competition free emission permits (Carbon Trust, 2009). This acts as a subsidy for the sector in question. Free allocation of permits was opposed by the Garnaut Climate Change Review as it considered there were no circumstances that justify it and that governments could deal with market failure or claims for compensation more transparently with the revenue from full auctioning of permits. The economically efficient option would, however, be border adjustments (Neuhoff, 2009; Newbery, 2009). Border adjustments work by setting a tariff on imported goods from less regulated countries. A problem with border adjustments is that they might be used as a disguise for trade protectionism. Some types of border adjustment may also not prevent emissions leakage. Issuing the permits: 'grandfathering' versus auctions Tradable emissions permits can be issued to firms within an ETS by two main ways: by free allocation of permits to existing emitters or by auction. Allocating permits based on past emissions is called "grandfathering" (Goldemberg et al., 1996, p. 38). Grandfathering permits, just like the other option of selling (auctioning) permits, sets a price on emissions. This gives permit-liable polluters an incentive to reduce their emissions. However, grandfathering permits can lead to perverse incentives, e.g., a firm that aimed to cut emissions drastically would then be given fewer permits in the future. Allocation may also slow down technological development towards less polluting technologies. The Garnaut Climate Change Review noted that 'grandfathered' permits are not 'free'. As the permits are scarce they have value and the benefit of that value is acquired in full by the emitter. The cost is imposed elsewhere in the economy, typically on consumers who cannot pass on the costs. However, profit-maximising firms receiving free permits will raise prices to customers because of the new, non-zero cost of emissions. A second method of "grandfathering" is to base allocations on current production of economic goods, rather than historical emissions. Under this method of allocation, government will set a benchmark level of emissions for each good deemed to be sufficiently trade exposed and allocate firms units based on their production of this good. However, allocating permits in proportion to output implicitly subsidises production. The Garnaut Report noted that any method for free permit allocation will have the disadvantages of high complexity, high transaction costs, value-based judgements, and the use of arbitrary emissions baselines. On the other hand, auctioning permits provides the government with revenues. These revenues