Environmental tax shocks and carbon emissions: An estimated DSGE model

Abstract

We develop an energy-environment-economy dynamic stochastic general equilibrium (DSGE) model with five sectors, including households, energy, government, final goods, and the environment. The model is used to assess the response of China's carbon emissions to environmental tax shocks. The core of the model establishes an exponential function of environmental taxes that are mapped against the share of fossil energy in the total energy use. The model parameters are obtained through a combination of calibration and Bayesian estimation. Using the impulse response analysis and variance decomposition, we find that environmental tax shocks can drive the reduction of carbon emissions in China. However, the mitigating effect of the environmental tax shocks can be weakened by some other exogenous shocks, and that China's carbon emissions are likely to grow over a long period of time. Moreover, environmental tax shocks can improve energy structure by promoting the introduction of clean energy which can reduce carbon emissions.