The issue of urban carbon emission efficiency (CEE) has become a critical problem for global sustainable development, particularly in China, where the phenomenon of shrinking cities has emerged after rapid urbanization. Using panel data from 283 Chinese prefecture-level cities (2000–2016), we examine how urban shrinkage affects CEE through both direct and spatial spillover effects. Our findings show that urban shrinkage significantly improves CEE both directly and indirectly; when a city shrinks, it increases the local CEE by 0.0132%, while the contraction of adjacent cities enhances the local CEE by 0.0312%, leading to a total improvement of 0.0445%. However, the overall CEE in shrinking cities remains lower than the nationwide average, with values consistently below 0.5. The main determinants of CEE are GDP per capita and population size, which show significant direct positive effects but opposing regional spillover effects. These findings offer important insights for urban development policies and sustainable city management in the context of population decline.