In this paper, we address the issue of energy taxation reform with an environmental focus. We do so using a multi-sector and multi-household dynamic computable general equilibrium model of the Portuguese economy. We analyze the environmental, macroeconomic, and distributional effects of different policies allowing for energy taxation to be replaced with carbon taxation while at the same time allowing for the IPCC 2018 emissions reduction targets to be achieved. Our analysis indicates a clear path in the quest for decarbonization. First, replace energy taxes with a carbon tax; second, adopt the levels of carbon taxation necessary to achieve the emissions goals; third, use extra tax revenues from the carbon tax to reverse any potential adverse macroeconomic and distributional effects of the carbon taxation. In the process, this would be a way around the pervasive problem of perverse fossil fuel subsidies, which would effectively disappear and as such would improve the efficiency of the tax system.
