Economics offers a century-old fix to climate change: carbon pricing. While widely accepted in policy circles, practical attempts to implement carbon taxes have been consistently met with fierce resistance. From the ‘yellow vest’ protests in France to the repeal of Australia’s carbon tax and the recent rollback of Canada’s consumer carbon price, political backlash has become a recurring feature of climate policy. These episodes raise a fundamental policy question: if carbon pricing is efficient in theory, why is it so difficult to implement in practice?

A growing literature suggests that distributional concerns may play a key role. While carbon pricing is designed to correct the environmental externality associated with emissions, it can also affect households through higher energy prices, changes in wages, and shifts in asset values. If these effects are unevenly distributed across the population, carbon pricing may increase inequality even if it improves environmental outcomes.

Recent research thus examines the distributional consequences of climate policy. Studies such as Andersson and Atkinson (2020) and Beznoska et al. (2012) document that carbon taxes can have regressive effects through higher consumer prices, particularly for energy-intensive goods. However, most existing work focuses on the direct effect of energy price increases on household consumption baskets. Less attention has been devoted to broader economic channels such as labour and financial markets, which may also play an important role.

In recent work (Bigio et al. 2025), we study the overall and distributional economic impacts of carbon pricing in Europe. Our findings suggest that the welfare costs of carbon pricing can be substantial and unevenly distributed, with indirect labour market effects playing a particularly important role. These results help explain why carbon pricing often encounters political resistance and highlight the importance of policy design when implementing climate policy.

Measuring the economic impact of carbon pricing

To study the distributional effects of carbon pricing, we focus on Europe, which has one of the world’s largest carbon markets: the EU Emissions Trading System (EU ETS). Since its introduction in 2005, the EU ETS has become the central pillar of European climate policy and currently covers around 40% of the EU’s greenhouse gas emissions.

A key challenge in measuring the economic effects of carbon pricing is identifying changes in carbon prices that are not driven by broader macroeconomic conditions. Carbon prices tend to rise during economic expansions, when demand for energy increases and climate policies may be more politically feasible. To isolate the causal effects of climate policy, we therefore exploit regulatory announcements that unexpectedly affect the supply of emissions permits. Changes in carbon futures prices around these announcements provide a measure of unexpected carbon policy shocks (Känzig 2023, 2025).

Using this approach, we estimate how carbon policy shocks affect a range of economic outcomes, including consumer prices, labour income, asset prices, and government transfers.

Carbon pricing affects households through multiple channels

Our analysis reveals several important channels through which carbon pricing affects households.

First, carbon pricing raises energy prices, which in turn spill over to other consumer prices such as housing, transport, and food. These direct price effects, illustrated in Figure 1, increase the cost of living for households. However, they account for only part of the overall economic impact.

Figure 1 Consumer price responses

Notes: Impact responses of HICP components per COICOP classification to carbon policy shock, normalized to increase HICP energy by 1%. Shown is the point estimate with 90% confidence bands.

Second, and more importantly, carbon pricing affects labour markets. Higher energy costs reduce economic activity in energy-intensive and demand-sensitive sectors and can lead to lower wages or employment. Figure 2 shows that labour income falls significantly following carbon policy shocks, particularly for low-income households.

Third, carbon pricing affects financial markets. Equity prices and dividends decline after carbon price increases, reflecting lower expected profits for firms. These changes affect households differently depending on their financial portfolios. Households that are accumulating financial assets may benefit from lower asset prices, while those who rely on selling assets – such as retirees – may experience losses.

Finally, government transfers and indexed pensions partly offset some of the negative effects, as higher inflation can increase certain transfers.

Overall, these channels highlight that the economic consequences of carbon pricing extend well beyond energy prices. Understanding these broader mechanisms is essential for evaluating the distributional impact of climate policy.

Figure 2 Labor market responses: Income

Notes: Impulse responses of labour income by income groups to carbon policy shock, normalized to increase HICP energy by 1% on impact. The solid line is the point estimate, and the dark and light shaded areas are 68% and 90% confidence bands-

The overall welfare impact

To quantify the economic impact of carbon pricing, we adopt the feasible set approach developed in Del Canto et al. (2025). The key idea is that the first-order welfare effect of a policy change can be summarised by how it alters households’ budget constraints. We combine the estimated price and income responses with detailed household-level data on consumption, income, and portfolios. This allows us to translate the resulting changes in household budgets into a money-metric measure of welfare that is expressed in income units.

Our estimates suggest that the short- to medium-term welfare costs of carbon pricing are economically meaningful. On average, a carbon policy-induced increase in energy prices of 1% reduces household welfare by roughly €250, corresponding to about 0.5% of three years of household consumption.

Importantly, these losses are not driven primarily by higher consumer prices. Direct price increases account for less than half of the overall welfare cost. Instead, the largest contribution comes from declines in labour income.

This finding helps reconcile two strands of the literature. Earlier studies focusing on consumer prices tended to find relatively modest distributional effects. Our results suggest that a more complete accounting – including labor market effects – reveals substantially larger economic impacts.

Carbon pricing has unequal welfare effects across households

Beyond the average effects, we document substantial heterogeneity across households. The impacts vary markedly across the income distribution. Figure 3 shows that low-income households face the largest losses, driven primarily by declines in labour income. Somewhat surprisingly, high-income households also experience non-negligible losses, while middle-income households appear more insulated, resulting in a U-shaped pattern across the income distribution. Differences also emerge across age groups: younger households are more strongly affected, whereas older households are relatively insulated because they are less exposed to the labour market.

Figure 3 Welfare losses by age and income groups

Notes: Money-metric welfare impacts, estimated based on feasible set approach. The welfare change is expressed as a share of total three-year consumption by age and group based on 2015 data. Positive values indicate welfare losses, while negative values indicate welfare gains. We present 68% bootstrapped confidence bands.

We also document meaningful heterogeneity across education groups. Households without a college degree experience losses roughly twice as large as those of college-educated households. The main reason is that lower-skilled workers are more exposed to labour market disruptions following carbon price increases.

Finally, we find large regional differences across Europe. Households in Southern and Eastern Europe experience larger welfare losses than those in Northern and Western Europe, reflecting differences in labour market institutions and economic structure.

In sum, these results indicate that the welfare effects of carbon pricing are highly unequal, largely driven by its impact on labour income.

Policy implications and concluding remarks

It is a curse of economics that the importance of a question is often inversely related to the precision with which it can be answered. In this column, we attempt to answer an important question: the distributional impact of carbon taxes. We do so by exploiting macro and household-level micro data on prices, consumption, income, and wealth. While our data is rich, the sample period is short and the policy variation limited, and thus our estimates remain imprecise.

Despite these limitations, our estimates offer several insights for the policy debate.

1. Public resistance may reflect genuine economic concerns. The estimated welfare losses are economically meaningful. This suggests that opposition to carbon taxes may stem from real economic burdens rather than simply ideological disagreement.
2. Indirect macroeconomic effects matter. Much of the existing discussion focuses on the direct impact of carbon pricing on consumer prices. Our results indicate that indirect macroeconomic feedback – particularly through labour income – plays a larger role. Policies aimed solely at offsetting higher consumer prices may therefore miss an important part of the burden. More expansionary policy responses, including accommodative monetary policy, could help mitigate these income effects.
3. The burden falls disproportionately on working-age households. Working-age households bear much larger welfare losses than retirees. This pattern suggests a natural direction for redistribution: transfers targeted toward younger households.

We hope this work inspires complementary research, leading to a shared consensus. Such consensus is essential for formulating a more comprehensive climate-change policy, one that also accounts for distributional impacts.

References

Andersson, J and G Atkinson (2020), “The distributional effects of a carbon tax: The role of income inequality”, CCCEP Working Paper No. 378.

Beznoska, M, J Cludius and V Steiner (2012), “The incidence of the European Union Emissions Trading System and the role of revenue recycling: Empirical evidence from combined industry-and household-level data”, Discussion Papers of DIW Berlin 1227,

Bigio, S, D R Känzig, P Sánchez and C Walsh (2025), “Carbon Pricing and Inequality: A Normative Perspective”, NBER Working Paper No. 34125.

Del Canto, F, J Grigsby, E Qian and C Walsh (2025), “Are inflationary shocks regressive? A feasible set approach”, The Quarterly Journal of Economics 140(4): 2685-2747.

Känzig, D R (2023), “Climate policy and economic inequality”, VoxEU.org, 25 June.

Känzig, D R (2025), “The unequal economic consequences of carbon pricing”, NBER Working Paper No. 31221.