The European Union is planning to unveil its carbon border adjustment (CBA) proposal by June this year and start implementing the mechanism by 2023. The proposal is aimed at protecting EU manufacturers’ competitiveness against their competitors overseas who are not subject to a carbon price. Currently, EU manufacturers are under the EU emissions trading system targeted at reducing greenhouse gas emissions. One of the key questions to be addressed in the proposal is which goods would be subject to the CBA. This will affect the revenue generated by the mechanism.
A standard border adjustment is the most commonly proposed mechanism to address international traded goods in the existing U.S. carbon tax proposals. A border adjustment under a carbon tax works by imposing taxes on imported goods and giving rebates for exported goods. It aims to tax the carbon content of goods consumed within the United States, including domestically produced goods and imported goods.
According to the European Commission estimates, the CBA could bring in between €5 and €14 billion annually depending on the actual mechanism’s scope and design. The EU proposed a €750 billion COVID relief package to address challenges in the bloc posed by the pandemic. Potential new sources of revenue from proposed policies such as the CBA and a digital tax are expected to help finance the repayment of the funds raised for the relief package.
While details of the proposal remain to be seen, cement, steel, and chemical industries have been brought up frequently as potential industries eligible for the EU’s CBA. The CBA mechanism could levy a tax on imported goods or extend the EU emission trading system to cover selective goods. It’s unclear whether the proposal will be a standard border adjustment.
How much net revenue would a border adjustment mechanism under a U.S. carbon tax generate? The Treasury Department in 2017 modeled a non-border-adjusted carbon tax that starts at $49 per metric ton of carbon. The tax’s net revenue in the first year (2019 in the model) was $194 billion, which does not account for the net revenue of a border adjustment.
A border adjustment’s net revenue can be estimated from the net imports of CO2 emissions. In 2018, the United States’ consumption-based CO2 emissions were 6.3 percent (latest data available) higher than its production-based emissions. In other words, the CO2 emissions embedded in net imports (imports minus exports) accounted for 6.3 percent of the total domestic emissions in the United States. This means that a border adjustment under a U.S. carbon tax covering a broad base of goods would raise positive net revenue. Multiplying the $194 billion that would be collected domestically by 6.3 percent produces an estimate of $12 billion for the net revenue of a broad-based border adjustment.
Obviously, a border adjustment’s net revenue would be affected by the design of a carbon tax, including the tax rate, tax base (types of greenhouse gases taxed), and the goods eligible for the mechanism. Ideally, a border adjustment would cover the carbon content embedded in all imported and exported goods. But if a border adjustment is designed to cover a narrow rather than a broad base of goods to lower administrative burden, its net revenue would be lower than the estimate for a broad-based mechanism.
Policymakers will need to determine the optimal scope of a border adjustment under a carbon tax. Net revenue is one important consideration among many others. It is also important to keep in mind that a border adjustment’s goal is to level the playing field between domestic and foreign producers, not giving undue advantages to certain industries over others.