Optimal Climate and Fiscal Policy in an OLG economy

Produced by: 
Pontificia Universidad Javeriana
Available from: 
June 2021
Paper author(s): 
Richard Jaimes
Topic: 
Environmental Economics
Fiscal Policy - Public and Welfare Economics
Year: 
2021

This paper develops a climate–economy model to study the joint design of optimal climate and fiscal policies in economies with overlapping generations. I demonstrate how capital taxation, if optimal, drives a wedge between the market costs of carbon (the net present value of marginal damages using the market interest rate) and the Pigouvian tax (the net present value of marginal damages using the consumption discount rate of successive overlapping generations). In contrast to deterministic infinitely-lived representative agent models, at the optimum, the capital income tax is positive, the carbon price equals the market costs of carbon but it falls short of the Pigouvian tax when (i) preferences are not separable over consumption and leisure; and (ii) labor income taxes cannot be age-dependent. I also show that restrictions on climate change policy provide a novel rationale for positive capital income taxes.

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