Unilateral actions to reduce CO2 emissions could lead to carbon leakage such as relocation of emissionintensive and trade-exposed industries (EITE). To mitigate such leakage, countries often supplement an emissions trading system (ETS) with free allocation of allowances to exposed industries, e.g. in the form of output-based allocation (OBA). This paper examines the welfare effects of supplementing OBA with a consumption tax on EITE goods. In particular, we investigate the case when only a subset of countries involved in a joint ETS introduces such a tax. The analytical results suggest that the consumption tax would have unambiguously global welfare improving effects, and under certain conditions have welfare improving effects for the tax introducing country as well. Numerical simulations in the context of the EU ETS support the analytical findings, including that the consumption tax is welfare improving for the single country that implements the tax.

The author is grateful to Knut Einar Rosendahl, Halvor Briseid Storrøsten and two anonymous referees for careful comments and helpful suggestions, and to participants at the 6th World Congress of Environmental and Resource Economists in Gothenburg. Valuable proofreading by Samantha Marie Copeland and help with the WIOD dataset from Jan Schneider is also highly appreciated.

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