Working Paper: CEPR ID: DP18645
Authors: Alessia Campolmi; Harald Fadinger; Chiara Forlati; Sabine Stillger; Ulrich Wagner
Abstract: High carbon prices in the EU might drive emission-intensive industrial processes towards countries with relatively lower carbon prices. To prevent such carbon leakage, the EU’s Carbon Border Adjustment Mechanism (CBAM) taxes emissions embedded in imports for the difference between carbon prices in the EU and the origin country. Because embedded emissions are very difficult to measure, CBAM applies to only five industries and accepts benchmarks instead of actual embedded emissions. These simplifications make CBAM tractable but compromise its effect on carbon leakage. We propose an alternative policy that requires no knowledge of embedded emissions and can be applied to all tradable sectors: the Leakage BorderAdjustment Mechanism (LBAM). LBAM implements import tariffs (and, possibly, export subsidies) that sterilize the changes in imports (and exports) induced by a higher EU carbon price. LBAM requires information only about domestic output-to-emissions elasticities as well as elasticities of import demand and export supply, which we estimate using publicly available data. We calibrate a granular structural trade model with 57 countries and 131 sectors to quantify the welfare and emission impacts of LBAM. We find that LBAM improves over CBAM in terms of global emissions and EU welfare. We assess how ‘climate clubs’ of countries that adopt common carbon prices and border adjustments mechanisms perform on these outcomes.
Keywords: carbon leakage; emission trading; carbon taxation; trade policy
JEL Codes: F13; F64; Q54; Q56
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| EU's CBAM (F36) | ineffective in preventing carbon leakage (H23) |
| complexity of EU's CBAM (F36) | misallocation of resources (D61) |
| LBAM (Y20) | effective in preventing carbon leakage (Q52) |
| LBAM offsets cost disadvantages for domestic producers (F14) | prevents leakage (G33) |
| unilateral carbon price increase (F69) | LBAM effective in preventing leakage (G33) |
| LBAM (Y20) | 12.8% reduction in global emissions (F64) |
| CBAM (F33) | marginal improvements in welfare and emissions (D69) |
| modest levels of LBAM tariffs and export subsidies (F14) | eliminate leakage (Y60) |
| LBAM (Y20) | significant emission reductions and welfare improvements compared to CBAM (D61) |