A Two-Regime Theoretical and Panel Data Threshold Approach to Decarbonization by Neutral Fiscal Policy- with 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 a balanced climate fiscal expenditure by a two-regime CO2-based threshold autoregressive model that separates the periods of rising emissions by negative CO2 log-differences and falling emissions by positive CO2 log-differences. Applied to data sets of 16 OECD countries over 23 years (1995-2018), we find that self-financing of equal amounts of tax and subsidy over the lifespan of the data set produces an outcome in which the CO2-reducing regime dominates with significant threshold and marginal policy impacts, on both output and employment. The policy impacts by the panel data variance decomposition forecast show policy shock to total output variance outweighs other effects up to three years and to total employment variance up to four years. The assessment of a two-regime/threshold model of neutral fiscal policy constitutes our contribution to the literature.