As the debate on reducing greenhouse gases (GHGs) has progressed, increasing concern has been raised about how a U.S. reduction program would interact with programs in other countries. In a global context where currently some countries have legally binding policies to reduce greenhouse gas emission and other countries do not—i.e., differentiated global carbon policies—the potential exists that countries imposing carbon control policies will find themselves at a competitive disadvantage vis-à-vis countries without comparable policies. The risks accompanying establishment of carbon control policies, in the absence of similar policies among competing nations, have been central to debates on whether the United States should enact greenhouse gas legislation. Specifically, concerns have been raised that if the United States adopts a carbon control policy, industries that must control their emissions or that find their feedstock or energy bills rising because of costs passed-through by suppliers may be less competitive and may lose global market share (and jobs) to competitors in countries lacking comparable carbon policies. In addition, this potential shift in production could result in some of the U.S. carbon reductions being diluted by increased production in more carbon intensive countries (commonly known as "carbon leakage"). In response to these concerns, several proposals introduced in Congress would attempt to mitigate the effect of carbon policies on affected U.S. industry. Proposed mitigating actions include, for example, providing assistance to greenhouse gas-intensive, trade-exposed industries, or imposing tariffs on certain greenhouse gas-intensive goods imported into the country from countries not implementing comparable carbon policies. This report examines the dynamics of this issue in three parts: (1) exploration of the nature of the problem with respect to international climate change policy, potential environmental effects, and potential economic effects; (2) identification of a range of possible options to address concerns; (3) analysis of issues raised by the proposed mitigating approaches and options; and (4) implications of the various approaches. There are three components of the problem of differentiated global carbon policies with respect to trade: (1) the lack of an international agreement with binding targets to reduce greenhouse gases; (2) the issue of carbon leakage; and (3) economic and competitive effects. Each of these is discussed below. For those policymakers who argue that human activities have changed or threatened to change the global climate, the policy debate on a U.S. climate change strategy has revolved about three major considerations: the posited reduction scheme's cost of compliance, its impact on the country's competitiveness , and its comprehensiveness with respect to developing countries who currently have no binding reduction targets. These three considerations (the "three Cs") are interlinked, especially the international aspects of competitiveness and comprehensiveness. That no international agreement addresses the international competitiveness and comprehensiveness issues has led to a major debate in the Congress about whether to include unilateral trade provisions, targeted subsidies, or other provisions in any domestic greenhouse gas reduction scheme to address them. It should be emphasized that this debate results from the lack of a comprehensive, international agreement to mandate strategies to reduce greenhouse gas emissions. The most effective and efficient solution, both economically and environmentally, would be a comprehensive agreement. Climate change is a global problem ultimately requiring a global solution. Any unilateral solution considered necessary would probably be temporary and transitional in nature. As stated by the Australian Government in its green paper on reducing carbon emissions: The first best solution to address the competitive concerns of EITE [emissions-intensive trade-exposed] industries would be to develop a comprehensive global agreement under which all major emitters have binding carbon constraints. Effective sectoral agreements for EITE industries would also address these concerns for industries covered by such agreements. However, in the absence of these developments, assisting EITE industries in response to the introduction of the scheme may be warranted on environmental grounds and because it may smooth the transition of the economy. However, it is not clear when such an agreement will be concluded and whether it would be acceptable to the United States. International working groups set up under the Bali "Action Plan" to develop a "Post-Kyoto" agreement are scheduled to present their results at the Copenhagen meeting of the Conference of the Parties to the United Nations Framework Convention on Climate Change (UNFCCC) (COP-15) and the Meeting of the Parties to the Kyoto Protocol scheduled for November 30 -December 11, 2009. A successful conclusion to these ongoing efforts leading up to that conference could render this issue moot. Although carbon leakage is generally defined in terms of differentiated carbon policies and their resulting impacts on greenhouse gas emissions, the phenomenon is much more complicated, involving differences in countries' economies (such as labor costs and exchanges rates) and trade flows among them. Thus carbon leakage, like the job leakage issues discussed later, is an interaction that will continue regardless of whether carbon policies are enacted. The focus here is on minimizing carbon leakage resulting specifically from differentiated carbon policies. In the context of analyzing the effect of differentiated carbon policies, carbon leakage is a two-fold problem. The first is the possibility that introduction of a carbon control regime in a country ahead of the introduction of a comparable policy in competing countries could result in the production of greenhouse gas-intensive products diminishing in the country attempting to control emissions and increasing in competing countries with no carbon controls. Basically, countries with carbon controls risk losing global market share to competing countries without controls. This would counteract the net reductions achieved by the country attempting to address climate change and reward economically the countries that were not. The second problem is a longer-term possibility that future investments by greenhouse gas-intensive industries could be channeled to countries with no (or less stringent) carbon controls, circumventing carbon reduction needs and potentially locking in obsolete technology. This relocation and construction of new facilities without carbon control could make future reductions more difficult and expensive. Studies of potential carbon leakage resulting from strategies to reduce greenhouse gases have produced a range of estimates. The only attempt to estimate the leakage impact of proposed U.S. legislation is the Environmental Protection Agency's (EPA) analysis of the Lieberman-Warner Climate Security Act of 2008 ( S. 2191 ) in the 110 th Congress. Not surprisingly, a leakage estimate for the year 2050 is highly dependent on assumptions about the U.S. economy, international actions to reduce emissions, and U.S. reduction strategies. EPA found that if non-Annex I countries were to adopt a greenhouse gas reduction target beginning in 2025 that holds their emissions at 2015 levels through 2034 and then further reduce their emissions to 2000 levels thereafter, then no emission leakage would occur under the proposed legislation. This result emphasizes the above point that the most effective solution to the leakage problem would be a long-term agreement to incorporate developing countries into an international accord on greenhouse gas emissions. EPA also conducted a sensitivity analysis assuming no greenhouse gas reductions by non-Annex 1 countries through 2050. Under this scenario, leakage of U.S. reductions were estimated at about 11% in 2030, and 8%-9% in 2050. EPA notes that part of the reason for the somewhat modest leakage rates estimated by the model is the significant demand by Annex I countries for international credits from non-Annex I countries, reducing their emissions. Leakage has also been studied by the European Union (EU) with the implementation of its Emissions Trading Scheme (ETS). In general, there has been little indication of any leakage resulting from phase 1 of the ETS. A variety of explanations are possible, including strong demand for aluminum and other commodities that has allowed manufacturers to pass on costs and remain profitable, the short time-frame (2005-2007) that makes it difficult to discern potential long-term investment trends, and the efforts of individual EU members to protect their industries through free allowance allocations. Studies suggest that leakage may be a longer-term issue as more stringent reduction targets are imposed. Analysis of the EU's climate change package that would lead to a 20% reduction in greenhouse gases from 1990 levels by 2020 (referred to as the post-2012 program) has produced a range of carbon leakage estimates. As indicated by Table 1 , assumptions about technology development and spillover effects, elasticity of energy supply, and the mobility (substitution) of energy-intensive production between countries produces estimates that make conclusions about the carbon leakage effects of a very aggressive reduction target difficult to assess. The Intergovernmental Panel on Climate Change (IPCC) has also weighed in on the carbon leakage debate with respect to the short-term Kyoto Protocol commitment period (2008-2012). In its 2007 assessment, the IPCC makes three observations with respect to carbon leakage: Model-based estimates of "carbon leakage" from implementing Kyoto Protocol commitments are in the range of 5%-20% (i.e., 5%-20% of domestic reductions may be offset by displacement abroad) (IPCC confidence in conclusion: medium agreement, medium evidence) Empirical studies on energy-intensive industries under the EU-ETS conclude that carbon leakage is "unlikely to be substantial" due to transport costs, local market conditions, product specialization of local suppliers, etc. (IPCC confidence in conclusion: medium agreement, medium evidence) Quantifying possible benefits of international transfer of low carbon technologies induced by industrialized country action is not possible. Competitiveness can be a rather abstract term for which any precise meaning can be elusive. As with carbon leakage, competitiveness is a continuing phenomenon, with companies becoming more or less competitive according to a host of factors, including productivity, market demand, resource costs, labor costs, exchange rates, and the like. As stated by the Australian Government in its Green Paper on carbon reduction schemes: Changes in the cost structures of entities and industries are not unusual and occur continuously in a market-based economy; nor is it unusual for Government policy to change cost structures. For example, the adoption of high quality occupational health and safety standards have affected the profitability of Australia's labour-intensive traded industries, making it more difficult for them to compete with foreign producers that are subject to lower standards.