The Macroeconomic Effects of a Carbon Tax to Meet the U.S. Paris Agreement Target: The Role of Firm Creation and Technology Adoption

Alan Finkelstein-Shapiro and Gilbert E. Metcalf

September 2022

We analyze the labor market and aggregate effects of a carbon tax in a framework with pollution externalities and equilibrium unemployment. Our model incorporates labor force participation and two margins of adjustment influenced by carbon taxes: (1) firm creation and (2) green production-technology adoption. A carbon-tax policy that reduces carbon emissions by 35 percent—broadly consistent with Biden Administration’s new Paris Agreement commitment—can generate mild positive long-run effects on consumption and output, an expansion in the number and fraction of firms that use green technologies, and greater labor force participation, with marginal changes in the unemployment rate. In the short term, the adjustment to a higher carbon tax need not be accompanied by losses in output and consumption or a substantial increase in unemployment. Abstracting from green technology adoption implies that the same policy has substantial adverse short- and long-term effects on labor income, consumption, and output. Our findings highlight the importance of considering endogenous technology adoption in assessments of the labor market and aggregate effects of a carbon tax.

Keywords: Environmental and fiscal policy, carbon tax, endogenous firm entry, green technology adoption, search frictions, unemployment, labor force participation

JEL Classification: E20, E24, E62, H23, O33, Q52, Q55