Unilateral BCAs fail – blue.

Leaving aside the multiplicity of ways to address leakage, this paper focuses on BCAs for three reasons. First, border adjustments appear consistently in draft U.S. carbon tax legislation and prominent proposals by climate advocates. Indeed, some argue that a BCA provision of some kind would be an essential component to successful legislation. Second, Böhringer, Carbone, and Rutherford (2012) suggest that BCAs are relatively more effective in reducing leakage and promoting global cost-effectiveness than alternatives like output-based rebates. Finally, while BCA design may superficially appear intuitive, within the policy design lurks a thicket of competing objectives, legal pitfalls, administrative headaches, and unintended consequences. This necessitates a careful review of the options in the spirit of resigned pragmatism. An elegant solution will likely elude us. First, policymakers can only hope to anticipate and counteract some of the myriad ways enterprising actors will game the system. Second, measures designed to deter gaming will likely complicate the administration of the program or incur some other tradeoff. And approaches that simplify administration would inevitably under- or over-compensate some domestic firms and over- or underprice emissions from some imported products. Moreover, approaches that would maximize the diplomatic value of BCAs may be more subject to WTO violations. Finally, the United States should be mindful that whatever approach it adopts might well be applied by other countries with respect to U.S. products. Policy approaches that might seem attractive unilaterally might appeal somewhat less in a multilateral framework. At least three potential motives apply to BCAs: reducing emissions leakage; preserving the competitiveness of U.S. manufacturers; and pressuring trading partners with less stringent climate policies to catch up. 4 These motives reflect proponents’ underlying goals of better environmental results and fairer distributional outcomes. Emissions leakage and competitiveness concerns arise from the uniquely intense incidence of the tax on EITE firms. In economics jargon, the statutory incidence of a tax falls on the person or company that gives the tax payment directly to the government. In contrast, the economic incidence of a tax falls in the lap of the person holding the hot potato after the initial taxpayer and others in the supply chain pass their costs along (Saez 2017). For example, under current law U.S. fuel distributors pay an excise tax to the federal government on gasoline upon taking it from bulk storage terminals. They pass that cost through to their customers, and the tax ends up embedded in the retail price of gasoline (Federal Highway Administration 2018). The statutory incidence falls on the fuel companies, but the economic incidence is on everyone who fills up their tanks and those further down the chain, perhaps riding in taxis and Ubers. For most goods with GHG emissions in their supply chain, a carbon tax will work the same way and eventually pass through to consumers in higher prices. However, shareholders and workers of firms that make EITE goods will likely bear relatively more of the economic incidence of a unilaterally-imposed carbon tax than other firms will bear. If they try to pass their carbon tax burden along, foreign competitors without those costs can undercut them. Such competition threatens both exports and domestic products that compete with imports, especially fungible commodities like ordinary aluminum or cement. If the U.S. carbon tax drives a product’s market share to foreign competitors, emissions from that product would rise abroad, potentially by more than they fall domestically. At the same time, American workers would lose jobs and wages and shareholders would lose wealth. Accordingly, members of Congress would include BCA authority in their bills in the hope of preempting emissions leakage and competitiveness losses and to garner support from powerful constituencies. Emissions leakage can also come from another economic force that BCAs cannot prevent. Price-based leakage occurs when major energy-using countries shift back their demand for fossil fuels and global prices for those fuels fall as a result. Lower global fuel prices increase consumption by countries that do not control their emissions. So, while BCAs can help lower competition-driven leakage, border adjustments have no direct effect on leakage that results from depressed global fuel prices. For that, we need other tools like vigorous diplomacy to promote coordinated global climate action. Some see BCAs as potential leverage in that diplomatic engagement. One can imagine negotiations in which the United States (having adopted a carbon tax) grants countries it deems sufficiently climate-ambitious an exemption from its BCAs. This scenario might start with bilateral or small multilateral agreements and expand until more and more countries are inside the climate club. In this way, the threat or impact of border adjustments, assuming they survive WTO adjudication, could pressure everyone to price carbon – or at least the carbon in their exported products.