Pollution Taxes and Clean Subsidies in an Open Economy

Owen Kay ()

No 2533, Working Papers from Federal Reserve Bank of Dallas

Abstract: In open economies, the effectiveness of carbon taxes is diminished by “pollution leakage,” where some polluting activity shifts abroad because of the tax. This paper shows that the same conditions that lead to pollution leakage enhance the efficacy of clean subsidies. As a result, the optimal policy in an open economy combines a pollution tax and a clean subsidy, the balance of which depends on the leakage rate. Furthermore, efficient policy sets the sum of the tax and subsidy rates, a measure of policy ambition, equal to the marginal damages from pollution, and does not depend on the leakage rate.

Keywords: energy taxes; energy subsidies; clean subsidies; pollution leakage; optimal policy; open economy (search for similar items in EconPapers)
JEL-codes: F18 H21 H23 Q41 Q42 Q48 (search for similar items in EconPapers)
Pages: 59
Date: 2025-08-18
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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddwp:101526

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DOI: 10.24149/wp2533

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