Preventing the most damaging effects of climate change requires countries to collectively adopt policies that cut carbon emissions. Carbon taxes, when adopted by a “climate club” of likeminded countries, can effectively reduce greenhouse gas emissions, providing large carbon emitters become members.
If both the United States and China join the club and there are no other holdouts, global emissions would fall by 24.8 percent. Global emissions would fall by only 20.0 percent if the United States holds out, 12.9 percent if China holds out, and 8.1 percent if both hold out.
But countries have an incentive not to comply if they can reap the benefits of others’ climate actions without suffering the economic costs associated with carbon mitigation. To deter these free-riders and encourage them to implement climate policies of their own, climate clubs could adopt punitive tariffs against all imports from nonmembers. A 30-percentage-point increase in tariff rates across the board, for example, would encourage nonmembers to join. But these tariffs alone would have a small direct impact on global emissions, reducing them by only a further 0.7 percentage point if applied to the United States and 0.8 percentage point if applied to China. If both the United States and China hold out, punitive tariffs would reduce emissions by 1.4 percentage points more than in a scenario without punitive tariffs.
The European Union has proposed a carbon border adjustment mechanism (CBAM) to offset the unfair market advantage of free riders by adding a tariff to some of their imports. Such CBAM tariffs would cause carbon-intensive imports to be more expensive depending on their carbon content, thereby protecting domestic producers of these goods. For example, in the EU-27, imports of CBAM commodities (fertilizer, iron and steel, aluminum, and cement) decline between 0.5 and 18 percent, depending on the trade partner and the magnitude of the tariff.
But CBAM tariffs do not by themselves reduce global carbon emissions. That is because non-carbon-taxing countries can divert trade away from member countries. If all high-income economies (the United States, Canada, the EU-27, other Europe, Japan, and high-income Asia) adopted carbon taxes of $75 per ton, global emissions would fall by 7.2 percent. This decline remains the same when these economies also introduce CBAM tariffs, regardless of how they are calculated (covering the imported product’s direct emissions only or extending to also cover the electricity used, or covering all direct and indirect emissions involved in its production).
CBAM policies can support global efforts to reduce carbon emissions and may be useful if they generate political support from domestic producers. But international cooperation around carbon-reduction policies, with buy-in from the highest emitters, is necessary to shrink emissions.
This PIIE Chart is based on Shantayanan Devarajan, Delfin S. Go, Sherman Robinson, and Karen Thierfelder’s Working Paper, How Carbon Tariffs and Climate Clubs Can Slow Global Warming. Produced and designed by Nia Kitchin and Oliver Ward.
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