Carbon Tariffs: Effects in Settings with Technology Choice and Foreign Production Cost Advantage

Abstract

Emissions regulation today is non-uniform, with some regions imposing carbon costs within their borders while many others do not. This gives rise to concerns over carbon leakage ― offshoring and foreign entry in response to regional asymmetry in carbon costs. It is widely believed that carbon leakage would result in increased global emissions, undermining the intent of emissions regulation. It is also widely believed that carbon tariffs ― carbon taxes imposed on goods imported from an unregulated region to a region subject to carbon costs ― would eliminate this leakage. Results here contrast these beliefs. This paper demonstrates that carbon leakage can arise despite a carbon tariff but, when it does, it decreases emissions in practical settings. Due in part to this clean leakage, imposing a carbon tariff is shown to decrease global emissions. Domestic firm profits, on the other hand, can increase, decrease, or remain unchanged due to a carbon tariff. Therefore a carbon tariff's general benefit is not protectionism disguised as climate policy, as some argue. Rather, a carbon tariff improves the efficacy of emissions regulation, enabling emissions price to be used to reduce global emissions in many settings in which it would otherwise fail to do so.

Keywords: Carbon regulation, Carbon leakage, Technology choice, Imperfect competition