A Dynamic Panel Threshold Approach to Decarbonization by Neutral Fiscal Policy: Application to the OECD

This paper addresses the output and employment impacts of a climate self-financed taxation/subsidy policy on CO2 emission reduction. We model balanced climate fiscal expenditure using a two-regime CO2-based threshold autoregressive model that separates periods of rising emissions by positive CO2 log-differences and of falling emissions by negative CO2 log-differences. Applied to data sets for 16 OECD countries over 23 years (1995–2018), we find that self-financing equal amounts of tax and subsidy over the lifespan of the data set yields a CO2-reducing regime that dominates, with significant threshold and marginal policy impacts on both output and employment. The policy impacts, as shown by the panel data variance decomposition forecast, indicate that the policy shock to total output variance outweighs other effects for up to three years, and to total employment variance for up to four years. The assessment of a two-regime/threshold model of neutral fiscal policy constitutes our contribution to the literature.