This paper investigates how carbon taxes affect emissions by examining British Columbia’s revenue-neutral carbon tax in the manufacturing sector. We theoretically demonstrate that carbon taxes can achieve emission reductions while increasing production. Recycling carbon tax revenues to lower corporate income tax rates encourages investments, allowing plants to emit less per unit of output. Using detailed confidential plant-level data, we evaluate this theoretical prediction by exploiting the treatment intensity through plants’ emission intensity. We find that the carbon tax lowers emissions by 4 percent. Furthermore, we find that the policy had a positive output effect and negative emission intensity effect, suggesting that the carbon tax encouraged plants to produce more with less energy. We provide initial evidence showing how a revenue-neutral carbon tax may achieve emission reductions while stimulating the economy.

This paper investigates how environmental taxes affect manufacturing productivity by examining British Columbia’s revenue-neutral carbon tax. I develop a new hypothesis, the “Productivity Dividend Hypothesis,” to show that environmental taxes can positively affect productivity by recycling tax revenues to reduce corporate income taxes. This revenue-recycling increases investment and could raise productivity more than environmental taxes lower productivity by diverting resources from production. I evaluate this hypothesis using detailed confidential plant-level data. I find that the carbon tax lowers productivity, although this is offset to some extent by the revenue-recycling. For some plants, the policy generates a net gain in productivity.

We compare the employment effect of the British Columbia carbon tax using two empirical methods, a reduced-form econometric model and counterfactual simulations conducted using an applied general equilibrium (CGE) model. The comparison allows us to test the theory-driven predictions of the CGE model. It also allows us to test the identification strategy of our econometric model. Ex-post, we find statistically and economically significant effects on sectoral employment levels from the carbon tax – with employment falling in the most carbon-intensive sectors and rising in the least carbon-intensive. The CGE model predicts employment responses of very similar sign and magnitude to our econometric estimates. We find no evidence to suggest that our econometric estimates are likely to be undermined by general equilibrium effects in this policy setting. Finally, we explore the use of the econometric estimates to deepen the empirical content of the CGE model.