The Impact of Converting Fossil Fuel Taxes to Pure Carbon Tax on Household Expenditure in Japan

Technical Summary: The Impact of Converting Fossil Fuel Taxes to Pure Carbon Tax on Household Expenditure in Japan

Problem Statement
Japan faces a critical policy challenge in aligning its fiscal instruments with its decarbonization targets (46% reduction by 2030, 73% by 2040). Currently, Japan's carbon pricing regime is fragmented: a modest "Tax for Climate Change Mitigation" (¥289/t-CO₂) coexists with gasoline and diesel excise taxes designed primarily for infrastructure financing rather than environmental correction. This misalignment fails to provide clear price signals for low-carbon innovation and creates inefficiencies. Furthermore, there is a significant concern regarding the distributional equity of carbon pricing. Existing literature suggests that carbon taxes are often regressive, disproportionately burdening low-income households and residents in colder regions (e.g., Hokkaido, Tohoku) due to higher expenditures on energy and heating necessities. The central research question is whether Japan can restructure its fossil fuel taxation into an explicit, high-rate upstream carbon tax while maintaining or improving distributional equity through targeted fiscal offsets.

Methodology
The study employs a quantitative approach utilizing Input-Output (IO) analysis combined with Household Survey data to model the general equilibrium effects of tax reform.

• Data Sources: The analysis integrates the 2020 Input-Output Tables for Japan (193 sectors), Embodied Energy and Emission Intensity Data (3EID), and Household Survey data. The IO tables were disaggregated to separate the petroleum industry into gasoline, diesel, and other products, and the electricity sector into thermal, renewable, and transmission/distribution components.
• Analytical Framework: The study uses an equilibrium price determination model based on vertical balance equations (referencing Fujikawa, 2002), modified to account for imports. A "converter" matrix bridges the gap between IO industrial classifications and Household Survey product classifications, weighting price changes by production values.
• Policy Scenarios: Three distinct scenarios were simulated:
  1. Case 1 (Revenue-Neutral): A carbon tax of ¥3,309/t-CO₂ replaces existing gasoline and diesel excise taxes, ensuring total revenue neutrality.
  2. Case 2 (High-Burden): A high-rate carbon tax of ¥10,000/t-CO₂ (approximating the social cost of carbon) replaces the excise taxes.
  3. Case 3 (Mitigation/Net Effect): The high-rate tax (Case 2) is combined with a 0% consumption tax on specific sectors: food-related industries, petroleum products, and electricity transmission/distribution. The revenue from the carbon tax funds this exemption.

Key Contributions

1. Extension of Directed Technical Change Framework: The study applies the framework of Acemoglu et al. (2012) to fiscal policy design, demonstrating how upstream carbon taxation can redirect production patterns without requiring permanent subsidies.
2. Granular Distributional Analysis: Unlike aggregate welfare analyses, this study disaggregates household impacts by income decile and geographical region, providing specific evidence on how tax reforms affect vulnerable groups and cold regions.
3. Fiscal Mechanism for Equity: It proposes and quantifies a specific fiscal mechanism—using carbon tax revenue to fund targeted consumption tax exemptions—to overcome the trade-off between environmental effectiveness and distributional equity.

Estimation Results

• Macroeconomic Price Effects:
  • Case 1: Resulted in a marginal aggregate price increase of 0.14%, as the removal of excise taxes largely offset the new carbon tax burden.
  • Case 2: Led to an aggregate price increase of 1.87%, driven by the high carbon tax rate exceeding the savings from excise tax removal.
  • Case 3: Showed a theoretical price decrease of 1.32% when isolating the effect of the 0% consumption tax. The net effect (Case 2 + Case 3) suggests a reduction in household expenditure burdens, though the study notes this is an approximation due to static model constraints.
• Sectoral Price Changes:
  • Petroleum Sectors: Prices for gasoline and diesel fell significantly (approx. -32% to -49%) due to the removal of excise taxes.
  • Carbon-Intensive Sectors: Prices rose sharply in thermal power generation (+29.96% in Case 2), renewable energy generation, steel, cement, and chemicals.
  • Downstream Effects: Under Case 2, price increases propagated to agriculture, marine products, and textiles. However, Case 3 successfully reversed these increases for food and essential services, with food sector prices falling by approximately 9%.
• Household Expenditure Impacts:
  • Income Regressivity: Case 2 confirmed that a high-rate carbon tax is regressive. Low-income households faced higher relative expenditure increases (e.g., +1.21% for the lowest income bracket vs. +0.83% for the highest) because they spend a larger share of income on energy and food.
  • Regional Disparities: Cold regions (Hokkaido: +1.96%, Tohoku: +1.65%) experienced significantly higher burden increases than warmer regions due to heating demands.
  • Mitigation Effectiveness: The combined scenario (Case 2 + Case 3) effectively neutralized regressivity. Low-income households saw a net reduction in expenditure (approx. -2.24%), while high-income households saw a smaller reduction (-1.74%). Similarly, the net burden in Hokkaido was reduced from +1.96% to -0.08%, though regional disparities were not fully eliminated.

Significance and Claims
The paper claims that the proposed "net effect scenario" offers a politically feasible and economically efficient pathway for Japan's decarbonization.

• Allocative Efficiency: By maintaining high upstream carbon prices, the policy preserves strong price signals for supply-side decarbonization in heavy industry.
• Distributional Equity: The targeted 0% consumption tax on essentials acts as a "double dividend," reducing the regressive burden on low-income and cold-region households without requiring lump-sum transfers. The study argues this approach enhances social acceptability by directly offsetting the cost of living increases for vulnerable groups.
• Fiscal Sustainability: The analysis suggests that a ¥10,000/t-CO₂ tax could generate ~9.5 trillion yen in revenue. After funding the ~3.7 trillion yen required for the consumption tax exemptions, a net revenue of ~5.8 trillion yen remains, sufficient to finance Green Transformation (GX) investments.

The authors conclude that while the static input-output model has limitations regarding dynamic behavioral responses, the findings provide robust evidence that targeted consumption tax reductions can effectively mitigate the regressivity and regional disparities inherent in high-rate carbon taxation, ensuring both environmental goals and social equity are met.