Climate and trade policies are gaining traction as lawmakers look to address emissions embedded in globally traded goods that are subject to different jurisdictions’ climate regulations. The European Union (EU) is taking the lead by implementing the world’s first carbon border adjustment mechanism (CBAM).
In the U.S., the recently introduced Clean Competition Act and Foreign Pollution Fee Act aim to address climate and trade. They differ significantly in policy design choices and are not what most would consider standard border adjustments that would be implemented along a domestic broad-based carbon tax.
Border adjustments under a carbon tax would work by levying taxes on imported goods and providing rebates for exported goods. A border-adjusted carbon tax would tax goods and services based on consumption and equalize the tax burden between domestic and foreign producers in both imports and exports. Importers and domestic producers selling to U.S. consumers would be subject to the carbon tax, while exporters and foreign producers who don’t sell to U.S. consumers would be exempt. This eliminates incentives for companies to relocate their production facilities to another jurisdiction to avoid paying for the carbon tax (known as “carbon leakage”) and ensures U.S. exporters can compete on a level playing field in foreign markets.
Experts believe that a border-adjusted carbon tax could be compliant with World Trade Organization’s (WTO) rules. Deviations from the standard policy design would risk violating international trade rules.
There are several key features of well-designed carbon border adjustments that make the policy effective:
- Domestic carbon price: this is a must-have feature
- Tax base: a broad base of products is covered to prevent tax evasion
- Preventing carbon leakage: with both import taxes and export rebates
- Credit or exemptions: it does not account for other jurisdictions’ domestic climate policies to provide a credit or an exemption against the import tax for legal, economic, and administrative reasons
Here’s a brief overview of the EU CBAM and the U.S. climate and trade bills:
- The EU CBAM levies import taxes on goods across several sectors that would mirror the carbon price domestic producers are subject to under the EU emissions trading system. It covers goods across the cement, iron, steel, aluminum, fertilizers, electricity, and hydrogen sectors.
- The Clean Competition Act, reintroduced by Senator Sheldon Whitehouse (D-RI) in December 2023, is a narrow-based border-adjusted carbon tax that targets emissions generated by manufacturing facilities above a certain threshold.
- The Foreign Pollution Fee Act, introduced by Senator Bill Cassidy (R-LA) in November 2023, proposes unspecified carbon tariffs on certain imported goods from targeted countries. This proposal does not include a domestic carbon price.
Table 1. How do the EU and U.S. climate and trade proposals compare to model carbon border adjustments
| Model carbon border adjustments | EU CBAM | Clean Competition Act | Foreign Pollution Fee Act | |
| Domestic carbon price | Yes, with a domestic carbon tax | Yes, with a domestic carbon price in an emissions trading system | Yes, with a narrow-based carbon tax | No, with explicit language stating the bill does not provide any authority to enact a domestic carbon price |
| Tax base | Broad, covers a broad base of goods | Narrow, six sectors | Narrow, a selective list of carbon-intensive industries | Narrow, a selective list of goods |
| Export rebates | Yes | No | Yes | No |
| Credit or exemptions against import taxes | No | Yes, exporters from countries with a carbon tax or cap-and-trade policy are eligible for partial or full exemption | Yes, exporters from countries with a carbon tax or cap-and-trade policy are eligible for partial or full exemption | Yes, a long list of exceptions under which foreign exporters can get their import taxes waived |
Source: Author’s analysis.
The Clean Competition Act is the closest to model carbon border adjustments across the EU and U.S. climate and trade proposals listed in Table 1. Despite covering a narrow base of industries and only a portion of emissions generated by manufacturing facilities, the bill includes a domestic carbon tax with import taxes and export rebates.
Regardless of its name, the EU CBAM is de facto import tariffs since it does not include export rebates. To avoid paying the EU carbon price, EU exporters might have incentives to relocate to a different country with less stringent regulations.
The Foreign Pollution Fee Act also proposes import tariffs, though the U.S.’s enactment of carbon tariffs is much less justified than the EU’s, as the latter has a domestic carbon price. It is driven more by geopolitical goals rather than climate goals considering the extensive list of tariff waivers in the bill.
All three proposals cover a narrow base of industries or goods instead of a broad coverage base. Covering a wide base of goods along the supply chains would be administratively more complex. However, covering only upstream primary goods and exempting finished goods in a border adjustment mechanism would incentivize companies to game the policy and evade taxes. Policymakers should weigh the tradeoffs between the administrative burden of broad-based coverage and the effectiveness of the policy.
Each EU and U.S. proposal provides partial or full exemptions against the import taxes for eligible foreign exporters, rendering them problematic on legal, economic, and administrative grounds. Legally, giving some trading partners more favorable treatment by exempting import taxes may violate the WTO’s non-discriminatory rules. Economically, accounting for other countries’ domestic climate policies to give them exemptions would lead to a loss of tax revenue that would have been collected otherwise. Administratively, it’s a daunting task to determine and validate how much credit a specific good produced by a foreign manufacturer is eligible for.
As U.S. lawmakers continue to explore climate and trade policy tools to tackle emissions in international trade, they should consider the policy choices of well-designed carbon border adjustments and the implications of any deviations from sound policy choices.