Environmental Tax Reform and Income Distribution with Imperfect Heterogeneous Labour Markets

This paper investigates the distributional and efficiency consequences of an environmental tax reform that distributes the revenue from a green tax according to varying labour tax rates. We build a general equilibrium model with heterogeneous workers, imperfect labour markets (search and match), and pollution consumption externalities. Preferences are non-homothetic (Stone–Geary utility) to take into account the potential regressivity of green taxes (the polluting good is assumed to be a necessary good). If the reform appears regressive, the gains from the double dividend can achieve Pareto improvement, using a redistributive non-linear income tax if the redistribution is not too great initially. Increasing progressivity influences the unemployment rate and can moderate the trade-off between equity and efficiency. We finally provide numerical illustrations for France and conduct sensitivity analysis.