A Framework for Integrating Climate Goals into Trade Agreements

A critical tension in global governance is that trade agreements have evolved largely in isolation from climate policy. This paper shows that the two domains generate systematic cross-externalities: larger gains from trade are associated with greater climate externalities imposed on partners, while linking carbon taxes to trade agreements produces distributive externalities that undermine the balance of trade concessions. To address this tension, we present a framework to integrate harmonized carbon pricing into the WTO subject to institutional and political-feasibility constraints. We explore two linkage designs. The first is a centralized Climate Fund, where all members apply a common demand-side carbon tax and contribute a portion of the revenues to the fund, capped by fiscal constraints. The Fund then reallocates these contributions to balance the tax burden across countries, subject to informational constraints. Quantitative analysis shows that even a simple fund allocation rule can sustain a carbon price of $138 per ton of CO2, reducing global emissions by 54%. The main binding constraint is informational: knowing the precise incidence of the carbon tax across countries ex ante would raise the feasible price to $265. The second is a decentralized design without transfers. Each member meets a carbon tax revenue floor but retains full discretion over its mix of demand-side and supply-side taxes. Energy exporters choose supply-side taxes while energy importers opt for demand-side taxes. These choices organically balance the tax burden and yield a 47% reduction in global emissions, almost rivaling the centralized Climate Fund.