OPTIMAL EMISSION PRICING IN THE PRESENCE OF INTERNATIONAL SPILLOVERS:DECOMPOSING LEAKAGE AND TERMS-OF-TRADE MOTIVES

Carbon control policies in OECD countries commonly differentiate emission prices in favor of energy-intensiveindustries. While leakage provides a efficiency argument for differential emission pricing, the lattermay be a disguised beggar-thy-neighbor policy to exploit terms of trade. Using an optimal tax framework,we propose a method to decompose the leakage motive and the terms-of-trade motive for emissionprice differentiation. We illustrate our method with a quantitative impact assessment of unilateral climatepolicies for the U.S. and EU economies. We conclude in these instances that complex optimal emissionprice differentiation does not substantially reduce the overall economic costs of carbon abatementcompared with a simple rule of uniform emission pricing....