Samuel Kortum, David A. Weisbach

We consider climate policy in a world with international trade where one region of the world imposes a climate policy and the rest of the world does not. The central concern in this setting is that unilateral climate policy may generate inefficient shifts in the location of extraction, production, and consumption, an effect known as leakage. We derive the optimal unilateral policy and show how it can be implemented through taxes. The optimal policy involves (i) a tax on extraction at a rate equal to the marginal harm from emissions, (ii) a border adjustment on the import and export of energy and on the import, but not the export, of goods, with the border adjustment at a different (usually lower) rate than the extraction tax rate, and (iii) an export policy designed to expand the export margin. The optimal policy allows the pricing region to exploit international trade to expand the reach of its climate policy. We calibrate and simulate the model to illustrate how the optimal policy compares to more traditional policies.

Areas of Focus: Climate Change
Definition
Climate Change
Climate change is an urgent global challenge. EPIC research is helping to assess its impacts, quantify its costs, and identify an efficient set of policies to reduce emissions and adapt...
Climate Law & Policy
Definition
Climate Law & Policy
As countries around the world implement policies to confront climate change, EPIC research is calculating which policies will have the most impact for the least cost.
A Solution to the Leakage Problem
Definition
A Solution to the Leakage Problem
A simple, clearly legal, and more effective alternative to border tax adjustments could be to tax domestic extraction along with border adjustments on imports and exports of energy.