Abstract Using a multi-sector dynamic spatial integrated assessment model, we argue that a carbon tax introduced by the European Union and rebated locally can, if not too large, increase the size of Europe’s economy by concentrating economic activity in its high-productivity non-agricultural core and by incentivising immigration to the European Union. The resulting change in the spatial distribution of economic activity improves global efficiency and welfare. A carbon tax introduced by the United States generates similar effects. This stands in sharp contrast with standard models that ignore trade and migration in a world shaped by economic geography forces.