Environmental Taxes in a Rational Expectations Overlapping Cohorts Model: An Applied Intertemporal General Equilibrium Analysis for Austria

Ronald Wendner
Department of Economics, University of Graz
Wendner@bkfug.kfunigraz.ac.at

Abstract

Applied general equilibrium analysis becomes increasingly prominent as one decision basis for the policy maker - Cockburn et al. (1995), for example, presented a database of studies applying CGE analysis which contains more than 600 applied models. But by now, few dynamic computable models exist, although the static structure of most of the applied models inhibits the analysis of important policy-related aspects - often the most important ones such as announcement effects, capital accumulation or intergenerational distribution - of the particular issues in question.

In this paper, a dynamic multi-sectoral model with 55 overlapping cohorts, deciding on consumption, saving and bequesting based on forward looking expectations, is developed and employed to study the effects of taxing CO emissions. However, the objective of the paper is not primarily to focus on a detailed prognosis of what happens when introducing an energy tax in Austria but rather to point out (1) the way an intertemporal model with rational expectations can be calibrated (i.e., how to find a base case solution for the unknown variables in years coming that are consistent with intraperiod as well as intertemporal equations when not starting with a steady state) and (2) which effects in addition to the ones covered by static models, such as announcement effects, are essentially to be taken into account when analyzing the implementation of a carbon tax.

The main findings of the simulation show the following impact of the carbon tax: Due to the substitution of energy with capital and (inelastically supplied) labour services, wages increase and so does lifetime income. Hence, even before implementing the tax, households (anticipating this increase) consume more and save less which causes capital accumulation to decline before the tax is actually enforced. The demand shift towards consumer goods increases the demand for labour-intensive goods and so, even before implementing the tax, wages increase slightly. This increase hinders investment to fall by more than consumption rises, hence, real GDP increases by more than without announcing (and implementing) an energy tax. After implementing the tax, actual wages increase faster and so does wealth accumulation and investment. But real GDP grows, although starting from a higher level, at a lower rate than without the tax. Whether GDP is rising or declining depends on the strength of each of these effects - it cannot be stated, as are results often from static analysis, that GDP actually does decline. With wages rising, especially those industries that are labour-intensive will face larger price increases and hence, regardless of exempting (the most) exposed industries from the tax or not, suffer losses from foreign trade. This makes elder claims appear highly topical according to which revenues from charging CO emissions should be spent for easing the tax burden on labour.