US Should Adopt Carbon Border Tax to Address Climate Change

As extreme weather events seem to punctuate the news on a weekly basis, the need to address global climate change continues to grow.

To that end, the EU last month passed a carbon border adjustment mechanism—a border-adjustment tax on carbon. A BAT attempts to tax a good based on where it’s consumed rather than where it’s produced. When applied to carbon, the goal is to offset the incentive for producers to evade a carbon tax in one country by producing goods in another.

The EU’s CBAM has set a precedent and provided cover that other nations are likely to take advantage of. The US should use this opportunity to pass its own CBAM.

Acting alongside the EU would be a force multiplier to encourage countries without a carbon pricing system, or with a very low cost per ton, to enact domestic policies that effectively account for the carbon released into the atmosphere during production. Further, it would enable the US to retain more revenue generated by carbon offsets and help make domestic production competitive with importation.

US Equivalent

Legislators have tried to pass a US CBAM equivalent before, but the political will wasn’t there. With more attention on the climate crisis now, the time is ripe for a renewed push. The EU CBAM gives the US another impetus to pass a similar policy.

A carbon pricing system that harmonizes with the EU CBAM not only will permit the US to retain more revenue from its own carbon-intensive production industries, but also will allow it to compete with the EU in compensation for the effects of climate change.

The lack of bipartisan agreement on climate change has hampered past attempts to pass a US version of the tax. This is where the EU’s success can serve as a model.

A new US proposal would fail again if it’s framed purely as a climate change initiative. However, the EU passage of its CBAM gives such a bill political cover through protecting domestic production: The EU will be taxing exports from the US under its new policy starting in 2026, and the US can either do the same or fall behind.

A properly defined and presented US policy could engender bipartisan support, as it simultaneously would address climate change concerns and support domestic manufacturing by placing imports on an equal footing from a carbon pricing perspective. The US is the second-largest import market in the world by itself and, in conjunction with the EU, would be far and away the largest.

A policy that might otherwise be condemned as protectionist could, in the context of the climate change benefits, be broadly supported. Polling indicates that, following a brief explanation of carbon border adjustments, a clear majority of Americans support them.

Attempts to pass a US CBAM would face legal hurdles in the form of the World Trade Organization and the General Agreement on Tariffs and Trade. The GATT is an agreement among countries, including the US, to encourage trade by minimizing trade barriers. A US tax would qualify as such a barrier and, in the short term, prompt tariffs to imports from states such as China. However, the US has run afoul of the WTO in the past, including for similar trade policies in the Inflation Reduction Act.

Children jump on a trampoline Adamsville, Ala., on April 11, 2021.

Photo by Andrew Caballero-Reynolds/AFP via Getty Images

Carbon Leakage

A BAT is a cousin to the value-added tax and, in the realm of carbon, the system intends to reflect the realities of a shared climate that doesn’t adhere to state borders. This crucial point hasn’t always been properly considered in carbon pricing policies.

The CBAM levies a tariff on products based on the carbon emissions generated during their production, and this tariff is imposed when these products are imported into the EU. This accounts for states without a carbon pricing system and discourages producers from engaging in “carbon leakage”—the outsourcing of production in carbon-intensive industries to states with no or lower carbon pricing policies.

Also, it creates a safe harbor for states with effective carbon pricing systems. The policy aims to apply equal standards to imported goods and domestic goods. Consequently, imports from states with effective carbon policies can offset the tariff by the amount of carbon tax or tariff paid in their state of production.

This not only avoids the issue of double taxation but also pressures states without a carbon pricing mechanism to create one to keep revenue that would otherwise flow to the EU via the CBAM. In sum, it asks would-be exporters, “Are you going to tax your producers on their carbon emissions, or should we?”

As the clock ticks toward the EU’s 2026 phase-in date, the US must act swiftly. The EU’s CBAM is a signal for the US to step up efforts to combat climate change and protect its own economic interests. It’s a win-win opportunity that shouldn’t be squandered.

Andrew Leahey is a tax and technology attorney, principal at Hunter Creek Consulting, and adjunct professor at Drexel Kline School of Law. Follow him on Mastodon at @andrew@esq.social.