| A carbon tax would penalize carbon intensive fuels like gasoline and shift fuel consumption to less carbon intensive alternatives like biofuels. Since biofuel production competes for land with agriculture, a carbon tax could raise land rents, divert land towards fuel production, and raise agricultural prices. This paper analyzes the welfare effect of a carbon tax on fuel with gasoline and biofuel as available fuel choices, in the presence of a labor tax and biofuel subsidy. The second-best optimal carbon tax is also quantified. Findings show that when biofuels is part of the fuel mix, the carbon tax has a commodity price effect which arises from tax-induced changes in land rent. The commodity price effect could exacerbate or attenuate the tax interaction... |
