A simple fix for carbon leakage? Assessing the environmental effectiveness of the EU carbon border adjustment

As part of its ambitious European Green Deal package, at the heart of which stands the commitment to become carbon-neutral by 2050, the European Commission announced that it would propose a "carbon border adjustment mechanism" to address the risk of carbon leakage. This study models the measure in a Computable General Equilibrium framework and analyses how effective it would be in reducing the incidence of carbon leakage. The analysis suggests that even a sectorally limited EU carbon border adjustment would reduce the carbon leakage rate by up to two thirds, making it more effective than the current system of free allocation. Besides environmental benefits, it would also offset competitiveness losses of European energy-intensive industries incurred by a higher EU carbon price and generate additional income for public budgets. At the same time, the analysis shows that around a third of the overall incidence of carbon leakage is driven not by competitiveness but by energy price effects, making it impossible to offset by border measures.