Policy options for preventing leakage:

an international perspective

Carolyn Fischer, RFF

May 7, 2012

Understanding and Estimating

Carbon Leakage

Two channels for carbon leakage:

– Shifting economic activity and investment

("competitiveness")

– Global energy market response to demand shifts

Leakage is hard to identify in practice; most

analyses use simulation models of global trade

– Roughly 5-20% overall, but can be much higher for

– certain sectors (energy intensive and trade exposed)

and small coalitions

Simulated Medium-Run Leakage

Rates for Europe

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Electricity Refined Oil Chemicals Nonmetallic Metals

Iron & Steel Nonferrous Metals

$50 / ton carbon price alone

(10 euro / ton CO2)

Unilateral EU policy

Options for Coping with Leakage

Global carbon pricing

Options for Coping with Leakage

Global carbon pricing

Weakening policies

“European carbon market in trouble” – Washington Post May 7, 2013

Options for Coping with Leakage

Global carbon pricing

Weakening policies

Measures to address competitiveness-related

leakage

Option 1: Border Carbon Adjustment (BCA)

Taxing imports based on a measure of their carbon

content

Ensures consumers pay carbon-inclusive price,

regardless of origin

Doesn’t address export competitiveness

– Could add refunding for exports for destination-based

carbon pricing, but may be WTO-incompatible

Controversial

– EU Aviation rule

Option 2: Output-Based Rebating (OBR)

Allocates allowances based on an industry average

performance benchmark

– Updated, not pure “grandfathering”

– Proposed in Waxman-Markey; EU uses a variant;

Sweden uses for NOx

Preserves carbon price signal, mitigates product

price increase

– Dampens leakage, but distorts conservation incentives

Implies other sectors will have to do more to meet same target

important for determining sector eligibility

% Change in Production,

of which Change in Net Exports

20% reduction target

in U.S.

Option 3: Exempting Certain Sectors

Can be complete or partial

– Sweden charges lower CO2 tax to industry

Mitigates cost increase, like OBR

But also reduces or eliminates incentives for those

sectors to reduce emissions!

Doesn’t address costs from indirect emissions

Poor option

Comparing Options:

Cost-Effectiveness

How well is the policy designed?

– Scope and details matter

How strong are conservation opportunities?

How much leakage comes from lost export

competitiveness?

How important is it to differentiate among trading

partners? How large is the coalition?

How else would you allocate the emissions

revenues?

Global Cost Savings of Antileakage

Measures, and Global Costs of Carbon Price

-5

-

5

10

15

20

25

EU EU+US A1 A1+BASIC All

Coalition

Per

cen

t C

han

ge

from

Tax

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

Per

cen

t C

han

ge

from

BA

U

OBR BAI FBA Global costs (Right-hand axis)

Comparing Options:

Acceptability

Domestic politics:

– How do they affect key sectors and consumers?

International politics:

– How do they affect the burdens of less

developed countries?

WTO compatibility:

– How effective are they at meeting

environmental aims?

Changes in Exports of EITE Products (Joint U.S. and EU Policies to reduce emissions 20%)

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

U.S. EU Japan Russia China India Brazil Oth.AFR

AUCTION OUTPUT TARIFF

Changes in Burdens:

Economic Adjustment Cost for China

-1,4

-1,2

-1

-0,8

-0,6

-0,4

-0,2

0

Tax OBR BAI FBA

Con

sum

ption

(in

% f

rom

Ba

U)

EU EU_US A1 A1_BASIC

Coalition

Changes in Burdens:

Use of BCA Revenues

Annex-I Coalition Non-Coalition

Auction

BCA (importer

keeps revenues)

BCA (exporter

keeps revenues)

Role of Revenue Recycling

Pre-existing taxes distort labor (and capital) markets

– Higher prices from regulation lower real wage, reducing

labor supply and tax revenue: “Tax Interaction”

– It matters how we use the revenues

Can make OBR better than BCA if revenues would

otherwise be grandfathered, rather than used to lower

tax burdens

Conclusions and Caveats

OBR and BCA have potential to improve efficiency

and reduce leakage from unilateral climate policy

– If appropriately circumscribed

– Must phase out OBR as more trade partners regulate CO2

Not recycling the revenue is costly

Serious practical challenges for both OBR and BCA

– defining appropriate metrics for eligibility, consistent

units of production, benchmarks that do not mute the

effectiveness of the carbon price, embodied carbon calcs

Most models (like ours) lack sufficient sectoral detail

to capture these issues and further research is needed.

Thanks!

Mistra Foundation INDIGO and ENTWINED programs are gratefully acknowledged.

- 10%

0%

10%

20%

30%

40%

50%

60%

Refined Oil Chemicals Nonmetallic Minerals

Iron & Steel Nonferrous Metals

No adjustment Import Tax (Foreign Carbon Intensity)

Import Tax (Home Carbon Intensity) Output - Based Rebating

Leakage by Sector (U.S. Policy; Fischer and Fox 2012, JEEM)

Global Leakage Effects

0%

5%

10%

15%

20%

25%

30%

U.S. policy EU policy U.S. and EU policies

AUCTION OUTPUT TARIFF

• ref leakage rates: ~ 5%-20% (mean: ~12%)

• BCA are quite effective in reducing leakage (mean: ~ 7.5%)

• btax is only slightly more effective in reducing leakage than tariff (mean: ~ 8%)

Leakage Rates (% from bau)

Burden Shifting (% ch GDP from bau)

-1.5%

-1.2%

-0.9%

-0.6%

-0.3%

0.0%

0.3%

AUCTION OUTPUT TARIFF

Changes in Burdens: ROW

(Consumption Effects of Joint U.S. and EU Action)

- 30,000

- 25,000

- 20,000

- 15,000

- 10,000

- 5,000

0

5,000

10,000

15,000

20,000

0

U.S. prefers OBR to BCA for EITE sectors

Sensitivity of U.S. Welfare Changes to Stringency of Emissions Reduction Target (Millions of 2004 USD)

Compared to 100% recycling

2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Auction

Auction

+ OBR

Auction

+ BCA

Grandfather

Grandfather

+ OBR

Grandfather

+ BCA

- 30,000

- 25,000

- 20,000

- 15,000

- 10,000

- 5,000

0

5,000

10,000

0 2 4

Sensitivity of Global Net Welfare Changes to Stringency of Emissions Reduction Target (Millions of 2004 USD)

Compared to 100% recycling

Global welfare highest with BCA + recycling,

while recycling generally preferred to OBR

If revenues are transferred,

OBR and BCA both preferred to

no treatment of EITE sectors

6 8 10 12 14 16 18 20 22 24 26 28 30

Auction

Auction

+ OBR

Auction

+ BCA

Grandfather

Grandfather

+ OBR

Grandfather

+ BCA