The Distributional Effects of EU Carbon Pricing

The EU member states have committed to achieving climate neutrality, i.e. netzero greenhouse gas (GHG) emissions, by mid-century. The two emissions trading systems (ETSs) in the EU—ETS1 and ETS2—are the lead instruments of EU climate policy to steer the transition to a carbon-neutral economy. Declining emission caps under ETS1 and ETS2 imply increasing carbon prices raising the question of aggregate economic cost and the distribution of costs among EU member states, regions, sectors, workers and households. Yet, given the enormous scale of the required transformation, surprisingly little is known about the distributional effects of future EU carbon pricing. This report provides an ex-ante analysis of the macroeconomic, labor market, distributional, and inequality effects caused by ETS1 and ETS2. We develop and apply novel structural simulation models, including a dynamic multi-country multi-sector general equilibrium with endogenous innovation in energy services, which fully integrates a micro-simulation module, a micro-simulation model to perform in- depth analyses of household, labor income, and inequality impacts in four EU countries (France, Germany, Poland, and Spain), and a spatial general equilibrium model to study worker re-allocation across occupations, sectors, and 100 EU regions. We find that achieving deep emissions reductions using the market-based instrument of emissions trading need not be costly at an aggregate EU level, but entails distributional effects of considerable magnitude and dispersion across different economic entities and market participants. This report provides new quantitative evidence on various distributional dimensions. Overall, our findings suggest that to increase the social acceptance and political feasibility of EU carbon pricing policies, targeted measures may be needed to address the unintended distributional consequences and policy-induced inequality.