Abstract:
We characterize optimal climate policy in an economy with heterogeneous households and non-homothetic preferences. We focus on constrained efficiency, where the planner is restricted from transferring resources across households. We derive three results. First, the constrained-optimal carbon tax is heterogeneous and progressive. Second, if restricted to a uniform tax, the optimal rate is lower than the standard Pigouvian level due to inequality. Third, this allocation is decentralizable using only uniform instruments - a carbon tax, clean subsidy, and a lumpsum transfer. In a quantitative application, we show this policy generates a Pareto improvement, reconciling climate efficiency with inequality concerns.