The European Union has been an early adopter of carbon insurance policies, with the introduction of the EU Emissions Buying and selling System (ETS) in 2005. This scheme units a typical worth for carbon and is utilized to essentially the most polluting manufacturing sectors. By growing the price of emissions-intensive manufacturing, the system incentivizes corporations to lower their use of fossil fuels. Nevertheless, as we present in a companion publish, the coverage’s impression was moderated by corporations growing their reliance on high-emissions imports. To remove this workaround, the EU will broaden the ETS to imports in 2026, by means of the Carbon Border Adjustment Mechanism (CBAM). The CBAM will primarily put a tariff on imported items primarily based on their carbon content material. Our current work supplies a quantitative evaluation of how the ETS and CBAM have an effect on corporations’ provide selection choices, and the ensuing adjustments in home costs and emissions.
A Quantitative Framework
Our companion publish confirmed that French corporations tailored to the ETS by growing their imports of ETS-regulated merchandise from outdoors the EU. Right here, we spotlight findings from a mannequin that enables corporations to decide on between unregulated and controlled inputs, primarily based on the relative prices of those inputs. The excellence between unregulated and controlled inputs makes it doable to imitate the 2 ETS coverage regimes: (1) a carbon tax on all inputs produced by regulated sectors in ETS member states, and (2) the ETS + CBAM system, through which the identical inputs imported from outdoors the EU are additionally taxed. These simulations thus permit us to check how including the CBAM impacts corporations’ provide chain changes throughout kinds of inputs and nations, together with the ensuing adjustments in emissions and in costs confronted by French households of their consumption of ultimate items.
Mannequin Estimation
Earlier than operating the model-based coverage simulations, we estimate a number of parameters that drive the sourcing choices of French corporations. One key statistic is a rustic’s sourcing potential, which captures the comparative benefit that corporations overseas have in producing an enter relative to these produced by French corporations. We use French corporations’ product-level import knowledge to estimate these sourcing potentials for pre-ETS knowledge for the yr 2004. This estimation supplies intuitive outcomes—for instance, that non-ETS nations like Russia and Australia and the ETS member Norway, all of that are main exporters of petroleum merchandise and high-emissions uncooked supplies, have a comparative benefit in producing such items relative to corporations working in France. The estimated mannequin is ready to generate knowledge that match the share of French imports of regulated and unregulated items noticed within the precise knowledge.
Coverage Situation Evaluation
Underneath the ETS-only state of affairs and making use of a carbon tax that matches the value of carbon within the ETS market, world emissions fall by 0.7 million tons of CO2, however at the price of a modest enhance within the worth of French manufacturing merchandise (0.87 p.c). The impression on emissions is small attributable to French corporations switching enter sourcing away from regulated nations—the carbon leakage we documented in our companion publish. Certainly, the mannequin replicates 80 p.c of the carbon leakage estimated within the knowledge.
After we lengthen the ETS system to incorporate imported merchandise, thus mimicking the long run CBAM, the worldwide discount in emissions will increase sevenfold whereas the manufacturing worth degree almost doubles (1.42 p.c). The mixed ETS + CBAM tax is much extra highly effective than ETS alone, because the CBAM eliminates the motivation to import regulated items. Corporations shift sourcing away from nations like Russia and China which might be outdoors the regulated space and towards much less polluting nations, equivalent to France. In response to the mannequin’s simulation, the ensuing lower in emissions comes with a price, nonetheless, as costs confronted by French customers rise fairly a bit given the upper price of inputs.
Conclusion
The leads to our two posts underscore the significance of contemplating the oblique impacts of carbon coverage by means of provide chain linkages. Corporations can adapt alongside a number of dimensions to attenuate the price of carbon insurance policies. These adaptation methods will be welfare-improving when incentivizing clear expertise funding, however they will additionally induce undesirable carbon leakage results when corporations adapt their sourcing technique. Whereas corporations in our mannequin reshore regulated inputs domestically beneath the ETS + CBAM coverage, thus lowering emissions generated by French manufacturing, corporations’ worldwide competitiveness can also be lowered, which ends up in increased costs confronted by home households.
Pierre Coster is an economics Ph.D. pupil on the College of Southern California.
Julian di Giovanni is an financial analysis advisor within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.
Isabelle Mejean is a professor of economics at Sciences Po.
The way to cite this publish:
Pierre Coster, Julian di Giovanni, and Isabelle Mejean, “What Is a Carbon Tariff and Why Is the EU Imposing One?,” Federal Reserve Financial institution of New York Liberty Road Economics, January 7, 2026, https://doi.org/10.59576/lse.20260107b
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Disclaimer
The views expressed on this publish are these of the writer(s) and don’t essentially mirror the place of the Federal Reserve Financial institution of New York or the Federal Reserve System. Any errors or omissions are the duty of the writer(s).
