- 6 October 2020
- WORKING PAPER SERIES - No. 2477Details
- Climate change is one of the greatest economic challenges of our time. Given the scale of the problem, the question of whether a carbon tax should be introduced is hotly-debated in policy circles. This paper studies the design of a carbon tax when environmental factors, such as air carbon-dioxide emissions (CO2), directly affect agents’ marginal utility of consumption. Our first result is that the optimal tax is determined by the shadow price of CO2 emissions. We then use asset-pricing theory to estimate this implicit price in the data and find that the optimal tax is pro-cyclical. It is therefore optimal to use the carbon tax to “cool down” the economy during booms and stimulate it in recessions. The optimal policy not only generates large welfare gains, it also reduces risk premiums and raises the average risk-free real rate. The effect of the tax on asset prices and welfare critically depends on the emission-abatement technology.
- JEL Code
- Q58 : Agricultural and Natural Resource Economics, Environmental and Ecological Economics→Environmental Economics→Government Policy
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
E32 : Macroeconomics and Monetary Economics→Prices, Business Fluctuations, and Cycles→Business Fluctuations, Cycles