The Niskanen Center collaborated with the Alliance for Market Solutions and the Climate Leadership Council to host a virtual event on carbon border adjustments this past Thursday, May 6th

The conversation generated many questions from participants, which we were not able to fully answer in the scheduled time. We thought it would be useful to highlight some of the most frequently asked questions here on the blog.

How can a border adjustment account for other countries’ climate policies? If a border adjustment is implemented disregarding other countries’ carbon pricing policies, wouldn’t it lead to double carbon taxation?

A carbon border adjustment mechanism’s goal is not to harmonize different countries’ carbon pricing policies. Rather, its main goal is to ensure all goods consumed within a jurisdiction are subject to the same domestic carbon tax. A domestic carbon tax combined with a border adjustment would incentivize other countries to enact a domestic carbon price with a border adjustment, so their exporters would not be subject to double carbon taxation. 

Treating countries differently in carbon border adjustments based on their domestic climate policies would be problematic from legal and administrative perspectives

Legally speaking, it would risk violating the most-favored-nation (MFN) clause in the WTO rules which prohibits WTO members from discriminating against other member countries. If a country decides to pursue such a differential treatment approach, Article XX in the General Agreement of Tariffs and Trade could be leveraged to justify this policy. However, research indicates that using Article XX as a justification for exception to the MFN principle would be quite difficult and subject to scrutiny at the WTO.

Administratively, it would be challenging to measure other countries’ equivalent carbon prices on a specific product, especially if a country has a mix of climate policies such as clean energy subsidies and command-and-control regulations. Additionally, individual firms might avoid the import levy through trans-shipping—shipping their products to countries that are partially or fully exempt from the import tax and then shipping to the final destination from those exempted countries to avoid the import tax. It would be administratively burdensome to deter such evasive trans-shipping behavior.

Can the United States implement carbon border adjustments without a federal carbon pricing policy? Can carbon border adjustments be implemented with command-and-control regulations such as performance standards?

A well-designed border adjustment should be combined with a domestic national carbon tax. Implementing carbon border adjustment on imported goods when there is not a national carbon price in the United States is equivalent to imposing protectionist tariffs on imports

It would be challenging to implement carbon border adjustments along with traditional environmental regulations for administrative, legal, and international trade reasons. Administratively, it would be difficult to convert all applicable carbon emissions regulations into an equivalent carbon price for any given product. Therefore, it would be hard to ensure the import tax levied on an imported good is equivalent to what a domestically produced good is subject to. Legally, taxing imported goods based on their associated carbon emission without a national carbon tax would risk violating WTO’s non-discriminatory rules. It may be perceived as protectionism by the United States’ trading partners and lead to retaliatory tariffs on U.S. exports. 

Why would a border adjustment apply rebates on exports? Wouldn’t the rebate encourage more exports and lead to higher carbon consumption in other countries? 

A border adjustment combined with a domestic tax ensures that goods are taxed based on where they are consumed, not where they are produced. Imported goods are for domestic consumption, so they are taxed. Exported goods are for foreign consumption, so they are exempted from the tax. 

In principle, economy-wide border adjustments are trade-neutral. They neither discourage nor encourage exports. It’s a misconception that export rebates in border adjustments would permanently boost exports. Economist Alan Viard explains in this paper that when an import tax and export rebate are implemented together at equal rates in a border adjustment, the trade effects of the import tax and those of the export rebate cancel out each other. Border adjustments are distinct from stand-alone import tariffs or export rebates, which are by design aimed at distorting trade flows. 

How to determine the amount of import tax levied on imported goods in border adjustment? How about goods that are manufactured across several countries?

A like-product approach could be used to apply taxes on imported goods as if they were produced domestically. This approach would make a border adjustment more likely to comply with the WTO rules because it assumes the carbon emissions associated with producing an imported product are equivalent to those of a like product manufactured domestically. The like-product approach also applies to goods that are manufactured across several countries, which would match imported goods with domestically produced goods based on the predominant production technology. 

Although the like-product approach does not account for the actual carbon emissions associated with imported goods with detailed precision, it is practical and would significantly ease the government’s administrative burden. Importers would need to be allowed to appeal to a designated government agency if they want to demonstrate that the carbon emissions associated with their goods are lower than the like domestically produced goods. The government agency would investigate and rule on foreign companies’ disputes on import taxes in border adjustments.