On the Design of a Carbon Border Adjustment Mechanism

Martin Richardson (), Frank Stahler () and Halis Yildiz ()
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Martin Richardson: Research School of Economics, The Australian National University, Canberra
Frank Stahler: School of Business and Economics, University of Tubingen, Tubingen, Germany
Halis Yildiz: Department of Economics, Toronto Metropolitan University, Toronto, Canada

No 98, Working Papers from Toronto Metropolitan University, Department of Economics

Abstract: We identify a condition in a general equilibrium model of trade with tariff bindings under which a customs union (CU) can design a carbon border adjustment mechanism (CBAM) that induces other countries to adopt the CU's carbon tax. Trade liberalization makes this easier and so would help the CU `export' its climate policies. We then show that, in an inter-industry, perfectly competitive framework with competing exporters, the optimal carbon tax is lower when the CU maximizes CU welfare than if it were to maximize global welfare. Furthermore, the CU optimally raises its tariff threat via CBAM by less than the difference in member and non-member environmental taxes. By contrast, in an intra-industry oligopoly model of trade with profit shifting incentives, we find the opposite result, with a "penalty" tariff threat that exceeds the difference in carbon taxes.

Keywords: Tariff Binding; Carbon Leakage; Climate Change; Carbon Border Adjustment Mechanism; European Union (search for similar items in EconPapers)
Pages: 31 pages
Date: 2026-01
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