Carbon Tax Border Adjustments: Good Politics, Bad for Consumers?

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This piece was first published in Forbes on July 26, 2020. It is reprinted with their permission.

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In June the European Union’s director general for trade announced that the EU is developing a carbon border levy that will be imposed on imports of carbon-intensive goods such as steel and cement.  The border adjustment, part of Europe’s Green Deal to dramatically curtail carbon dioxide emissions, in part through carbon pricing, will aim to protect the bloc’s industries from cheaper foreign goods from countries where no carbon price is in place.  The EU will release its finished proposal by mid-2021.

On this side of the Atlantic, the eight carbon pricing proposals now circulating through Congress all include border adjustments to protect American companies from imports not burdened by a carbon price in their country of origin.  A corresponding refund of the carbon price on American exports would help ensure that American goods sold overseas are not priced out of foreign markets.

With all of the attention paid to carbon border adjustments, it would seem that they must be a good thing.  Yet the full story is more complex.  Border adjustments are a zero-sum game if not carefully designed, and where there are winners, there are likely those that won’t fare so well.

Border adjustments are meant to protect carbon-intensive domestic industries from foreign competitors not subject to a carbon price, and reduce the temptation for industries to transplant production overseas to avoid higher costs, preserving jobs at home.

Yet, while border adjustments alleviate economic pressure on polluting industries, at least in the near term, they transfer that pressure onto consumers.  In an oft-cited 2016 paper, University of Chicago law professor David Weisbach and Yale economist Sam Kortum explore the impact of border adjustments on consumers. 

“The basic question we wanted to ask is whether border adjustments would make the American people overall better off,” Weisbach recently said.  “Not just the industries that are complaining about the carbon tax, but really everybody.”

“We found out that they probably don’t help U.S. consumers.”

Border adjustments level the competitive playing field by levying a carbon fee on imports that’s equivalent to the carbon price borne by products made at home.  Similarly, exports from a country with a carbon tax, such as a hypothetical future U.S. with serious national climate policy, have their carbon price refunded at the border, eliminating any pricing handicap in export markets.

While the carbon price burden is lifted from domestic industry, the underlying cost of carbon still exists.  That cost is shifted onto domestic consumers, who now pay the baked-in price of a carbon tax for goods produced domestically, and on imports.  Meanwhile, foreign consumers are freed of any carbon price burden.

“What the border adjustment has done effectively is shift the tax off of foreign consumers and put it on U.S. consumers,” Weisbach says.  “Foreign consumers are really happy about this. And U.S. consumers — well, not so much.”

Border adjustments may also reduce the competitive pressure on industries to lower the carbon intensity of their operations and products versus manufacturers of similar products, as carbon content becomes less relevant to pricing.  Of course, consumers will still have an incentive to seek out substitutes to carbon-intensive goods, to the extent they’re available.  But the pressure on companies to become more carbon efficient versus their direct competition is diluted.

And it might be argued that by preserving jobs in fossil energy production and carbon-intensive manufacturing, border adjustments do ultimately help consumers.

“To the extent that we think that border adjustments are really preventing those industries from shifting out of the U.S., it’s not really clear how much in the long-run you’re going to stop those industries from having to retool anyway,” says Weisbach.  “It’s not clear that border adjustments, by trying to continue to protect these industries from retooling are really doing something that’s good for the U.S. in the long-run.”

“I think the supporters of border adjustments are the affected industries. They are the loudest voices out there, and they have an easy time making their views known in Washington. But nobody is out there speaking the American public generally.”

Competitive issues aside, Weisbach and Kortum found that border adjustments will be immensely complex and costly to implement.  Imagine the difficulty in calculating the carbon content of a car produced overseas. That car will have components produced by a number of suppliers, through a variety of methods and from a potentially dizzying array of source countries.

“The global supply chain is just too complex,” says Weisbach.  “There’s no way to impose a reasonably accurate border adjustment, and that’s why they’d be limited to simple fuels or steel.  Implementing on any comprehensive basis would be impossible, the cost would be overwhelming.”

“So border adjustments are crude and inaccurate, and then you induce problems because you’re not getting the incentives you want.”

None of which is to say that carbon pricing itself isn’t a good idea.  “There could be huge benefits in having a carbon tax,” says economist Kortum.  “It’s really an issue of whether you should leave it on the extraction sector, the energy sector, or push it downstream either to the production sector or to the consumers.”

The easiest solution by far would be the global adoption of a uniform carbon price.  The Paris Climate Agreement takes a step in this direction by driving nearly all countries toward some level of carbon price, either explicit or implicit.

“I think the big picture is that if all countries get together and impose a common policy, that’s just by far the best way to solve the issue of climate change,” says Kortum.  “And what we’ve been talking about today is the second-best situations, where only some countries have a policy.”

Nobel laurate economist William Nordhaus has proposed an alternate solution he calls Climate Clubs, whereby a uniform tariff is imposed on all imports from countries that don’t have a carbon price.  The plan is theoretically made stronger because countries with carbon pricing would band together to levy the tariffs, putting extra pressure on non-conformers to join the community of carbon pricing nations.  Yet another option would be to implement border adjustments that are based on industry-average emissions for a given class of goods, avoiding the complexity that would come with measuring the carbon pollution for individual products.

Kortum suggests that a partial border adjustment that still leaves pressure on extracting industries may also be a good compromise.

All of these options are being explored.  What’s clear is that border adjustments, and their alternatives, are messy solutions in a world that isn’t unified in its response to climate change.