The Politics of Carbon Pricing: Young vs. Old, Debtors vs. Creditors

We develop a small open economy model with overlapping generations to analyse the macroeconomic, distributional, and political economy effects of unilateral climate policy under an emissions cap. Carbon pricing lowers wages and thus human wealth, while financial assets continue to earn the world interest rate. This asymmetry generates sharp generational and cross country differences: in creditor economies the young lose most, whereas in debtor economies the old bear the heaviest burden as they must reduce their debt when incomes fall. We compare constant carbon taxes with efficient Hotelling price paths and show that delayed implementation dramatically raises the carbon price needed to meet a fixed emissions cap, especially in debtor economies. Hotelling pricing yields substantially lower near term welfare losses. Across all policies, carbon pricing depresses wages, reduces consumption and human wealth, and induces capital flight; labour supply responses differ by asset position. Public debt can be used to secure majority support for climate policy by shifting part of the burden to future generations—more easily so in creditor economies than debtor ones. Since labour tax cuts counteract the wage depression caused by climate policy, less debt is needed to obtain a political majority.