The Distributional Effects of Carbon Pricing in Germany

Even though economists prefer the instrument of carbon pricing to reduce greenhouse gas emissions over regulatory policies, fears of regressive effects that disproportionately burden low-income households lead to low public support, hindering the political feasibility of carbon pricing. In light of an ongoing policy debate and lacking evidence for the German context, this paper investigates the distributional effects of carbon pricing in Germany, as well as possible redistributive polices. I analyze three channels through which carbon pricing affects the distributional outcome: the direct price effect, the indirect price effect and the behavioral response. I then compare a lump-sum transfer, a targeted transfer per income deciles and reductions in labor and income taxes as redistributive policies, providing evidence on their effect on counteracting adverse distributional consequences from carbon pricing.

Methodologically, this thesis extends the ifo Tax and Transfer Microsimulation Model, which is based on the GSOEP, with a carbon pricing module. This extension models the direct and indirect price effects by using household consumption data from the EVS combined with data on emission intensities and estimates the behavioral responses with Engel curves. Using the model, I simulate the introduction of a 200€ carbon price per ton of CO2-equivalent on all direct and embedded emissions in household expenditures for the year 2018.

The analysis of the simulation results yields three main findings. First, the carbon price achieves substantial emission reductions of 221 Mt CO2eq and generates 97.09 bn. € in revenue but also decreases household consumption expenditures by an average of 5,171€ per year, corresponding to an average price burden of 2,090€ per household. Second, the policy exhibits regressive distributional effects, as the price burden amounts to 8.1% of disposable income for households in the lowest income decile and 4.4% in the highest decile. Decomposing the channels shows that regressivity is mainly driven by the disproportionately high energy burden of lower-income households and their lower ability to respond to price increases. Third, the evaluation of revenue rebating policies reveals that lump-sum transfers and transfers differentiated by income deciles significantly reduce regressivity, whereas reductions in labor or income taxes have limited equality-enhancing effects. These results enable a detailed ex-ante distributional analysis by embedding carbon pricing into a microsimulation model of the German tax-benefit system. Further, the findings provide empirical evidence to a scarce study base on the distributional effects of carbon pricing and different redistributive policies for the German context. The analysis also highlights the persistence of horizontal inequalities within income groups, suggesting the need for more targeted and differentiated redistribution mechanisms. Beyond contributions to literature, this thesis provides insights for policymaking. Introducing a high carbon price requires the design of effective and equi-table rebating, considering heterogeneous effects over and within deciles.