How can a carbon tax benefit developing economies with informality? A CGE analysis for Côte d’Ivoire

This study investigates how a carbon tax could reduce fiscal and economic distortions as well as cut carbon emissions in developing-country economies. A computable general equilibrium model is developed to analyze the economic impacts of a hypothetical carbon tax in Côte d’Ivoire, a country in Sub-Saharan Africa with large losses of tax revenues due to informality and leakage. The model represents informal as well as formal production activities. The analysis shows that the economic impacts of a carbon tax and the levels of CO2 reduction vary significantly among alternatives for recycling the carbon tax revenue. A carbon tax with revenues recycled to reduce the existing value-added tax would increase GDP and economic welfare. If the revenue is used to cut the existing tax on labour, the carbon tax would not only increase GDP but also induce the migration of workers from informal to formal activities. The analysis also shows that if energy producers are not excluded from carbon tax revenue recycling, the carbon emission reduction is significantly lower due to a rebound effect. A carbon tax with lump-sum transfers of revenues to households would be progressive as the revenue is equally transferred to all households, but it reduces economic output and does not help reduce informal economic activities.A carbon tax can be beneficial to developing countries by generating fiscal co-benefits through revisions of other taxes.The size of the fiscal co-benefits depends on the carbon tax design.A carbon tax with revenue recycled to cut labour taxes incentivizes informal economic activities to move to the formal sector and to increase economic welfare.Using carbon tax revenues to reduce the value-added tax can reduce tax evasion and increase economic welfare.Unless energy producers are prevented from receiving the benefits of carbon tax revenue recycling, emission reduction is decreased due to a rebound effect.