Understanding regressivity: Challenges and opportunities of European carbon pricing

Highlights: • Carbon tax incidence is mostly neutral or progressive for 23 European countries. • Between-countries differences yield carbon taxes regressive at the European level. • Redistribution schemes, either at national or European level, allow achieving progressivity of the tax. • Especially affected households are located mainly in Bulgaria, Poland and Romania. • The results are robust to demand-side responses and alternative specifications. We examine how a European carbon price will affect citizens by studying its incidence on households in 23 countries of the EU. At the national level, the distributional impact before revenue recycling is mainly neutral, sometimes progressive. At an aggregate EU level, however, the impact is regressive because some low-income countries would be strongly affected by the carbon price. While national redistribution can yield a progressive EU incidence, we show that European-wide redistribution is more effective for the most affected households. We offer two indicators to offset regressive distributional effects of EU climate policy, such as the recently proposed Green Deal. The first renders the tax burden proportional; the second focuses on compensating the households most severely affected. Including both indicators in European redistribution makes for a better representation of the initial burden of carbon pricing and could increase public acceptability.