Carbon Tariffs

We evaluate the economic and environmental consequences of carbon tariffs—taxes on imports of goods based on their carbon content. The analysis uses the simplest possible partial equilibrium framework, with a polluting good traded internationally on world markets, and one small economy whose tariffs do not affect world prices. It relies on graphs of supply and demand rather than equations, hoping to reach readers familiar with basic economics. Despite its simplicity, the framework imparts numerous lessons. (1) Carbon tariffs prevent leakage by shifting the burden of carbon taxes away from producers who might relocate production overseas onto consumers who cannot easily move their consumption abroad. (2) In the absence of a domestic price on carbon, a carbon tariff not only imposes the same costs on domestic consumers as a domestic carbon price but also subsidizes domestic pollution. (3) If one small country imposes a carbon tariff, with or without a domestic carbon tax, the economic incidence of the tariff falls on its consumers. (4) If a newly enacted domestic carbon policy leads to a decline in domestic production offset by a rise in imports, that does not necessarily represent leakage. It could instead describe the cessation of leakage from foreign countries with carbon policies to the domestic economy when it did not have a carbon policy. And (5) if other countries do not appropriately regulate emissions, no single small country can use a combination of carbon taxes and carbon tariffs to fully correct the problem caused by its consumers or producers.