Carbon Pricing Myths: Part 5. A Carbon Fee Would Increase Prices and Thus Make U.S. Companies Less Competitive Globally

Most studies indicate that any such impact would be very small. British Columbia adopted a carbon tax in 2008, and its per capita GDP growth has outperformed Canada’s. (Meantime, the tax has reduced fossil fuel consumption by 9 percent, while use in the rest of that country has risen.) “Far from a ‘job killer,’ it is a world-leading example of how to tackle one of the greatest global challenges of our time: building an economy that will prosper in a carbon constrained world,” according to a commentary by two Canadian professors and the chairman of Pan American Silver Corporation and Alterra Power.

The most vulnerable companies would be those in the energy-intensive, trade-exposed (EITE) industrial sectors. They comprise less than 2 percent of U.S. GDP and less than half of 1 percent of non-farm labor. But these industries and jobs (basically, steel, aluminum, cement, glass, some paper and chemicals) are important, and there would be greater economic impact in regions where these industries are most significant. Since such businesses could be at a competitive disadvantage with businesses in no-tax countries, the United States should take steps to maintain a level playing field.

There is another—and more compelling—reason to do so. If the United States becomes a more expensive place to produce goods due to a price on carbon, we will have created an incentive for production in countries where there is no price on carbon. This is known as carbon leakage. Since a ton of carbon dioxide damages the global climate equally no matter where it is emitted, leakage renders our efforts to combat climate change less effective.

What, then, is the best way to ensure that a U.S. carbon tax would have its desired impact? The most common suggestion is a border tax adjustment (BTA). EITE goods arriving from nations that have no equivalent carbon price would pay a fee at our border. Similarly, U.S. EITE exporters would receive a credit to ensure that companies are all playing on level ground.

BTAs lie at the heart of the challenge of reconciling international trade and climate policies, according to Brian P. Flannery of Resources for the Future (RFF). In “Carbon Taxes, Trade, and Border Tax Adjustments,” an April 2016 policy brief, he wrote that language in the United Nations Framework Convention on Climate Change (UNFCCC) and its protocols and agreements reference trade and limiting adverse consequences of policies to address climate change, but they provide no procedures to resolve differences. Disputes over trade implications of climate measures could be addressed by the WTO.

WTO forbids tariffs designed primarily to protect the competitive position of a nation’s industries. Preventing leakage, however, is considered a legitimate goal. In a 2016 study Joel P. Trachtman, a professor of international law at Tufts’ Fletcher School, provided a detailed discussion of the WTO rules that should be considered in designing BTA’s. He noted that many aspects remain speculative because existing case law provides little clarity on how WTO rules might be interpreted in testing BTA’s.

WTO rules should not deter nations from moving ahead, wrote Jennifer Hillman, a former member of the WTO’s Appellate Body. After analyzing the organization’s provisions governing harmonizing border provisions for carbon taxes, she concluded: “...provided that policymakers carefully design a [carbon] tax, keeping in mind the basic requirements of the WTO not to discriminate in favor of domestic producers or to favor imports from certain countries over others … the threat of WTO challenges should not present a barrier to policy makers wishing to adopt a carbon tax system now.”

If BTA’s are adopted, those who devise them will have to find ways to deal with the fact that intermediate supply and value chains may cross borders multiple times before final goods are bought or consumed. Determining a product’s origin could be a challenge in some cases.

Could the 2015 Paris accord diminish the need for border adjustments? Sam Kortum (Yale University) and David Weisbach (University of Chicago Law School) raised that possibility, writing that “all countries will have some implicit carbon price” (unlike the Kyoto Protocol, where developing nations had no emissions obligations).

Kortum and Weisbach concluded that BTA’s would entail high administrative costs, are likely to be complex and inaccurate, and would almost certainly depend on political choices to decide which goods, emissions, and nations would be covered. The best that can be done, they suggested, is crude BTA’s that roughly estimate emissions for broad categories of goods from a select group of countries—and imposing even that system would be difficult. In their Resources for the Future paper (March 2016), they recommended that BTA’s be applied only to activities and products associated with EITE sectors.

Democracy has been famously described as the worst possible form of government—except for all the others. Perhaps a similar description fits border adjustments. The best approach, Kortum and Weisbach wrote, might be to threaten to impose BTA’s in the future on countries that do not meet a specified standard for emissions reductions or a specified carbon price. That might induce countries to impose a price on carbon while avoiding the complexities of actually imposing BTA’s. Moreover, if producers know that imports from a given country will in the future face such levies, they may not relocate there in the first place, reducing leakage. In other words, threatening to impose BTAs may provide all the benefits of actually imposing them.