Carbon pricing policy is one of the most efficient tools to mitigate carbon emission, while it alters the income distribution. The progressive individual income tax system redistributes income and reduces inequality. With a multi-regional dynamic CGE model, this study intends to explore the distributional effect of carbon pricing policy in China and to evaluate how the carbon revenue recycling scheme influences income inequality as well as the redistributive effect of individual income tax. Results show several key findings. First, in order to achieve the national emission peak by 2030, carbon pricing policy will lead to greater income inequality, increasing the after-tax Gini coefficient by 0.59% and 1.88% in 2030 and 2040 respectively. Second, if the carbon pricing revenue is recycled through the individual income tax return, the redistributive effects vary according to the design of the tax return rate. The proportional recycling scheme, i.e. all income groups have the same tax return rate, will continue widening the inequality, while the progressive recycling scheme, i.e. lower income groups have higher tax return rates, will narrow the income gap since 2030. Third, carbon pricing policy with a progressive recycling scheme influences income inequality by means of both reducing distortions of carbon policies on the economy and enhancing the redistributive effects of individual income tax. The carbon pricing policy increases the income inequality because of the domination of a positive economic distortion effect at first, while the carbon pricing policy turns to decrease the income inequality since 2025 because both distortion effect and redistributive effect are negative.
Keywords Carbon Pricing Policy, Tax Revenue Recycling, Income Inequality, Distributional Effects, CGE model