Measuring the Welfare Effects of Tax Changes Using the LES: An Application to a Carbon Tax

This paper explores the use of a parametric approach to the measurement of compensating and equivalent variations resulting from price changes. The approach is based on the application of the Linear Expenditure System (LES) to each of a range of household income groups, rather than being based on a ‘representative’ consumer. The method is then used to examine the distributional effects of a carbon tax, designed to reduce carbon dioxide emissions. The price changes resulting from a carbon tax depend on the ‘carbon intensities’ of each good, which depend in turn on the nature of inter-industry transactions (the input-output matrix). The use of transfer payments to compensate for adverse distributional effects of a carbon tax is investigated, using social welfare functions based on equivalent incomes.