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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 19, NO. 3, PP. 385-399
© 2003 Oxford University Press and the Oxford Review of Economic Policy Limited

Fiscal Interactions and the Case for Carbon Taxes Over Grandfathered Carbon Permits

Ian W. H. Parry
Resources for the Future1

Abstract

This paper provides simple formulas for adjusting the costs of carbon taxes and tradable carbon permits to account for interactions with pre-existing tax distortions in the labour market. Both policies reduce labour supply as they increase product prices and reduce real household wages; the resulting efficiency losses in the labour market can be substantial relative to partial equilibrium abatement costs. However, much of this added cost can be offset, and perhaps more than offset when additional distortions from the tax system are considered, if revenues from carbon taxes or auctioned permits are used to reduce distortionary taxes. Consequently, there can be a strong case on efficiency grounds for using carbon taxes or auctioned permits over grandfathered carbon permits.


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