Environmental Taxation and International Trade in a Tax-Distorted Economy

Abstract

International environmental agreements have been met with the reluctance of some national authorities to accept general commitments aimed at reducing greenhouse gas emissions. While acknowledging the crucial significance of the climate change process, politicians and regulators in some countries have argued that pollution measures would have a negative impact on their domestic welfare. This article uses a standard general equilibrium model of perfect competition to examine the welfare effects of taxing a polluting-exported good through an explicit representation of the trade relations of the economy in the presence of pre-existing taxes. The equivalent autarky model is used to contrast the welfare impacts with the open economy situation. The results extend the scope of the literature on second-best environmental taxation by identifying the complexity of the components affecting welfare in open economies.