Who pays the bill? Climate change, taxes, and transfers in a multi-region growth model

Abstract

This paper presents a quantitative study of a dynamic climate-economy model with multiple regions to evaluate how implementing an optimal climate tax affects production, emissions, and welfare in each region. We develop a numerical algorithm which is generally applicable to compute equilibria in the presence of arbitrarily many regions and under alternative climate policies. Our simulation model distinguishes six major world regions and incorporates a wide array of regional heterogeneities including a detailed description of the energy production process in each region. We also quantify the full range of Pareto-improving transfers under which each region has an incentive to join the global climate agreement. Our results show that optimal taxation reduces coal consumption in each region substantially by about 70% and leads to higher GDP within the next 100 years in most regions. The only exception is China which suffers losses in GDP for the next 130 years due to its strong dependence on coal and must be incentivized via transfer payments to implement the optimal tax. We also show that the increase in global temperature under optimal taxation is compatible with the two-degree target.