DP8215 Growth and the Optimal Carbon Tax: When to Switch from Exhaustible Resources to Renewables?

Author(s):	Frederick van der Ploeg, Cees Withagen
Publication Date:	January 2011
Keyword(s):	carbon tax, exhaustible resources, global warming, Green Paradox, growth, intergenerational inequality aversion, renewables, second best
JEL(s):	D90, E13
Programme Areas:	International Macroeconomics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=8215

Optimal climate policy is studied in a Ramsey growth model. A developing economy weighs global warming less, hence is more likely to exhaust fossil fuel and exacerbate global warming. The optimal carbon tax is higher for a developed economy. We analyze the optimal time of transition from fossil fuel to renewables, amount of fossil fuel to leave in situ, and carbon tax. Subsidizing a backstop without an optimal carbon tax induces more fossil fuel to be left in situ and a quicker phasing in of renewables, but fossil fuel is depleted more quickly. Global warming need thus not be alleviated.