Carbon taxes and footprint leakage: Spoilsport effects

This paper uses simple variants of Melitz (2003) to illustrate how a unilateral consumption tax can reduce consumption everywhere. The tax—levied on the carbon embodied in consumer goods—reduces demand for dirty goods, lowering the profitability of the global industry. As profitability falls, so does entry, reducing competitive pressure on remaining firms. Less entry and competition translates to fewer varieties and higher average prices for all consumers, including in policy-inactive countries. As a result, a unilateral tax on embodied carbon may reduce the carbon footprint of every country.