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The suboptimal nature of applying Pigouvian rates as border adjustments

Author

Listed:
  • Hidemichi Yonezawa

    (Division of Economics and Business, Colorado School of Mines)

  • Edward J. Balistreri

    (Division of Economics and Business, Colorado School of Mines)

  • Daniel T. Kaffine

    (Division of Economics and Business, Colorado School of Mines)

Abstract
We consider a North-South trade model with cross-border environmental damage where the North imports the relatively dirty good. The North sets domestic production taxes according to each industry's contribution to environmental degradation (Pigouvian taxes), but this exacerbates cross-border damages. It is well understood that a large economy in this situation can use border taxes to mitigate the damage, but a large economy also has an incentive to use trade policy to extract rents (Markusen, 1975). We formulate a model that neutralizes the rent-seeking incentives, through an endogenous transfer, to focus only on environmental incentives. We find that setting the North's import tariff at the Pigouvian rate is above the optimal, because it indirectly reduces the North's exports, favoring consumption of the dirty good in the South. Even in the case of full border tax adjustment, where the import tariff is partially canceled out by an export subsidy set at the Pigouvian rate for the export industry, trade is taxed too much. Considering the inherent general equilibrium nature of trade policy, the North's optimal border adjustment to mitigate the cross-border damage is a net import tariff set below the Pigouvian rate.

Suggested Citation

  • Hidemichi Yonezawa & Edward J. Balistreri & Daniel T. Kaffine, 2012. "The suboptimal nature of applying Pigouvian rates as border adjustments," Working Papers 2012-02, Colorado School of Mines, Division of Economics and Business.
    • Handle: RePEc:mns:wpaper:wp201202
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    File URL: http://econbus-papers.mines.edu/working-papers/wp201202.pdf
    File Function: First version, 2012
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    References listed on IDEAS

    as
    1. Joseph E. Aldy & Alan J. Krupnick & Richard G. Newell & Ian W. H. Parry & William A. Pizer, 2010. "Designing Climate Mitigation Policy," Journal of Economic Literature, American Economic Association, vol. 48(4), pages 903-934, December.
    2. Rutherford, Thomas F., 1995. "Extension of GAMS for complementarity problems arising in applied economic analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 19(8), pages 1299-1324, November.
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    Cited by:

    1. Christoph Böhringer & Jared C. Carbone & Thomas F. Rutherford, 2018. "Embodied Carbon Tariffs," Scandinavian Journal of Economics, Wiley Blackwell, vol. 120(1), pages 183-210, January.
    2. Edward J. Balistreri & Daniel T. Kaffine & Hidemichi Yonezawa, 2019. "Optimal Environmental Border Adjustments Under the General Agreement on Tariffs and Trade," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 74(3), pages 1037-1075, November.
    3. Christoph Boehringer & Thomas Fox Rutherford, 2017. "Paris after Trump: An inconvenient insight," Working Papers V-400-17, University of Oldenburg, Department of Economics, revised Jun 2017.
    4. Michael Jakob & Jan Christoph Steckel & Ottmar Edenhofer, 2014. "Consumption- Versus Production-Based Emission Policies," Annual Review of Resource Economics, Annual Reviews, vol. 6(1), pages 297-318, October.
    5. repec:old:wpaper:345 is not listed on IDEAS
    6. Böhringer, Christoph & Bye, Brita & Fæhn, Taran & Rosendahl, Knut Einar, 2012. "Alternative designs for tariffs on embodied carbon: A global cost-effectiveness analysis," Energy Economics, Elsevier, vol. 34(S2), pages 143-153.
    7. repec:zbw:hohpro:345 is not listed on IDEAS
    8. Fischer, Carolyn & Fox, Alan K., 2012. "Climate policy and fiscal constraints: Do tax interactions outweigh carbon leakage?," Energy Economics, Elsevier, vol. 34(S2), pages 218-227.
    9. Weitzel, Matthias & Hübler, Michael & Peterson, Sonja, 2012. "Fair, optimal or detrimental? Environmental vs. strategic use of border carbon adjustment," Energy Economics, Elsevier, vol. 34(S2), pages 198-207.

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