Carbon pricing versus environmental tax incentives: is it “or” or “and”?

Abstract

The Paris agreement and the European Green Deal set out ambitious goals for the climate transition and the related decarbonisation. Achieving those goals will require radical technological and behavioral changes in a short term horizon having in mind the intermediate goal for 2030. Climate change and environmental issues are dominated by externalities. On the one hand, external cost of pollution have to be charged on economic agents that are responsible for it to induce the required behavioral changes. On other hand, technological changes will only arise from research and development and the policy should also take into account the positive externalities they create and reward accordingly firms engaging in R&D. Governments may use various instruments, among them tax incentives and environmental taxes and we look for complementarity. The former rewards good practices, including positive externalities, while the latter is the best option to deal with negative externalities. While they seem to work in opposite directions, they may reinforce each other. In this paper, we discuss the corresponding policy choices, with special attention to environmental incentives. As any tax expenditure, they raise a number of concern regarding their effectiveness, distributive issues and budget management. In addition to that, environmental tax incentives raise a number of specific issues. The discussion of those issues is complemented by a brief survey of the available empirical evidence on incentives in housing, transport and industry.