Carbon taxes, CO2 emissions, and the economy: The effects of fuel taxation in the UK

Abstract

Carbon taxes remain economists’ preferred policy tool to curb emissions, but they are often criticized by the wider public as ineffective and damaging to the economy. This paper provides new evidence of the effectiveness of carbon taxation through empirical ex-post analysis, using the synthetic control method. We base our quantitative work on a theoretical general equilibrium model with dirty and clean transportation. We take the predictions of the model to data on the UK Fuel Tax Escalator, and estimate the impact of the tax on CO2 emissions, GDP, and transport behaviour. With a potential control pool of OECD countries, we estimate the difference between the observed outcome in the UK and a synthetic counterfactual UK. We find that the tax has a large and significant impact on CO2 emissions from traffic, while there is no discernible impact on GDP or growth. We do not find large changes in driving behaviours, but the available evidence points to a possible switch to rail travel from road travel. Our results are relevant for energy policy makers as they show how a suitable pricing system can effectively reduce climate-damaging emissions without causing macroeconomic damage.