account for household behavioral responses to higher consumer prices.<sup>24</sup>

# **3.3 Simulated scenarios**

We use CPAT to simulate the impacts of an economy-wide carbon tax that, from 2024 onwards, gradually increases to reach US$25/ton of CO2e in 2030, in real 2021 United States dollars (US$). This (moderate) US$25/ton CO2e carbon tax is assumed to apply upstream to all sectors and fuels and in addition to any pre-existing taxes or subsidies. It is also considered as a reasonable price floor and yardstick for low-income developing economies (Chateau et al., 2022). Under this main scenario, we focus entirely on the carbon tax effects, assuming that fossil fuel subsidies, price controls and exemptions are phased out in both the BAU and carbon tax scenarios.

In Section 4.5, we consider a ‘comprehensive energy price reform’ (CEPR) package, which evaluates the aggregate impact of both: i) the gradual introduction of the US$25/ton CO2e carbon tax by 2030; and ii) the gradual (but complete) phaseout of fossil fuel subsidies and related price controls and exemptions (assumed, in this case, to not take place in the BAU).

The use (or ‘recycling’) of revenues from climate mitigation policies for compensation will be a key component of such policies because it can significantly enhance the transition by boosting buy-in from the population. The choice of what to do with the revenue proceeds is context specific. In some economies, the optimal strategy may be to allocate these revenues towards general fiscal adjustment. In the case of South Asia, the money could be used to strengthen social safety net systems or for adaptation (e.g., better insurance against weather-related disasters in rural areas, or greater renewable energy production, including via new energy infrastructure). Two revenue recycling ‘modes’ are simulated under both the US$25/ton CO2e carbon tax and CEPR in this paper:

- (a) targeted cash transfers to households in the bottom 70 percent of the consumption distribution;<sup>25</sup> and

(b) public investment in the form of infrastructure access provision (e.g., to support Sustainable Development Goals, SDGs), based on household access to the following infrastructure types: electricity, water, sanitation, Information and Communications Technology (ICT), and public transport.<sup>26</sup>

> 24 All incidence effects are adjusted downwards using decile-consumption item-specific price elasticities of demand (assuming a constant elasticity of substitution household utility function) from the United States Department of Agriculture (USDA). See: https://www.ers.usda.gov/data-products/commodity-and-food-elasticities/.

> 25 This revenue recycling ‘mode’ may not be as efficient (e.g., relative to cutting distortionary taxes on labor), but may be required to guarantee crucial support for reform from most of the population (particularly the middle class). See also Section 5 below.

> 26 Household-level access to the infrastructure types mentioned above is also obtained directly from HBSs. The associated revenue recycling ‘mode’ is set up as follows: if, for example, the average infrastructure access rate of the poorest (e.g., bottom 10 percent) individuals is equal to 30 percent, climate mitigation policy revenues are allocated to the remaining 70 percent of these individuals and so on for subsequent segments of the population. The gains from

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