Measuring Leakage Risk
AbstractThe global nature of the climate change problem creates challenges for regional climate change policy. When a policy regulating greenhouse gas emissions applies to only a subset of emitting firms (i.e. the policy is “incomplete”), regulated sources can find it difficult to compete with firms in less regulated jurisdictions. A policy-induced shift in economic activity to less regulated jurisdictions can substantially undermine policy effectiveness via emissions “leakage”. Concerns about leakage loom large in the debate about how to design and implement regional policy responses to the global climate change problem.
Economists generally agree that, in a world of incomplete carbon regulation, full auctioning of permits, together with some form of border tax adjustment, would be the preferred approach to mitigating emissions leakage. For several reasons, however, this approach has been difficult to implement in practice. Thus, economists have been exploring what amounts to the next-best option: output-based rebating (e.g. Fischer and Fox 2007, Fowlie et al 2015, Quirion 2009, Fischer and Fox 2012, Meunier et al 2012). The basic idea involves off- setting potentially adverse competitiveness impacts of climate policy with a production-based subsidy. In the case of a tax the subsidy comes out of tax revenues. In the case of an emissions trading program, the subsidy can be paid in terms of free emissions permits.
Although output-based rebating can effectively mitigate leakage, these provisions come at a cost. In light of these costs and limitations, it is important to carefully target leakage mitigation measures and associated compensation to industries truly at leakage risk. The metrics currently used to identify eligible industries are somewhat ad hoc. These metrics provide a very useful point of departure.