From Trade War to Green Transition: Optimal Electric Vehicle Tariffs with Revenue-Funded Subsidies

We study the optimal design of trade and industrial policy when governments pursue environmental objectives alongside traditional welfare goals. Motivated by the global transition to electric vehicles (EVs) and growing concerns about competitiveness, energy security, and climate change, we develop a framework in which policymakers choose tariffs and domestic production subsidies to maximize welfare, defined as the sum of consumer surplus, domestic profits, environmental benefits, and tariff revenue. We combine a theoretical model of differentiated-product oligopoly with a structural demand model estimated using vehicle-level data from 13 countries that together account for the vast majority of global EV sales. Our central finding is that the optimal policy combines a moderate tariff on imported EVs with a subsidy to domestic EV production financed through tariff revenue. This policy substantially outperforms both outright protectionism and laissez-faire. Relative to current policies, it preserves consumer access to affordable EVs, accelerates fleet electrification, supports domestic producers, and remains budget-neutral. For the United States, the optimal policy more than doubles EV market share, generates over $45 billion in annual welfare gains, and avoids approximately 95 million tons of lifetime CO2 emissions. A key mechanism underlying these results is the pass-through of tariffs and subsidies to prices, which depends critically on demand curvature, product substitution, and market structure. More broadly, our results suggest that effective industrial policy requires careful attention to market structure and country-specific conditions, balancing consumer, producer, fiscal, and environmental objectives rather than adhering to ideological prescriptions.