Should Environmental Taxes Be Countercyclical?

“Green recovery” is one of the key themes of the stimulus packages implemented worldwide in response to the Covid-19-related economic downturn. Traditionally, the answer to economic crises has focused on monetary policy and financial assistance programmes. However, as interest rates get closer to the zero lower bound, alternative stimulus policies are gaining attention in academic and policy circles. Recent research points to the potential role of countercyclical environmental policy as an instrument to stimulate a quicker recovery. According to this research, in some circumstances, suspending or scaling back regulations in periods of economic downturn can allow companies to “breathe”, – thereby facilitating a swift economic recovery. The more lenient environmental regulation during recessions should be counterbalanced with more stringent regulation in times of economic growth. In this blog, that builds on our recent research, we have addressed two key questions related to this practice: should we implement countercyclical environmental policy, including environmental taxes? If yes, what environmental instruments (e.g. carbon taxes vs. cap-and-trade) are better suited to stimulate the economy in periods of economic downturn? Below, we provide a summary of our key findings.