The unilateral efforts of a single country or region to
reduce the emissions of greenhouse gases could reduce exports, increase imports
and lead to higher emissions elsewhere—what economists call “leakage.”
Unilateral efforts could, however, work better if other sources of energy were
used as substitutes, thereby creating “negative leakage,” according to research
by University of Illinois energy policy experts.
Don Fullerton, a finance professor and former deputy
assistant secretary of the United States Treasury Department, says the fear of
any one country raising its own costs of production through a carbon tax, and
thus making itself less competitive with its neighbors, is somewhat unfounded.
“Other researchers have missed this ‘abatement resource
effect,’ or what we call ‘negative leakage,'” said Fullerton,
a researcher in the U. of I. Institute of Government and Public Affairs and in
the Center for Business and Public Policy in the College of Business.
Fullerton, who co-wrote the
paper with Kathy Baylis, a professor of agricultural and consumer economics at Illinois, and Dan Karney, a graduate student in economics
says the omission has led to overstated fears about the leakage from a
unilateral carbon policy.
“What we show is that, in some cases, those fears are
overstated, and leakage may not be that bad,” Fullerton said. “With some concentration on
those favorable cases, one country might be able to undertake some good for the
world without the fear that it is going to lose business to other countries or
says positive leakage arises when consumers can easily shift their purchases
away from the taxed country or sector’s output to the same traded—but untaxed—good.
“If the context were two countries that produce the same
traded good, like steel produced by the U.S.
then a carbon tax in one country always increases imports from the other
country,” he said. “That creates positive leakage.”
If the two goods are quite different, however, then
consumers might still demand the good produced by the taxed sector.
“Given these conditions, the taxed sector draws resources
away from the unregulated sector or region, which could reduce their output and
emissions,” he said.
So if producers can shift their inputs easily—away from
greenhouse gas emissions to windmills, solar cells, and other energy-efficient
machinery and vehicles—then that taxed sector could draw resources away from
the other sector, Fullerton
“If that effect is large enough, the result might shrink
those other sectors’ operations overall, and thus possibly shrink emissions
elsewhere,” he said. “But even if overall leakage is still positive, it may be
overstated in models that do not allow for substitution in production. If
consumer flexibility is low compared to producers’ ability to abate pollution
by use of other resources, then we show that overall leakage may be negative.”
The best possibility for negative leakage might be a tax or
permit price for carbon emissions only in the electricity-generating sector
within one country.
“Demand for electricity is usually thought to be inelastic,
which means consumers buy almost the same amount of it even as the price
said. “If firms need to produce almost as much electricity, while substantially
reducing their greenhouse-gas emissions, they would have to invest a lot of
labor and capital into windmills, solar panels, and carbon capture and
sequestration technologies. With any given total number of workers and
investment dollars in the economy, then fewer greenhouse-gas emitting resources
are used to produce all other goods.”
Fullerton cites California’s unilateral
effort to enact a carbon tax as an example.
“They are a small open economy and, depending on how they do
it, they might be able to get away with it,” he said. “Electricity is a good
that doesn’t really transport all that well. In other words, it’s possible for California to buy electricity from Nevada
or Oregon, but not from Iowa. So California might be able to put a
carbon tax on electricity because people buy nearly as much electricity as they
did before, and it provides some incentives to companies to build alternatives
like windmills and solar cells.”
If California had a carbon
tax, the question then becomes what does it do at the border for any imports, Fullerton says.
“What they would like to do is tax any import according to
its carbon content, which is called a border-tax adjustment,” he said.
But the reason that’s tricky is that you don’t really know
the carbon content of the electricity—or any other good—that was produced
“It’s hard to know how to do that, exactly, except maybe for
oil or coal,” Fullerton
said. “Who knows how much carbon dioxide was associated with the production of,
say, a washing machine, toaster oven, or some other widget.”
Although it seems somewhat esoteric, the concept is
“Every economist who studies leakage seems to assume it must
be positive,” he said. “They just can’t fathom any way in which it can be
negative. They automatically assume that anyone who unilaterally imposes a
carbon tax must be raising the cost of their own production, thereby putting
themselves at a competitive disadvantage and handing business over to some
other country who, when they increase their output, will increase their
emissions. Therefore the carbon tax doesn’t do any good. But that’s not
necessarily the case.”