Revenue-Neutral Tax-Subsidy Policy for Carbon Emission Reduction

One of the benefits of biofuel use is a reduction in greenhouse gas emissions relative to fossil fuels, but no policy directly targets carbon emissions across the full spectrum of renewable and nonrenewable fuels. In light of the political unpopularity of carbon taxes in the United States, we develop a model for a revenue neutral price instrument that maximizes social welfare subject to an exogenously determined net tax revenue target. This approach may be more palatable because it has the potential to change the relative price of the low-carbon and highcarbon components of blended fuel while limiting increases in taxes and motor fuel prices. Our model shows that the targeted tax revenue level and share of output to total gross domestic product in all fuel sectors are important factors determining the revenue-neutral tax levels for each fuel type. Interestingly, we also find that the marginal damages of pollution are not the primary determinants of the revenue neutral price instrument, but instead it is the relative marginal damages per unit price of each fuel type. This implies the counterintuitive possibility that with a revenue neutrality constraint, higher net carbon emitting fuels such as gasoline or diesel may implicitly be subsidized using revenues from carbon taxes on lower emitting fuels.