Combining Carbon Taxation and Offset Payments: A New Approach to Climate Policy in Low-Income Countries

Abstract

I consider a “low-ambition” (LA) country with no current climate policy, with two sectors. Sector 1 can in principle sell an unlimited amount of carbon offsets to a bloc of “high-ambition” (HA) countries. A condition for access to the right for sector 1 to sell unlimited offsets is that sector 2 of the LA country implements a comprehensive carbon tax. When the two sectors have equal size, and public and private revenues are valued equally by the LA government, a carbon tax in sector 2, equal to the offset price for sector 1, can be incentivized. The HA country bloc then buys offsets from the LA country at a price equaling its carbon externality cost. When sector 1 is larger (smaller) than sector 2, the offset price in sector 1 will be lower (higher) than the carbon tax in sector 2. When public funds are more valuable than private funds to the LA government, the implementable carbon tax is higher, and the optimal offset price lower. The model provides a novel mechanism by which a bloc of HA countries can incentivize LA countries to implement enhanced greenhouse gas mitigation.