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Understanding Border Carbon Adjustments

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This training reviews the basics of border carbon adjustments, how they're viewed constitutionally and in terms of trade legality, and the practical aspects of border carbon adjustment implementation along with its constraints.
TOC and Guide Section
What are the basics?

The Border Carbon Adjustment is an important provision of the Energy Innovation and Carbon Dividend Act. To protect U.S. manufacturers and jobs, carbon-emitting fuels and carbon-intensive goods from countries that do not have a carbon emissions reduction program analogous to ours will pay a border carbon adjustment. 

Conversely, producers of fuels and carbon-intensive goods exported from the United States to countries that do not have a carbon emissions program will receive a rebate for the carbon fees that were levied under the act. Note: fees are not levied directly on producers of carbon-intensive goods, but due to fees on fuels consumed, their production costs are higher. 

This border adjustment prevents a US carbon fee from putting American businesses at a competitive disadvantage in global markets.  It will also remove the incentive for them to relocate overseas to avoid the carbon fee. In addition, it will encourage foreign countries to adopt their own carbon fee so they would get the money instead of us.

In fact, the act specifically recommends that the Secretary of State negotiate with other nations to form treaties, agreements, or partnerships to reduce greenhouse gas emissions. Such agreements would naturally include harmonizing emissions mitigation programs among a group of countries so that border carbon adjustments would not be necessary for trade within the group. 

Questions concerning the mechanisms of the Border Carbon Adjustment, how it would affect our trade with China, and whether it would be approved by the World Trade Organization (WTO) has been in the top ten areas of interest for Congress each year since CCL started keeping track of data, so it’s particularly important for CCL members interacting with members of Congress to have a good understanding of this provision and how it works. 

Additionally, the proposed EU Border Carbon Adjustment Mechanism is due for implementation in 2023. With this mechanism in place, If the US does not have a price on carbon or other carbon emissions mitigation programs, U.S. industry may have to pay fees to export certain goods to the EU. 

What are carbon-intensive goods?

Besides a large range of fuels that emit CO2 or other greenhouse gases when burned, the carbon border adjustment also affects carbon-intensive goods, which require large amounts of fossil fuel energy to produce. These goods include products like steel, aluminum, cement, glass, pulp, paper, chemicals, or industrial ceramics.

While energy is used to produce most products, the amount is generally low as a percentage of total production cost - under two percent. A product is considered carbon-intensive when more than five percent of its production costs is attributed to fossil fuel energy usage. In addition, to fall under the Border Carbon Adjustment, at least 15 percent of the total national production must be traded internationally.  These goods are more properly known as “Emission-Intensive Trade-Exposed (EITE) goods.

The amount of EITE goods that the US exports or imports that would be affected by a border adjustment is not actually that large. In the case of US exports, fewer than ten percent of US industry groups would be affected, totaling about 12 percent of US manufacturing output. 

And, due to the WTO requirement that each country maintain a “harmonized”  tariff schedule (including products without a tariff) 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 also the State of California to identify the carbon content of the hundreds of different types of imported fossil fuels, so that calculating a border adjustment fee would not impose an administrative or logistical burden. 

Would Border Carbon Adjustments be permitted under international trade agreements for which the US is a signatory? 

The U.S. along with most countries is a member of the World Trade Organization (WTO) and is a signatory to the General Agreement on Tariffs and Trade (GATT). GATT is a legal agreement among trading countries 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.

It is generally agreed that a properly designed border carbon adjustment would be compliant with relevant provisions of the GATT. 

The most important provision is Article 1, the “Most Favored Nation” principle, which means trade without discrimination. The most favorable treatment accorded one trade partner must be accorded to all trade partners which signed the GATT. So a country cannot charge different tariff rates to different countries, but must charge the same tariff for a particular good to all trade partners. 

Even though border carbon adjustments for a particular imported good, such as steel, might vary from one trading partner to another depending on the product’s embedded carbon emissions and also the particular country’s emission mitigation programs, the criteria and method of calculating an adjustment would not vary, thus treating all countries equally. 

Plus, a border carbon adjustment is not actually considered a tariff, but a fee levied on the carbon emissions resulting from the production of the good, not a fee on the good itself. 

Another important provision of the GATT is Article III, paragraph 2, which states that imported goods should not be subject, directly or indirectly, to taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to similar domestic products. Since the border adjustment rates would be identical to the carbon fees assessed domestically, a border carbon adjustment would be in compliance with this provision. 

However, even if the border adjustment were considered discriminatory, Article 20, paragraphs (b) and (g) (i.e. “Article XX, paragraphs (b) and (g)” in legalese) of the GATT 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.

The Complexity of Border Carbon Adjustments and Climate Diplomacy

While Border Carbon Adjustments encourage trade partners to implement their own prices on carbon, Border Carbon Adjustments are administratively complex. Citizens Climate Lobby believes that the best case scenario is that Border Carbon Adjustments are not needed for the most part, due to equivalent carbon pricing programs among our trading partners. 

In fact H.R.2307 includes a specific provision to encourage “the Secretary of State, or the Secretary’s designee, to commence and complete negotiations with other nations with the goal of forming treaties, environmental agreements, accords, partnerships or any other instrument that effectively reduces global greenhouse gas emissions to zero percent of 2010 levels by 2050 and which respect the principle of common but differentiated responsibilities and respective capabilities.”

There are various paths that 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. In fact, at one point Canada’s PM indicated he’d like to use the NAFTA negotiations to incorporate carbon pricing across the NAFTA territory.

Another way countries could cooperate diplomatically is to petition the WTO for a climate waiver, waiving relevant disciplines to clarify that there are no issues with carbon pricing and border adjustments. 

The EU Border Carbon Adjustment Mechanism

In March 2021, the EU Parliament voted to institute a Border Carbon Adjustment Mechanism, and in July 2021 they released extensive details about the border mechanism, which is scheduled for implementation in 2026.  Because the EU does not have a carbon tax - they have a cap-and-trade system - they are adding the term “mechanism.”. The EU emissions trading system, however, only covers about 40 percent of EU greenhouse gas emissions and also has some “holes” or free allowances. Evidently the EU is hoping that the exceptions in Article 20 of the GATT will permit their Border Adjustment Mechanism to be implemented.

Nonetheless, the mechanism would tax both direct emissions from the production processes of the eligible imported goods and indirect emissions associated with generating the electricity used in the manufacturing processes. The import tax price would be set according to the price of carbon emission certificates in their cap-and-grade system. It’s not clear if there would be a rebate for EU exporters.

Imported goods from countries with a carbon price could be fully or partially exempted from the import tax.

If the US has not implemented carbon pricing by the time the EU border carbon adjustment mechanism is implemented, import taxes on carbon intensive goods or fuels would significantly disadvantage the US when compared with other countries that had carbon pricing in place.

Additional Helpful Readings

Outside Articles:

CCL Blogs:

  1. How Europe's carbon pricing could affect U.S. trade
  2. Europe's upcoming border carbon adjustment
  3. Canada increasing its carbon price
  4. When Canada first implemented their carbon price

Laser Talks:

  1. Carbon Pricing Around the World (current laser talk)
  2. Carbon Fee Border Adjustment(current laser talk)
  3. Canada's Carbon Taxes (current laser talk)
  4. EU Border Adjustment (current laser talk)
  5. WTO and the Border Adjustment (old laser talk, links still good)
Press play to start the video (42m 16s)
Video Outline
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Intro & Background

Context & History of International Trade

What Are Tariffs & Resolving Disputes

Adjustment Design For Fossil Fuels

Carbon Intensive Goods

Global Diplomacy Considerations

Q&A Video Discussion (Separate): 

Dr. Ross Astoria

Download Google Slides presentation.

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Press play to start the audio (42m 16s)
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Audio Outline
To skip ahead to a specific section go to the time indicated in parenthesis.

Intro & Background

Context & History of International Trade

What Are Tariffs & Resolving Disputes

Adjustment Design For Fossil Fuels

Carbon Intensive Goods

Global Diplomacy Considerations

Q&A Video Discussion (Separate): 

Dr. Ross Astoria
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