Strategic Carbon Taxation, Emissions and Welfare

We model equilibrium carbon emissions and welfare in an imperfectly competitive two-country world in which countries strategically choose carbon taxes to maximize national welfare. Each country trades off total national surplus and the cost of global carbon emissions, but differs in its degree of concern about global emissions (CAE) and in its carbon efficiency (CE). We show that CAEs and CEs influence the strategic interaction between countries and, hence, Nash equilibrium carbon taxes, emissions and welfare. Our simulations demonstrate that there is no clear-cut relationship between equilibrium emissions and welfare. While an increase in one country’s CAE reduces global emissions -and global welfare - individual country emissions and welfare may rise or fall. Moreover, an increase in a country’s CE does not guarantee lower emissions or higher welfare nationally or globally. Our results suggest that international trade can reduce global emissions; consumers can access more carbon-efficient sources of production.