The U.S. Makes Carbon Pricing More Complicated Than It Needs to Be

(Bloomberg Opinion) -- As the November climate conference in Glasgow approaches, debate over the value of carbon “border adjustment” mechanisms in many countries is picking up. Most puzzling is a U.S. approach proposed in Congress.

A border adjustment is a fee that a country would impose on the quantity of carbon embodied in imports. The idea is to mitigate “leakage” of emissions toward countries with looser climate policies, and encourage those countries to adopt stricter ones. Where countries differ in the stringency of their efforts to lower emissions, the mechanism can push toward lower emissions everywhere. And it can discourage counterproductive shifts in the location of polluting industries.

Europe is leading the way. Earlier this year, I suggested that the Europeans would move ahead despite international counterpressure, and that indeed is what’s happening. The European mechanism has been fleshed out in the European Commission’s “Fit for 55” agenda, which lays out a plan to reduce emissions 55% by 2030, compared with 1990 levels. The European strategy has raised many questions, including whether it is compatible with international trade rules — China argues it is not — and even whether it would do all that much in practice. A recent think tank report suggests it would have “negligible impacts” on trade.

But I’d like to focus here on an even more extraordinary development, which is the idea that the U.S. could impose its own border adjustment mechanism even though, unlike the European Union, it has no federal carbon price — no permit trading system or tax. To see why that’s unusual, consider that the whole purpose of a border adjustment mechanism is to impose the same carbon price on goods produced abroad as on those produced domestically.

If a country sets its domestic carbon price at, say, $50 a ton, then the adjustment mechanism would impose a fee of $50 a ton on imported carbon (and typically also provide a rebate of $50 a ton on exported carbon). The objective is to level the playing field, so that producers abroad face the same incentives as local producers to reduce emissions. According to the EU, under its mechanism, “EU importers will buy carbon certificates corresponding to the carbon price that would have been paid, had the goods been produced under the EU’s carbon pricing rules.”

Even with a domestic price for carbon in place, a border adjustment can be challenging to carry out. It may be hard, for example, to identify with any precision how much carbon an import contains. But at least where there is a domestic carbon price, the intended size of the adjustment is clear.

It would thus be particularly unusual to impose a carbon fee at the border in the absence of any carbon price imposed domestically. Yet Senator Chris Coons of Delaware and Representative Scott Peters of California have proposed a U.S. border adjustment mechanism.

William Pizer and Erin Campbell of Resources for the Future have outlined how this could work. The U.S. would estimate the effects of other policies, apart from pricing, that affect carbon emissions. “Here, we bump into the particularly tricky issue with nonprice policies: prices are not observed,” the authors note. “Nonetheless, there are several alternative solutions.” Imagine, for example, a clean air standard for steel plants that requires lowering carbon emissions by a certain amount. An estimate of a price on carbon that could generate the same emissions reductions from steel — the implicit price that the regulation imposes — could then be the basis for a fee on imports.

Carrying out this approach would be even more complicated than in Europe. But it would have an odd political economy effect: It would indirectly reveal a carbon price for the U.S. That fact is worth highlighting, because a key reason the U.S. has been unable to impose a national carbon tax or permit trading system is skittishness over the potential political attacks it would bring.

If we can handle revealing a carbon price through a border adjustment mechanism, why not just take the more direct route by setting a carbon price in the first place? A carbon price may not be the panacea it’s sometimes presented as in Econ 101 discussions. And it’s true that the U.S. can make significant progress toward reducing emissions without one. But the border adjustment mechanism illustrates how much more complicated we make things by being unwilling to simply and directly impose a price on carbon.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Peter R. Orszag is a Bloomberg Opinion columnist. He is the chief executive officer of financial advisory at Lazard. He was director of the Office of Management and Budget from 2009 to 2010, and director of the Congressional Budget Office from 2007 to 2008.

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