Unilateral climate policy design: Efficiency and equity implications of alternative instruments to reduce carbon leakage

Global cost-effectiveness of unilateral emission abatement can be seriously hampered by carbon leakage. We assess three widely discussed proposals for leakage reduction: carbon-motivated border tax adjustments, industry exemptions from carbon regulation, and output-based allocation of emission allowances. We find that none of these measures amounts to a “magic bullet” when both efficiency and equity criteria matter. Compared to unilateral emission pricing alone, border carbon adjustments are most effective in leakage reduction and promotion of global cost-effectiveness but can markedly exacerbate regional inequality; exemptions and output-based allocation tend to avoid distributional pitfalls but are less effective in leakage reduction and global cost savings; exemptions may even decrease global cost-effectiveness of unilateral emission abatement.

► We compare border tax adjustments, output-based allocation and industry exemptions. ► None of these measures is a “magic bullet” when both efficiency and equity criteria matter. ► Border tax adjustments cut leakage and provide global cost savings but exacerbate inequality. ► Exemptions produce very little leakage reduction and may imply higher efficiency cost. ► Output-based allocation does no harm to equity but also provides only little efficiency gains.