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«Will border carbon adjustments work? Niven Winchester*,†,‡, Sergey Paltsev* and John Reilly* Abstract The potential for greenhouse gas (GHG) ...»

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Will border carbon adjustments work?

Niven Winchester*,†,‡, Sergey Paltsev* and John Reilly*

Abstract

The potential for greenhouse gas (GHG) restrictions in some nations to drive emission increases in other

nations, or leakage, is a contentious issue in climate change negotiations. We evaluate the potential for border

carbon adjustments (BCAs) to address leakage concerns using an economy-wide model. For 2025, we find that

BCAs reduce leakage by up to two-thirds, but result in only modest reductions in global emissions and significantly reduce welfare. In contrast, BCA-equivalent leakage reductions can be achieved by very small emission charges or efficiency improvements in nations targeted by BCAs, which have negligible welfare effects. We conclude that BCAs are a costly method to reduce leakage but such policies may be effective coercion strategies. We also investigate the impact of BCAs on sectoral output and evaluate the leakage contributions of trade and changes in the price of crude oil.

Contents

1. INTRODUCTION

2. BCA LEGISLATION

3. MODELING FRAMEWORK

3.1 Embodied GHGs and BCAs

3.2 BCA scenarios

4. MODELING RESULTS

4.1 Welfare changes

4.2 Output changes

4.3 Leakage

5. ALTERNATIVE LEAKAGE CONTROLS

6. CONCLUSIONS

7. REFERENCES

APPENDIX

1. INTRODUCTION There has been longstanding concern about the competitiveness and leakage effects when some countries implement emissions reductions policies while others do not. Early studies of the Kyoto Protocol examined the potential for leakage—an increase in emissions in countries not covered by policy that result from impacts on global energy prices or from relocation of energy intensive industry from countries with controls to those without them (e.g. Bernstein, et al., 1999). Concerns among domestic industries, especially those involved in energy intensive production activities, often are directed towards a loss of competitiveness, fearing that imports of similar products that do not face higher energy prices due to carbon policy will gain an advantage over domestically produced goods. That is one channel of leakage—growth in foreign production of energy intensive goods, and the emissions that go with it, at the expense of domestic production of similar goods. Concerns about such leakage are reflected in the bill passed by the U.S. House of Representatives as the American Clean Energy and Security Act * MIT Joint Program on the Science and Policy of Global Change, Cambridge, MA, U.S.A.

† Department of Economics, University of Otago, Dunedin, New Zealand.

‡ Corresponding author: Niven Winchester (Email: niven@mit.edu).

(H.R. 2454) of 2009, commonly known as the Waxman-Markey Bill (U.S. Congress, 2009a).

Title IV, Subtitle A of H.R. 2454 seeks to “prevent an increase in greenhouse gas emissions in countries other than the U.S.” (p. 1087) by requiring importers of certain products to purchase emission allowances, a measure analogous to a tariff. It is unclear whether border carbon adjustments (BCAs), or tariffs on embodied GHG emissions, are permissible under existing trade laws, but some authors argue that World Trade Organization (WTO) provisions for border tax adjustments (BTAs) provides scope for such charges.

The Bill does not reference competiveness concerns but it appears that members of the House were mindful of such issues when designing the Bill. Indeed, in the discussion draft of the Bill, Subtitle A of Title IV was labeled “Ensuring Domestic Competiveness” with the purpose “to compensate the owners and operators of entities in eligible domestic industrial sectors and subsectors for carbon emission costs” (U.S. Congress, 2009b, p. 537). It is also likely that competitiveness concerns will be important in Senate negotiations. Shortly after the Bill passed the House vote, Michigan Senator Stabenow asserted that keeping BCAs in the legislation was her biggest concern. Similar sentiments were echoed by other senators from states with large manufacturing industries, including Ohio Senator Brown, “I don’t think you can fully take care of manufacturing [and pass the Bill] without some border equalization” (Hale, 2009).

Additionally, Democrat Senator John Kerry and Republican Senator Lindsey Graham voiced their support for climate change legislation in a New Your Times Article, providing that BCAs are included (Kerry and Graham, 2009). Senator Graham’s view indicates that Republican support for H.R.5425 in the Senate may hinge on the inclusion of BCA provisions.

Although H.R. 2454 was approved by the House of Representatives in June 2009, political arguments for BCAs are not new. Notably, forerunners to H.R. 2454 – the Bingaman-Specter (S.

1766) and Lieberman-Warner (S. 2191) Bills – included instruments tantamount to tariffs on embodied GHG emissions. Elsewhere, French President Sarkozy has voiced that the EU should impose additional tariffs on imports from countries that do not restrict GHG emissions, a proposal that has be criticized by the EU’s Environmental Commissioner but has reportedly been supported by a number of EU member states (ICTSD, 2009a).

Opposing the view of the U.S. and the EU, countries that do not plan near-term GHG reductions, particularly India and China, have voiced concerns about GHG border measures. At informal climate talks in Bonn, Germany in August 2009, Indian officials put forth a resolution that developed countries shall not resort to any form of countervailing border measures against imports from developing countries (ICTSD, 2009b). If BCAs eventuate, Columbia Economist Jagdish Bhagwati claims that they will lead to massive, justified, WTO-legal retaliation by India and China (Hale, 2009). President Obama is wary of such concerns and has criticized the Bill’s provision for BCAs (Broder, 2009).





Tariffs imposed by nations that restrict GHG emissions (the climate coalition) on imports from regions that do not control emissions (the non-coalition) have been evaluated by a series of computable general equilibrium (CGE) studies.1 In this literature, BCAs have mixed leakage impacts while there is broad agreement that tariffs will significantly reduce welfare and will be ineffective at addressing competitive concerns.2 We contribute to the debate by evaluating the economic impacts of BCAs on embodied GHG emissions using the MIT Emissions Prediction and Policy Analysis (EPPA) model, a CGE model tailored to evaluate climate policy questions.

We analyze tariffs in the context of a scenario representative of a post-Kyoto climate agreement and the special features of tariff provisions in H.R. 2454. Our study further builds on previous work by evaluating the efficiency of tariffs relative to direct leakage controls, and assessing the relative leakage contributions of trade and the decline in the oil price induced by GHG restrictions.

Section 2 of this paper details provisions for BCAs in H.R. 2454 and discusses international trade rules surrounding these measures. Our modeling framework is detailed in Section 3 and results are discussed in Section 4. Alternative leakage controls are analyzed in Section 5. Section 6 concludes.

2. BCA LEGISLATION The International Reserve Allowance Program in H.R. 2454 requires importers of covered goods in “eligible industrial sectors” to purchase emission allowances related to the amount of GHG emissions embodied in imported products. Eligible industrial sectors are defined using three concepts: energy intensity, GHG intensity and trade intensity. Energy intensity in H.R.

2454 is calculated by dividing the cost of purchased electricity and fuel costs by the value of output. GHG intensity is determined by multiplying the number of tons of carbon dioxide equivalent emissions from fuel combustion, processing and electricity by 20 and then dividing by the value of output. Trade intensity is defined as the sum of the value of imports and exports divided by the sum of the value of output and the value of imports.

A sector is eligible for the program if it has (i) an energy intensity or a GHG intensity greater than 5%, and a trade intensity greater than 15%, or (ii) an energy intensity or a GHG intensity greater than 20%. Several restrictions circumvent these rules. First, a sector is excluded if 85% or more of U.S. imports in that sector are produced in countries that either have economy-wide GHG reduction programs at least as stringent as in the U.S. as part of an international agreement, or have equal or lower energy or GHG intensities than the U.S. Second, imports sourced from nations responsible for less than 0.5% of global GHG emissions and accounting for less than 5% of U.S. imports in the sector in question are exempt. Third, products from the least-developed nations and refined petroleum products are excluded.

H.R. 2454 requires that the price for international reserve allowances equals the clearing price from the most recent auction of allowances, but does not specify how the GHG content of See, for example, Babiker and Rutherford (2005), Droge and Kemfret (2005), Peterson and Schleich (2007), Burniux et al. (2008), Alexeeva-Talebi et al. (2008) and Mckibbon and Wilcoxen (2009).

BCAs are also investigated in partial equilibrium analyses. See, for example, Gielen and Moriguchi (2002), Demailly and Quirion (2008) and Ponsand and Walker (2008).

imports will be calculated. Instead, the Bill requires the administrator to establish “a general methodology for calculating the quantity of international reserve allowances that a U.S. importer of any covered good must submit” (U.S. Congress, 2009a, p. 1123). The administrator must also adjust the number of international emission allowances per unit imported to account for the benefits to eligible industrial sectors from emission allowance rebates and the provision of free allowances to electricity.

One issue is whether the trade provisions of H.R. 2454 are legal under WTO rules and this may depend on how they are classified relative to existing trade-related measures. The extra import charges called for by H.R. 2454 could be branded punitive tariffs, countervailing duties (imposed on the basis that unregulated GHG emissions in foreign countries are illegal subsidies) or BTAs (additional taxes on imports to offset differences in tax structures across countries). A number of studies examine whether BCAs are consistent with rules governing international trade set out by the WTO3. The consensus in this literature is that punitive tariffs violate tariff concession rules specified in the General Agreement on Tariffs and Trade (GATT);

countervailing duties violate both GATT rules and the WTO’s Subsidies and Countervailing Measures agreement; but BTAs may be possible under WTO law. In this connection, a joint report by the WTO and the United Nations Environment Programme (UNEP) (WTO-UNEP, 2009, p. 89) notes that “the general approach under WTO rules has been to acknowledge that some degree of trade restriction may be necessary to achieve certain policy objectives, as long as a number of carefully crafted conditions are respected.” GATT Article II.2(a) details rules governing BTAs on imports, allowing countries to impose a charge equivalent to an internal tax on imports under certain conditions. Indirect taxes (taxes on products such as sales taxes) are eligible for adjustment but direct taxes (levies on producers such as payroll taxes) are not, so a key issue is whether taxes on inputs such as energy are indirect taxes. Article II.2(a) also stipulates that BTAs on imports are only allowed (i) in respect to articles from which the imported product has been produced, and (ii) against taxes imposed on “like” domestic products (GATT, 1986, p. 4). Some authors conclude that the wording of (i) restricts the use of BTAs to inputs physically incorporated in the final product, which would exclude emissions charges. However, others argue that (ii) allows BTAs to be used to offset taxes on inputs used during the production process (i.e., applied indirectly on products), which provides scope for WTO-legal BTAs for GHG emissions.



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