Tax Progressivity of Carbon and Gasoline Taxes: The Role of Income Inequality

Abstract We present a simple model showing how income inequality and the income elasticity of demand jointly shape the tax progressivity of indirect taxes, with rising inequality increasing the regressivity of taxes on necessities. We test the model’s predictions by analyzing the Swedish carbon tax on transport fuel. We find that the tax becomes increasingly regressive over time, closely tracking rising income inequality. We also show that the relative incidence shifts from regressive to progressive when using annual expenditure rather than annual income as the welfare measure, as expenditure is more evenly distributed. A cross-country analysis of gasoline taxes in high-income nations further supports our findings, establishing a strong correlation between higher inequality and greater regressivity. Our model helps policymakers identify when complementary redistributive measures such as lump-sum transfers may become necessary.