Gathering support for carbon taxation by combining transfers with lower income taxes

In the coming years, major reductions to carbon emissions are going to be required to meet Irish and European objectives on climate action. A key part of this strategy will be the use of carbon taxes, which increase the price of carbon-intensive commodities. However, this can be unpopular and lead to many households being “worse off” in an economic sense, in particular poorer households who spend a larger share of their budget on energy and other emissions intensive products. To offset this, in Ireland, a portion of carbon tax revenues is used to finance transfers. Existing literature suggests that recycling all revenues from the carbon tax as a visible and transparent lump-sum transfer can generate enough political support to make green tax reform politically acceptable. However, we demonstrate that this argument does not hold for Germany. We show that a mix of lump-sum transfers with a lower income tax can benefit a larger number of households. We assume that those that benefit financially will provide political support for the reform.