CARBON BORDER TAX? OR PROTECTIONISM?

Emily Meredith - Jul 27,2021

US policymakers targeting aggressive emissions reductions are rolling out new tax proposals that would levy duties on imports from countries that do not have strong climate policies. The idea is to prevent “carbon leakage” -- the potential that emissions controls at home will incentivize production and manufacturing in countries where regulations are lax. But in unifying climate policies and trade policies, there is a risk that policymakers focus on proposals that skew toward trade protection rather than emissions reduction.

Last week, US Democrats in Congress debuted their own carbon border tax, following an EU proposal along similar lines the week before (EC Jul.16'21). Policymakers in Canada and the UK are also considering such adjustment mechanisms, amid a growing recognition that governments need to deploy more tools if they are going to stay on track with the goal of limiting global warming to 1.5°C or 2°C above preindustrial levels.

Legislation put forward by Democratic lawmakers would levy a tax on imports of energy and manufactured goods such as aluminum, cement, iron and steel when those imports are more carbon-intensive than those produced in the US. Under the draft legislation, oil, gas and coal importers would have to pay a fee based on the upstream emissions of their fuel, multiplied by the cost of environmental regulations imposed on that same fuel in the US. Importers of manufactured goods would follow a similar process.

Proposed by US Sen. Chris Coons, an ally of President Joe Biden, and Rep. Scott Peters, the “Fair Transition and Competition Act” is the most comprehensive carbon border tax legislation on the table in the US. It comes shortly after Democrats working on a $3.5 trillion spending package said they had agreed in principle to including one in their deal, expected to move forward without Republican votes. The Coons legislation could be used to inform what goes into the eventual package, although there are no guarantees it will serve as a template.

In March, the Office of the US Trade Representative said the administration would consider a carbon border adjustment. More recently, Biden Climate Envoy John Kerry has said the US is reviewing the idea, despite having warned European leadership in an interview with the Financial Times that a carbon border tax should be a “last resort,” as it could have “serious implications for economies, and for relationships and trade.”

Coordination or Competition?

For those focused on addressing the problem of carbon leakage, the new US legislation has a worrying emphasis on trade competitiveness. “It says a lot that there’s ‘competition’ in the name of this act,” notes Aaron Cosbey, with the International Institute for Sustainable Development. A fact sheet from Coons and Peters notes that in addition to helping to meet climate goals, their bill would “protect US jobs” and “reduce reliance on foreign energy sources.”

Carbon border taxes are, of course, meant to insulate domestic producers from seeing their markets erode as customers turn to cheaper but more greenhouse gas-intensive imports. But they aren’t supposed to serve as another means of protecting domestic industry.

That kind of language, however, could be the thing that holds appeal for US Republicans, says George David Banks, a former Trump administration official who now advises Republicans on energy and climate policy. “I think Republicans would come at it from more geopolitical and commercial perspective, as in: ‘If we're going to have a trade and climate agenda why would we do it?’ And the answer is China, China, China.”

The EU’s Carbon Border Adjustment Mechanism proposal allows for a reduction in the fee an importer pays if the manufacturer was subject to a carbon price at home, a European Commission spokesperson says. The US legislation does not appear to do that. Cosbey says that could risk a Canadian producer subject to a carbon tax at home being hit twice when selling into the US market.

Carbon Price Conundrum

So far, the US has not led on crafting an economy-wide price on carbon, an almost necessary foundation for a carbon border adjustment. Without a domestic carbon tax, border adjustments could prove very difficult to execute and possibly wouldn’t survive international trade disputes, Cosbey says.

After the failure of cap-and-trade legislation early in former US President Barack Obama’s tenure, domestic carbon pricing has largely fallen by the wayside. It has the support of big business groups but divides Democrats -- some of whom view a carbon tax as regressive. And Republican lawmakers largely remain opposed to initiatives to increase taxes, regardless of their structure.

That said, data compiled by the Climate Leadership Council -- a business-backed group advocating a carbon tax whose membership includes several large oil and gas companies -- show that US goods are mostly less carbon-intensive than those produced in regions other than Europe. “The United States is enormously competitive,” said Catrina Rorke, the Council's vice president for policy. “There’s a lot of opportunity for the United States to lead.”

True believers see an opportunity for a carbon tax as lawmakers look for ways to raise cash for large spending packages, but the general view is that a carbon tax’s best prospects are years away. Others are still less optimistic: A pithy faux obituary in the Atlantic this week declared the idea “dead.”

As focus on carbon border adjustments -- and attendant trade concerns -- grows, the International Monetary Fund (IMF) last month proposed an international carbon “price floor” both to spur climate policy creation within countries and to circumvent “emerging pressure for border carbon adjustments.” The floor would be negotiated among a few key large emitters, centering on a minimum carbon price rather than a prescribed international level. The G20, the IMF notes, will make up about 85% of global emissions in 2030.

A voluntary floor may start out low, but it could serve to “neutralize the effect of carbon pricing on the relative cost of domestic and foreign goods and head off the prospect of unilaterally imposed [border carbon adjustments],” the IMF report reads.

Emily Meredith is a reporter and deputy Washington bureau chief for Energy Intelligence.

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