The Welfare Effects of Carbon Taxation on Italian Households

Abstract

We simulate the welfare effects of the Carbon-Energy Tax introduced in Italy at the beginning of 1999 which asks for smooth increases, over a number of years, in the prices of most fossil fuels. The welfare effects have been calculated using True Cost of Living index numbers and their parameters have been obtained through estimation of a demand system, using households-data from 1985 to 1996. The welfare loss at the aggregate level turns out to be quite substantial and affects Italian households in a non-negligible way, but the distribution of welfare losses across different levels of total monthly expenditures does not allow sustaining the regressivity of Carbon taxation, as the effect becomes bigger as we move up the income distribution. This evidence might encourage the use of Carbon Taxes as cost-effective instruments of environmental policy, especially after the recent negotiations on Climate Change. However, other important implications of Carbon taxation such as those on competitiveness and the environmental impact are not assessed in this study.