Fowlie, Meredith and Reguant, Mar “Mitigating Emissions Leakage in Incomplete Carbon Markets” (September 2021) (Revised version published in the Journal of the Association of Environmental and Resource Economists, 9(2): 307-343, 2022) | WP-320R | Online Appendix
Policies regulating greenhouse gas emissions apply to a small subset of emitting sources. This raises a formidable concern: emissions can ‘leak’ from regulated to unregulated sources. We provide a theoretical basis for deriving industry-specific measures of leakage risk, and for calibrating the output-based subsidies which are currently used to mitigate leakage. Using U.S. energy price variation as a proxy for variation that would be induced by a domestic carbon price, we show how theoretically consistent leakage mitigating subsidies can be calibrated. We simulate the impacts of a domestic carbon price on U.S. manufacturing with and without these subsidies. Absent mitigation, emissions leakage is substantial. Output-based subsidies targeted on the basis of our leakage risk measures significantly reduce this leakage risk. In contrast, the current practice of coarsely targeting subsidies on the basis of emissions intensity and trade exposure delivers a small fraction of leakage mitigation benefits while incurring significant costs.