The rise of carbon-based trade policy

Buoyed in part by discussions in Europe, trade policy is increasingly taking center stage in climate policy discussions in the United States – on both sides of the aisle.

Carbon border adjustments are an emerging set of trade policy tools that aim to prevent carbon-intensive economic activity from moving out of places with relatively stringent climate policies and into those with laxer rules. Border adjustments have the potential to increase the environmental effectiveness of climate policies, by averting shifts in economic activity that could lead to higher total greenhouse emissions—a phenomenon known as “carbon leakage.” They are also seen as a way of promoting basic fairness, “leveling the playing field” between domestic and foreign producers. Indeed, given that U.S. manufacturers emit much less carbon, on average, than their competitors in China and many other countries, a carbon border adjustment could boost U.S. economic competitiveness.

Read our fact sheet, Carbon Border Adjustments: Considerations for Policymakers.

The European Union (EU) is pursuing what it terms a carbon border adjustment mechanism (CBAM) that would make the region the first in the world to enact a carbon-based fee on imported goods. In this case, the fee would be aligned with the price of an allowance to emit greenhouse gases in the EU’s emissions trading system (EU ETS), which EU producers are already required to purchase.

Typically, carbon tax proposals in the U.S. Congress have included a border adjustment to match an explicit carbon price that would be applied domestically. But partly owing to the challenges of passing a federal carbon price, interest in border adjustments without an explicit price is growing.

Last year, Senator Chris Coons (D-Del.) and Rep. Scott Peters (D-Calif.) introduced a bill that would implement a border adjustment using an implicit price based on a range of regulatory and other policies at the local, state, and federal levels. The Biden administration has also shown openness to a border adjustment based on an implicit price. Republican interest in a border adjustment without an explicit price has accelerated as well, led by Senator Kevin Cramer (R-N.D.) and Senator Bill Cassidy (R-La.).

This sort of bipartisan interest is welcome to all of us interested in seeing durable, effective climate policy. At the same time, imposing a border adjustment without an explicit price on carbon raises a host of potential concerns, including the practical difficulty of calculating an appropriate implicit price, as well as the likelihood that other countries would bring a challenge under World Trade Organization rules designed to promote free trade.

However, there’s a third approach to consider. Senator Sheldon Whitehouse (D-R.I.) recently introduced a proposal that would pair a border adjustment with a domestic performance standard. Under this approach, both importers and domestic producers in each covered sector (largely emissions-intensive industrial commodities like cement, steel, and chemical products) would be charged a fee for emissions. The fee would be set above a benchmark pegged to the average performance of U.S. producers in that sector. The fee would be set near the federal government’s current estimate of the social cost of carbon ($51 per metric ton of carbon dioxide) and increase over time.

Senator Whitehouse’s proposal effectively occupies a middle ground: potentially more palatable politically than a conventional carbon price, while still establishing a domestic policy that could both send a strong signal for U.S. producers to decarbonize and serve as a fair and transparent basis for a border adjustment.

The wealth of emerging border adjustment proposals raises a host of design considerations: What sectors and goods should be covered? How should the fee be calculated? How should the border adjustment handle exports? Should countries with strong climate policies be exempted from the border adjustment?

C2ES outlines these and other key aspects of policy design in a new fact sheet, Carbon Border Adjustments: Considerations for Policymakers that also reviews the EU’s proposed CBAM,  U.S. congressional border adjustment proposals introduced in 117th Congress (2021–2022), and the broader contours of discussion on border adjustments in the United States.

As discussions around climate and trade policy continue to heat up, it’s crucial that we’re operating from a common understanding about the key issues at play. That’s exactly the gap this primer aims to fill. There’s real potential to enhance climate action through alignment with trade policy, but the details matter, and we need to get this right.