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Endogenous carbon quotas and the effectiveness of carbon tariffs

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  • Wang, Kenneth (Wei)
  • Zhong, Cassie (Xiaoqian)

Abstract

The European Union’s Carbon Border Adjustment Mechanism (CBAM) imposes a carbon tariff on imports. To evaluate the effectiveness of such tariffs in reducing carbon emission in exporting countries, we develop a general equilibrium model with an endogenous domestic emissions quota. We show that treating exporting countries’ climate policies as strictly exogenous is misleading: without government intervention, a carbon tariff merely reallocates emissions allowances from exporting to non-exporting firms, leaving aggregate domestic emissions unchanged. However, we prove that the exporting country’s government can improve social welfare by strategically tightening its overall carbon quota. By doing so, the government reduces the tariff rent that would otherwise be extracted by the importing countries. Consequently, this endogenous strategic response is central to the effectiveness of CBAM.

Suggested Citation

  • Wang, Kenneth (Wei) & Zhong, Cassie (Xiaoqian), 2026. "Endogenous carbon quotas and the effectiveness of carbon tariffs," Economic Analysis and Policy, Elsevier, vol. 93(C), pages 1477-1498.
    • Handle: RePEc:eee:ecanpo:v:93:y:2026:i:c:p:1477-1498
    DOI: 10.1016/j.eap.2026.08.023
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