The incidence of CO2 emissions pricing under alternative international market responses A computable general equilibrium analysis for Germany

Highlights: • International market responses to domestic emissions pricing are an important factor for economic adjustment costs • The small-open-economy setting overstates overall economic adjustment costs in the case of Germany • The small-open-economy setting understates the progressiveness of CO₂ revenue recycling across heterogeneous households in the case of Germany We investigate the economic impacts of CO₂ emissions pricing for Germany in the context of the Paris Agreement where we highlight the role of international market responses for the incidence across heterogeneous households. We consider three settings for international spillover effects: (i) a small-open-economy framework where international commodity prices remain constant, (ii) a multi-region-trade framework with endogenous terms of trade where only Germany undertakes emission pricing, and (iii) a multi-region-trade framework where all other regions also price CO₂ emissions. In all three settings Germany complies to a given domestic CO₂ emissions reduction target through economy-wide uniform CO₂ emissions pricing. CO₂ revenues are recycled lump-sum to households on an equal-per-household basis. We find that the small-open-economy setting in the case of Germany not only overstates overall economic adjustment costs to CO₂ emissions pricing, but also understates the degree of progressiveness of CO₂ revenue recycling. The reason is that in the multi-region-trade frameworks Germany is able to pass through part of its economic adjustment costs to trading partners via higher export prices. As a consequence, the CO₂ prices required to achieve the domestic emissions reduction target are higher, yielding more CO₂ revenues that are recycled to households.