Recycling of Eco-Taxes, Labor Market Effects and the True Cost of Labor – A CGE Analysis

Computable general equilibrium (CGE) modeling has provided a number of important insights about the interplay between environmental tax policy and the pre-existing tax system. In this paper, we emphasize that a labor market policy of recycling tax revenues from an environmental tax to lower employers’ non-wage labor cost depends on how the costs of labor are modeled. We propose an approach which combines neoclassical substitutability and fixed factor proportions. Our concept implies a user cost of labor which consists of the market price of labor plus the costs of inputs associated with the employment of a worker. We present simulation results based on a CO2 tax and the recycling of its revenues to reduce the nonwage labor cost. One simulation is based on the market price of labor and the other on the user cost of labor. We found a double dividend under the first approach but not under the second one