This week, E&E News reported that the European Union is considering implementing a border adjustment mechanism as part of its effort to reduce greenhouse gas emissions. If such a policy were to take effect, according to the story, the border adjustment would apply a carbon tax on products from countries that have less-aggressive carbon pricing than the EU. With carbon prices in Europe now trading in their Emission Trading System (EST) at around €24 (approximately $26) per metric ton of CO2 emissions, and no meaningful carbon pricing in the U.S. outside of California, such a move could increase trade tensions between the countries. 

A border tax adjustment is a levy on imports and rebate on exports. Border adjustments are frequently used by governments to harmonize the effects of a value-added tax or other excise taxes between international and domestic goods. In the context of a carbon tax, a border adjustment helps define the base of the carbon tax, ensuring that it is assessed on the carbon content of goods consumed within a country. Imports are goods consumed in a country and their associated emissions should be taxed. Exports are consumed elsewhere and shouldn’t be taxed (excepting a carbon tax in the other jurisdiction). 

The primary benefit of a border adjusted carbon tax is that it levels the playing field between domestic and foreign manufacturers. Goods are subject to the carbon tax, regardless of where they are produced. In addition, a border adjustment reduces the chances of companies shifting their production to other countries with less ambitious carbon emission pricing policies, a phenomena—known as carbon leakage—the EU is trying to prevent. 

While it will take time for the European Union to design the border tax adjustment, it could become the first jurisdiction to implement one. It is hard to predict how things will play out exactly without knowing the details of the E.U. plan, but it could increase trade tensions with the U.S.. For some time, the argument is that carbon tariffs would allow countries with a meaningful carbon price to incentivize their trading partners to price carbon as well. It doesn’t look like that would be the immediate U.S. response. Instead, Commerce Secretary of Commerce Wilber Ross implied the United States “would react” with unspecified measures.  

If the EU raised a carbon adjustment at prices equivalent to the permit price in the ETS, the tariff would be commensurate with a meaningful carbon price. Several of the carbon tax bills that have been introduced in Congress, such as the SWAP Act and MARKET CHOICE Act, would raise carbon border adjustments at similar levels ($30 and $35 per metric ton to start) and could allow for a trade regime which carbon was priced in both Europe and the U.S. without interrupting trade. It would be an opportunity worth seizing.