A Carbon Tax Credit Policy in the Presence of Technological Spillovers

We model an environmental policy problem with two representative firms in two countries (one for each country). Firms are subject to environmental taxation, aimed at reducing CO2 emissions, and a unilateral technological spillover takes place: one of the two countries (innovating country) is responsible for generating the technological spillover while the other country is the one benefiting from the spillover e¤ect. Two different scenarios are analysed: one where countries do not cooperate and one where a single supranational authority is in charge of setting environmental policy. At first, both countries feature emissions taxation aimed at reducing CO2 emissions. In such a case, we show that the standard international externality applies, i.e. a suboptimal emission tax rate is set, leading to larger than efficient pollution. However, the tax rate is larger than marginal national damages in the innovating country due to the need to provide incentives towards technical change. Then we present a setting where the two countries are both subject to a national tax on emissions but the innovating country introduces a tax credit which is directly proportional to the innovative effort. In such a setting, we obtain counterintuitive results: interestingly, for a sufficiently large spillover, the tax rate in the non cooperative setting might exceed the one arising under cooperation.