Abstract: To address the growing threat of climate change, countries have agreed to transition away from fossil fuels and significantly increase renewable energy. This paper examines positive and normative questions that arise with the joint use of carbon taxes and green energy subsidies in a world economy, allowing for lobbying pressures from the fossil and green energy sectors. The open economy setting provides a unilateral welfare rationale for the use of green subsidies, owing to a “reverse leakage” effect, whereby green subsidies can reduce fossil fuel output both at home and abroad. International climate agreements (ICAs) will always seek to increase carbon taxes, but the effect on green subsidies is more nuanced. An ICA removes green subsidies, even though they have positive international externalities at the noncooperative equilibrium. If, however, policies can only be changed gradually, an ICA may start by increasing subsidies before decreasing them over time. When we consider the welfare impacts of lobbying, we find that in the noncooperative scenario, pressures from the fossil lobby tend to reduce welfare, while pressures from the green lobby tend to increase welfare. We also find that in the presence of lobbying pressures, an ICA can decrease welfare relative to the noncooperative equilibrium, even though its only purpose is to correct climate externalities and it changes carbon taxes and green subsidies toward their efficient levels.

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