Assessing the Efficiency and Fairness of the Fit for 55 Package toward Net Zero Emissions under Different Revenue Recycling Schemes for Italy

One of Italy’s key objectives is to reform and modernize the tax system to increase tax efficiency and improve environmental sustainability and regional economic outcomes, in line with the European Union strategy. Within the framework of the European Green Deal, Italy is committed to contributing to the goal of becoming the first climate neutral region by 2050 (the “Fit for 55” package). As an intermediate step toward the 2050 target, the European Union must reduce greenhouse gas emissions by at least 55 percent by 2030 compared to 1990 levels. Carbon pricing is at the core of the proposal, but its full implementation is also expected to have regressive effects, harming poorer households, and adverse economic impacts, reducing firms’ competitiveness. This paper evaluates the effects of the carbon pricing proposal of the “Fit for 55” package on welfare, sectoral production, and income distribution. To tackle the adverse social and economic effects, it compares different revenue recycling schemes shifting the tax burden from major direct and indirect taxes to carbon emissions. It finds that well-targeted revenue recycling policies might significantly reduce the negative effects. The analysis adopts the Italian Regional and Environmental Computable General Equilibrium of the Department of Finance model, which is a new (recursive) dynamic computable general equilibrium model developed by the Italian Ministry of the Economy with technical assistance from the World Bank. It has a detailed energy specification that allows for capital/labor/energy substitution in production, intra-fuel energy substitution across all demand agents, a multi-output and multi-input production structure, an extended energy system with 11 different types of technologies, multiple households to address distributional impacts, and detailed information on the Italian tax system.