By Andrew Lautz, National Taxpayers Union
Sen. Chris Coons (D-DE) and Rep. Scott Peters (D-CA) have introduced legislation that would place new tariffs on carbon-intensive imports — a so-called border carbon adjustment (BCA). The bill’s sponsors say this policy would “protect U.S. jobs, reduce global emissions, and drive resilience in frontline communities.” While BCA proposals are hardly new in the U.S., this Coons-Peters legislation, the “Fair, Affordable, Innovative, and Resilient (FAIR) Transition and Competition Act,” is particularly flawed as it could lock in complex and inefficient domestic regulatory regimes, invite retaliation from America’s trading partners, punish U.S. exporters, and potentially even hinder global efforts to reduce greenhouse gas (GHG) emissions.
What’s in the FAIR Transition and Competition Act
First, a brief summary of the FAIR Transition and Competition Act:
- The bill instructs the Treasury Department to annually measure the costs that a few emissions-intensive U.S. economic sectors incur in complying with federal, state, and local environmental laws and regulations; those sectors are natural gas, petroleum, coal, steel, aluminum, cement, iron, and any sectors that federal agencies determine in the future should be subject to a BCA;
- From there, the Environmental Protection Agency (EPA) must annually determine the prior-year GHG emissions of each sector, as well as the GHG emissions for the top one percent of production sites;
- Starting in 2024, importers of any of the fuels or goods mentioned above must pay a tariff (or “fee”) that’s equal to the domestic environmental costs estimated by Treasury (see above) multiplied by the production GHG emissions of the import (or upstream emissions, in the case of a fuel);
- Certain low-income countries are exempt from the tariffs, as are countries that both 1) have GHG emissions reduction laws or regulations in place that are equal to or more ambitious than U.S. laws and regulations, and 2) do not levy a tariff on U.S. exports;
- Tariff revenues first go to U.S. Customs and Border Protection (CBP), which will be responsible for administering the tariffs. Any remaining revenues are split between 1) federal research funding for technologies that reduce or eliminate GHG emissions and 2) grants to states to invest in climate resiliency and in communities at the frontlines of climate change impacts (e.g., coastal municipalities exposed to rising sea levels).
As noted above, Sen. Coons and Rep. Peters are hardly the first lawmakers to propose a border carbon adjustment (BCA), sometimes referred to as a carbon border adjustment (CBA; the current European Union proposal is called a carbon border adjustment mechanism, or CBAM). By our rough count of an up-to-date Congressional Research Service (CRS) summary of carbon pricing legislation over the past few decades, lawmakers have proposed some version of a BCA at least 40 times since 2007.
However, that does not make BCA proposals any less complex and problematic to design and administer. Challenges abound from both an international trade and an emissions reduction perspective. Further, some unique features of the Coons/Peters proposal could have particularly troubling implications for the U.S. economy and consumers.
Carbon Pricing, Without the Price
What sets the FAIR Transition and Competition Act apart from most (if not all) of the dozens of previous BCA legislative proposals is that, rather than being tied to a carbon tax or a national cap-and-trade program, the bill would ask federal regulators to determine the cost that different sectors of the economy incur when complying with various federal, regional, state, and local laws, regulations, policies, and programs. Sounds complicated? It is.
In his legislation Sen. Coons, a close ally of President Biden and a past supporter of President Obama’s Clean Power Plan, seems to be setting the stage for President Biden’s Energy Efficiency and Clean Electricity Standard (EECES) — a possible successor to the since-replaced Clean Power Plan — by requiring federal agencies to tie the carbon tariff rate to the rough costs of compliance with environmental regulations, rather than tying the rate of a carbon tariff to a carbon price (set by a carbon tax or by a market-based cap-and-trade system). By forcing regulators to determine sector-by-sector compliance costs, and asking them to fold in overlapping and/or duplicative standards like those in California or in the Regional Greenhouse Gas Initiative, the Coons/Peters legislation is making the process for determining the domestic cost of regulatory compliance quite complicated.
This choice would also lend itself to apples-to-oranges comparisons with the legislative or regulatory regimes of other countries, rather than apples-to-apples comparisons. Rather than comparing, say, a domestic carbon tax rate with the carbon tax rate levied in another country — or rather than comparing the carbon price in a domestic cap-and-trade system with the carbon price in the cap-and-trade system established by the EU — the FAIR Transition and Competition Act will ask domestic regulators to compare a difficult-to-determine estimate of regulatory compliance costs with the carbon taxes or cap-and-trade systems of other countries. Or, as the Brussels think tank Bruegel put it:
“…implementing a CBA in the absence of a federal carbon price will be a major challenge because environmental regulations impose widely divergent compliance costs per ton of carbon on emitters, based on their individual marginal abatement cost curves…”
These complexities could, in turn, invite challenges on tariff pricing from U.S. importers, foreign exporters, or U.S. trading partners who are upset with U.S. regulators’ determinations, which could then lead to World Trade Organization (WTO) challenges and/or retaliatory trade measures from other countries.
Risking WTO Challenges and Retaliatory Measures
Even an advocacy group supporting the Coons/Peters legislation, Citizens’ Climate Lobby, wrote in their endorsement of the bill that “[i]mportant details with respect to the WTO still need to be resolved.” That is an understatement.
Unfortunately, the FAIR Transition and Competition Act kicks much of the most difficult WTO work to federal regulators, rather than attempting to build a BCA regime from the start that could withstand challenges at the WTO or retaliatory measures from U.S. trading partners.
The bill instructs the Treasury Department to ensure that the BCA is consistent with international trade agreements, but offers no guidance on how the Treasury should go about ensuring consistency. This is similar to the European Union (EU) claiming that their carbon border adjustment mechanism (CBAM) is WTO-compliant even as Brazil, South Africa, India, and China express their “grave” concerns about the “discriminatory” trade “barriers” raised by the EU’s CBAM.
In fact, the very framing Sen. Coons and Rep. Peters used in introducing their bill may increase the odds such a BCA tariff receives a WTO challenge. Some proponents of a BCA claim that such a measure could withstand a WTO challenge under an exception for environmental measures under the General Agreement on Tariffs and Trade (GATT) Article XX. The OECD summarizes the exception as:
“…allow[ing] for measures intended for environmental objectives to violate other GATT principles, provided that the breach is justified by the desired end (tackling climate change) and is neither arbitrary nor carried out in a way that protects domestic interests over imports.”
Two of three headline justifications for the Coons/Peters bill, though, make it clear their intent is to protect domestic interests (emphasis ours):
“Imposing a BCA will protect U.S. jobs, reduce global emissions, and drive resilience in frontline communities.”
In short, Sen. Coons and Rep. Peters said the quiet part out loud. That, in turn, could damage trading relationships with the nations mentioned above — and additional low- or middle-income countries that do not receive BCA exceptions under the legislation. Beyond lengthy and complicated WTO challenges, the BCA could invite retaliatory tariffs from U.S. trading partners, much like the ones that held back the U.S. economy over the past five years.
The bill requires the Treasury Department to set up a “fair, timely, [and] impartial” petition procedure for the revision of regulatory determinations on an import’s level of production GHG emissions, but — much like asking Treasury to ensure a BCA meets international trade commitments — this is much easier said than done.
No Export Rebate
Another challenge at the WTO, according to the OECD, is an export rebate that lawmakers have, in most prior U.S. proposals, paired with the carbon import tariff. While such an export rebate is important to ensuring domestic exporters are not disadvantaged by both a domestic carbon regulatory regime and its accompanying import tariff, the OECD explains why export rebates present additional challenges at the WTO:
“[Export rebates are] more difficult to justify in the WTO, as it is less clearly aimed solely at reducing carbon leakage, and may also be harder to justify in environmental terms as encouraging global action on reducing GHG emissions.”
The Tax Policy Center adds that determining the amount of an export rebate is even more troublesome, especially since pegging the rebate amount to “averages … rather than firm-level behavior” could encourage “overcompensation” of U.S. firms that could, again, lead to a WTO violation and/or challenge:
“Such benchmarks would simplify the administration of the program, but then BCAs would diverge from firms’ actual costs; some would be overcompensated and some undercompensated. A U.S. [energy-intensive and trade-exposed] EITE firm that already uses a low-emissions process could get an export rebate even though its production costs have not significantly increased as a result of a tax, simply because its domestic counterparts use a dirtier process. Such overcompensation would raise a potential WTO violation.”
The Coons/Peters bill gets around some of these challenges by excluding an export rebate, but as American Enterprise Institute Senior Fellow Kyle Pomerleau points out, the lack of an export rebate makes the Coons/Peters proposal more like a tariff than a border carbon adjustment.
The export rebate is a bit of a catch-22, but it’s unfortunate that Sen. Coons and Rep. Peters do not even attempt to address the matter in the FAIR Transition and Competition Act.
More Harm Than Good?
Ultimately, an underlying concern with this latest BCA proposal, and with the EU’s CBAM proposal, is that border carbon adjustments will do more harm than good in the effort to reduce GHG emissions. The OECD asks:
“Could a BCA instead be designed to be a more positive, cooperative mechanism, aimed at stimulating competition and a ‘race to the top’ across key industrial sectors globally?”
The United Nations (UN) study of the EU’s CBAM proposal further posits that CBAM could have deleterious effects on the real income of developing countries. Without a CBAM exemption for developing countries, the UN warns, “up to $16 billion of developing country exports … could face an additional charge.” The Coons/Peters bill has exemptions, but only for a few dozen of the world’s poorest countries.
Underscoring this potential harm to developing countries (and to the U.S. through retaliatory trade measures) is 1) the difficult decisions and trade-offs policymakers must address when designing a BCA, and 2) significant doubts as to whether a BCA will even achieve policymakers’ stated goals.
On the first point, consider what the Congressional Research Service says about how to create an “economically efficient” BCA (emphasis ours):
“…policymakers must decide which goods and/or industries would be covered by a BCA and how the adjustment program would assess the comparability of varied climate-related policies in other nations. In addition, accurately determining and verifying the volume of GHG emissions embodied in a particular imported product would be data intensive and challenging. To alleviate some of the measurement complexity, policymakers could limit the program to selected industries and apply default values and assumptions to particular manufacturing processes. However, this simplified approach could result in less accurate import price adjustments, which could potentially affect the accuracy of GHG emission reductions achieved by the carbon tax program.”
On the second point, consider evidence from the Tax Policy Center and the UN that carbon leakage — the very problem BCAs are meant to address; in other words, the movement of carbon-intensive production processes to countries that are not subject to carbon pricing or environmental regulations — is relatively small. Is a BCA, therefore, actually a solution in search of a problem? Could a BCA do more harm than good, if it doesn’t manage to meaningfully reduce GHG emissions but inspires global trade chaos instead of cooperation? These are questions lawmakers should consider carefully.
In short, the Coons/Peters carbon tariff suffers from a number of design flaws, and both Congress and the Biden administration would be better off leaving it in the dustbin. U.S. consumers and taxpayers require long-term solutions to the climate impacts of GHG emissions, but a carbon tariff moves in the wrong direction.
Andrew Lautz is the Director of Federal Policy for National Taxpayers Union.