Border adjustments may reduce leakage but they have uncertain and possible perverse welfare effects. Imposing border adjustments will also require a high level of administrative costs. As a result, they will inevitably be inaccurate and complex.
- Border adjustments have uncertain welfare effects. They may increase welfare in regions that do not impose a carbon tax and reduce welfare in regions that have a tax. The extent of leakage is not a good proxy for welfare.
- Accurate border adjustments will be difficult and expensive to impose. Because of information problems, border adjustments will rely on proxies such as average emissions intensities for categories of goods.
We consider the economics and the design of border adjustments (BAs) under a carbon tax. BAs are taxes on imports and rebates on exports on the emissions from the production of a good. They are thought to be a method of reducing inefficiencies from a unilateral carbon price, such as shifts in the location of production, known as leakage. After examining the basic economics of BAs, we examine three design issues: which goods BAs should apply to, which emissions from the production of those goods should be taxed, and from and to which countries BAs should apply. We conclude that BAs will impose high administrative costs and need strong welfare justifications.