Green Fiscal Reforms and the Demographic Squeeze: Lessons from Japan

Abstract

We investigate how demographic change affects the efficiency and equity of carbon pricing using an overlapping generations general equilibrium model of Japan. Demographic change erodes the tax base, so that the fiscal response has a larger impact on welfare than the carbon policy itself. We find that implementing a carbon policy during Japan’s projected population decline reduces welfare costs by 11% relative to a steady-state population, especially when revenues offset capital taxes. However, microsimulation indicates that low-income households face higher short-run welfare losses under policies that are most efficient in the long run, highlighting a trade-off between efficiency and progressivity.