## Executive Summary

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---

### Overview
- Focus: EU immediate neighbors (EUN) — Albania, Bosnia and Herzegovina, Kosovo, Moldova, Montenegro, North Macedonia, Serbia, and Türkiye — and the effects of the EU’s decarbonization policies on them.
- Central questions:
  - Current emissions and mitigation policies in EUN countries.
  - Importance of EU policy stringency for emissions reductions in EUN countries and likely impacts of the EU’s carbon border adjustment (CBAM).
  - Implications of unilateral EUN adoption of economywide carbon taxation for emissions, domestic output, and household welfare.

### Emissions landscape and key sources
- Combined GHG emissions (excluding Ukraine) are lower than those of Germany; Türkiye accounts for over ¾ of EUN emissions.
- Since 2000, carbon footprint of EUN countries has risen steadily; energy-efficiency improvements moderated emissions growth in some countries.
- EUN economies are more emission intensive (CO2 relative to GDP) than more developed European peers; many appear close to the “tipping point” in the environmental Kuznets curve.
- Power (heat and electricity) generation is the main source of GHG emissions; industrial and transport sectors are less dominant compared to power.
- Coal (lignite) is a primary driver of high emissions intensity in electricity generation:
  - In Kosovo, Serbia, and Bosnia and Herzegovina, lignite accounts for more than 60 percent of electricity generation.
- Air pollution (PM2.5) concentrations range from 11 to 30 μg/m3, exceeding WHO guideline of 5 μg/m3.
  - Air pollution estimated responsible for nearly one in ten deaths in Türkiye, North Macedonia, Bosnia and Herzegovina, and Serbia; more than five percent of deaths in other EUN countries.
  - Costs of poor air quality caused by fossil fuels estimated at up to 20 percent of GDP in EUN countries.

### Emissions mitigation policy performance
- EUN countries have significantly lagged EU members in mitigation policy implementation; gradual move toward market-based instruments since 2000.
- Explicit fossil fuel subsidies average 1.5 percent of GDP in EUN countries.
  - Comparators: Asia 0.2 percent of GDP; Latin America and the Caribbean 0.9 percent of GDP.
  - Western Balkans: subsidy cost below 1 percent of GDP; Ukraine and Moldova: subsidy cost exceeds 3 percent of GDP.
- Implicit subsidies (externalities not covered by consumer prices) are large; largest component is local air pollution (health impacts), followed by climate change (GHG emissions).
- Nationally Determined Contributions (NDCs):
  - All EUN countries declared NDCs and most signed the Paris Agreement.
  - Some NDCs imply an increase in emissions between 2018 and 2030 in Albania, Serbia, and Türkiye.
  - Emission reduction in the other EUN countries will be close to 16 percent, on average (excluding Ukraine), between 2018 and 2030.
  - NDC targets imply an improvement in emissions-output ratio by 2030 in all countries except Türkiye.
  - North Macedonia aims to converge to EU levels.

### Evidence on EU policy spillovers
- Trade links: EU is largest trading partner for most EUN countries; accounts for more than half of total trade for all Western Balkan countries; Bosnia and Herzegovina, North Macedonia, Albania, and Moldova near 60 percent.
- Empirical panel regression (2002–19, 126 countries, country and time fixed effects):
  - A 10 percentage points increase in EU environmental policy stringency is associated with:
    - ~1 percent reduction in CO2 emissions in EU countries themselves, and
    - an additional 1 to 3 percent reduction in CO2 emissions in EUN countries.
  - EU environmental policy stringency rose from about 1.6 to 3.5 between 2000 and 2020 — suggesting potential reduction in emissions in EUN countries through spillovers by as much as 10 to 20 percent.

### CBAM and EU policy developments: design, timeline, and impacts
- CBAM objectives: import tax on embedded carbon of certain carbon-intensive goods from non-EU countries to preserve a level playing field and promote carbon pricing abroad.
- Timeline:
  - CBAM entered into force on May 16, 2023.
  - Transitional period scheduled to start on October 1, 2023 (reporting required; payments not collected).
  - Full operationalization completed in 2026, aligned with removal of free EU ETS allowances.
  - Free allowances in CBAM sectors to be reduced by 48.5 percent between 2026 and 2030, with full phase out scheduled for 2034.
- Coverage: carbon-intense sectors and products — metal, chemical, wood, textile, transportation equipment, and other EITE industries.
- Exposure and impacts:
  - EUN exports that fall under current classification of CBAM goods account for less than 5 percent of GDP and around 15 percent of total exports.
  - Direct impacts concentrated on exports of emissions-intensive industries, particularly metals and energy; North Macedonia and Serbia heavily exposed.
  - Example: North Macedonia — CBAM goods would comprise 11 percent of total exports and could be required to forego 0.9 percent of GDP per year if EU imposes a $50 per ton CBAM using exporting country’s domestic standard. Foregone revenue for $75 per ton would be proportionally higher.
  - Foregone revenues estimate: "0.4 percent of GDP." If applying EU’s carbon intensity standard (lower than EUNs’), the foregone revenues will be smaller.
- Longer-term EU developments that could create further spillovers:
  - EU ETS emissions cap for power and industry set to converge to zero by 2040.
  - An ETS on emissions for buildings and transport is envisioned.

### Rationale for unilateral carbon pricing in EUN
- Economic argument: economywide carbon price is “perhaps the most effective incentive to alter the behavior of firms and consumers to decarbonize.”
- Benefits:
  - Raises price of carbon, rebalances consumption and production toward low-carbon options, decarbonizes exports faster and more comprehensively than CBAM.
- Concerns:
  - Potential tradeoff between carbon taxation and output/employment; risk of deindustrialization and worker layoffs.
  - Distributional concerns; poor households may be affected.
  - Real costs depend on availability of alternative green technologies; stranded-asset and employment-transition risks in specific activities/regions.
  - Political economy constraints can make carbon pricing politically unfeasible.

### CPAT scenarios: carbon tax trajectories, emissions, output, and fiscal revenue
- Model: IMF’s Climate Policy Assessment Tool (CPAT); partial-equilibrium; no international spillovers.
- Two carbon tax scenarios:
  - Introduce $10 per ton in 2023, gradually increased to:
    - $50 per ton by 2030; or
    - $75 per ton by 2030.
  - Note: "$75 per ton price of carbon is closer to the average EU carbon price in 2023 of about $86 per ton."
- Revenue recycling assumptions (share of additional collection):
  - Reduction in labor tax: 15 percent.
  - Increase in public investment: 40 percent.
  - Increase in current expenditures on education and healthcare: 30 percent.
  - Higher allocation for targeted cash transfers: 15 percent.
- Key macro results (under $75 per ton scenario):
  - Fiscal revenues relative to BAU: about 3 percentage points of GDP on average.
  - CO2 emissions reduction by 2030: about 25 percent relative to business-as-usual (about 11 percent lower by 2030 than the current level).
  - Output impacts:
    - Small dip in output not exceeding "1 percent of 2023 GDP".
    - Output would almost recover to 2023 level by 2030 for Serbia and Türkiye; for the rest, output would be "less than 1 ppt of GDP lower."
  - Albania and Türkiye: revenue impact below 2 percent of GDP under $75 tax.
  - Household consumption: total loss around 2–3 percent of household consumption.
  - Distributional impact: carbon tax would not be regressive; impact on poorer households not sizably more than on richer households.
  - Firm-level impacts: industrial firms disproportionately affected; greater burdens on smaller, older, and more labor-intensive firms.

### Sectoral and firm-level impacts
- Direct channel: increase in energy costs depending on carbon content of fuels.
  - Increase in input energy costs particularly high "by about 15 percent or more" in chemicals, non-metallic minerals (Serbia and Albania), and basic metals (Albania).
- Indirect channel: higher input costs transmitted upstream through supply chains; significant in rubber and plastics, transport equipment, wood and paper — accounting for almost half of the price increase in affected industries.
- Country-specific:
  - Serbia: increase in input costs highest — exceeding "10 percent in 5 of the most affected industries."
  - North Macedonia and Türkiye: milder input cost increases (mostly below "15 percent").
- Firm-level heterogeneity (WBES sample: 21,793 observations across 11 countries and 12 industries):
  - Outcomes measured as energy cost relative to total sales.
  - Econometric findings:
    - A 10 percent increase in labor productivity associated with lower energy dependence of "4 percent."
    - An increase in number of employees by 100 associated with lower energy dependence of "1 percent of total cost."
    - Exporting firms could be "27 percent" less affected by higher energy costs than firms solely supplying domestic market.
    - Characteristics associated with higher energy dependency: smaller firms, older firms, less productive firms, labor-intensive firms, domestically focused firms.
  - Selected regression coefficients (significance indicated):
    - Employees (log): -0.11*** (0.01)
    - Age (log): 0.01*** (0.02)
    - Productivity: -0.32*** (0.04)
    - Profitability: -0.16*** (0.03)
    - Labor intensity: 0.48*** (0.02)
    - Skill intensity: -0.14*** (0.03)
    - Exporting: -0.24*** (0.04)
    - Constraints to financial access: 0.04*** (0.01)
  - Up to "99 percent of all enterprises in the region are classified as small or medium-sized."

### Household-level impacts and distributional outcomes
- CPAT simulations for Serbia and Türkiye (tax from 2023 to $75 per ton by 2030):
  - Without recycling: $75 per ton tax would reduce household consumption "by about 2½ to 3 percent in Türkiye and Serbia, respectively."
  - Little evidence of regressivity; consumption drop largely uniform across distribution; reduction slightly larger in rural than urban households in Serbia.
  - With revenue recycling (same shares as macro scenario): recycling into productive spending and reduction in labor tax yields an improvement in consumption across the distribution and "a progressive one at that."
  - Compensating transfers to the poor (bottom four deciles) further boost household consumption.
- Note: CPAT distributional impact based only on consumption effects through price changes; does not account for household income changes via wages and employment.

### Health co-benefits
- Gradual implementation of carbon tax to reach $50–$75 in 2030 would lead to a modest decline in average PM2.5 concentration and an estimated reduction of more than 2,000 air-pollution-related deaths in Western Balkans and Moldova by 2030, with greatest improvements expected in Serbia.

### Policy implications and recommended path forward
- Carbon pricing identified as the most economically efficient and equitable policy response for EUN.
- Important complementary measures:
  - Provide social assistance and safety nets where industries and workers are hit hard.
  - Revenue recycling to offset distributional concerns and yield fiscal resources (about 3 percentage points of GDP under $75 tax scenario).
  - Return revenues as output-based rebates, combine pricing with a CBAM, or use feebates or a TPS for industry to address competitiveness concerns.
- Sequencing and strategic considerations:
  - Given strong economic integration with the EU and accession processes, keeping pace with EU mitigation is in EUN interest.
  - Up-front adoption of a comprehensive decarbonization strategy (e.g., economywide carbon tax) preferable to postponing action.
  - Early decarbonization can attract green FDI and technology flows, aid infrastructure and investment gaps, and facilitate integration with EU-linked global value chains.
  - A regional ETS could be a precursor to eventual integration with the EU ETS.
  - Policies should include technical retraining and measures to avoid disorderly adjustment when CBAM operationalizes and tightens.

*Source: wpiea2023246-print-pdf*

### Executive Summary

### Executive Summary

### Overview
- Focus: EU immediate neighbors (EUN) — Albania, Bosnia and Herzegovina, Kosovo, Moldova, Montenegro, North Macedonia, Serbia, and Türkiye — and the effects of the EU’s decarbonization policies on them.
- Central questions addressed:
  - Current emissions and mitigation policies in EUN countries.
  - Importance of EU policy stringency for emissions reductions in EUN countries and likely impacts of the EU’s carbon border adjustment (CBAM).
  - Implications of unilateral EUN adoption of economywide carbon taxation for emissions, domestic output, and household welfare.

### Emissions landscape and key sources
- EUN combined GHG emissions (excluding Ukraine) are lower than those of Germany; Türkiye accounts for over ¾ of EUN emissions.
- Since 2000, the carbon footprint of EUN countries has risen steadily; improvements in energy efficiency have moderated emissions growth in some countries.
- EUN economies are more emission intensive (CO2 relative to GDP) than more developed European peers; many EUN economies appear close to the “tipping point” in the environmental Kuznets curve.
- Power (heat and electricity) generation is the main source of GHG emissions in EUN countries; industrial and transport sectors are less dominant compared to power.
- Coal (lignite) is a primary driver of high emissions intensity in electricity generation:
  - In Kosovo, Serbia, and Bosnia and Herzegovina, lignite accounts for more than 60 percent of electricity generation.
- Air pollution (PM2.5) concentrations range from 11 to 30 μg/m3, substantially exceeding WHO guidelines of 5 μg/m3.
  - Air pollution is estimated to be responsible for nearly one in ten deaths in Türkiye, North Macedonia, Bosnia and Herzegovina, and Serbia, and more than five percent of deaths in other EUN countries.
  - Costs of poor air quality caused by fossil fuels are estimated at up to 20 percent of GDP in EUN countries.

### Emissions mitigation policy performance
- EUN countries have significantly lagged EU members in emissions mitigation policy implementation and have moved only gradually toward market-based instruments since 2000.
- EUN countries still maintain substantial fossil fuel subsidies and compare unfavorably in terms of implicit subsidies (the cost of fossil fuel externalities not covered by consumer prices).
- Nationally Determined Contributions (NDCs):
  - All EUN countries have declared NDCs and most have signed the Paris Agreement.
  - Some NDCs imply an increase in emissions between 2018 and 2030 in Albania, Serbia, and Türkiye.
  - Emission reduction in the other EUN countries will be close to 16 percent, on average (excluding Ukraine), over the same period.
  - NDC targets imply an improvement in emissions-output ratio by 2030 in all countries except Türkiye.
  - North Macedonia stands out as ambitious, aiming to converge to EU levels.

### Evidence on EU policy spillovers
- Empirical findings indicate EU policy stringency has spilled over to EUN countries:
  - Over the 2000-20 period, a near doubling of EU environmental policy stringency was associated with a potential reduction in emissions in EUN countries by as much as 10 to 20 percent, after controlling for other factors.

### CBAM and future EU policy developments: impacts and exposure
- The CBAM entered into force on May 16, 2023.
- Under the currently proposed form and once fully operationalized in 2026, CBAM output effects on EUN countries would be limited overall.
- Direct impacts are concentrated on exports of emissions-intensive industries, particularly metals and energy.
  - North Macedonia and Serbia are heavily exposed in these sectors.
- Over the next decade and beyond:
  - The EU ETS emissions cap for power and industry is set to converge to zero by 2040.
  - An ETS on emissions for buildings and transport is envisioned.
  - These future developments could produce spillover effects for EUN countries, though these countries have less of a catch-up to do in buildings and transport.
- In the long run, further tightening of CBAM could affect competitiveness of EUN countries given their trade integration with the EU, necessitating tightening of their own emission mitigation policies.

### Economywide carbon pricing exercise and fiscal implications
- Policy simulated: an economywide carbon tax of $75 (with revenue recycling to reduce labor tax wedge and increase spending on health, education, capital expenditure, and targeted household transfers).
- Key simulation results:
  - Fiscal revenues from a $75 carbon tax, relative to a business-as-usual scenario, would amount to about 3 percentage points of GDP on average.
  - The $75 carbon tax would result in an about 25 percent reduction of CO2 emissions by 2030.
  - The $75 carbon tax and offsetting fiscal policies would not have negative effects on output and household consumption at the aggregate level.
  - Household distributional impact: the carbon tax would not be regressive; the impact on poorer households would not be sizably more than on richer households.
  - Total loss of household consumption would amount to only around 2-3 percent of household consumption.
  - Firm-level impacts: industrial firms would be disproportionately affected, with greater cost burdens on smaller, older, and more labor-intensive firms.

- Additional health co-benefits:
  - A gradual implementation of carbon tax to reach $50-$75 in 2030 would lead to a modest decline in average PM2.5 concentration and an estimated reduction of more than 2,000 air-pollution-related deaths in Western Balkans and Moldova by 2030, with most significant improvements expected in Serbia.

### Policy implications and recommended path forward
- Putting a price on carbon is identified as the most economically efficient and equitable policy response for EUN.
- Policymakers should be mindful of industries that could be hit hard and provide social assistance and safety nets where needed.
- Revenue recycling is important to offset distributional concerns and can yield significant fiscal resources (about 3 percentage points of GDP under the $75 tax scenario).
- Given strong economic integration with the EU and the accession process for many EUN countries, keeping pace with EU emission mitigation speed is in their interest; up-front adoption of a comprehensive decarbonization strategy (e.g., economywide carbon tax) is preferable to postponing action.
- Policies to address competitiveness concerns for industry include returning revenues as an output-based rebate, combining pricing with a CBAM, or using feebates or a TPS for the industry sector.

_Executive Summary — wpiea2023246-print-pdf_

### 2030. Decarbonization will require a better mix of policies, including taxes, subsidies, and administrative

### 2030. Decarbonization will require a better mix of policies, including taxes, subsidies, and administrative

### Policy effort implied by carbon pricing scenarios
- IMF estimates of potential emission reductions from an economy-wide carbon tax of $50 or $75 per ton indicate:
  - Only the relatively unambitious NDC targets of Albania, Serbia, and Türkiye would be achievable by 2030 under a $75 dollar/ton carbon tax.
  - In other EUN countries, significantly greater policy effort, or a much higher carbon tax rate, or both will be needed.
- The calculations underpinning these statements are discussed in greater detail in section 4. of the source.

### Evolution of emissions mitigation policies in EUN countries
- Progress since 2000:
  - EUN countries have made some progress in introducing emission reduction policies since 2000, but they lag EU members.
  - The New Climate Institute Climate Policies Database documents a time series of the number of policies implemented by type and sector.
  - Türkiye saw the greatest increase over the past two decades in the number of policies implemented (Figure 3.1).
- Policy instrument mix:
  - EUN countries mainly rely on regulatory measures, policy support, and targets; gradual increase over time in adoption of economic instruments (Figure 3.2).
  - In 1994 the most commonly used policy in all sectors was regulatory instruments; by 2022, electricity and heat, and buildings sectors commonly used economic instruments.
  - No EUN country employs meaningful carbon taxation or ETS, though there is an evolution toward market instruments.

### Market-based instruments versus non-market instruments
- Theoretical and empirical context:
  - Market instruments such as carbon taxes offer a comprehensive way to reorient the economy away from carbon, but other instruments may not be substantially inferior (Chateau and others, 2022).
  - Explicit carbon taxes tend to be less publicly acceptable than “hidden” measures such as targets, regulations and standards.
  - Adoption likelihood of market-based instruments rises with country income; EMDEs are more likely to use non-market instruments (Linsenmeier and others, 2022).

### Energy subsidies and implicit externalities
- Explicit fossil fuel subsidies:
  - Explicit subsidies measured as the gap between domestic and international prices amount to 1.5 percent of GDP on average in EUN countries (Figure 3.3).
  - Explicit subsidies are significantly higher in EUN countries than in other EMs:
    - Asia: 0.2 percent of GDP
    - Latin America and the Caribbean: 0.9 percent of GDP
  - Substantial intra-group variation:
    - Western Balkan countries: subsidy cost is below 1 percent of GDP
    - Ukraine and Moldova: subsidy cost exceeds 3 percent of GDP
- Implicit subsidies (externalities not covered by consumer prices):
  - EUN countries compare unfavorably—the largest implicit cost component is local air pollution (health impacts), followed by climate change (GHG emissions).
  - Most implicit fossil fuel subsidies can be attributed to the prevalence of coal.

### EU policy spillovers: trade integration and empirical evidence
- Trade links:
  - EU is the largest trading partner for most EUN countries, accounting for more than half of total trade for all Western Balkan countries; Bosnia and Herzegovina, North Macedonia, Albania and Moldova near 60 percent.
  - Western Balkan countries’ exports to the EU have doubled over the past 10 years.
- Spillover channels:
  - Unfavorable spillovers: leakage—EU production relocates to neighbors with weaker carbon policies.
  - Favorable spillovers:
    - Carbon-saving technological innovations in the EU reduce mitigation and green transition costs in EUN countries.
    - Tightening EU policies increases import demand for goods with low carbon inputs.
    - EU financial and technical assistance can nudge EUN economies to adopt similar mitigation policies and practices.
- Empirical panel regression results (2002–19, 126 countries, country and time fixed effects; Table 3.1):
  - A 10 percentage points increase in EU environmental policy stringency is associated with:
    - a reduction of about 1 percent in CO2 emissions in EU countries themselves, and
    - an additional 1 to 3 percent reduction in CO2 emissions in EUN countries.
  - EU environmental policy stringency increased from about 1.6 to 3.5 between 2000 and 2020.
    - This suggests a potential reduction in emissions in EUN countries through spillovers by as much as 10 to 20 percent.

### Carbon Border Adjustment Mechanism (CBAM): design, timeline, and implications
- CBAM objectives and design:
  - CBAM is an import tax on embedded carbon of certain carbon-intensive goods from non-EU countries, intended to preserve a level playing field and promote carbon pricing abroad.
  - Aims to reduce carbon policy leakage and encourage trading partners to adopt domestic carbon pricing.
- Implementation timeline (Box 3):
  - CBAM approved and entered into force on May 16, 2023.
  - Transitional period scheduled to start on October 1, 2023; during transition the EU will not collect CBAM payments, but importers must report embedded GHG emissions to the CBAM authority.
  - Full operationalization will be completed in 2026, aligned with the removal of free EU ETS allowances.
  - Free allowances in CBAM sectors will be gradually reduced by 48.5 percent between 2026 and 2030, with full phase out scheduled for 2034.
- Coverage and sectors at risk:
  - CBAM applies to carbon-intense sectors and products (metal, chemical, wood, textile, transportation equipment, and other EITE industries).
  - These sectors will face challenges to reduce carbon footprint or pay additional costs to comply with CBAM.
- Expected fiscal and trade impacts for EUN:
  - EUN exports that fall under the current classification of CBAM goods account for less than 5 percent of GDP and around 15 percent of total exports (Figure 3.5).
  - Potential or foregone revenues could be large for some EUN countries.
    - Example: North Macedonia
      - Exports of CBAM goods would comprise 11 percent of total exports.
      - Could be required to forego 0.9 percent of GDP per year if EU imposes a $50 per ton CBAM on its exports using exporting country’s domestic standard.
      - The foregone revenue for $75 per ton CBAM would be proportionally higher.

*Source: wpiea2023246-print-pdf*

### 0.4 percent of GDP. If applying EU’s carbon intensity standard, which is lower than EUNs’, the foregone

### 0.4 percent of GDP. If applying EU’s carbon intensity standard, which is lower than EUNs’, the foregone

### CBAM analysis and immediate implications
- Foregone revenues estimate: "0.4 percent of GDP." If applying EU’s carbon intensity standard (lower than EUNs’), the foregone revenues will be smaller.
- Distributional effects:
  - The burden of EU CBAM would fall most heavily on industrial sectors, such as metals and commodities.
  - In the current proposed form, with narrow application to only carbon-intensive industries whose exports form a small share of EUN exports to EU, CBAM is not likely to have major impact on overall GDP in EUN countries.
- Coverage in the CBAM analysis: six carbon intensive sectors — chemicals, metals, textiles, transport equipment, wood, and other EITE.
- Note on standards used:
  - "Domestic standard" refers to estimation using carbon intensity of exporting countries (i.e., EUNs).
  - "Country specific standard" refers to estimation using carbon intensity of importing countries standard (i.e., EU-27).

### Rationale for unilateral carbon pricing in EUN
- Economic argument: an economywide carbon price is presented as "perhaps the most effective incentive to alter the behavior of firms and consumers to decarbonize."
- Benefits cited:
  - Raises the price of carbon, making carbon-intensive goods and services dearer.
  - Helps rebalance consumption and production toward low-carbon options.
  - Decarbonizes exports faster and more comprehensively than CBAM.
- Perceived and real concerns with carbon tax:
  - Fear of tradeoff between carbon taxation and output/employment; potential deindustrialization and worker layoffs.
  - Distributional concerns: consumers, particularly poorer ones, may be hit.
  - Real economic costs depend on costs, availability, and implementation of alternative green technologies; certain activities (e.g., maritime and air transportation) lack clear alternatives.
  - Risks of stranded assets and large employment transitions in specific activities/regions.
  - Political economy concerns can make carbon pricing politically unfeasible.

### CPAT scenarios: carbon tax trajectory, emissions, output, and fiscal revenue
- Model: IMF’s Climate Policy Assessment Tool (CPAT); partial-equilibrium tool; does not account for international spillovers.
- Two carbon tax scenarios:
  - Introduce $10 per ton in 2023, gradually increased to:
    - $50 per ton by 2030; or
    - $75 per ton by 2030.
  - Note: "$75 per ton price of carbon is closer to the average EU carbon price in 2023 of about $86 per ton."
- Revenue recycling assumptions (share of additional collection):
  - Reduction in labor tax: 15 percent.
  - Increase in public investment: 40 percent.
  - Increase in current expenditures on education and healthcare: 30 percent.
  - Higher allocation for targeted cash transfers: 15 percent.
- Key macro results:
  - A unilateral carbon tax imposed in EUN countries would not result in much negative macroeconomic implications by 2030 but would yield considerable dampening of emissions relative to BAU.
  - With a $75 per ton carbon tax:
    - EUN region would reduce its CO2 emissions by 2030 by about 25 percent compared to the business-as-usual level (about 11 percent lower by 2030 than the current level).
    - To meet self-declared NDC targets, "a significantly higher carbon tax rate would be needed to meet the NDCs, except for Serbia."
    - Output impacts: Following a small dip in output that would not exceed "1 percent of 2023 GDP", output would almost recover to 2023 level by 2030 for Serbia and Türkiye, and would be "less than 1 ppt of GDP lower for the rest."
    - Average fiscal revenue would be about "3 percentage points of GDP higher relative to a BAU baseline" under a $75 carbon tax, with Albania and Türkiye showing particularly small revenue impact of "below 2 percent of GDP."

### Sectoral implications: direct and indirect effects
- Two channels of impact:
  - Direct: increase in energy costs depending on carbon content of fuels used.
  - Indirect: higher costs of inputs transmitted upstream through supply chains.
- Direct effects highlighted:
  - Increase in input energy costs would be particularly high, "by about 15 percent or more, in chemicals, non-metallic minerals (Serbia and Albania) and basic metals (Albania)."
- Indirect effects:
  - Indirect effects significant in rubber and plastics, transport equipment, wood and paper—accounting for almost half of the price increase in affected industries.
- Country-specific note:
  - Serbia: increase in input costs will be the highest—exceeding "10 percent in 5 of the most affected industries."
  - North Macedonia and Türkiye: relatively milder input cost increases (mostly below "15 percent").
- Policy implication: carbon pricing can be reinforced by sectoral instruments (ideally price-based and revenue neutral), and revenue recycling could target EITE industries via rebates proportional to output (or an ETS with free allowances) and potentially be phased out over time.

### Firm-level impacts and heterogeneity
- Firms in EUN countries tend to have higher energy costs relative to sales than those in the EU.
- Industries with significant exposure: mining and quarrying in Albania; other manufacturing in North Macedonia and Kosovo; chemicals and pharmaceuticals in Moldova and Montenegro; textiles and garments in Serbia.
- Econometric findings (sample: 21,000 firms in 12 industries):
  - A 10 percent increase in labor productivity is associated with lower energy dependence of "4 percent."
  - An increase in the number of employees by 100 is associated with lower energy dependence of "1 percent of total cost."
  - Exporting firms: a EUN firm that exports some of its production could be "27 percent" less affected by higher energy costs than a firm solely supplying domestic market.
  - Firm characteristics associated with higher energy dependency:
    - Smaller firms, older firms, less productive firms, labor-intensive firms, domestically focused firms.
  - Regression results (Table 4.2) — selected coefficients (significance indicated):
    - Employees (log): -0.11*** (0.01)
    - Age (log): 0.01*** (0.02)
    - Productivity: -0.32*** (0.04)
    - Profitability: -0.16*** (0.03)
    - Labor intensity: 0.48*** (0.02)
    - Skill intensity: -0.14*** (0.03)
    - Exporting: -0.24*** (0.04)
    - Constraints to financial access: 0.04*** (0.01)
  - Interpretation: smaller, less productive, domestically oriented firms are disproportionately vulnerable; up to "99 percent of all enterprises in the region are classified as small or medium-sized."

### Household-level impacts and distributional outcomes
- Main concern: carbon tax could reduce household consumption and potentially affect poorer households more heavily.
- CPAT simulations for Serbia and Türkiye (carbon tax imposed in 2023 and gradually increased to $75 per ton by 2030):
  - In absence of revenue recycling, a $75 per ton carbon tax would cause a small and distributionally-neutral reduction in household consumption — "by about 2½ to 3 percent in Türkiye and Serbia, respectively."
  - Little evidence of regressivity: drop in household consumption is largely uniform across distribution.
  - Reduction in consumption slightly larger in rural than urban households in Serbia.
- With revenue recycling (same shares as macro scenario), outcomes improve:
  - Recycling into productive spending and reduction in labor tax yields an improvement in consumption across the distribution, and "a progressive one at that."
  - Compensating transfers to the poor (bottom four deciles) further boost household consumption.
  - Net effects include boosts to real GDP growth and household consumption via increased public investment and higher current spending on health and education.
- Note: distributional impact in CPAT based solely on consumption effects through price changes; not accounting for household income changes via wages and employment.

### Policy lessons and implications
- Emissions drivers and exposure:
  - Emission problem in EUN countries arises largely from carbon-intense power generation and industrial sectors; high natural endowment of coal has made coal a major local energy source.
  - Power sector is main user of coal and a major contributor to emissions; it affects carbon footprint of downstream activities.
- Policy stance and historical record:
  - EUN countries’ record on emissions mitigation policies is generally weak and they have significantly lagged EU members.
  - Explicit fossil fuel subsidies remain substantial; implicit subsidies (externalities not covered by consumer prices) are unfavorable.
- Spillovers from EU policies:
  - Empirical evidence shows favorable spillovers: increasing stringency of EU climate policies over two decades appears to have spilled over considerably to EUN emissions reductions.
- CBAM implications:
  - While CBAM output effects are limited once fully operational in 2026, exports of emissions-intensive industries would be directly affected (particularly metals and energy industries); North Macedonia and Serbia particularly exposed.
  - Over the next decade, EU ETS cap for power and industry set to converge to zero by 2040; an ETS on buildings and transport is envisioned — these could have further spillovers for EUN countries.
- Policy recommendation and sequencing:
  - Putting a price on carbon is described as "the most economically efficient and equitable policy response."
  - Policymakers should be mindful of industries likely to be hit hard: coal mining, power generation, and other carbon intensive industries. Policy action should include social assistance and technical retraining.
  - Other viable options: market instruments other than carbon tax, non-market instruments (standards and regulations), "coal tax" as potentially less politically contentious, and energy efficiency measures.
- Timing and strategic considerations:
  - Given proximity to the EU, trade and FDI linkages, and candidacy for EU accession, EUN countries face choice to front-load decarbonization or delay.
  - Argument for early adoption:
    - Front-loading decarbonization would restructure economies to be compliant with EU standards and carbon content, supporting export-led growth and integration into EU-linked global value chains.
    - Early green FDI and technology flows from the EU could help close infrastructure and investment gaps sooner, aiding convergence.
    - Complementary reforms (business climate, investor leveling) would help.
    - A regional ETS could be a precursor to eventual integration with the EU ETS.
    - Early decarbonization helps avoid disorderly adjustment when CBAM operationalizes and tightens.

*Source: IMF staff calculations and analysis in wpiea2023246-print-pdf (excerpt provided).*

### Annex 1. Methodology: Firm-Level Analysis

### Annex 1. Methodology: Firm-Level Analysis

### Data source and sample
- Data source: World Bank Enterprise Survey (WBES).
- Geographic focus: European Union's immediate neighborhood (sample of 11 countries).
- Countries in the sample: Albania; Bosnia and Herzegovina; Belarus; Kosovo; Moldova; Macedonia, FYR; Montenegro, Rep. of; Russia; Serbia; Turkey; Ukraine.
- Time span of analysis: 2002 to 2013.
- Number of observations: 21,793 observations.
- Industry coverage: 12 industry categories, including construction; electricity, gas, and water supply; financial intermediation; health and social work; hotels and restaurants; manufacturing; mining and quarrying; other community, social, and personal service activities; public administration; real estate; transport, storage, and communications; wholesale and retail trade; repair of motor vehicles and motorcycles.
- Note on survey timing: Data collection cycles for the 11 sample countries were conducted at different intervals; in some cases the survey was conducted one year ahead. The WBES was initiated in 2002; questionnaire structure differed significantly prior to 2006; post-2019 the survey focus shifted to COVID-19 impacts.

### Outcome and alternative measures
- Primary impact measure: energy cost relative to total sales for each firm (used to define potential impact of carbon taxation).
- Alternative (not primarily used): energy cost relative to production cost — available for approximately 11,000 observations only, hence not used to maximize coverage.

### Firm characteristics and variable definitions
- Firm profitability: calculated as the difference between sales and production costs.
- Firm size:
  - Small: firms having less than 20 employees.
  - Medium: firms having more than 20 employees but less than 100 employees.
  - Large: firms having more than 100 employees.
- Firm age: current year minus established year.
- Labor productivity: ratio of (sales minus material cost) to number of employees (reflects value contributed by a single employee).
- Export activity: captured by export share in sales.
- Factor intensity and skill intensity:
  - Labor intensity: ratio of total labor cost to sales.
  - Skill intensity: ratio of total labor cost to number of employees.
- Financial constraints: dummy variable for firms answering affirmatively to facing constraints on interest rates, fees, or collateral.

### Empirical strategy
- Regression framework: firm-level fixed-effect regression of firm energy dependency on firm characteristics and fixed effects.
- Estimated specification (as presented):
  - ln(energydependency_{ijct}) = α + β × keyvar_{ijct} + industry_{j} + country_{c} + year_{t} + ε_{ijct}
- Indexing and fixed effects:
  - i = individual firm, j = industry, c = country, t = year.
  - country_{c} controls for time-invariant macroeconomic conditions specific to the country.
  - year_{t} controls for global business cycles and survey timing differences.
  - industry_{j} controls for industry-specific factors in the impact of carbon taxation.
- Interpretation:
  - β is the coefficient representing the impact of a specific firm characteristic on the firm's energy dependency within the context of carbon taxation.

### Robustness checks and alternative specifications
- Robustness across alternative identification approaches reported:
  - Firm profitability: consistent results using dummy variables for high profitability, profitability ratios, or natural log of profit.
  - Firm size: significant results using either categorized firm size dummy variables (Size 1,2) or continuous number of employees (log employees).
  - Firm age: robust using continuous age or natural log of age (log age).
  - Labor productivity: robust using sales per employee and sales excluding material cost per employee (productivity; productivity 2).
  - Labor intensity: robust using total labor cost per employee and total labor cost excluding material cost per employee (labor intensity; labor intensity 2).
  - Capital intensity and skill intensity were considered (capital intensity; capital intensity2; skill intensity).
  - Financial constraints: included as a dummy variable (financial constraint).
- Additional robustness notes:
  - Results remain robust with the addition of control variables in specific regression models.
  - A robustness comparison figure/table reports coefficients with at least 10% statistical significance across these alternative measures (labels shown: profitability 1, profitability 2, profitability 3, profitability 4; size 1, size 2; log sales; log employees; log labor costs; log age; productivity; productivity 2; exporting; labor intensity; labor intensity 2; capital intensity; capital intensity2; skill intensity; high labor intensity; financial constraint; SampleEU).

### Key statistics and sample table notes
- Sample observation counts by country (as provided in source table block):
  - Albania: 170 204 304 175 360 1213
  - Bosnia and Herzegovina: 182 200 349 360 1091
  - Belarus: 250 325 272 360 1207
  - Kosovo: 270 202 472
  - Moldova: 174 103 350 362 360 1349
  - Macedonia, FYR: 170 200 342 360 1072
  - Montenegro, Rep. of: 250 100 300 115 150 915
  - Russia: 506 601 997 421 463 18
  - Serbia: 250 408 300 386 360 1704
  - Turkey: 514 557 1127 1344 3542
  - Ukraine: 463 594 851 100 22910
- Note: the source presents these counts in a formatted table under the heading “# of firms Observations 2002 2003 2005 2007 2008 2009 2012 2013 Total” (table layout preserved as presented in source).

### Summary of methodological conclusions
- Using WBES data and a sales-based energy-cost measure allowed broader coverage (21,793 observations) than the production-cost alternative (~11,000 observations).
- Fixed effects for country, year, and industry were employed to control for unobserved heterogeneity.
- A comprehensive set of firm characteristics (profitability, size, age, productivity, exports, factor and skill intensity, financial constraints) were analyzed.
- Results were robust across multiple alternative definitions and identification strategies for each firm characteristic.

*Source: Annex 1. Methodology: Firm-Level Analysis (from wpiea2023246-print-pdf).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2023/english/wpiea2023246-print-pdf.pdf_