Marginal abatement cost curves and the budgetary impact of CO2 taxation in Portugal

By Alfredo Marvão Pereira and Rui M. Pereira

The objective of this paper is to study CO2 taxation in its dual role as a climate and a fiscal policy instrument. It develops marginal abatement cost curves for CO2 emissions associated with CO2 taxation using a dynamic general equilibrium model of the Portuguese economy which highlights the mechanisms of endogenous growth and includes a detailed modeling of the public sector. It also considers a pair of complementary cost curves corresponding to the impact of CO2 taxes on GDP and on the public budget. Simulation results show that a tax of 17.00 Euros per tCO2 has the technical capacity to limit emissions growth to 62.6 Mt CO2 in 2020, consistent with the existing climate policy target for Portugal. In turn, changes in tax revenues together with reductions in public spending, lead to a decline of 2.7% in the public debt. These desirable outcomes, however, come at the cost of a 0.7% reduction in GDP relative to steady state baseline levels. In general, we find that stricter emission targets imply greater equilibrium CO2 tax levels and larger GDP losses, although these are accompanied by greater reductions in public debt. Finally, the paper highlights the importance of public spending behavior when projecting the net impact of CO2 taxes on public revenue and the public account and in the designing of policies to promote fiscal consolidation.

Dynamic general equilibrium is not only about macroeconomics. It is also very well suited to the study on environmental problems, one because of the dynamics and two because environmental economics is all about effects of one market on another. One could also add that uncertainty can be important. This paper is a very good example of this, as it mixes macroeconomics aspects of taxation and climate policy.

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