Demand Shocks Change the Excess Burden From Carbon Taxes

Two basic propositions underlying the economics of taxation -- that excess burdens increase in elasticities and tax rates -- are shown to cause the stringency of a Pigouvian tax to vary nonlinearly with output prices. This varying stringency of carbon taxation contributes to unfavorable competitiveness consequences following shocks to demand. Empirically, this paper measures the change in carbon tax stringency by structurally recovering the supply schedule for a particular industry such that elasticities and carbon tax rates change according to the distribution of output prices. Based on this supply function, the relationship between marginal excess burden, a measure of policy stringency from the industry's perspective, and product prices is estimated. Results for the Canadian cattle industry show that with moderately high output prices, supply elasticities are small, tax rates are low and the efficiency cost of a carbon tax (gross of environmental benefits), such as the one introduced in Canada, is less than \$0.01 per dollar tax revenue. As prices decline, supply curves become increasingly elastic, tax rates rise and marginal excess burdens grow rapidly.