Fighting climate change requires ambitious global policies, which are undermined by free-riding incentives. Multilateral agreements and carbon tariffs are usually proposed to address this issue, c.f. Nordhaus (2015) among others. Moreover, climate policy has strong redistributive effects across countries due to inequality in income, climate impacts, effects on energy markets, or trade leakage, which exacerbate non-cooperation. In this context, how can we design a climate agreement that accounts for all these different channels to fight climate change? Through the lens of an Integrated Assessment Model (IAM) with heterogeneous countries and international trade, Thomas Bourany studies the taxation of carbon when countries can exit climate agreements. Participation constraints create a policy tradeoff between an intensive margin – a “climate club” with few countries implementing large emission reductions – and an extensive margin — accommodating a larger number of countries at the cost of lowering the carbon tax. Thomas solves for the optimal design of the club. Despite full discretion in the choice of carbon tax and tariffs, one cannot achieve the world’s optimal policy with complete participation. It can be beneficial to leave several fossil fuels producing and developing countries outside of the climate agreement. He explores how transfers, as proposed in the COP’s loss and damage fund, or fossil-fuel specific tariffs can increase abatement and welfare by mitigating the adverse redistributive effects of climate change and carbon taxation.
