Understanding Border Carbon Adjustments
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Looking for previous hand-outs we used to explain Border Carbon Adjustments? Here's the hand-out links:
What Is A Border Carbon Adjustment?
Most bills to create a carbon price in the United States include provisions for a U.S. “border carbon adjustment” (BCA) to mitigate the cost impacts of a carbon tax on U.S. manufacturers and jobs, and to promote global cooperation on carbon pricing. https://community.citizensclimate.org/content/contents/training/cbam-explainer.pdf
A border carbon adjustment is typically a tariff placed on goods imported from countries without an equivalent carbon price, and a rebate on U.S. exports to those countries.
The level of the adjustment is based on the magnitude of the carbon price and the carbon content of the goods being traded.
Why are border carbon adjustments an important part of climate policy?
Border carbon adjustments serve several goals:
- They prevent a US carbon fee from putting American businesses at a disadvantage in global markets against competing producers using artificially cheap fossil fuels.
- They remove the incentive for U.S. firms to relocate overseas to avoid the carbon fee, or for untaxed foreign manufacturers with higher emissions to flood the U.S. market. Both forms of “leakage” would undercut the impact of the U.S. carbon tax on global carbon emissions.
- Finally, they encourage foreign countries to adopt their own carbon fees so they will get the revenues instead of us, and so their manufacturers do not face a competitive disadvantage in the U.S. market. This incentive will help drive global cooperation on climate solutions.
How much difference would a border carbon adjustment make?
In addition to covering fuels that emit greenhouse gasses when burned, proposed carbon border adjustments usually target “emissions-intensive” goods whose costs would rise substantially with a carbon price, and “trade-exposed” goods that are subject to significant competition from abroad. These products, commonly known as “Emissions-Intensive Trade-Exposed” (EITE) goods, include steel, aluminum, cement, glass, pulp, paper, chemicals, and industrial ceramics.
A landmark study by the Environmental Protection Agency in 2009 concluded that “the vast majority of U.S. industry” would be “largely unaffected” by any drag from carbon pricing on their international competitiveness. It identified only 44 out of 500 manufacturing industries, representing just 6 percent of manufacturing employment, that would be “presumptively eligible” as EITE industries for special treatment.
The models it consulted found that for the most affected sectors, a carbon price of $20 per ton of CO2 would increase production costs–and net imports–at most about 2.5 percent. Such a modest carbon price would also do little to promote emissions “leakage” abroad. However, measures to level the playing field, like a border carbon adjustment, would largely eliminate both the competitive threat and any leakage.
Since then, according to the Congressional Research Service in 2022, “Some studies have questioned whether BCAs would be justified, considering the expected benefits, implementation challenges, and potential consequences that may result.” It continued:
For example, a 2017 study concluded that “our review of the economics of unilateral carbon taxes, however, does not find strong justifications for [BCAs].” A 2015 study concluded that “attempting to ‘protect’ energy-intensive U.S. manufacturing firms from international competitive pressures through various policies may have only a limited impact on these firms.… [G]iven the magnitude of the competitiveness impacts on climate policy in our simulation, the potential economic and diplomatic costs of such policies may outweigh the benefits and justify no action.”
However, both the industry impact and rationale for BCAs will increase as countries adopt higher carbon tax levels (see figures below for a $50 tax rate). To affected workers and industries, moreover, even small percentage impacts can loom large. For that reason, BCAs may be important as a means to win political acceptance for carbon taxes even if they don’t have large-scale economic impacts.
Source: Michael Keen, et al., Border Carbon Adjustments: Rationale, Design and Impact (International Monetary Fund WP/21/239, 2021)
Would border carbon adjustments be permitted under international trade agreements?
Border carbon adjustments raise many complex issues with regard to international trade law. The United States along with most countries is a member of the World Trade Organization (WTO) and a signatory to the General Agreement on Tariffs and Trade (GATT). GATT is a legal agreement to minimize barriers to international trade by eliminating or reducing quotas, tariffs, and subsidies while preserving important trade regulations. The agreement also provides a system to arbitrate commercial disputes among nations.
Most authorities agree that a properly designed border carbon adjustment would be compliant with relevant provisions of the GATT. GATT allows WTO members to impose, “on the importation of any product … a charge equivalent to an internal tax” levied on domestic producers. In 2021, WTO Deputy Director-General Jean-Marie Paugam said “nothing in the WTO rules prevents the adoption of such a mechanism by a Member if it does not constitute unjustifiable discrimination or disguised protection.” However, some proposals for a border carbon adjustment without a domestic carbon price could be judged an illegal and discriminatory tariff.
GATT’s “Most Favored Nation” principle, embodied in Article 1, requires trade without discrimination. The most favorable treatment granted one trade partner must be granted to all trade partners who signed the treaty. Signatory countries, who account for the vast majority of world trade, generally must apply the same tariff for a particular good to all trade partners. With border carbon adjustments, equal treatment means that the method of calculating adjustments for each good would not vary between trading partners. The actual fee could still vary from one trading partner to another depending on the product’s embedded carbon emissions and the partner’s carbon price.
Another important provision of the GATT states that imported goods should not be subject, directly or indirectly, to taxes or other internal charges beyond those applied, directly or indirectly, to similar domestic products. So long as the border adjustment rates are identical to the carbon fees assessed domestically, such a program would comply with this “National Treatment” provision.
Even if a trading partner considered the border adjustment discriminatory, moreover, Article 20 allows for exceptions to a practice in violation of the GATT if necessary to protect human, animal, or plant life or health, or to conserve exhaustible natural resources. Countries could also petition the WTO for a climate waiver, to clarify that there are no issues with carbon pricing and border adjustments.
The complexity of border carbon adjustments and climate diplomacy
Border carbon adjustments are complex to administer. However, due to the WTO requirement that each country maintain a “harmonized” tariff schedule for all imported goods, we already have a robust system in place for identifying imported or exported products that would be subject to the border carbon adjustment. Additionally, extensive work has already been done by Argonne National Laboratory and the State of California to identify the carbon content of the hundreds of different types of imported fossil fuels, so administering a border adjustment fee would be a difficult but manageable burden.
Ideally, if every major trading partner imposed a similar carbon pricing program, border carbon adjustments would not be needed. Various paths could lead to a cooperative movement toward a global carbon price. Maybe the most pragmatic and promising is a multilateral carbon price agreement among a group of nations with a border carbon adjustment that incentivizes others to join. For example, the US, Canada, Europe, China and India could start a “carbon club” with no border adjustment among them but a common border carbon adjustment for any other country without a carbon price.
International actions and reactions to border carbon adjustments
The Biden administration stated in 2021, as part of its UN declaration under the Paris Agreement, “The United States will work to ensure that our firms and workers are not put at an unfair competitive disadvantage and cooperate with allies and partners that are committed to fighting climate change. As appropriate, and consistent with domestic approaches to reduce United States greenhouse gas emissions, this includes consideration of carbon border adjustments in relation to carbon-intensive goods.” In Congress, some legislators have introduced bills to put border carbon adjustments front and center, either with or without a domestic carbon price.
Without a domestic carbon price, however, such proposals are much harder to justify under international trade agreements and could smack of protectionism. CCL believes, both as a matter of good climate policy and to ensure compliance with international trade agreements, that a domestic carbon price should always accompany border carbon adjustments. Since nearly all major trading nations have some form of carbon pricing (see figure below), the United States will be at a competitive disadvantage if other countries begin to impose border carbon adjustments.
Source: Michael Keen, et al., Border Carbon Adjustments: Rationale, Design and Impact (International Monetary Fund WP/21/239, 2021)
Indeed, the EU is making rapid progress on plans for a Carbon Border Adjustment Mechanism (CBAM) to take effect in 2026. It would levy an import fee equal to the EU’s carbon price on embedded carbon emissions in iron, steel, cement, aluminum, fertilizers, electricity, and hydrogen imports from countries with no carbon price. If the United States does not implement carbon pricing by the time the CBAM takes effect, or make other political arrangements, an estimated $17 billion in U.S. exports may face added import duties. Key members of Congress have already sounded the alarm over the potential for “discrimination against U.S. businesses.” However, competitors from China and other emissions-intensive countries would face a much steeper effective tariff.
With carbon pricing now adopted in several dozen countries, interest in border carbon adjustments is spreading. The Canadian government, which administers a nationally rising carbon tax, says it is “exploring BCAs as a tool to address potential carbon leakage and any resulting competitiveness issues.” So is the United Kingdom. A key policy question for the United States going forward is whether to fight back or join them in accelerating a global solution to the climate crisis.
Intro & Background
(0:00)
Context & History of International Trade
(2:29)
What Are Tariffs & Resolving Disputes
(6:37)
Adjustment Design For Fossil Fuels
(16:24)
Carbon Intensive Goods
(19:14)
Global Diplomacy Considerations
(26:47)
Q&A Video Discussion (Separate):
https://youtu.be/OAdXY2bVCE8
Download Google Slides presentation.
Intro & Background
(0:00)
Context & History of International Trade
(2:29)
What Are Tariffs & Resolving Disputes
(6:37)
Adjustment Design For Fossil Fuels
(16:24)
Carbon Intensive Goods
(19:14)
Global Diplomacy Considerations
(26:47)
Q&A Video Discussion (Separate):
https://youtu.be/OAdXY2bVCE8
Download this episode (right click and save).
Find the episode on CCL's iTunes channel.
Outside Articles:
- Niskanen Center's: What Do We Know About the EU's Carbon Border Tax Proposal So Far?
- Changing Climate for Carbon Taxes – Jennifer Hillman (outside link)
- WTO-UNEP: Trade and Climate Change (outside link)
- RFF's Border Carbon Adjustments 101 and Framework Proposal for a US Upstream Greenhouse Gas Tax with WTO-Compliant Border Adjustments (outside link)
- Brookings' Adele Morris - Making border carbon adjustments work in law and practice (outside link)
CCL Blogs:
- CBAMs: What are they and why do they matter?
- How Europe's carbon pricing could affect U.S. trade
- Europe's upcoming border carbon adjustment
- Canada increasing its carbon price
- When Canada first implemented their carbon price
Laser Talks:
- Carbon Pricing Around the World (current laser talk)
- Carbon Fee Border Adjustment(current laser talk)
- Canada's Carbon Taxes (current laser talk)
- EU Border Adjustment (current laser talk)
- WTO and the Border Adjustment (old laser talk, links still good)