Is there a case for carbon-based border tax adjustment? An applied general equilibrium analysis

Growing concern that unilateral greenhouse gas emission reductions could foster carbon leakage and undermine international competitiveness of domestic industry have led a number of EU and US politicians to advocate the use of border-tax adjustments (BTAs) to "level the playing field". Such proposals have so far often been dismissed on administrative feasibility and protectionist grounds, but surprisingly little economic analysis has been performed to assess their actual impacts on leakage, competitiveness and welfare. This paper uses the global recursive-dynamic general equilibrium model ENV-Linkages to fill this gap. Two alternative scenarios are considered under which either the EU alone or Annex- I countries as a whole cut their emissions by 20% by 2020 (and 50% by 2050) relative to 2005 levels. A broad range of checks are performed to assess the robustness of the main results to key model parameters, country coverage, targets and design features of BTAs. Two main conclusions stand out. First, BTAs are an effective way of reducing carbon leakage, if there is only a small coalition of acting countries, such as, just the EU, because leakage (while typically small) mainly occurs through the competitveness rather than through the fossil fuel price channel in this case. However, the need for, and the effectiveness of BTAs declines rapidly with the size of the coalition, as BTAs address a smaller share of an even smaller rate of leakage. Second, BTAs entail small welfare losses as a world level. Perhaps more strikingly, they do not necessarily curb the output losses incurred by the domestic energy intensive-industries (EIIs) they are intended to protect in the first place. This is in part because EIIs in the EU and the US make important use of carbon-intensive intermediate inputs produced by these same EIIs in other geographical areas. Another, deeper explanation is that EIIs are ultimately more adversely affected by carbon pricing itself than by any international competitiveness losses.