Central Bank of Luxembourg publishes research finding high carbon tax needed to limit warming and richer countries less willing to adopt it

The Central Bank of Luxembourg published Cahier d’études No. 205, “The rich, the poor, and the carbon tax”, which develops a multi-country growth and climate model to assess the feasibility and effects of a global carbon tax, including which countries would support such an initiative and how preferences change with the time horizon. The model combines a neoclassical growth framework with a climate module in which production generates CO2 that accumulates in the atmosphere and reduces growth, calibrated using data on output, capital stocks and energy use for more than 130 countries, alongside global energy prices and atmospheric CO2 concentrations. The paper finds that limiting temperature increases requires a high carbon tax, illustrating that a tax of USD 351/tCO2 would cap the temperature increase since 2021 at 0.25°C by 2050 and 1.2°C by 2100, whereas USD 37/tCO2 leads to 0.7°C by 2050 and 3°C by 2100. It also concludes that richer countries are less inclined than poorer countries to adopt a carbon tax, attributed to greater capacity to adapt to climate impacts, and that support depends on whether countries focus on short-term growth costs or longer-term gains as lower emissions ultimately raise productivity growth enough to offset the initial drag from higher fossil energy prices and slower capital accumulation. The authors note that the study’s views do not necessarily represent those of the Central Bank of Luxembourg or the Eurosystem.