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This paper examines how the general equilibrium incidence of an environmental tax depends on the effect of different incomes and preferences of heterogeneous households on aggregate outcomes. We develop a Harberger-type model with general forms of preferences and substitution between capital, labor, and pollution in production that captures the impact of household heterogeneity and interactions with production characteristics on the general equilibrium. We theoretically show that failing to incorporate household heterogeneity can qualitatively affect incidence. We quantitatively illustrate that this aggregation bias can be important for assessing the incidence of a carbon tax, mainly by affecting the returns to factors of production. Our findings are robust to a number of extensions including alternative revenue recycling schemes, preexisting taxes, non-separable utility in pollution, labor-leisure choice, and multiple commodities.

This paper examines pollution tax differentiation across industries in light of social equity concerns using theoretical and numerical general equilibrium analyses in an optimal tax framework. We characterize the drivers for non-uniform optimal taxes emanating from the interaction of household heterogeneity with social preferences. Quantitatively assessing the case of price-based CO2 emissions control in the U.S. economy, we find that optimal carbon taxes differ largely across industries, even when social inequality aversion is low. Our results are robust with respect to the stringency of the environmental target, non-optimal redistribution schemes, and parametric uncertainty in firms’ and households’ equilibrium tax responses.

This paper examines the effects of knowledge diffusion on growth and costs of climate policy. We develop a general equilibrium model with endogenous growth which represents knowledge diffusion between sectors and regions. Knowledge diffusion depends on accessibility and absorptive capacity which we estimate econometrically using patent and citation data. Knowledge diffusion leads to a “greening” of economies boosting productivity of “clean” carbon-extensive sectors. Knowledge diffusion lowers the costs of global climate policy by about 90% for emerging countries (China) and 20% for developed regions (Europe and USA), depending on the substitutability between different knowledge types.

Firms subject to cost-of-service regulation cannot withhold windfall profits associated with free emissions allowances. This paper examines the efficiency and distributional impacts of two approaches to transfer free allowances to consumers: output subsidies and lump-sum payments. We employ an empirically calibrated model of the U.S. economy that features regulated monopolies in the electricity sector and many heterogeneous households. Under a carbon dioxide cap-and-trade policy, we find that using free allowances to subsidize regulated electricity prices increases aggregate welfare costs by 40-80 percent relative to lump-sum transfers. These inefficiencies are disproportionately borne by households in the tails of the income distribution., Economics Working Paper Series, 13/178

Economics Working Paper Series, 16/229