<p>The costs and speed of the energy transition are closely linked to the elasticity of substitution between fossil fuels and clean energy sources. Yet, despite its central role, this parameter has been treated as exogenous and constant in numerical studies of climate policy. Drawing on recent empirical evidence, this paper incorporates an endogenous elasticity of substitution that flexibly interacts with the relative share of clean energy in the economy into the CITE model—a dynamic CGE model of Switzerland featuring endogenous growth and heterogeneous households. Using this refined approach, I compare the equity and efficiency implications of carbon taxation under endogenous versus exogenous energy substitution and explore alternative revenue recycling schemes, including lump-sum transfers to households and output subsidies for clean energy. Although beneficial to the economy as a whole, the dynamic feedback effect arising from endogenous energy substitution has distributional impacts favoring high-income households, challenging its presumed progressivity. Redistributing carbon tax revenues as output subsidies for clean energy is most efficient in terms of aggregate welfare under low-to-moderate climate targets. However, due to the absence of direct household transfers, this policy option leads to the most regressive outcome, highlighting an equity–efficiency trade-off in the design of tax-based climate policy.</p>