Minimizing the Costs of Climate Policy with Environmental Tax Reform

The objective of this paper is to study options in public finance for maximizing the cost-effectiveness of climate policy in Portugal. The focus of this research is the capacity for environmental tax reform to reduce the costs of reducing carbon dioxide emissions from fossil fuel combustion activities. The central component of environmental tax reform is the introduction of carbon taxation in a revenue neutral fashion. Carbon tax revenue may be used to reduce distortionary taxes on labor, corporate profits, and value-added taxes. In addition, the revenue from carbon taxes may be used to finance productive public sector investments in infrastructure and human capital or to provide investment tax credits for private investment and renewable energy. This study compares the economic impact and environmental effectiveness of these tax reform packages within the framework of a dynamic general equilibrium model for energy, environment and economic interactions and ranks their performance. This allows us to assess the feasibility of realizing a double dividend -- a simultaneous improvement in environmental quality and economic performance -- and the extent to which environmental tax reform can reduce the costs of climate policy in Portugal.