Carbon taxation and precautionary savings

Working paper 841
Working Papers
Lees voor

Gepubliceerd: 15 september 2025

Door: Stefan Wöhrmüller

How does uninsurable idiosyncratic risk shape the optimal design of carbon taxation? To answer this question, I augment a heterogeneous-agent incomplete-markets model with a climate externality on total factor productivity and dirty energy demand of households and firms. A government sets a carbon tax on energy and redistributes its revenue via lump-sum transfers. When labor tax instruments are held fixed, I find that the optimal carbon tax rises with the level of uninsurable idiosyncratic risk. In contrast, when labor taxes can adjust, the carbon tax remains relatively stable across different economic environments. Overall, welfare gains are primarily driven by improved insurance provision.

Keywords: heterogeneous agents; precautionary savings; carbon taxation
JEL codes D31; D52; E21; H21; Q50

Working paper no. 841

841 - Carbon taxation and precautionary savings

1,4MB PDF
Download 841 - Carbon taxation and precautionary savings

Research highlights:

  • This paper develops a heterogeneous-agent incomplete-markets model with endogenous labor supply, capital accumulation, and a climate externality linking pollution to productivity loss.
  • I introduce Stone-Geary preferences to reflect the higher energy expenditure share of low-income households, and show that these preferences generate nonlinear Engel curves due to idiosyncratic risk and precautionary savings.
  • Depending on the available tax instruments, an increase in uninsurable idiosyncratic risk leads to a higher welfare-maximizing carbon tax in general equilibrium.
  • When only the carbon tax is adjusted, it rises to a level over five times higher than when both the carbon tax and average labor income tax are adjusted, reflecting that the carbon tax-transfer scheme alone contributes to redistribution and insurance in the heterogeneous-agent economy.
  • Improved insurance against idiosyncratic shocks is the primary driver of welfare gains.

Ontdek gerelateerde artikelen