Border Adjustments under Unilateral Carbon Pricing: Are they Warranted in the Case of Australian Carbon Tax?

In the absence of a global agreement to reduce emissions, Australia has adopted a carbon tax unilaterally to curb its own emissions and to counter climate change. During the debate prior to passing the carbon tax legislation, there were concerns about the challenge that Australia’s emissions intensive and trade exposed (EITE) industries may face having to experience decreasing international competitiveness due to the unilateral nature of the tax and hence the potential for carbon leakage. Domestic climate policies to limit carbon emissions can put extra pressure on industries that use emission-intensive energy sources in their production leading to cost differentials between domestic production and production in countries where carbon emissions are not constrained. It has been argued that such climate policy differences could place Australian industries at a competitive disadvantage in both home and foreign markets The potential adverse impact on Australia’s competitiveness and seemingly inevitable carbon leakage have been used by opponents to the climate policy in order to undermine the carbon pricing strategy in Australia. Some have argued in favour of introducing border adjustments to make a levelled playing field with international competitors in a carbon constrained world. In order to address these concerns, this paper explores the border adjustment policies to complement the domestic carbon regulation in Australia using the multi-sector, multi-country computable general equilibrium (CGE) modelling approach. In particular we use the GTAP-E model which has a detailed specification of energy substitution possibilities and carbon emissions accounting. The analysis reported in the paper is based on GTAP version 8 data base. We consider four border adjustments: border adjustments on imports (green tariffs) based on domestic emissions; border adjustments on exports via a rebate for exports; domestic production rebate; and full border adjustment on both exports and imports. We compare the numerical simulation results of these scenarios with no border adjustments scenario from the standpoint of welfare, international competitiveness, and carbon leakage. In line with most of the international findings of border adjustment measures in climate policy analysis, the results reveal that their effects towards easing the negative impact on Australia’s EITE sectors are fairly small. The paper concludes with the consideration of whether the border adjustments are warranted in the Australian case.