Supply‐ Versus Demand‐Side Policies in the Presence of Carbon Leakage and the Green Paradox

Abstract

We consider a climate coalition that seeks to reduce global emissions in the presence of carbon leakage and resource exhaustibility. We show that a credible announcement of future unilateral supply‐side policies delays foreign emissions, and we derive the optimal combination of consumer taxes and producer taxes when we consider leakages from free riders, both within periods and across periods. The tax shares generally differ over time. A decline in the present value of the social cost of carbon over time supports a time path where the consumers’ tax share of the total carbon tax also declines over time. We illustrate our findings with a numerical model.

Keywords: Carbon leakage, climate coalition, demand‐side climate policy, green paradox, supply‐side climate policy