Integrated Assessment Models (IAMs) are widely used to estimate the social cost of carbon, i.e. the economic cost caused by an additional ton of carbon dioxide emissions. Such models assume full employment and aggregate demand while abstaining from a financial sector. Against this background, we create an agent-based climate-economy model as a disaggregated, behavioural approach to IAMs. It describes networks of heterogeneous consumers, banks, power plants and firms, while it is calibrated to generate patterns of growth and carbon dioxide emissions consistent with Dynamic Integrated Climate-Economy model (DICE). We pay attention to how climate change affects, notably through unemployment, three types of inequalities, namely in consumption, wealth and income. These provide an essential but overlooked link between climate-change damages and the optimal carbon tax. In the model, climate damages reduce budgets of individual consumers. By comparing three distributions of damages – proportional, uniform, and inversely proportional to individual wealth – we find that the first of these gives rise in the highest rate of firms’ bankruptcies and income inequality. This translates into a lower estimate of the social cost of carbon compared to other damage distributions. Another finding is that using tax revenues to support investments in renewable energy is more equitable in income and consumption, but not in wealth, than tax rebates. This is due to more favourable employment effects. Bounded rationality in the form of habits is found to negatively affect distributional equity of a carbon tax.
