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Pareto-improving climate policy with heterogeneous abatement costs in the building sector

Author

Listed:
  • Matthias Kalkuhl

    (PIK Potsdam, MCC Berlin, University of Potsdam, CEPA)

  • Maximilian Kellner

    (PIK Potsdam, MCC Berlin)

  • Noah Kögel

    (PIK Potsdam, MCC Berlin, University of Potsdam)

  • Lennart Stern

    (PIK Potsdam, MCC Berlin)

Abstract

We build a dynamic model in which home owners decide when and how to switch to carbon-neutral heating. Agents differ with regard to carbon intensity and abatement costs, the latter being private information which is non-observable by the government. The heating-related investment model is nested in an overlapping generations Mirrlesian optimal taxation model with heterogeneous home ownership and labor productivity. We develop a compensation mechanism which guarantees a weak Pareto-improvement for every agent when aggregate benefits of climate policy exceed aggregate costs. The mechanism includes carbon pricing with category-based transfers, uniform ad-valorem subsidies on investments that are financed by public debt, and an income tax adjustment based on climate mitigation benefits, used to service debt. We show that exact compensation of homeowners’ dynamic abatement cost requires only minimal information: the interest rate and the future fossil fuel price path. By means of exact compensation, our model utilizes the income-tax system to redistribute heterogeneous transformation costs between households according to any number of normative considerations without efficiency losses. We numerically illustrate subsidy rates and income tax adjustments for Germany.

Suggested Citation

  • Matthias Kalkuhl & Maximilian Kellner & Noah Kögel & Lennart Stern, 2024. "Pareto-improving climate policy with heterogeneous abatement costs in the building sector," CEPA Discussion Papers 82, Center for Economic Policy Analysis.
    • Handle: RePEc:pot:cepadp:82
    DOI: 10.25932/publishup-66606
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    References listed on IDEAS

    as
    1. Klenert, David & Mattauch, Linus, 2016. "How to make a carbon tax reform progressive: The role of subsistence consumption," Economics Letters, Elsevier, vol. 138(C), pages 100-103.
    2. Berry, Audrey, 2019. "The distributional effects of a carbon tax and its impact on fuel poverty: A microsimulation study in the French context," Energy Policy, Elsevier, vol. 124(C), pages 81-94.
    3. Koichiro Ito, 2014. "Do Consumers Respond to Marginal or Average Price? Evidence from Nonlinear Electricity Pricing," American Economic Review, American Economic Association, vol. 104(2), pages 537-563, February.
    4. Erica Myers, 2019. "Are Home Buyers Inattentive? Evidence from Capitalization of Energy Costs," American Economic Journal: Economic Policy, American Economic Association, vol. 11(2), pages 165-188, May.
    5. Ottmar Edenhofer & Matthias Kalkuhl & Christina Roolfs, 2021. "Carbon Pricing and Revenue Recycling: An Overview of Vertical and Horizontal Equity Effects for Germany," CESifo Forum, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 22(05), pages 10-14, September.
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    More about this item

    Keywords

    climate policy mix; building sector; heterogeneous abatement; Pareto improvement; compensation; income tax adjustment; subsidies;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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