Border Carbon Tax: What Would a Carbon Fee Accomplish?

Climate change is a global problem and solving it requires global action. However, most of the policymaking authority rests with national governments. One challenge facing national legislators is carbon leakage, which occurs when one jurisdiction imposes an emissions reduction policy, but companies move their operations to another, less regulated jurisdiction. The result is an economic pain for the regulated jurisdiction with no net reduction in global emissions.

Leaks are a real concern, although they only explain a small part of the emissions reduction in regulated countries. Senators Kevin Cramer (R-ND) and Christopher Coons (D-DE) recently inserted to bill laying the groundwork for a possible solution to the problem: a tax on the carbon content of imports. But it falls short of the optimal approach in several ways.

The bill, known as the “Try It Act,” would commission an Energy Department study on the emissions content of certain imported products, particularly iron, steel and other energy- or carbon-intensive products. The results of the study could form the basis for a carbon border fee or pollutant import fee, which would tax imports with high emissions.

Proponents claim that the policy would constitute a “carbon rim trim”, but that is a mistake. A border adjustment is a component of a tax on internal consumption, which taxes imports and exempts exports. In the context of carbon emissions, a border adjustment would exempt emissions associated with exports and tax emissions associated with imports.

A border adjustment shifts the burden of a carbon tax from production emissions to homes consumption emissions Sens. Cramer and Coons’ proposed border tax is not a border adjustment: it is a tariff on emissions from imports without a corresponding tax on goods produced and consumed domestically.

He defense of the policy in these terms it is that the United States has an implicit price on carbon, thanks to regulations aimed at reducing carbon emissions, and that a border tax would simply make the implicit price explicit on imported goods. Estimating the implicit US carbon price is a complicated process, as different sectors and different states also face a variety of different emissions reduction policies. Even assuming the implicit carbon price argument, the border tax does not include an exemption for exports, so it is still not a border adjustment.

The border tax would make US-produced goods more competitive in domestic markets relative to imports from high-carbon countries. As a result, the tax could marginally reduce emissions based on domestic consumption. That could translate into a marginal reduction in emissions based on foreign production.

But the idea that the carbon fee would incentivize countries like China to drastically cut their carbon emissions is dubious. In 2017, Chinese exports to the United States were associated with 288 megatons of CO2 emissions. Undoubtedly, that is a substantial amount, more or less equivalent to the total carbon emissions from Thailand in 2022. But in the context of China, it is a drop in the ocean. In 2017, Porcelain produced more than 10 billion tons of CO2, meaning that Chinese exports to the United States accounted for less than 3 percent of China’s carbon emissions.

The border carbon tariff would fall short of capturing even that 3 percent of China’s carbon emissions. The tariff would only apply to certain carbon-intensive goods, rather than all the emissions involved in the production of all imports. Administering a carbon fee is more challenging than administering a national carbon tax because under a national carbon tax, it is possible to tax upstream fossil fuel emissions (where fossil fuels are originally produced) at a low administrative cost. By contrast, it is impossible for the United States to tax carbon emissions upstream in a foreign jurisdiction. Instead, managers must undertake the imperfect and difficult process of estimating the emissions content of a finished good.

A carbon fee is not nothing in terms of addressing international carbon emissions or US competitiveness with more polluting economies. And a study to assess the emissions content of imports would be useful to policymakers seeking to design a more comprehensive carbon tax that includes a border adjustment. But the policy in question falls far short of that ideal.