Understanding Distributional Impacts of Carbon Pricing–Insights from Comparative Analysis

Carbon pricing is becoming increasingly common but raises equity concerns and is frequently perceived as putting higher burdens on the poor than the rich. This paper discusses the reasons for unequal carbon price burdens across countries and population groups, through the lens of a comparative analysis for two countries with comparable climates but different income levels, Lithuania and Finland. The simulations consider multiple revenue recycling options, and they account for both the direct burdens from households’ fuel consumption and indirect burdens associated with the impact of carbon charges on the prices of other goods. With no compensation to affected households, average burdens are larger and also more regressive in Lithuania than in Finland, largely because of cross-country differences in energy expenditure patterns. Net distributional outcomes depend crucially on how carbon tax revenues are used, however, and carefully designed compensation can prevent regressive impacts of carbon-price packages.