling
PDF: Full Paper
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