Conference Agenda

To prevent carbon leakage induced by the European Union (EU) Emission Trading System (ETS), the EU has designed a Carbon Border Adjustment Mechanism (CBAM) that taxes imports based on their carbon content at the ETS carbon price. Since estimating the carbon content of imports is very complex, CBAM will be applied only to a few emissions-intensive sectors. As a consequence, CBAM is unlikely to effectively eliminate leakage as it can easily be avoided by offshoring final production, creating distortions across sectors. We propose a simple alternative route towards leakage prevention with significantly lower information requirements and administrative burden which can be applied to all tradable sectors: the Leakage Border Adjustment Mechanism (LBAM). LBAM offsets ETS-induced cost disadvantages of domestic producers relative to foreign competitors and requires knowledge only about product-specific output-to-emissions elasticities and import demand and export supply elasticities but does not depend upon information on the carbon content of imports. We propose a structural trade model that allows us 1) to compute Leakage Border Adjustment Taxes (LBATs) — i.e., product-level tariffs on imports and subsidies on exports – that prevent leakage induced by ETS; 2) to compare LBAMs and CBAMs in terms of welfare and emissions.