Carbon Tariffs as Climate Policy

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) Absent a domestic price on carbon, a carbon tariff imposes the same costs on domestic consumers as a domestic carbon price, but a carbon tariff also subsidizes domestic pollution. (2) 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. If all countries impose carbon taxes, with or without carbon tariffs, the incidence of the taxes depends on the relative elasticities of world supply and demand. (3) If a holdout country joins the rest of the world by enacting its own carbon regulation and consequently imports more from other countries, those increased imports are not “leakage.” They are the cessation of leakage from other regulated countries when the holdout country’s policy was lax. And (4) 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.