Levying carbon tariffs considering foreign competition and technology choice

Abstract

Firms operating in regions with strict carbon regulations often face foreign competition from exports in regions with laxer regulations. Carbon tariffs, taxes imposed on imported goods, significantly affect these firms’ technology choices and production. This study evaluates the efficiency of three prevalent carbon tariffs: the default low/high-pollution tariff and the nondefault tariff. The former is levied based on default green/existing technology, while the latter is based on firms' actual applied technology. We investigate the equilibrium decisions made by domestic and offshore firms regarding technology and production given the carbon tariffs established by the domestic government. The carbon tariffs are evaluated in terms of green technology incentivization, market share retainment, and total greenhouse gas (GHG) emissions reduction. Moreover, social welfare, a composite indicator of concern to policymakers, is considered so that a social maximum can be achieved. Our findings reveal that although the imposition of carbon tariffs incentivizes domestic firms to utilize green technology, it can disincentivize offshore firms from doing so. In terms of market share retainment and total GHG emissions reduction, the default high-pollution tariff performs at least as well as the default low-pollution tariff and the nondefault tariff. Moreover, for policymakers with the objective of social welfare maximization, it is not always optimal to impose carbon tariffs as carbon tariffs can fail to improve social welfare. Further, when the imposition of carbon tariffs improves social welfare, it is the default high-pollution tariff that improves the most.