The regressivity of carbon taxation when green consumption is a luxury and agents are heterogeneous

Carbon taxation is often reported as regressive in the literature, yet the macroeconomic models for its analysis tend to neglect its distributional impact. We aim to fill this gap with a model featuring heterogeneous agents and two sectors. The polluting sector is subject to carbon taxation since it generates CO2 emissions, while the green sector is environmentally neutral due to expenditure on abatement costs. Consumers’ priority is to secure some basic consumption, keeping environmental issues as a secondary concern. Therefore, less affluent households are in a worse position to switch to more expensive green goods. As a consequence, raising carbon taxation will impact these individuals more severely. In this framework, the role played by the government in determining the optimal tax and the use of tax revenues becomes particularly important, as it has to deal with a trade-off between the attainment of environmental goals and the reduction of inequality.