Border carbon adjustment (<scp>BCA</scp>) and heterogeneous firms trade

Abstract I explore the effect of a carbon tax and a border carbon adjustment (BCA) under the asymmetric heterogeneous trade model of Melitz (2003, Econometrica , 71, 1695). I achieve several results with welfare and policy implications. First, firms in both the home and foreign country tend to adopt high technology because of the home country's stricter environmental policy, and the imposition of BCA stimulates this technological upgrade further for the home country. Second, as a result of a higher emission tax, the home country is worse off from consumption, and lessens the emissions. Whereas, the foreign country can enjoy higher welfare from its consumption, and increases the emissions in its exports (‘carbon leakage’). The imposition of BCA can alleviate these problems, but it relocates the emissions back to the home country, and thus the total emissions increase slightly.