Abstract: 

How should nations price carbon? This paper examines how interregional equity considerations and the availability of international climate finance affect optimal carbon prices—two key policy aspects not reflected in standard estimates. I develop theory to identify the conditions under which accounting for differences in marginal utilities of consumption across countries leads to more stringent global climate policy in the absence of international transfers. In calibrated simulations, I find that this inequality-sensitive approach reduces optimal global emissions, both if carbon prices are allowed to be regionally differentiated and if they are constrained to be globally uniform. I then assess the impact of the Paris Agreement’s $100 billion annual transfer on optimal carbon prices and emissions, finding that it further reduces global emissions if directed toward mitigation projects in developing countries. Accounting for inequality and transfers reduces optimal global emissions by 31% compared to a policy that excludes these factors.