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 emissions with a taxation scheme that taxes greenhouse gas 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 greenhouse gas tax rates applied are identical and new revenues are in both cases recycled via lower social security contributions of employers. The article shows 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 greenhouse gas emissions. Both taxation schemes are also regressive for household incomes emphasising the importance of the choice of revenue recycling. In terms of emission reduction, we find the taxation of emissions embodied in consumption less effective.