Environmental tax reform and endogenous growth

In September 2013, the Swiss Federal Council announced a set of proposed fiscal measures aimed at reaching its energy and environment-related strategic targets for 2050 (Energy Strategy 2050). In the context of the announced proposal, the existing promotional measures used to finance subsidies for renewables and for building renovation will be replaced after 2021 by a "steering" system. In this system, fiscal measures will lead to the agreed upon energy and environmental targets by setting appropriate price signals through the market. Moreover, the revenues of these fiscal measures shall be redistributed among the public. The strand of applied economic literature used in this consultation consists of static CGE (Computable General Equilibrium) models replicating the Swiss economy without considering any growth effects.

This project uses modern theoretical and numerical economic modelling to answer the following question: could higher environmental taxes go hand-in-hand with higher economic development and growth? The current work aims at identifying and quantifying the dynamic effects of an environmental tax reform on the long-term economic performance of Switzerland.

The results show that, in the Swiss economy, an environmental tax reform with stringent CO2 emission targets can result in a positive growth dividend through input reallocation towards innovation. Higher levels of innovation make the economy more specialised and efficient; this positive growth effect can counteract the negative effect of higher carbon taxes on production, leaving overall economic development unaffected. A positive growth dividend strongly depends on the tax revenue redistribution scheme: redistribution through lowering capital taxation is the preferred option with respect to growth. The same option prevails when focussing on aggregate social welfare. However, a tax reform cannot be solely based on efficiency considerations; it also has to respect equity considerations. The results on equity between social segments are not straightforward: low CO2 reduction targets would justify lump-sum redistribution; however, the results become regressive when one considers very stringent emissions reduction.

Relevance for research

This project pushed the boundaries of research in the field in two directions: first, by theoretically developing a stylised model of endogenous growth based on R&D activity that explains the mechanics of the growth dividend from an environmental tax reform. It could be shown that energy affects economic growth primarily through the channel of capital accumulation: an increase in the carbon tax can mobilise scarce resources towards innovation, resulting in higher economic growth. Second, a multi-sectoral computational model of endogenous growth based on sectoral R&D activity was developed, with several heterogeneous households, and a full representation of the Swiss tax system.

Relevance for practice

The results are relevant for policy makers in that they underline the implications of such a policy on economic growth and how this in turn affects the economic development of Switzerland: higher taxes can go hand-in-hand with higher economic development; redistributing carbon tax revenue by lowering capital taxes is the preferred option for economic efficiency; in an advanced economy where R&D is the engine of economic growth, a stringent CO2 emissions target might make a lump-sum redistribution less equitable.

Environmental Tax Reform and Endogenous Growth - The Swiss Case