Working Paper Series,
Norwegian University of Life Sciences, School of Economics and Business

Abstract: Unilateral climate policy induces carbon leakage through the relocation of emission-intensive and trade-exposed industries to regions with no or more lenient emission regulation. Both analytical and numerical studies suggest that emission pricing combined with border carbon adjustment is a secondbest instrument, and more cost-effective than output-based rebating, in which case domestic output is indirectly subsidized. No country has so far imposed border carbon adjustment, while variants of output-based rebating have been implemented. In this paper we show that combining output-based rebating for emission-intensive and trade-exposed goods with a consumption tax on the same goods can be equivalent with border carbon adjustment. Moreover, we demonstrate that it is welfare improving for a region which has already implemented emission pricing along with output-based rebating to also introduce such a consumption tax. We conclude that supplementing output-based rebating with a consumption tax constitutes smart hedging against carbon leakage: Compared to output-based rebating stand-alone it constitutes a robust strategy for improving cost-effectiveness of unilateral climate policy; compared to border carbon adjustment it limits the risks of potentially detrimental trade disputes.

Keywords: Carbon leakage; output-based rebating; border carbon adjustment; consumption tax

JEL-codes: D61; H23; Q54

41 pages, September 18, 2015

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