International taxation reform hit a milestone in July this year when 130 countries agreed to a broad framework that included a global minimum corporate tax. With the global tax reform gaining traction, the International Monetary Fund proposed a global minimum carbon price to facilitate meaningful international efforts on greenhouse gas reduction. The IMF proposal recommends a global carbon price floor as a better alternative to carbon border adjustments. 

There are significant challenges to achieving a global carbon price floor, however. Domestic carbon taxes coupled with border adjustments would be quicker and more practical in encouraging international decarbonization.

OECD/G20 global minimum corporate tax agreement

The Organization for Economic Cooperation and Development and G20 countries started a base erosion and profit shifting (BEPS) initiative in 2013 that facilitates negotiations to address multinational corporations’ tax avoidance behavior. After nearly a decade, 136 countries announced an agreement in early October on new global tax rules. The agreement would update the rules determining where large multinational corporations pay taxes on a portion of their profits and enact a global minimum tax of 15 percent on large corporations’ foreign profits. The agreement seeks to implement these new global tax rules by 2023. Countries that signed the agreement will need to pass new tax laws at home and update their existing tax policies to comply with the agreement.

IMF global minimum carbon price proposal 

Recently some policy experts have floated the idea of leveraging the OECD/G20 framework to pass a global minimum carbon tax. IMF released a detailed proposal for an international carbon price floor this summer. The proposal includes several key elements

1) Large carbon emitters would need to agree on a minimum carbon price (the proposal lists the U.S., China, the EU, the U.K., Canada, and India as large emitters); 

2) A differentiated price floor ($75, $50, $25) would apply to the six jurisdictions based on their development level; 

3) Countries would be allowed to use non-pricing policies such as regulations to meet the price floor requirement; 

4) The proposal leaves it open whether the global minimum carbon price floor would take the form of a voluntary agreement or an international treaty. 

The proposal concludes that an international carbon price floor is a better option than carbon border adjustments in incentivizing global emissions reductions. A global price floor, the proposal argues, would “likely circumvent pressure for unilateral border carbon adjustments.” 

What are the challenges to achieving a global carbon price floor? 

While the idea of a global carbon price floor among the world’s biggest emitters seems straightforward and appealing, there are significant challenges with such an approach. 

First, it’s one thing to agree on a tax rate, it’s another to agree on the base of that tax. Even if multiple countries come to an agreement on a tax rate, the base of the tax might be different. In the context of a carbon tax, the tax base is determined by the type of greenhouse gas and the sector(s) subject to the tax. Imagine, for example, that country A and country B agree on a carbon tax rate of $10/ton. Country A levies the tax on carbon dioxide in the power sector and the industrial sector, while Country B levies the tax economywide on carbon dioxide and methane. Obviously, even with the same tax rate, the tax base in these two countries would be different. The IMF proposal recognizes this issue and suggests starting with a nominal price and transitioning to an effective price over time. But agreeing on a nominal price instead of an effective price would likely render the agreement symbolic rather than functional.  

Second, accommodating non-pricing policies would diminish the effectiveness of a global price floor. The IMF proposal acknowledges the difficulty of implementing carbon pricing in some countries and concludes that “further flexibility to accommodate non-pricing approaches with emissions-equivalent outcomes may therefore be needed.” Allowing countries to meet the minimum carbon price requirement with non-pricing policies would likely open the floodgates to various interpretations of what counts as meeting the “minimum.” 

Third, international negotiations are long, difficult, and uncertain. It took eight years for countries to sign the OECD/G20 global minimum corporate tax agreement from the initial project launch. Countries still need to revise their tax laws to comply with the agreement. Although the agreement is seeking to implement the new rules by 2023, some tax policy experts believe the target is ambitious. Many details of the agreement still need to be worked out, and countries may wait for others to move first on implementation before taking action — especially amid doubts that the U.S. Congress will sign off. If achieving global emission reductions quickly is a priority, negotiating a global carbon price floor may pose significant challenges. 

Why are border adjustments better?

A border adjustment under a carbon tax includes an import tax on imported goods and export rebate on exported goods at the same rate as the domestic carbon tax. This approach has its own challenges. My previous white paper discusses in detail the key design and implementation hurdles, and this blog post addresses the most common questions about carbon border adjustments.   

But a domestic border-adjusted carbon tax has several advantages over a global carbon price floor in incentivizing decarbonization globally: 

  • Border adjustments do not require the long and complex international negotiations a global carbon price floor would entail. Any country can implement a unilateral border-adjusted carbon tax. 
  • Well-designed border adjustments could be applied equally to all trading partners without accounting for their domestic climate policies. This would significantly ease the administrative burden and ensure the border-adjusted carbon tax is compliant with World Trade Organization rules. 
  • Border adjustments are effective in incentivizing foreign producers to decarbonize their supply chains if they want to sell goods to consumers in the jurisdiction imposing the policy. 

IMF researchers’ major critique of border adjustments is the coverage of products: “BCAs are far less efficient and effective than price floors in achieving emissions reductions as they apply to only a small portion of a trading partner’s emissions.” 

It is true that all the existing carbon border adjustment proposals limit their scope to certain products and industries to ease the administrative burden of implementation. But a well-designed border adjustment would ideally be broad-based. In this white paper, I explained why a broad-based border adjustment under a carbon tax may not be as onerous as many fear. There is a way to design a framework to track product-level emissions throughout the supply chain for the implementation of border adjustments. 

If the world’s biggest emitters could agree on a meaningful global carbon price floor, it would contribute significantly to climate mitigation. But it’s important to keep in mind the significant challenges of achieving such an agreement. Border adjustments implemented alongside carbon taxes will be quicker and more practical in encouraging international decarbonization. 

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