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Solving a Climate Policy Problem with Smart Design: WTO-Compliant Border Adjustments

Politically acceptable US climate legislation will require border adjustments. A new framework describes a WTO-compatible approach to manage exports and imports.

Proponents and opponents of action to address climate change have long recognized that ambitious climate policies may disadvantage manufacturers in energy-intensive, trade-exposed (EITE) industries by shifting production to nations with less-stringent policies. These shifts result in lost business, jobs, and investments, as well as “leakage” of greenhouse gas (GHG) emissions (i.e., emissions increases in jurisdictions with weaker or no policies to reduce GHG emissions compared to other regions). Remedies to overcome these economic and environmental concerns rely on border adjustments aimed to provide relief for exports and impose charges on imports. However, devising border adjustments consistent with national obligations under the World Trade Organization (WTO) has proven to be challenging. To avoid lengthy, potentially divisive battles between trading partners (and tensions between independent international institutions), it would be desirable to formulate policies that are compatible with national obligations under both the WTO and United Nations Framework Convention on Climate Change (UNFCCC).

In recent work with RFF’s Jan W. Mares and in collaboration with Jennifer Hillman and Matthew Porterfield of Georgetown Law School, we propose a framework for climate policy with border adjustments consistent with WTO obligations. Our proposal is based on an upstream GHG tax, with export rebates and import charges for products from EITE industries. A companion compendium to the report also will be available soon with further details and specific recommendations on implementation for 35 EITE industries. The framework’s proposed border measures are designed to be nondiscriminatory and therefore should not give rise to any valid claims of WTO violations. Even if such claims should be raised, a strong defense of the framework could also be made under the environmental exceptions to the WTO rules.

Much of the information required to implement the proposal is currently available based on objective methods to measure and report GHG emissions from facilities (e.g., chemical and power plants) and operations (e.g., producing oil fields). However, the framework requires two extensions beyond current practice. The first is to specify how GHG emissions from suppliers (e.g., of electricity and commercial fuels) and on-site operations contribute to determine the cumulative GHG emissions required to produce various individual products. The second is to determine how GHG emissions from entire facilities (and operations) can be apportioned to their products. In general, the framework tracks GHG emissions along the chain from suppliers to producers in a manner analogous to a tax design familiar to many, the value added tax (VAT)—which the relevant WTO rules permit to be rebated on exported products and imposed on imports.

The forthcoming compendium to the report describes how this may be done in a variety of industries, and discusses cross-cutting issues requiring special attention, in particular, cogeneration of heat and electricity and use of recycled materials. Because the number of products involved ranges from one to several thousand in different sectors, the compendium also proposes approaches to simplify administrative challenges. In combination, the framework and compendium serve the dual environmental and administrative goals of reducing GHG emissions without an unworkable administrative burden.

The framework seeks to provide a balance that allows a GHG tax and border adjustments in combination to reduce emissions without an unworkable administrative burden.

Another significant aspect of the framework concerns the treatment of GHG policies, regulations, and costs already imposed on firms that export to the United States: the framework does not take account of them. To do so runs the risk of violating Most Favored Nation principles of nondiscrimination on the basis of national origin of imports. In practice, this is likely to cause other countries to consider whether and how they might provide relief (from their own national GHG policies) to firms that export to the United States. Indeed, if the US adopted this approach, it might encourage other nations also to adopt the more efficient GHG tax as a basis to mitigate domestic emissions and facilitate exports to the United States and other nations that adopt this approach.

As with major efforts begun two decades ago to develop reliable methods to measure and report GHG emissions in EITE industries (e.g., GHG Protocol and the Guidelines published by IPIECA/API/OGP) and other sectors, implementing border adjustments on products within this new framework will require additional efforts and cooperation (perhaps in voluntary public-private partnerships) among firms, trade associations, regulators, and other stakeholders. The benefits will be worth it: a WTO-compatible framework provides a solution—a legal and politically viable tool to address environmental and economic issues associated with highly differentiated climate regulations and policy ambitions around the world. And domestic manufacturers will benefit from the opportunity to continue to compete in international trade.

The longer-term implications of this approach could be to stimulate convergence among nations to more similar and effective approaches to mitigate emissions. Broadly speaking—for nations that adopt it—this proposal fundamentally shifts costs to mitigate emissions for internationally traded products from where they are produced to where they are consumed.

About the Author

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Brian P. Flannery

Brian P. Flannery is a visiting fellow at RFF.

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