Environmental Policy
Carbon taxes

According to standard welfare theory, all users of carbon should face the same carbon tax, as the environmental externality of carbon use is independent of where it is used. This argument is valid where there are no other distortions in the economy. One important possible distortion is that an international climate agreement may be incomplete. In Discussion Paper No. 1066, Michael Hoel argues that if some, but not all, countries are co-operating to reduce CO2 emissions, a high carbon tax on carbon-intensive tradable sectors in the co-operating countries will reduce the production of goods from these sectors, and therefore reduce CO2 emissions in those countries. This will to a large extent be counteracted by increased production of such goods in the countries which have no such policy, however. Since it is total CO2 emissions from all countries which is relevant for the climate, there is little advantage in a policy which simply shifts CO2 missions from the co-operating countries to other countries. Carbon-intensive tradable sectors should thus face a lower carbon tax than other sectors of the economy.

The author shows that a carbon tax should not be differentiated across sectors in the economy, provided import and export tariffs can be used on all traded goods. It is also shown that such a differentiation of carbon taxes is optimal for the co-operating countries if they are prevented from using tariffs on the traded goods. Informational or political factors constraining the use of tariffs are also likely to constrain the possibility of differentiating carbon taxes between sectors, however.

Should a Carbon Tax be Differentiated Across Sectors?
Michael Hoel
Discussion Paper No. 1066, December 1994 (IT)