Carbon Taxes and U.S. Manufacturing Competitiveness Concerns

The Issue:

As President Trump begins the process of rolling back Obama Administration environmental regulations like the Clean Power Plan, the question is now what climate change policies are possible under a Republican-controlled Congress. Recently, senior Republican statesmen proposed a $40 a ton carbon tax with proceeds returned to Americans in the form of a monthly dividend check (see the EconoFact post on this proposal.)  Could this type of environmental regulation be compatible with President Trump's emphasis on supporting American heavy manufacturing? To prevent the tax from making American-made products less competitive relative to carbon-intensive goods from countries with lax environmental rules, the proposal includes border carbon adjustments: it would impose taxes on certain carbon-intensive imports and rebate carbon taxes on U.S. exports. Similarly, the American Opportunity Carbon Fee Act, a carbon “fee” bill introduced in 2015 by Senators Sheldon Whitehouse (D-RI) and Brian Schatz (D-HI) also calls for border carbon adjustments.

Taxing energy intensive imports and exempting some U.S. export goods from carbon taxes could level the playing field with competitors from countries that don't have a carbon tax.

The Facts:

• Economists widely agree that carbon pricing is the most efficient and least costly way to reduce U.S. emissions. Based on a 2016 U.S. Department of Treasury analysis, if the U.S. were to implement an economy-wide carbon tax starting at $49 a ton in 2019, we could reduce carbon emission by 21 percent by 2028 and raise over $2.2 trillion in revenue over the next ten years.
• The macroeconomic trade effects of a unilateral carbon tax on employment, investment, and competitiveness for large, diverse economies like the U.S. would be small (see for instance these studies: 1,2,3). However, certain sectors would likely suffer, and in order to gain broad, bipartisan support, any carbon tax proposal would likely need to include a carbon border tax.
• Border carbon adjustments (BCAs) are taxes on energy intensive imports and rebates on the carbon tax paid on energy intensive exports. These carbon adjustments mean that carbon emissions are taxed based on where the goods are consumed rather than where they are produced. Border tax adjustments level the playing field between U.S. firms in energy-intensive, trade-exposed sectors and competitors from countries that don't have a carbon price in place.
• Border carbon adjustments require measuring the carbon content of products to set the import tax or export rebate. While reasonably good data exists to estimate the carbon content of energy intensive U.S. exports, it would be difficult to estimate the carbon content of imported goods with any precision. In response, a number of economists and trade experts have argued for setting the tariff on selected energy intensive imports based on the carbon content of "like" U.S. products. The border carbon adjustments would only be needed on a small set of imported and exported commodities including steel, aluminum, cement, paper, and petrochemicals, because they represent industries that are highly energy intensive and vulnerable to global competition.
• Carbon border tax adjustments can satisfy both World Trade Organization (WTO) rules and protect U.S. carbon-intensive manufacturing, according to a 2016 Resources for the Future analysis. While policy- specific design and implementation issues would have to be considered, many experts believe that WTO exemptions to protect human, animal, and plant life are well suited for a carbon pricing policy and that border carbon adjustments could be exempted. While any border carbon adjustment would have to be crafted in close collaboration with the WTO, the deliberative nature of negotiations would likely keep such adjustments in compliance.  (See also the 2016 analysis by Trachtman)
• A border carbon adjustment will level the playing field between domestic and imported energy intensive highly traded products but is unlikely to influence foreign production practices. Only a small share of energy intensive goods produced in countries like China, South Korea, and Russia are exported to the United States. China, for example, is a major source of imported steel in the United States. Yet China exports less than 0.3 percent of its total steel production to this country. Although Korea exports nearly twice as much steel as China to the U.S., the share is still only about 6 percent of Korean production. Russia and China export substantial amounts of aluminum to the United States but those exports constitute less than 9 percent of domestic production in those countries. As yet another example, Korean cement makes up a significant share of imported cement in the U.S. but only accounts for 2.6 percent of Korean cement production. Given the small share of production of energy intensive goods that are exported to the U.S. from countries that are unlikely to have a robust carbon price, setting the BCA tariff based on the actual carbon content of imports will have little impact on production practices in those countries.