Proposals to levy a carbon tax in the United States uniformly include a mechanism to ensure that domestic industry can stay competitive in international markets. Such a mechanism needs to prevent domestic manufacturers from shifting their production offshore, which would cause emissions leakage and lost jobs. The most common mechanism is a border adjustment. It works by levying a tax on imports and a rebate on exports. For each product, the adjustment should vary based on the carbon emissions associated with its production. While this seems relatively simple, the implementation of a border adjustment will require a well-thought out policy design.
One of the critical design issues of a border adjustment is determining carbon emissions associated with imported products. Calculating carbon content is straightforward for some goods, such as a barrel of oil, but gets more complicated for final goods produced through complex supply chains. This is by no means an easy task, but it could be possible and administratively feasible with a well-designed mechanism.
In a recent article, Michael Mandel of the Progressive Policy Institute argues that it’s “almost impossible” to assign carbon emissions to imported products with complicated supply chains that cross multiple national borders.
Mandel is correct with the practical challenges of border adjustment. If policymakers aspire to precisely account for carbon emissions associated with producing each part and the assembly process along the complex global supply chains, it is obviously impossible to reach such a detailed level of accuracy.
However, accounting for imported products’ carbon emissions can be achieved through a “like” product approach.This approach would levy a tax on an imported product that is equivalent to the carbon tax on a “like” domestically manufactured product. Jennifer Hillman, a former member of WTO’s Appellate Body, defines a “like” product as one “produced by the predominant method of production, or even the best available technology, in the United States.” The “like” approach would significantly reduce the administrative burden and cost associated with products crossing borders at different production stages.
The like approach has already been incorporated in new legislation. The SWAP Act included a proposal similar to a “like” approach that treats imported products as equivalents to similar domestic products.
But what if an imported product’s actual emission is lower than its “like” U.S. product? In this case, an official government committee should be designated to investigate and rule on foreign companies’ disputes on import taxes. If an importer can demonstrate that its products are associated with lower carbon emissions than what is levied by the border adjustment, it can appeal to the committee.
Policy design sometimes requires creativity and flexibility. Policymakers need to keep this in mind when constructing a border adjustment mechanism for a carbon tax.