Efficiency–equity trade-off in the Irish carbon tax: A CGE investigation of mixed revenue recycling schemes

Highlights

• We developed a multi-sectoral multi-household intertemporal CGE model.
   
• We analysed the Irish carbon tax with several revenue recycling (RR) schemes.
   
• Lowering a distortionary tax can increase GDP.
   
• Increasing household transfers can decrease inequality.
   
• Mixing RR can increase GDP and reduce inequality.
   

Abstract

The literature shows that earmarking carbon tax revenues to reduce other distortionary taxes can mitigate the tax’s adverse economic implications, whereas transferring revenues directly to households can reduce the tax’s negative equity implications. This paper employs a dynamic applied general equilibrium model to examine the inherent efficiency–equity trade-off in Irish carbon tax revenue recycling (RR). We analyse pure RR schemes, where total carbon tax revenues are allocated either to increased household transfers or to tax rate reductions and mixed schemes, which combine these two. The findings show that all tax reduction RR options can reduce emissions while increasing gross domestic product and welfare (creating a double dividend), but they also increase inequality. However, when sales tax reductions are combined with household transfers, increased efficiency and equity can be found, resulting in a triple dividend. This paper contributes to the literature by directly investigating the efficiency–equity trade-offs in detailed mixed RR schemes. From a policy perspective, we conclude that mixed RR options generate better outcomes as the government can directly balance efficiency and equity outcomes.