The welfare impact of climate action: A distributional analysis for Italy

Abstract

Achieving the climate targets the European Union sets requires a complex policy mix, which is expected to cause a general increase in end-user prices, especially for carbon-intensive goods. For those countries already affected by large inequalities, this constitutes a risk of further negative impacts in distributional terms. This paper contributes to the debate by assessing the distributional impacts on Italian households of a policy mix coherent with the EU climate targets. The policy instruments considered are the removal of fossil fuels subsidies and carbon taxation. The analysis is carried out by soft-linking a dynamic CGE model with a microsimulation model at the household level. The estimation of a consumer demand system includes direct, indirect, and demand-side effects of the policy scenario. We then complement the analysis on the uses-side by simulating the impacts on the sources-side, computing the burden imposed on households by changes in the returns to production factors. The overall impacts of the climate policy lead to a welfare loss for households at all levels of the expenditure distribution. However, we find that both the uses and sources-side impacts of the policy are progressive, and the sources-side effects strongly reinforce the uses-side ones. Finally, we show that reinvesting revenues in clean energy technologies is key to improving the progressivity of climate policies in Italy.