Unilateral Carbon Taxes, Border Tax Adjustments, and Carbon Leakage

Abstract

We examine the impact of a unilateral carbon tax in developed countries focusing on the expected size of carbon leakage (an increase in emissions in non-taxing regions as a result of the tax) and the effects on leakage of border tax adjustments. We start by analyzing the problem using a simple two-country, three-good general equilibrium model to develop intuitions. We then simulate the expected size of the effects using a new, open-source, computable general equilibrium (CGE) model. We analyze the extent of emissions reductions from a carbon tax in countries that made commitments under the Kyoto Protocol (Annex B countries), the expected carbon leakage, and the effects of border tax adjustments on carbon leakage, all relative to our baseline projections for emissions. We also perform extensive sensitivity tests on the parameters of the CGE model. Finally, we consider the effects of imperfect border tax adjustments on leakage, such as global or regional schedules of border taxes.