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U.S. Industry and Cap-and-Trade: Designing Provisions to Maintain Domestic Competitiveness and Mitigate Emissions Leakage

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This paper is part of a series of studies on the policy design issues for cap-and-trade. As part of the Energy Security Initiative Policy Brief Series, this paper focuses on domestic competitiveness.

Introduction

The potential range of affected sectors and the scale of impacts on domestic industries that would result from economy-wide climate legislation are unprecedented in the history of U.S. environmental regulation. Even a cursory consideration of how the balance sheets of American companies would be impacted by a price on their greenhouse gas emissions reveals the complexity of designing evenhanded domestic climate policies.

Pricing carbon emissions, either through a cap-and-trade system or an emissions tax, will not only adversely affect electricity and primary energy producers, but it will also hurt the competitive performance of heavy fossil-fuel users in downstream industries, especially in trade-exposed sectors such as steel and chemicals.

This gives rise to two overarching concerns. First, a small but prominent subset of domestic companies may be disproportionately burdened if carbon mitigation policies affect their operations but not those of their international competitors. Second, some of the environmental benefits might be eroded if increases in U.S. manufacturing costs from uneven international carbon pricing caused economic activity to shift to nations with weaker greenhouse gas mitigation policies or none at all.

This paper reviews the evidence on the competitiveness burdens imposed on domestic energy-consuming industries as a result of a unilateral or near-unilateral carbon pricing policy. We also examine the nature and magnitude of emissions leakage that could undermine the environmental effectiveness of such a policy. Subsequently, we analyze a range of options designed to address these concerns, with particular emphasis on the measures included in the American Clean Energy and Security Act of 2009 (ACESA). Overall, we find that this bill adopts a quite reasonable approach to the multiple challenges involved, although we do identify a number of possible refinements that might be considered as parallel legislation is discussed in the Senate.



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