Emissions Disclosures in Global Supply Chains

Abstract

Countries committed to reducing global warming must contend with the reality that emissions are largely caused by activities in foreign countries that fall beyond direct domestic regulatory control. While governments may attempt to use their regulatory authority pertaining to domestic firms to tax the emissions associated with the production of international inputs, such approaches often have to rely on voluntary disclosures by foreign trade partners. Recognizing these challenges, we study a government's optimal regulatory policy when facing domestic firms that source inputs from international supply chain partners who cannot be forced to provide accurate emissions disclosures, but rather choose them voluntarily. We show that contrary to the prescriptions of the Pigouvian tax principle underlying carbon credit markets, taxes should be a convex function of disclosed emissions within a supply chain relation. Our analysis characterizes how domestic households' exposure to the damages associated with global emissions shape both a government's optimal regulatory interventions and the granularity of foreign firms' voluntary disclosures.

Keywords: Global warming, Carbon credit markets, Environmental ratings, Market power, Optimal taxation

JEL Classification: F18, L11