Environmental taxes and productivity: Lessons from Canadian manufacturing

•I develop a new hypothesis, the “Productivity Dividend Hypothesis.”.•Environmental tax can raise productivity by using tax revenue to lower corporate tax.•I investigate a revenue-neutral carbon tax implemented in British Columbia, Canada.•I find that recycling revenues alleviates productivity shocks from the carbon tax. This paper investigates how environmental taxes affect manufacturing productivity by examining British Columbia’s revenue-neutral carbon tax. I develop a new hypothesis, the “Productivity Dividend Hypothesis,” to show that environmental taxes can positively affect productivity by recycling tax revenues to reduce corporate income taxes. This revenue-recycling increases investment and could raise productivity more than environmental taxes lower productivity by diverting resources from production. I evaluate this hypothesis using detailed confidential plant-level data. I find that the carbon tax lowers productivity, although this is offset to some extent by the revenue-recycling. For some plants, the policy generates a net gain in productivity.