Are rural households hit hardest? Exploring the distributional effects of region-specific compensation payments in the Austrian CO2 pricing scheme

In 2022 Austria has introduced a CO2 pricing scheme that aims at emissions from activities not covered by the EU Emissions Trading System. To increase social acceptability, the policy includes a region-specific compensation scheme, with higher transfers for households living in less densely populated areas. This is motivated by the hypothesis that rural households are hit harder by a CO2 price due to their relatively higher emission intensity of consumption. We test this hypothesis by using a recursive-dynamic computable general equilibrium model. Specifically, we compare the macroeconomic and distributional effects of three recycling schemes: i) region-specific transfers (the system in place), ii) no compensation but increased public consumption and iii) region- and income-specific transfers. At the macroeconomic level we find negative effects on GDP and welfare, compared to a baseline scenario without unilateral CO2 pricing under all three schemes. Interestingly, welfare effects are progressive irrespective of the recycling measure. Furthermore, we find that the scheme without compensation does not burden households in rural areas substantially more than those in urban areas. This results from an income side effect that works against the relatively stronger rise of consumer prices for rural households. However, the latter finding is sensitive to the labour market model closure, with a slightly higher burden for rural households under the assumption of full employment (as compared to our default closure with endogenous labour supply). Overall, we conclude that carbon pricing policies do not necessarily need to contain region- or income-based compensation schemes to enhance distributional equity.