Carbon taxes, complementary policies and the labor market

Glasgow Climate Pact reaffirmed efforts to limit global warming to 1.5°C above pre-industrial levels, recognizing countries’ commitment to reduce global carbon dioxide emissions by 45 percent by 2030 from 2010 levels. But meaningful action to combat climate change in the next few years will be hampered as the coronavirus pandemic has left many countries with high unemployment and deteriorating fiscal space.. After a sharp deterioration in employment and national income in 2020, the average employment rate remained at about 4.7 percent below pre-pandemic levels. Millions of people, especially in low- and lower-middle-income countries, are out of work, so poverty and inequality have risen. Growing budget deficits are forcing governments to think seriously about how to fund spending and whether and where to spend more. There is always a hidden fear that aggressive climate action will lead to further job losses, and their economic costs could hurt the living standards of low-income households.

Not all doom and gloom

But recent evidence suggests that the situation is not so dire. One of the few policy proposals to gain support in Glasgow was “the phasing out of inefficient fossil fuel subsidies”. $5.9 trillion or 6.8 percent of GDP in 2020. Instead of harming the poor, it is better to replace these negative prices with fuel taxes. likely to be progressive-impartiality-increase. Why? Since carbon-intensive industries tend to be very capital-intensive, and setting the right prices will lower the demand for capital relative to labor, resulting in not only lower returns on capital relative to wages, but also an increase in economy-wide demand for labor (cm. Gulder et al. 2018, Markandya and others 2016).

Because carbon-intensive industries tend to be very capital-intensive, and setting the right prices will reduce the demand for capital relative to labor, resulting in not only lower returns on capital relative to wages, but also an increase in economy-wide demand for labor .

A recent study comparing employment multipliers of environmental taxes and personal income taxes in a group of 75 countries found the employment impact of environmental tax reforms. Another study done Metcalfe & Stock (2020) estimated the dynamic impact of carbon taxes on employment for a group of 31 European countries and found them to be small and insignificant.

An in-depth study of a dozen countries in Central and Eastern Europe confirms these findings in the wider literature.. After an increase in income tax revenue of 1 percent of GDP, aggregate employment declines slightly, by 0.1 percent within one year and by 0.8 percent within two years. Environmental taxes do not have a significant deterrent effect on employment. But a 1 percent increase in GDP is expected to increase employment by 0.2 percent within one year and by 1 percent over four years (Figure 1). Therefore, raising environmental taxes and using income to lower income tax should be expected to increase employment.

Figure 1. Modeling the impact of personal and environmental taxes on employmentModeling the impact of personal and environmental taxes on employmentFigure 1. Cumulative annual percentage response of employment to a permanent 1 percent increase in relevant tax revenues for Central and Eastern European countries: personal income tax (left panel) and environmental taxes (right panel). Dark (light) shaded areas represent 70 percent (90 percent) confidence intervals. Source: WBG staff/ EU regular economic report.

All multipliers are not equal

How can this increase in employment be explained? The size of employment multipliers for environmental or carbon taxes depends on two characteristics: how easily a country’s energy and manufacturing sectors can reduce their carbon intensity, and how higher energy prices affect labor demand. The more flexible the structure of production, the easier it is for firms to replace energy-intensive production methods with more labor-intensive ones, the stronger the demand for workers grows. On the contrary, the income tax directly affects aggregate demand, indirectly increases the cost of labor and reduces the share of labor in production. Therefore, empirical analysis shows that employment multipliers tend to be negative for income taxes but positive for carbon taxes.

A proper tax structure, based on prior policy analysis, can lead to sectoral employment effects that improve equity, especially when combined with social or labor market policies that reduce sectoral and spatial frictions. One important lesson documented in the literature is that jobs tend to be redistributed rather than lost entirely, depending in large part on policy development (e.g. Hille and Möbius 2019, Marin and Vaughn 2019). Recent EU regular economic report shows that across the economy, A carbon tax and subsidy reform, where revenues are channeled to tax cuts on low-skilled workers, could combine to create small but economy-wide jobs with demand for below– employees disproportionately increase (see Fig. 2A, distribution by wage deciles). The underlying sectoral heterogeneity is high, with mining jobs the hardest hit and the electricity and services sectors seeing job growth (see Chart 2B). Empirical Analysis confirm this finding of induced job creation in local service enterprises, but losses in larger, more energy-intensive manufacturing firms.

Figure 2. Greening Bulgaria through carbon taxes coupled with tax cuts on low-skilled laborFigure 2. Greening Bulgaria through carbon taxes coupled with tax cuts on low-skilled laborFigure 2. Changes in labor demand driven by an economy-wide carbon tax when lowering the tax on low-skilled labor. Left: A). by regions and wage deciles; right: B) by sectors. Source: WBG staff/EU regular economic report based on the multi-regional input-output model (MRIO) with price-endogenous technology.

Additional measures needed – domestically and internationally

Accompanying occupational analysis shows that while many skills can be transferred to others, active labor market support such as retraining and skills development programs can help facilitate the reallocation of workers across industries and avoid an increase in (pre-existing) skill mismatches and shortages. Social protection measures can support regions experiencing concentrated job losses.

In times of economic recovery, carbon taxes can be less of a dampening effect on the economy, providing an effective means of expanding fiscal space while stimulating low-carbon structural change.

In times of economic recovery, carbon taxes can be less of a dampening effect on the economy, providing an effective means of expanding fiscal space while stimulating low-carbon structural change. Taken together, carbon tax reforms can have net positive employment multipliers. But the underlying sectoral heterogeneity can be significant and will depend on policy development, economic fabric countries, integration into global value chains and the climate ambitions of trading partners. While net job creation inherently benefits those low-income strata that have been more likely to lose your job During the coronavirus pandemic, sectoral redistribution will entail different distributional and equity effects in terms of income groups, skill levels and occupations, as well as in spatial relation between provinces and countries. Targeted social and labor market interventions can facilitate and simplify redistribution between occupations or regions and reduce frictional costs.