Why Carbon Tariffs Are a Bad Idea-For Now

Originally posted on the Argument at ForeignPolicy.com

March 26, 2009

Barack Obama's mild-mannered energy secretary, Steven Chu, made news last week when he signaled his openness to carbon tariffs as a "weapon" in the incipient US war on climate change. The tariffs, as the argument goes, would address two reoccurring fears: that cutting US emissions won't stop global warming unless China and India follow suit, and that pricing carbon at home will induce US industry to move to less-regulated countries. "If country X doesn't [apply a cost to carbon] then I think we should look at considering perhaps duties that would offset that cost," Chu explained.

At first glance, this seems like a reasonable approach; any politically palpable US climate legislation will have to address concerns about domestic competitiveness as well as international participation. (Indeed, most climate bills introduced last year would adopt this strategy, imposing duties on goods entering the United States from countries that stay outside a global climate change agreement.) But if the United States uses the same tool both to pressure international carbon compliance and save domestic production, it will succeed at neither.

Unilateral threats of carbon sanctions will not persuade other countries to reduce emissions. This is particularly true in the case of China. Selling goods to the US market has been an important driver of Chinese economic growth-growth that has made China the world's largest greenhouse gas emitter. Yet while China produces labor-intensive toys and electronics primarily for export, the energy-intensive steel and cement sectors are for domestic consumption. A carbon tariff on Chinese imports would therefore scrape off less than 0.1 percent of Chinese GDP-not much of a stick in relation to the cost of enacting climate policy economy-wide.

Besides, China doesn't need much cajoling to play a constructive role in global climate talks. While the United States spent the last decade on the sidelines, the rest of the world (China included) moved ahead in formulating an international response to climate change. As part of its National Climate Change Program, Beijing is doing more to reduce emissions than is required of a developing country under the Bali road map. Beijing has indicated a willingness to help reduce global emissions by 50 percent by 2050-if the United States takes the lead. A strong commitment at the Copenhagen negotiations this December, backed up by domestic legislation, is the most potent leverage the United States has.

It is true, however, that a successful outcome from Copenhagen would only tackle one of the United States' existential climate fears. It will not in and of itself prevent companies from migrating abroad, as carbon prices are likely to differ between countries for years to come. Additional measures will be needed to ensure that this doesn't put US industries at a disadvantage vis-à-vis their Chinese competitors (or, for that matter, put European industries at a disadvantage vis-à-vis the United States).

In the short term, the best way to "level the playing field" is to provide tax breaks or free emission allowances to trade-exposed, carbon-intensive industries in order to offset costs arising from climate policy. The European Union is already taking this approach as part of the third phase of its emissions trading scheme, and Australia has followed suit. In the United States, Representatives Jay Inslee and Mike Doyle are looking to do this in ways that encourage industry to cut emissions while maintaining employment. Their proposal, called "output-based rebating," would provide credits large enough to offset future carbon permit costs for firms that invest in new, more-energy-efficient technology now.

Ultimately the United States will need to phase out domestic support for carbon-intensive industries, both to create a stronger incentive to reduce emissions and free up taxpayer dollars for other purposes.

This is where trade policy enters the equation. Chu was right that carbon tariffs can create a level playing field, but to be successful they must be applied multilaterally. In addition to negotiating emission reduction targets at the national level, the United States and its major trading partners need to come up with international rules, via the World Trade Organization or some other vehicle, through which to price the environmental cost of carbon emissions in traded goods. Until then, the United States should steer clear of carbon tariffs if it wants to reach a global agreement on climate change.