Taxing Carbon under Market Incompleteness

This paper is the first attempt, to the best of our knowledge, to study the impact of a carbon tax by means of a heterogeneous agents model. The objectives of the paper are two: i) To assess how the results of a representative agent model compare to those coming from a model accounting for heterogeneity across agents when evaluating aggregate economic and environmental impacts of a carbon tax; ii) To assess the distributional implications of a carbon tax and how they can be mitigated through different recycling schemes. We find that heterogeneous agents models may deliver different results from those derived using a representative agent model, the main tool used to guide policy making so far. In particular, we find evidence of a double dividend for several recycling schemes and carbon taxes as high as 20% of the energy price. In addition, we find the potential for redistributive channels related to carbon policies that can only be appreciated applying this type of modeling. JEL codes: Q58, Q54, E2.