Abstract
A carbon tax trades off the distortionary costs of taxation and the future gains from slowing down global warming. Because the cost is local and the benefit is global, this trade-off tends to be unfavorable to unilateral carbon taxes. This logic breaks down in a world whose economic geography is shaped by agglomeration economies and other externalities. Using a spatial integrated assessment model (SIAM), this paper shows that a 40 US$/tCO2 carbon tax introduced by the European Union and rebated locally would improve EU welfare by further concentrating economic activity in its high-productivity industrial core. Such a carbon tax increases global inequality, with much of the developing world gaining and much of the developed world losing. This growing inequality is mitigated if carbon tax revenues are rebated globally.