What is the potential impact of a taxation system reform on carbon abatement and industrial growth in China?

- The levy of carbon tax has a negative but very small shock on industrial output.
- The levy of carbon tax is bound to abate the CO2 emissions intensity.
- The levied carbon tax should vary among industrial sectors and increase over time.
- The carbon tax should be charged in enterprises according to their gross emissions.

Economists have long argued that market-based environmental policy such as an environmental tax is beneficial to abate pollution emissions. This study aims at investigating the impact of carbon tax levy on carbon dioxide (CO2) abatement and industrial growth in China. To this end, the marginal abatement cost (MAC) of industrial CO2 emissions is estimated as the benchmark of setting the carbon tax rate by using the directional distance function (DDF). This paper employs the polynomial dynamic panel model to forecast the impact of carbon tax levy on target variables such as sectoral value-added and CO2 intensity. The results reveal that the levy of a CO2 tax has a negative impact on industrial output only in the short term. In the long term, the impact of CO2 tax levy on output will become positive. The levy of a CO2 tax is always beneficial to reduce CO2 intensity. Corresponding policy suggestions for an environmental taxation system reform are given in the concluding section.