How Tight is the Deadlock? Strategic Interactions in Climate Policy Revisited

Abstract

We investigate strategic interactions in non-cooperative climate actions in a two-country model with integrated capital and goods markets. We find that there is strategic substitutability in the abatement dimension of policy, but that, contrary to common perception, there is strategic complementarity in the taxation dimension even though both motives are present. When trading partners increase their climate tax, it induces a substitutability motive because the marginal benefit of climate action decreases, but a less fierce tax competition also makes it less costly to raise public funds domestically which induces complementarity. In baseline, complementarity dominates. Our results show that the green transition may be easier than predicted, as climate actions, at least in the tax dimension, could very well reinforce each other.

Keywords: Strategic interaction, carbon taxes, climate change, non-cooperative policy