Introduction

Governments worldwide have adopted diverse climate policy strategies. The European Union (EU) operates a comprehensive carbon emissions trading system (ETS), whereas the United States (US) has prioritised clean energy subsidies through the Inflation Reduction Act and administrative measures to curtail fossil fuel infrastructure. China has utilized industrial policies to lead global manufacturing in solar photovoltaics (PV), batteries, and electric vehicles (EVs). This research categorises climate policies into demand-side (targeting consumption) and supply-side (targeting extraction) and examines the economic trade-offs across four dimensions: local versus global emissions reductions, practical efficacy, global decarbonisation, and distributional consequences.

Basic model for demand and supply-side policies

In an idealised Pigouvian model of an economy in autarky, the surplus-maximising policy is a carbon tax equal to the social cost of carbon (SCC). In this scenario, demand-side taxes on use and supply-side taxes on extraction are equivalent in their economic effects and incidence. Clean energy subsidies are considered inefficient in this basic framework because they induce over-consumption of energy. Ordinarily, the statutory incidence of a tax—whether levied on the producer or consumer—does not affect its economic incidence.

Unilateral demand and supply-side policies in an open economy

In an open economy, carbon policies face the challenge of “leakage”, where domestic emissions reductions are offset by increases abroad. Demand-side carbon pricing alone lowers global fuel prices, which increases consumption in non-participating jurisdictions. Conversely, supply-side extraction pricing raises global fuel prices, counteracting this leakage. Combining both instruments allows a jurisdiction to manipulate global energy prices to reduce total emissions. For a major producer like the US, a model calibration with an SCC of $50/tonne suggests an optimal policy mix of a $29/tonne extraction tax, a $19/tonne use tax, and a $2/tonne clean energy subsidy. This combination reduces global emissions by 0.88 gigatonnes of CO2 (GtCO2) per year. For the EU, which has less extraction, the optimal extraction tax remains high at $28/tonne, but its inclusion is of secondary importance for emissions reduction compared to the use tax.

Demand and supply-side climate policies in practice

Climate policies in practice often depart from theoretical ideals. Supply-side measures frequently take the form of narrow infrastructure restrictions, such as blocking the Dakota Access Pipeline (DAPL) or US liquefied natural gas (LNG) export terminals. These are often inefficient; for instance, 82% of oil flows from DAPL would have likely shifted to more expensive rail transport rather than staying in the ground. On the demand side, retail electricity prices are frequently marked up above marginal costs due to volumetric charges by utilities, which hinders the electrification of transport and heating. Barriers to long-distance transmission investment also limit clean energy development. In the US, balkanised planning processes and misaligned utility incentives—including the Averch–Johnson effect—favour local over inter-regional projects. Relieving inter-regional congestion in the MISO and SPP regions could have reduced generation costs by $2 billion in 2022, though it would have reduced revenues for high-cost fossil fuel owners like Entergy by over $1 billion.

Innovation, industrial policy, and global emissions reductions

Decarbonising the world requires emissions reductions from low- and middle-income countries. Domestic demand-side policies can stimulate these reductions by driving down the costs of clean technologies. Public support for research and development (R&D) and green industrial policy is essential to overcome innovation market failures. Evidence from China shows that local policy support accounted for 50% of the reduction in solar PV prices between 2006 and 2020, with costs falling from $5/watt to $0.25/watt. By 2023, China accounted for 63% of global solar PV cell production and 85% of battery cell capacity. Such “big push” production subsidies can help supply chains escape low-adoption equilibriums and transition to stable, high-adoption states.

Distributional impacts of demand-side and supply-side policies

Domestically, carbon pricing transfers surplus from fossil fuel producers and consumers to taxpayers. In an open economy, an extraction tax falls mainly on domestic extractors; in the US model, 93% of the burden is borne by extractors. For an emissions tax, domestic consumers bear 92% of the burden. These impacts are geographically concentrated, with ten US counties accounting for 37% of oil production and 93% of growth from 2020 to 2024. Globally, the benefits of mitigation accrue primarily to the global poor. While supply-side pricing raises global fuel prices and could harm low-income fuel importers, data indicates a minimal correlation (-0.03) between CO2 net imports and GDP per capita, suggesting no systematic global equity trade-off between pricing instruments.

Concluding discussion

Economics points toward a portfolio of policies rather than a single instrument. Efficient global mitigation requires combining standard demand-side carbon pricing with broad-based supply-side extraction pricing to minimise leakage. Supply-side policies should move away from narrow infrastructure blocks toward comprehensive pricing. Additionally, clean energy policies should focus on reforms to utility governance and transmission planning to unlock resource potential, alongside targeted innovation support and green industrial policies to enable global adoption of clean technologies. While distributional consequences create policy “losers”, a multi-faceted approach is necessary to navigate the trade-offs of the global energy transition.