Carbon Leakage: Making the Best of a Second-Best Policy

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Congress is debating climate change legislation to reduce greenhouse gas emissions through the creation of a cap-and-trade system. Critics have expressed concern that this legislation could reduce domestic employment in trade-sensitive industries and cause a shift in production (and pollution) to less developed (and less regulated) countries. These critics have advocated a border adjustment policy to counter these effects. This article addresses the importance of identifying the emissions abatement policy objective (domestic versus global), then explores the competing analytical frameworks regarding border adjustment from trade and tax policy perspectives, and lastly describes the importance of political economy considerations in designing legislation. In short, while some type of border adjustment policy appears logical from a tax analysis standpoint, trade theory principles raise serious questions about this approach.

Scott C. Ganz was formerly the program manager for economic studies at AEI. He is currently a senior analyst at Matrix Global Advisors.

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