Optimal Unilateral Carbon Policy

104 Pages Posted: 30 Nov 2021

See all articles by Samuel S. Kortum

Samuel S. Kortum

Yale University

David A. Weisbach

University of Chicago - Law School

Multiple version iconThere are 3 versions of this paper

Date Written: November 29, 2021

Abstract

We derive the optimal unilateral policy in a general equilibrium model of trade and climate change where one region of the world imposes a climate policy and the rest of the world does not. A climate policy in one region shifts activities—extraction, production, and consumption—in the other region. The optimal policy trades off the costs of these distortions. The optimal policy can be implemented through: (i) a nominal tax on extraction at a rate equal to the global marginal harm from emissions, (ii) a tax on imports of energy and goods, and a rebate of taxes on exports of energy but not goods, both at a lower rate than the extraction tax rate, and (iii) a goods-specific export subsidy. The policy controls leakage by combining supply-side and demand-side taxes to control the price of energy in the non-taxing region. It exploits international trade to expand the reach of the climate policy. We calibrate and simulate the model to illustrate how the optimal policy compares to more traditional policies such as extraction, production, and consumption taxes and combinations of those taxes. The simulations show that combinations of supply-side and demand-side taxes are much better than simpler policies and can perform nearly as well as the optimal policy.

Keywords: carbon taxes, border adjustments, leakage, climate change

JEL Classification: : F18, H23, Q54

Suggested Citation

Kortum, Samuel S. and Weisbach, David, Optimal Unilateral Carbon Policy (November 29, 2021). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2021-138, Available at SSRN: https://ssrn.com/abstract=3973615 or http://dx.doi.org/10.2139/ssrn.3973615

Samuel S. Kortum

Yale University ( email )

David Weisbach (Contact Author)

University of Chicago - Law School ( email )

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