Consumption and production-based CO2 pricing policies: macroeconomic trade-offs and carbon leakage

This paper applies a DYNK (Dynamic New Keynesian) model to compare the traditional environmental tax reform for greenhouse gas (GHG) emissions with a taxation scheme that taxes GHG emissions embodied in consumption within the framework of a unilateral policy of the EU-27. The embodied emissions of different commodities are taxed independently of their origin. The GHG tax rates applied are identical and new revenues are in both cases recycled via lower social security contributions of employers. The results show the macroeconomic results, driven by the different impact of the taxation schemes on price competitiveness of EU-27 firms. These differences drive the leakage and show negative leakage in the case of taxing embodied GHG emissions. Both taxation schemes are also regressive for household incomes emphasizing the importance of the choice of revenue recycling. In terms of emission reduction, we find the taxation of emissions embodied in consumption less effective.