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Does idiosyncratic risk matter for climate policy?

Published online by Cambridge University Press:  02 November 2022

Richard Jaimes Open the ORCID record for Richard Jaimes [Opens in a new window]
Richard Jaimes*
Affiliation:
Department of Economics, Pontificia Universidad Javeriana, Carrera 7 # 40 - 36, Bogotá, Colombia
*
*Corresponding author. E-mail: jaimes_rv@javeriana.edu.co
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Abstract

This paper studies the implications of distortions in intertemporal margins for the conduct of climate policy. We do so by introducing a framework that combines a standard two-period overlapping generations (OLG) model with a tractable model of household heterogeneity, in which over-accumulation of capital arises from uninsurable idiosyncratic labor income risk. We illustrate that market-based climate policies must be adjusted when the government cannot provide full insurance to households by taxing only capital and is constrained to transfer resources across generations for risk-sharing. In a numerical exercise, we find that idiosyncratic risk leads to an optimal capital income tax rate of 35 per cent and a carbon price 7.5 per cent lower than its first best.

Keywords

externalitiesenvironmental policiesfiscal policyoptimal taxation

JEL classification

E62: Fiscal Policy Q58: Government Policy H21: Efficiency • Optimal Taxation H23: Externalities • Redistributive Effects • Environmental Taxes and Subsidies
Type
Research Article
Information
Environment and Development Economics , Volume 28 , Issue 4 , August 2023 , pp. 353 - 367
Copyright
Copyright © The Author(s), 2022. Published by Cambridge University Press

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