Road to Net Zero: Carbon Policy and Redistributional Dynamics in the Green Transition
Alessandro Sardone
IWH Discussion Papers,
No. 16,
2025
Abstract
This paper examines the macroeconomic and distributional effects of the European Union’s transition to Net Zero emissions through a gradually increasing carbon tax. I develop a New Keynesian Environmental DSGE model with two household types and distinct energy and non-energy sectors. Five alternative uses of carbon tax revenues are considered: equal transfers to households, targeted transfers to Hand-to-Mouth households, subsidies to green energy firms, and reductions in labor and capital income taxes. In the absence of technological progress, the carbon tax policy induces a persistent increase in energy prices and a reduction in GDP, investment, and consumption. Headline inflation falls below zero in the medium run, reflecting weaker aggregate demand. Distributional outcomes vary significantly depending on the implemented revenue recycling scheme: targeted transfers are the most progressive but entail larger macroeconomic costs, while subsidies and tax cuts mitigate output and investment losses but are less effective in narrowing the consumption gap. A limited foresight scenario, in which agents learn about policy targets sequentially, generates more volatile adjustment paths and temporary inflationary spikes around announcements, but long-run outcomes remain close to the baseline.
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