Posted: Wednesday, 27 October 2010

Carbon leakage occurs when there is an increase in greenhouse gas emissions in one country as a result of an emissions reduction by a second country with a strict climate policy. When a company is facing increased costs in one country due to emissions pricing, they may chose to reduce, close or relocate production to a country with less stringent climate policies. Leakage can result in the transfer of greenhouse gas‑intensive industries, and consequently of GHG emissions and industrial jobs, from countries or states/provinces applying strict emission controls to countries with less stringent environmental regulations.

This paper examines the causes of leakage as well as considers policy solutions for addressing leakage.

Background

Most policy proposals designed to address climate change, including cap-and-trade and carbon tax, are based on the idea that a price on carbon will provide an incentive to emit less carbon by making it more expensive.

There are two dominant approaches to carbon pricing: cap-and-trade systems and carbon taxes. A carbon tax is an indirect tax placed on carbon emissions; a price is paid for each tonne of carbon emitted. The biggest downside of a pure carbon tax is that emissions are not limited by setting a cap. As a result, a carbon tax does not directly reduce emissions, it simply makes it more expensive to emit.

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