When standards have better distributional consequences than carbon taxes

Abstract

Carbon pricing is the efficient instrument to reduce greenhouse gas emissions. Nevertheless, the geographical and sectoral coverage of substantial carbon pricing remains low, often due to concerns about increasing economic inequality. Regulations such as fuel economy standards are more popular. Could the reason be that they have an equity advantage over carbon pricing? We develop two models, one representing energy services and the other the carbon-intensity of consumption, to identify the economic situations in which this is the case. First, we prove that an efficiency standard can be more equitable than carbon pricing when consumers prefer high-carbon technology attributes. Evidence from the US vehicle market confirms this finding. Second, we show theoretically, and through a numerical application to the Chinese transport sector, that intensity standards are preferable when richer households consume a greater share of high-emissions goods. Our results hold when the redistribution of carbon pricing revenue is not progressive. These insights may help advance decarbonisation when pricing instruments remain unpopular.