The Environmental and Economic Effects of a New Carbon Tax in Portugal:A Dynamic General Equilibrium Model Assessment

We consider the environmental, economic, and budgetary effects of a new carbon tax indexed to the carbon price in the EU-ETS market in the context of a dynamic general equilibrium model of the Portuguese economy. We show that the careful recycling of the carbon tax revenues to finance reductions in the personal income tax, in the social security taxes and increases in investment tax credits, in particular when these changes are connected to energy efficiency promoting activities, allows for the carbon tax reform to yield three dividends – reduction in emissions, improvement in economic conditions, and improvements in the budgetary position. By doing so we show that it is possible to design a carbon tax reform that is politically feasible as it satisfies the main constraints of the domestic economy – the quest for growth and for fiscal consolidation – and can accommodate the legitimate interests and needs of different social players–the focus on environmental goals by environmental groups, the concerns with households distributional issues by consumer advocacy groups, and with international competitiveness by business groups.