On the strategic use of border tax adjustments as a second-best climate policy measure

We investigate the interaction between a developed country that imports a carbon-intensive product, such as electricity, and a transitioning economy that exports the product. Production of the good generates a transboundary externality related to climate change; if this externality is priced improperly, the application of a feed-in tariff or border tax adjustment can provide an indirect policy instrument. We analyze the application of such a measure in a stark model where the importing country cares about climate-related damages while the exporting country does not; this can be viewed as reflecting a scenario where the (developed) importing country is more concerned about climate change than is the (transitioning) exporting economy. Because climate change will occur over a long time frame, the problem is dynamic. In this modeling context, we describe the manner in which the (second-best) tariff-cum-border tax adjustment relates to the carbon stock.

STRATEGIC EFFECTS OF A BORDER TAX ADJUSTMENT

Carbon leakage and competitiveness concerns are some of the main reasons why an international environmental agreement is lacking to fight climate change. Many studies discussed the adoption of a border tax adjustment (BTA) to allow countries that would like to implement a carbon tax to level the playing field with imports. The big drawback from these studies is that the other country is not allowed to react by adopting itself a carbon tax to avoid being punished with the BTA. The model proposed in this paper looks at the optimization of two different governments and their respective firms. Parametric values inside the set [0, 1) are used to represent the possible extents of the BTA depending on both countries environmental policy allowing countries to have different carbon policies. The result that a BTA parameter of 0.5 yields the highest total welfare could increase its acceptance within the World Trade Organization (WTO).