Unilateral Carbon Taxation in the Global Economy: The Green Paradox and carbon leakage revisted

Unilateral, second-best carbon taxes are analysed in a two-period, two-country model with international trade in final goods, oil and bonds. The increase in oil demand and acceleration of global warming resulting from a future carbon tax are large if the price elasticities of oil demand are large and that of oil supply is small, but are attenuated by the fall in the world interest rate especially if intertemporal substitution is weak. Despite this Green Paradox effect, green welfare rises if the fall in oil exploration is strong enough. If the current carbon tax is too low, the second-best future carbon tax is set below the first best to mitigate adverse Green Paradox effects. Unilateral exceed first-best carbon taxes due to an import tariff component. The intertemporal terms of trade effects of the future carbon tax increase current and future tariffs and those of the current tax lower the current tariff. Unilateral taxes are time inconsistent. Finally, carbon leakage and globally altruistic and unilateral optimal carbon taxes if other oil importers do not price carbon are analysed in a three-country model of the global economy.