Dynamic Border Carbon Taxes to Enhance Green Growth

Abstract

This paper theoretically analyzes the growth and welfare impacts of dynamic Border Carbon Taxes (BCT) across trading countries. I build a trade model with dynamic investment decisions using a Ramsey growth model. The government in each country can invest either in costly nonpolluting capital or in cheap polluting capital. The model is solved numerically for an open loop Nash equilibrium to study different configurations of BCTs across countries. I find that a unilateral BCT is welfare enhancing for the country that applies it and an effective tool to shift the growth of the other country towards greener path even when countries are not concerned about the environment. Results show that a bilateral BCT becomes welfare enhancing for both countries if governments care sufficiently about the environmental quality of their consumers. Moreover, the asymmetry in initial development levels across countries induces a slower growth for the initially poorer country only if the other country is richer in the polluting capital. Furthermore, the model shows that trade openness should be achieved gradually along the development path of countries.