Environmental Fiscal Reform and Fiscal Consolidation: The Quest for the Third Dividend in Portugal

This paper explores the capacity for environmental fiscal reform to reduce CO2 emissions, stimulate economic performance, and promote fiscal sustainability. Simulation results suggest that reforms based on CO2 taxation stimulate GDP when tax revenues are used to promote private or public investment and stimulate employment when used to finance reductions in personal income taxation or firms' social security contributions. More generally, reforms allow for reductions in the costs of climate policy, a weaker realization of the second dividend. In addition, several reforms lead to reductions in public debt, the realization of a third dividend. When political constraints on reducing public spending are considered, however, this third dividend only materializes when revenues finance public investment or reductions in the firms' social security contributions. Overall, our results suggest that low growth and high public debt need not be regarded as hindrances for environmental fiscal reform but can actually be seen as catalysts.