Carbon pricing and household burdens in newly affluent countries - An application to Lithuania

Abstract

This paper assesses household burdens from a carbon tax with revenue recycling and compares them to price changes during the recent cost-of-living crisis. The illustration focuses on Lithuania, an OECD country that attained high-income status a decade ago, and that recently enacted a €60/ton CO2 carbon tax despite a challenging policy context, with high poverty rates and major concerns about the affordability of energy and other necessities. Although households spend large shares of their budget on energy, the average impact of the carbon tax on their overall cost of living is comparatively modest. At around 3 % on average, it is substantially smaller than the impact of inflation between 2021 and 2024 (35.8 %). Results confirm that direct burdens from higher fuel prices fall disproportionately on lower-income households. But indirect effects of carbon pricing, from higher prices of goods other than fuel, are sizeable and broadly “flat” across the income distribution, which dampens regressivity. We simulate seven different options for compensating households by recycling carbon-tax revenues back to them through transfers or by lowering other taxes. When carefully designed, revenue recycling allows considerable scope for cushioning burdens, and for addressing concerns about disproportionate costs for some groups of households and voters.