The Opportunities and Limitations of Neutral Carbon Tariffs

Because carbon taxes can lead to loss of competitiveness, applying tariffs on imports from non-carbon-restricting countries helps address the cost disadvantage faced by producers in carbon-restricting countries. Such tariffs, known as border carbon adjustments (BCAs), can also help reduce possible carbon “leakage,” or the growth in foreign emissions due to increased production of carbon-intensive goods in non-carbon-restricting countries. We demonstrate that BCAs that do not exceed the burdens imposed by carbon taxation on domestic like products could be consistent with World Trade Organization (WTO) rules. However, “neutral” (i.e., nondiscriminatory) BCAs might still be inefficiently high from a global welfare perspective. This stems from the misaligned focus of BCAs on imports rather than production—the real cause of emissions. The discrepancy between neutrality and efficiency enables carbon-restricted industries to seek inefficiently high BCAs. Recognition of this discrepancy strengthens the case for multilateral alternatives that curb global carbon emissions.