Using energy and emissions taxation to finance labor tax reductions in a multi-sector economy

Abstract

In this paper, we introduce an environmental multi-sector dynamic general equilibrium model to analyze the effects of financing a labor tax reduction through higher consumption, energy or emissions taxation. Employing a closed-economy framework calibrated for the EU-27 plus the UK, we find that, for sufficiently high environmental damage, using taxes on brown energy consumption or output-based emissions taxes as financing instrument eventually outperforms the application of consumption taxes due to a positive productivity-like shock. However, it takes time for the positive effects to materialize. Manufacturing, transportation and brown energy production sectors tend to lose (or gain only marginally) while administration, services and research sectors tend to benefit from the introduction of an environmental taxation as a financing instrument. As demand moves towards sectors less affected by the tax shift, the aggregate economic effects differ in the multi-sector economy compared to a conventional one-sector economy.