Green fiscal policies to reduce the environmental impact of consumption through a non-regressive carbon tax

Abstract

Environmental tax reform is at the forefront of policy discussions. Of particular concern is the distributional impact, as such taxes are often found to be regressive. Using granular data on Value Added Tax (VAT) rates, we employ a microsimulation model to quantify the effects of an environmental tax reform proposal in the case of Ireland. The so-called ‘Green Value Added Tax (GVAT)’ imposes a carbon tax on heavily polluting commodities and reduces the VAT rate on others. The results show that the reform raises VAT revenue by more than 2% and reduces the environmental impact of consumption by 1% in a non-regressive manner. Therefore, a GVAT may be an alternative to a revenue recycling mechanism to mitigate potential undesirable distributional effects of carbon taxation. We also estimated the results of a progressive income tax and found that this creates more inequalities within income levels than the GVAT.