Unilateral Climate Policy with Production-Based and Consumption-Based Carbon Emission Taxes

Abstract

This paper characterizes a sub-global climate coalition’s unilateral policy of reaching a given climate damage reduction goal at minimum costs. Following Eichner and Pethig (J Environ Econ Manag, 2013) we set up a two-country two-period model in which one of the countries represents a climate coalition that implements a binding ceiling on the world’s first-period emissions. The other country is the rest of the world and refrains from taking action. The coalition can make use of production-based carbon emission taxes in both periods, as in Eichner and Pethig (J Environ Econ Manag, 2013), but here we consider consumption-based carbon emission taxes as an additional instrument. The central question is whether and how the coalition employs the consumption-based taxes along with the production-based taxes in its unilateral cost-effective ceiling policy. All cost-effective policies identified analytically and numerically consist of a mix of both types of taxes implying that there is a tax mix which is less expensive for the coalition than stand-alone consumption-based or stand-alone production-based taxes. With full cooperation both taxes are perfect substitutes (in our model), but in case of unilateral action they are imperfect substitutes, because coalition’s total welfare loss from two different but moderate distortions is smaller than that from a single but severe distortion.