Carbon Border Adjustments and Trade

The European Union is on the way to taxing many imports based on their greenhouse-gas emissions. The plan, which was agreed by the European Commission and the European Parliament on December 13 but is not yet final, is one more factor likely to constrain the growth of international trade.

The plan would establish an import taxation system called the Carbon Border Adjustment Mechanism, designed to force importers of certain products to pay for the carbon emitted in making their products. The tax would equal the amount an EU manufacturer would have paid to purchase permits for those emissions under the EU Emissions Trading System. The point is to stop the “leakage” that occurs when companies import products that would be subject to carbon charges if produced in the EU. Initially, imports of iron, steel, cement, aluminum, fertilizers, hydrogen, electricity, and products made from iron or steel will be subject to the tax, and some chemicals and polymers may be taxed as well. Imports from countries that tax carbon emissions as the EU does would not be taxed.

Implementing this well-intended policy is likely to prove more complicated than EU officials are letting on. While calculating the tax on a bag of imported cement may be straightforward, accurately figuring the charge on a product containing steel from multiple mills drawing on multiple power sources may not be so easy.

It’s possible that the new taxes will be ineffectual; if, for example, an Asian manufacturer simply ships fertilizer from an older plant to Africa while selling output from newer plants with lower carbon emissions to the EU, the tax might have no net effect on emissions. On the other hand, if the EU succeeds in convincing its trading partners to impose their own taxes on carbon emissions or if proceeds to require significant carbon border adjustments instead, some goods could become more expensive in Europe, and might therefore be traded less.

This isn’t necessarily a bad thing. As the economist Joseph S. Shapiro has shown, countries’ failure to adequately regulate greenhouse-gas emissions provides a massive subsidy to international trade. Taxes on emissions could be one more factor weighing on trade as companies reconsider their supply chains.

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