At the United Nations’ annual climate conference in Dubai this week, the World Trade Organization’s Director-General, Ngozi Okonjo-Iweala, discussed the role that trade could play in climate policies. She emphasized the importance of trade in making “people realize that free, open and predictable trade is an essential part of the tool kit for getting to net zero.” To that end, in recent months, the EU started implementing the data collection phase of the EU Carbon Border Adjustment Mechanism and U.S. lawmakers introduced several climate bills that use trade policies to encourage emissions reduction. For example, Senator Bill Cassidy (R-LA) introduced the Foreign Pollution Fee Act, a carbon tariff bill to penalize more carbon-intensive imports. And yesterday, Senator Sheldon Whitehouse (D-RI) reintroduced the Clean Competition Act, a narrow-based border-adjusted carbon tax. 

This updated legislation is similar to the original 2022 version, with some notable updates. 

The Clean Competition Act proposes:

  • Enacting a narrow-based domestic U.S. carbon tax at $55 per metric ton of CO2 equivalent starting from 2025 and rising at a 5 percent real growth rate.
  • Collecting the domestic carbon tax at manufacturing facilities from a selective list of carbon-intensive industries for the portion of emissions that exceed the industry-specific average carbon intensity benchmark.
  • Levying an import tax on imported primary goods that mirror the equivalent domestically produced goods which would expand to cover certain eligible finished goods. Calculating the import tax liability is similar to calculating the domestic carbon tax liability.
  • Providing rebates for domestic manufacturers of certain exported primary and finished goods subject to the domestic carbon tax. The 2022 proposal only provides rebates for exported primary goods. Since certain exported finished goods would also be subject to the domestic tax, expanding the coverage to finished goods is an improvement. 
  • Distributing most of the revenue from the border-adjusted carbon tax to a domestic competitive program that helps domestic carbon-intensive industries decarbonize. The rest of the revenue goes to help developing countries decarbonize.

These components would incentivize domestic emissions reduction from the covered carbon-intensive manufacturers and equalize the tax burden between domestic and foreign producers through its carbon border adjustment mechanism. Border adjustments are a critical component of a carbon tax, as they include taxes on imported goods and rebates for exported goods. A border-adjusted carbon tax would tax domestic consumption based on carbon content rather than domestic production.

One notable update is the inclusion of a carbon clubs clause intended to encourage other countries to implement carbon pricing policies. The clause states that an exporter who paid an explicit carbon price on the emissions of the goods in the country of origin could get some or all the import tax exempted. This may prove challenging to implement for several reasons.

First, it would be difficult to determine the partial or full refund for a specific imported product because it would require validating the carbon price a foreign producer has paid in the country of origin. This would be especially difficult to track if some foreign producers seek to reduce their import tax liability by trans-shipping their exports to an exempted country and then selling the products to the U.S. market. Second, in treating U.S. trading partners differently, carbon clubs may be non-compliant with the WTO’s non-discriminatory rules. Finally, other countries might be incentivized to max out their domestic carbon prices to increase the revenue that the U.S. government could have collected. 

Effective climate policy addresses emissions both at home and in global trade. A border-adjusted carbon tax does both. As a narrow-based border-adjusted carbon tax, the Clean Competition Act is an effective step toward encouraging domestic and global decarbonization.