Introduction

Carbon pricing disparities across countries can lead to carbon leakage — where emissions reductions in countries with stringent carbon prices are offset by increases in countries with lenient regulations. Possible channels include trade and firm relocation. Since January 2026, the European Union (EU) has officially imposed carbon tariffs on imports of carbon-intensive goods through its carbon border adjustment mechanism (CBAM). Export rebates of carbon prices can also address leakage, though the EU CBAM does not currently include them; the EU Commission announced plans in July 2025 to mitigate leakage risk for exports.

This paper examines whether carbon tariffs can prevent emissions leakage caused by firm relocation, and evaluates their effects — together with export rebates — on social welfare and global emissions.

Related literature

The paper builds on existing theoretical and quantitative studies of border carbon adjustments (BCAs), including computable general equilibrium (CGE) models examining leakage through trade channels, and partial equilibrium models considering firm relocation. It is most closely related to studies by Cheng and Ishikawa (2021) and Elboghdadly and Finus (2022), extending those works by allowing for asymmetric emissions intensity between firms and introducing export rebates — a policy tool not considered by Elboghdadly and Finus (2022).

The model

The paper uses a partial equilibrium North-South duopoly model in which a northern firm may relocate production to the South to reduce carbon costs. The northern firm uses less emissions-intensive technology than the southern firm. Three carbon tax regimes are considered: (1) a carbon tax alone; (2) a carbon tax with a carbon tariff; and (3) a carbon tax with both a carbon tariff and an export rebate.

Effects of carbon tariffs on firm’s plant location

The carbon tariff does not necessarily reduce the northern firm’s incentive to relocate to the South. If the northern firm’s emissions intensity is less than fifty percent of that of the southern firm, a carbon tax with a carbon tariff — even combined with an export rebate — increases the incentive to relocate. If the northern firm’s emissions intensity exceeds fifty percent of that of the southern firm, the carbon tax with the carbon tariff and export rebate reduces the relocation incentive and can prevent relocation entirely (p.11–12).

Impacts of carbon tariffs on emissions

If the northern firm’s emissions intensity exceeds fifty percent of that of the southern firm, the carbon tariff with export rebate prevents emissions leakage through relocation, thereby preventing an increase in global emissions (p.16–17). If the northern firm’s emissions intensity is less than fifty percent of that of the southern firm, the carbon tariff fails to prevent leakage even with the export rebate. However, in this case, relocation reduces global emissions because the expansion of the northern firm’s low-carbon output more than offsets the contraction of the southern firm’s high-carbon output (p.17).

North’s optimal carbon tax regime

The North’s optimal carbon tax regime, which maximises its social welfare, incorporates both a carbon tariff and an export rebate (p.28). The carbon tariff improves the terms of trade in imports and alleviates the worsening of the northern firm’s production efficiency, while the export rebate eliminates the negative effect of the carbon tax on production efficiency in export sales. Crucially, the North’s optimal carbon tax regime can also benefit the South, through a sufficient reduction in global emissions (p.29–30).

Concluding remarks

Carbon tariffs paired with export rebates form the North’s optimal carbon tax regime and can prevent emissions leakage that would otherwise increase global emissions. Where leakage is not prevented, it does not worsen the global environment. Future research could extend the model to consider Bertrand competition, bilateral or multilateral climate policies, and the effects of carbon tariffs on investment in low-carbon technology (p.31).