Recently, there has been notable momentum in conversations about carbon border adjustments. The European Union leaders recently announced their intent to have a carbon border adjustment mechanism by January 1st, 2023. Details of this proposal still need to be worked out over the next two years. Before we find out the full details of the EU carbon border adjustment proposal, it’s difficult to tell whether it will be an import tariff or a border adjustment.  

A recent op-ed authored by Arvind Ravikumar published on the MIT Technology Review strongly opposes a carbon border adjustment, calling it “hypocritical” and “unjust.” Ravikumar argues that a carbon border adjustment is a protectionist measure that punishes developing countries for their carbon-intensive production and would perpetuate historical inequities between the developed and developing worlds. 

Ravikumar defines a carbon border adjustment in his op-ed as “a tax on imported goods such as steel or cement, where the amount of tax depends on the carbon emissions associated with producing those goods.” What Ravikumar describes is an import tariff, not a border adjustment. Border adjustments and import tariffs are often confused for each other, but they are not the same. Their differences might address some of the issues that Ravikumar has raised. 

An import tariff is a tax levied on certain imported goods. A border adjustment consists of both import tax and export rebate. As explained by the economist Alan Auerbach, “Unlike tariffs on imports or subsidies for exports, border adjustments are not trade policy. Instead, they are paired and equal adjustments that create a level tax playing field for domestic and overseas competition.” 

Alan Viard explains why the economic effects of border adjustments continue to be widely misunderstood in his paper. Viard argues that the commonly held claims about the trade effects of a border adjustment – that it would permanently boost exports and reduce imports by making imports more expensive and exports more lucrative, are incorrect. A stand-alone import tariff unaccompanied by an export rebate would reduce imports and distort trade. But when an import tariff and an export rebate are adopted together at equal rates, the trade effects of the import tax and those of the export rebate offset each other.  

A border adjustment is a mechanism that ensures consumers within a jurisdiction pay the same tax for a good or service regardless of whether the good or service is produced domestically or imported. It works by levying tax on imported goods and giving rebates to exported goods. In the case of a country with a domestic carbon price, it helps to prevent companies from shifting their production to countries without a carbon price and leveling the playing field between U.S. and foreign manufacturers. Border adjustment is widely used around the world, most commonly in the value-added tax (VAT). Countries have different VAT rates, and they border-adjust imports and exports to ensure consumption of goods within the country is subject to the same VAT rate.

Ravikumar argues that the history of Western investment in developing countries favoring extractive and polluting industries would make a border adjustment hypocritical. But that history cannot be separated from the fact that environmental standards in the West had no border adjustment, such that producers could shift production to countries with less stringent environmental standards, even as air quality in the West improved. If the United States were to enact a meaningful carbon tax without border adjustment, it would risk committing the same mistake: incentivizing shifting carbon-intensive production to developing countries and creating the risks of stranded assets a decade or two, as global climate ambition increases. 

It’s important to keep in mind that a border adjustment is not a punitive trade policy. It’s a tax policy that equals the tax burden on imported goods and domestically produced goods. Under a border adjustment, imported goods from developing and developed countries are treated the same. They are all taxed based on their associated carbon emissions. Domestic producers are not given any undue advantage through the border adjustment mechanism. They are competing on a level playing field with foreign producers. 

Ravikumar raises important considerations that have clearly influenced the history of international climate policy, and must be included in future designs. He is particularly concerned with how to balance the needs of developed and developing nations, and how to leverage differential capacity in the course of decarbonizing the world economy. The tools he proposes to develop clean infrastructure in developing countries, like technology transfer and financing, are worth considering. But they would be complemented by a well-designed border adjustment under a carbon tax. 

Research suggests that most countries are not hitting the Paris agreement climate goals. A serious climate mitigation strategy is overdue, and it requires putting a price on carbon. A well-designed carbon tax should have a border adjustment mechanism. Until we all recognize that a border adjustment is not a trade policy, we cannot have a meaningful discussion on this topic.

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