Global Talks on Border Carbon Tax – Where should we start

The European Union Carbon Border Adjustment Mechanism (EU CBAM), in place as of late 2023, may be only the first in a host of national measures that put a price on carbon embedded in imported goods. Because this is a new instrument, its implementation-and possibly proliferation-are running ahead of our understanding of how it should fit into the complicated puzzle of international economic and environmental governance. But the urgent need for cooperation in this space is frustrated by the breadth of topics to be addressed, some of which are politically sensitive. To make progress, the international community should focus first on low-hanging fruit-obvious and urgent cases for cooperation where the issues are mostly technical in nature.

The need for cooperation

Border carbon adjustment (BCA) instruments such as the European Union (EU) CBAM have, in a few years, gone from being absent from the policy agenda to being implemented or actively considered in many countries. The United Kingdom has already indicated it will put a CBAM in place as of 2027. Chinese Taipei has put a BCA regime in law, though its draft implementing legislation proposes to back off from the idea. Australia is in the process of formally considering whether it will adopt a similar regime. The United States has several bills before Congress that aim to enact carbon-related border measures, and its recently announced Task Force on Climate and Trade is likely to recommend proposals along those lines this year. Canada is also considering a BCA mechanism, having wrapped up a formal consultation on the question in 2022.

Rising interest in BCAs is driven by the fact that more and more governments are putting carbon pricing regimes and regulations in place that will impact their energy-intensive, trade-exposed industrial sectors. As long as not all countries have carbon pricing in place, there is a risk that such measures will simply shift production-related emissions to foreign competitors-a phenomenon known as carbon leakage.
BCAs are controversial policy options, not least with trading partners that might see their exports impaired as a result, and particularly with those that have limited means for supporting their industries' transition to low-carbon production. But pragmatically, however the instrument is judged, the prospect of many large markets putting in place such regimes underscores the urgent need for international cooperation. This is so for at least three reasons:

• The spaghetti bowl: Every BCA regime will be different since each is designed to complement a distinct national set of climate change policies. The risk is that they will differ in ways that make exporters comply with a spaghetti bowl of different requirements, for example, on the measurement, reporting, and verification of the carbon embedded in their goods. The final result of this lack of international cooperation restricts trade, impeding a key engine for poverty alleviation and development. International efforts should focus on making the various standards and requirements either the same or compatible enough to be able to work together.
• The inevitable costs: Even the most thoughtfully crafted BCA regime will impose costs on foreign producers. For highly emissions-intense producers, that may manifest in terms of lost market share (though, by the same token, clean producers will be advantaged). But all foreign producers will bear the costs of compliance, which in some cases can be much more significant than the border charges themselves. This is particularly likely for exporters from less developed economies since they tend to have fewer existing national requirements for GHG reporting, fewer public means of support for decarbonization, and higher costs of capital for investments in industrial decarbonization. Cooperation among developed economies implementing BCAs should aim to lower the costs of compliance and decarbonization while bolstering exporter state capacity to support their producers.
• Preventing trade frictions: Absent international cooperation to agree on principles and best practices in the elaboration and implementation of BCAs, domestic policy-makers may simply fail to take into account the ways their policies affect others-in particular, those with less experience or capacity to comply with complex BCA regimes. Or they may be lobbied by domestic interests to design and implement BCAs in ways that deliberately protect domestic producers. Agreement on best practices would help domestic policy-makers in the process of creating BCA regimes, providing a template for design and insulating them, to some extent, from domestic protectionist pressures.

All three forms of international cooperation are needed, and the speed at which governments are reaching for BCA-type measures makes that need urgent. However, pursuing all of them simultaneously may not be the most effective approach. It might be more strategic to start with the issues that are politically less sensitive.

A strategic approach to international cooperation on BCAs

In an ideal world, we would see international cooperation on the elaboration and implementation of BCAs and BCA-like regimes that is guided by a set of best practices agreed upon at the multilateral level. However, there are important obstacles to that sort of agreement. For one thing, governments that are already advanced in the elaboration of their regimes might be hesitant to participate in a process that might not fully embrace their existing design choices. For another, some governments are hesitant to discuss how best to construct a regime that they regard as fundamentally illegitimate. That is, since they object to BCAs at a fundamental level, they are disinclined to engage in discussions on what BCAs should look like.

And yet, trade does not stop and the need for cooperation remains. One way forward might be to initiate discussion on technical issues relevant to BCA design where the need for cooperation, or at least coordination, is clearest and most urgent for the affected business community and where the subject matter is far removed from politically fraught arguments. Ideally, gradual alignment in those areas might, in time, lead to a willingness to engage on more politically charged aspects of BCA design. The discussions could aim at least to parse the options available and their technical and substantive implications; if agreement or alignment on some options appears possible, they could then be pursued.

It is worth noting that the discussions need not be-and probably should not be-focused specifically on BCAs. The topics described below are relevant to any conceivable trade measure that is based on the carbon embedded in goods, including BCAs, but also green government procurement specifications, carbon-based product standards, and any policy variations that might eventually be developed. This is not the full panoply of trade-related climate measures, at which level the discussion might be too general, but neither is it just a focus on BCAs that risks excluding important players from the conversation (i.e., those that have developed BCA regimes).

What technical areas are candidates for cooperative discussions?

Candidate issues for agreement are described below, drawn from extensive consultations and discussions IISD has convened with a variety of stakeholders, including the affected business communities.
All of these issues are technical details of regime operations. But technical does not mean trivial; for most of these issues, options have, in fact, been proposed that could be argued to be unfair to foreign producers, with significant economic impacts.

How do we measure greenhouse gas (GHG) intensity at the product level?

Several standards with broad international agreement can calculate GHG emissions at the project or installation level, but none can be used for the purposes of carbon-based trade measures (i.e., to calculate GHG emissions embodied in a good). The EU has had to develop highly detailed sui generis CBAM methodologies for the various covered goods. The concern is that each jurisdiction with a regime of carbon-based trade measures will similarly develop methodologies that accord with existing domestic practices and requirements, resulting in a spaghetti bowl of different standards to which exporters must measure, report, and verify.

There is a clear need for agreement on how to avoid this trade-restricting result. At a minimum, doing so requires looking for modes of mutual recognition, or at least inter-operability-a result that would address the fact that the EU has already had to pioneer its own methodology. While standard-setting of this type is not easy, it is mostly a technical exercise of agreeing on common system boundaries, emission factors, handling of co-products, etc. And it is a focus with a much broader application than BCAs alone. It is worth noting that the WTO Secretariat has undertaken similar work, convening steel sector stakeholders to try to advance cooperation on agreed standards for embodied carbon in steel. However, no such work has been done with sectors with much less experience in carbon measurement.

How far downstream should such measures extend?

There is scope for a technical conversation about how far downstream in a value chain embedded carbon should be priced in border measures like BCAs. If a measure aims to differentiate between products based on their embedded carbon in order to incentivize production with lower emissions, then the coverage of that measure should only extend to products for which the good's embedded carbon constitutes a significant portion relative to its value. That would probably mean cutting off coverage somewhere between basic steel and automobiles, for example. Violating that principle would see coverage for manufactured goods that would have little climate benefit but would probably involve high administrative costs and disruptive trade impacts. Agreement in this space would likely be at the level supporting the technical process of selecting goods to cover and would probably not raise concerns for conflict with the specific choices of existing regimes like the EU or United Kingdom CBAMs.

Which emissions should be covered?

Most proposed trade-related climate measures like BCAs cover Scope 1 (direct) emissions. Some might also cover Scope 2 (electricity) emissions. Then there is the question of which upstream emissions, embodied in input goods, should be covered (upstream Scope 3). The scope of emissions covered is a technical decision, but it has real impacts. Not covering Scope 2 emissions for steel, for example, denies an advantage to steel producers that have access to clean electricity, and in particular those that also use electricity-intensive (cleaner) electric arc furnace technology. Covering upstream Scope 3 emissions makes compliance more difficult-it means that producers must try to get emissions data from suppliers that, in many cases, do not have it.

What credit should be granted for a foreign carbon price paid?

Assuming a charge is levied on embodied carbon in the importing jurisdiction, should a credit be granted if such a charge has already been levied in the export economy? If so, what types of charges should count? Would a fuel excise tax be considered a carbon price? Or a carbon price that was levied only on exports, not on domestically consumed goods? Should free allowances or carbon tax breaks in the country of export be deducted from the credit? If trade measures that aim to equalize the costs of carbon paid between similar products are to be effective and inclusive, agreement is needed on a number of technical but important details about such crediting*. In the EU and the United Kingdom CBAMs, this question has not yet been definitively answered, leaving a window of opportunity-albeit soon closing-for relatively non-controversial discussion.

Should a good's reported embodied carbon be allowed to be lowered by means other than the firm itself lowering its GHG intensity?

In many domestic carbon pricing regimes, firms can reduce their payment obligations either by lowering their own GHG intensity or by purchasing emission reduction credits (offsets) from others that have done so. Usually, those offsets will be generated domestically, but the Paris Agreement's Article 6 provides a mechanism that would, in effect, extend the use of offsets to international sources. Should BCAs and similar regimes accept offsets as a means to lower foreign producers' reported GHG intensity of production? If offsets are allowed, should it be acceptable to declare that some specific types of offsets are not acceptable (as the EU did with Certified Emission Reductions from the Kyoto Protocol's Clean Development Mechanism)? Outside of offsets used to comply with national mitigation requirements (the so-called compliance market), many firms use voluntary carbon market credits to lower their reported emissions. Should these be allowed? While these are not easy questions to answer, they would not likely be particularly divisive and could be addressed at the level of principle.

A way forward?

The urgent need for international cooperation on BCAs need not necessarily be frustrated by the fact that some aspects of international cooperation are politically charged. Some progress is possible in important areas, with potential benefits, in particular, for exporters based in less developed economies-producers that are most vulnerable to the impacts of BCAs. It may even be-in fact, it is to be hoped-that progress in these areas will eventually lead to more productive discussions in those critically important areas that are, at present, too hot to handle.

*Note that this discussion might not want to encompass the highly controversial question of whether credit should be granted for non-price-based climate measures in the country of export.

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