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Abstract: Alleviating the economic damages from climate change is, to first order, a problem of efficiently limiting firms’ emissions. We analyze a neoclassical general-equilibrium model in which fossil-energy use generates climate damages. The model crucially incorporates substantial cross-firm heterogeneity in emission intensity that we document using a novel firm-level dataset spanning 150 countries. Firms choose energy and other inputs and self-report emissions that are otherwise privately observed. Our central result is a simple formula for the optimal carbon tax that modifies marginal externality damages to account for firms’ incentives to distort reported emissions. Unlike standard carbon-tax proposals, the optimal tax varies markedly across firms as a function of emission intensities and exceeds common uniform-tax benchmarks, on average. Quantifying the model shows large welfare gains from internalizing reporting incentives: the constrained optimal tax recovers 3/4 of the potential welfare benefits; a uniform tax that does not internalize reporting incentives, by contrast, recovers almost none of them.

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