Selective Carbon Taxation in Production Networks: Evidence from Mexico

Abstract

Many governments consider carbon taxation as an efficient tool to reduce carbon emissions, but carbon taxation can negatively affect welfare. How can carbon taxation be best introduced? This paper examines the effect of carbon taxation on aggregate emissions and output in the context of input-output linkages. Our contribution is to model carbon taxes as a charge on the emissions of individual energy sources rather than on output or the final consumption good. We introduce the measure of emission centrality and show that it is a key statistic to gauge the effect of a tax on aggregate emissions and output. We also provide a simple methodology that allows to compare at the margin trade-offs between emissions and output for each energy source. We use the introduction of carbon taxation in Mexico in 2014, and use input-output data, to show that the political economy effects that made government eliminate taxation on some energy sources resulted in welfare reductions. Our model suggests that government could have implemented a more optimal carbon taxation than it initially proposed, which would have resulted in 87% lower emission reductions but in return for a 99% lesser reduction in aggregate output.