One option for containing costs for carbon-intensive manufacturing industries in climate legislation is to exclude them altogether from the list of regulated entities. At less than 6 percent of total U.S. emissions, carving out this sector of the economy may seem like an acceptable sacrifice if it alleviates enough concern about industrial competitiveness to win support for broader climate legislation.

However, carveouts in U.S. policy create incentives for major trading partners to follow suit. While only 11 percent of the U.S. total, direct emissions from manufacturing account for 31 percent of all emissions in China. If indirect emissions are included, manufacturing accounts for two-thirds of the CO2 China emits. Therefore, if carveouts are selected as a policy option, then an alternative regime, such as an international sectoral agreement, should cover industries excluded from a domestic cap-and-trade or carbon tax system, rather than exempting them altogether.