Smart hedging against carbon leakage

SUMMARY Policy makers in the EU and elsewhere are concerned that unilateral pricing of carbon externality induces leakage through relocation emission-intensive trade-exposed production to other regions. A common measure mitigate such is combine an emission trading system with output-based allocation (OBA) allowances where latter works as implicit subsidy regulated industries. We show analytically it optimal impose addition a consumption tax on OBA goods (i.e., entitled OBA) at rate which equivalent value rate. The explanation alleviates excessive goods, distortionary effect introducing OBA. Using multi-region multi-sector computable general equilibrium model calibrated empirical data, we quantify welfare gains for imposing top its existing run Monte Carlo simulations account uncertain exposure increases whether highly exposed or not, hence can be regarded smart hedging against leakage.