The Role of Environmental Tax Reform in Responding to the COVID-19 Crisis

This paper aims to show that environmental tax reforms may be the best option to mobilize revenues during fiscal consolidation while reducing distortions and environmental externalities by shifting the tax burden from labor to carbon emissions. The paper discusses the role of environmental tax reform, including adjustments in environmental taxes, labor taxes, and public investment, in tackling the challenges arising in the post-COVID recovery. In addition to a thorough review of the relevant literature, this chapter will provide original research on the tax and spending multiplier effects on output and employment for a large sample of high, and low-income countries. In addition, the chapter will discuss the role of public investment, green investment, in complementing and reinforcing the role of environmental taxation in moving the economy towards a low-carbon transition. The remainder of the paper proceeds as follows: section two reviews the fiscal policy measures implemented during the early stages of the COVID-19 recession to provide economic stimulus and summarizes the debate on the usefulness of different policy measures. It assesses environmental taxes in the context of guidelines for optimal tax policy. Section three discusses the theory of optimal tax policy. Section four reviews the empirical evidence of environmental tax multipliers as well as labor tax multipliers. Section five discusses the literature on green investment multipliers. Section six derives policy implications.

By Dirk Heine and Christian Schoder

Click here to read full World Bank report