The Economic and Environmental Effects of Border Tax Adjustments for Climate Policy

The Economic and Environmental Effects of Border Tax Adjustments for Climate Policy Warwick J. McKibbin (bio) and Peter J. Wilcoxen (bio) For the foreseeable future, climate change policy will be considerably more stringent in some countries than in others. Indeed, the United Nations Framework Convention on Climate Change explicitly states that developed countries must take meaningful action before any obligations are to be placed on developing countries. However, differences in climate policy will lead to differences in energy costs, and to concerns about competitive advantage. In high-cost countries, there will be political pressure to impose border tax adjustments (BTAs), or "green tariffs," on imports from countries with little or no climate policy and low energy costs. The BTAs would be based on the carbon emissions associated with the production of each imported product, and they would be intended to match the cost increase that would have occurred had the exporting country adopted a climate policy similar to that of the importing country. Several justifications have been proposed for including BTAs as a key component of climate policy. Some researchers—including Stiglitz, Kopp and Pizer, and Ismer and Neuhoff—argue that BTAs are required for economic efficiency in carbon abatement.1 An alternative argument is that BTAs are needed to keep climate policy from being undermined by the "leakage" of emissions through migration of carbon-intensive industries to low-tax countries and, as a corollary, to protect import-competing industries in high-tax countries.2 There are also a number of papers that argue that the approach could be used to punish countries that did not participate in the Kyoto Protocol, or could be used as a threat to encourage recalcitrant countries to join a global regime.3 Finally, End Page 1 there is also a considerable literature debating the legality of BTAs for climate polices under World Trade Organization rules.4 These arguments are reflected in the political debate in Europe and the United States. In 2006 then–French prime minister Dominique de Villepin suggested that countries that do not join a post-2012 international treaty on climate change should face additional tariffs on their industrial exports. The European Parliament's (2005/2049) resolution was focused on penalizing countries such as the United States for nonparticipation in the Kyoto Protocol. In the United States, both the Bingaman-Specter Bill (S 1766) and the Leiberman-Warner Bill (S 2191) include mechanisms that would, in effect, impose BTAs under some circumstances for imported goods from countries deemed to be making insufficient effort to reduce their greenhouse gas emissions.5 Most of the arguments in the literature, however, have been theoretical. Little empirical work has been done to determine either the magnitude that BTAs would take in practice, or on the economic and environmental consequences they would cause. This gap leads to a range of important questions. Would BTAs actually improve global carbon abatement? How much would they help or hurt the economy of the country imposing them? How much would they help or hurt the global economy? Are the gains, if any, large enough to justify the administrative costs involved? In this chapter, we address several of these questions. We estimate how large such tariffs would be in practice,6 and then examine their economic and environmental effects using G-Cubed, a detailed multisector, multicountry model of the world economy.7 We find that the tariffs would be small on most traded goods, would reduce leakage of emissions reduction very modestly, and would do little to protect import-competing industries. We conclude that the benefits produced by BTAs would be too small to justify their administrative complexity or their deleterious effects on international trade and the potentially damaging consequences for the robustness of the global trading system.8 In a sense, these results are not surprising, because most carbon emissions are from domestic activities, such as electricity generation and local and regional End Page 2 transportation, which are largely nontraded and are little affected by international trade.9 In practice, the most important mechanism through which leakage could occur would be world oil markets, not trade in manufactured goods. A sufficiently large carbon tax imposed in a major economy would lower...