A bipartisan group of US lawmakers are working on a carbon border adjustment mechanism (CBAM) as an alternative to a carbon tax. The carbon border would mean higher costs for carbon-intensive imports, but it could mean a level playing field for US companies.
“The current system incentivises countries like China and India and Vietnam to not pay attention to emissions because you can produce a good cheaper by not paying,” said Bill Cassidy, Republican Senator for Louisiana.
The bipartisan group includes Democratic Senator Joe Manchin, who opposed a carbon tax proposal in September 2021. The carbon tax proposal would have imposed a levy of $20 per tonne. The $20 rate would have gradually been increased on carbon to drive businesses to reduce costs.
Manchin favours a North American zone – including Canada and Mexico – that would raise higher tariffs on cement and steel imports. This would benefit US multinational enterprises with domestic operations, but also provide an incentive to reduce the carbon footprint of offshore production.
The Biden administration may back Manchin’s proposal because climate change has been at the forefront of its policy agenda. However, the discussions are in the early stages and the US mid-term elections are due in November.
Nevertheless, the Senate group is spurred on by the EU’s plans for a CBAM and the US administration may be looking to secure positive headlines for its climate agenda.
The rise of carbon borders
The EU intends to reach its net-zero energy target by 2050 with the European Green Deal. The package seeks to reduce EU greenhouse gas emissions by 55% by 2030 and it is the first step to carbon neutrality by 2050.
The package is composed of more than 100 initiatives, including the CBAM. ITR reported in May 2021 that the plan for an EU CBAM could ‘trigger’ a wave of similar tax initiatives worldwide. The US proposal may be the most significant if it goes ahead.
Countries outside the EU, particularly those with carbon-intensive or developing economies, have expressed concern that the CBAM would affect their domestic industries and could be prepared to retaliate against measures perceived to be ‘discriminatory’.
The US administration warned that the EU CBAM should be a “last resort” back in March 2021, but lawmakers soon began discussing the possibility of a US carbon border. By July, the US Senate Democrats had released a draft proposal but the work to finalise it continues.
The 2021 iteration of the US draft proposal would raise costs on imported goods compared to domestically produced goods. This is where US and EU policy would align, but there are still significant differences.
While the EU would link the import fee to carbon pricing under the Emissions Trading System (ETS), the US would calculate the fee based on the costs of compliance. This is partly why the US CBAM proposal is seen as an attractive alternative to a carbon tax for US lawmakers.
As a result, the US could end up imposing very different costs on high-carbon imports compared to the EU. This poses calculation problems for affected businesses because the cost can be difficult to estimate. The EU CBAM may even be imposing higher tariffs.
Much like the trade wars of the Trump era, the US and the EU may be facing another phase of tax competition. Except this time the stakes are for the environment, but this means a gradual reduction in carbon emissions.
Even still, the beneficiaries of a US CBAM will not just be the renewable energy industry. A US carbon border would impose higher costs on oil imports than on domestic natural gas. The costs may even be lower than a carbon tax for natural gas.
The carbon border proposal might be more likely to gain majority support in Congress than alternatives because of its characteristics. A carbon border mechanism could be used to create incentives for domestic businesses, including tax rebates.
However, the politics of carbon borders are not just about climate change. The US has had trade tensions with China for several years and this is a key part of considerations behind the CBAM proposal.
“I’ve always thought a price on carbon, a market mechanism, is where I think the world’s ought to be headed, and it also puts a penalty in place for those countries like China,” said Mark Warner, Democratic Senator for Virginia.
The US may be set for greater trade tensions with China and the EU over carbon borders, but these tensions may push more businesses to cut carbon emissions faster.
