Green barricade: Trade faces a new test as carbon taxes go global

The US power industry and its unions are rarely assiduous cheerleaders of campaigns for higher taxes and tighter environmental standards. But the energy barons become more enthusiastic when American lawmakers are seeking to impose those burdens on other countries.

Traditionally, many trade officials, particularly from developing countries, have been suspicious that environmental provisions in trade agreements are covert protectionism by rich nations. Sure enough, several wealthy countries are mulling taxing imports to take account of greenhouse gases emitted during their manufacture. The plans are in their early stages, but they may at the very least serve as a negotiating tactic to get reluctant countries to agree to control emissions themselves.

Environmentalists and companies in energy-intensive sectors say that by adopting carbon taxes or quotas without requiring that others do the same, economies such as Europe’s merely encourage free-riding and “carbon leakage” – carbon emissions rising as industries decamp to less regulated countries. They have argued for the playing field to be levelled by levying a “carbon border tax” – a tariff that taxes imports from unregulated countries as though the foreign companies that made them were domestic businesses.

Two separate bills being considered by the US Senate would combine a new national cap-and-trade system for carbon emissions with charges on imports from countries that do not tax carbon, by requiring them either to buy US or equivalent emission credits – in effect a border tax – or pay a fee. The proposal had substantial input from American Electric Power, one of the US’s largest electric utilities, and the International Brotherhood of Electrical Workers (IBEW), which represents many power employees. The latter in particular is a familiar opponent of liberalisation that has lobbied against the US signing bilateral trade deals and setting up guest-worker programmes for immigrants.

Although the European Commission opposed the adoption of a direct border tax in this week’s proposals for the EU’s carbon emission regime, it floated the same idea of requiring importers to buy credits in the future. Carbon equalisation measures have been repeatedly demanded by France, traditionally one of the most trade-sceptical EU member states, while European parliamentarians called for a “Kyoto carbon tax” to be imposed on imports from the US after it failed to join the international emissions protocol (see chart).

The new debate over carbon border taxes adds new tension to a trade system already struggling with faltering negotiations in the so-called “Doha round” of trade talks and the outbreak of protectionist rhetoric across the US and Europe.

Whether or not such measures would comply with World Trade Organisation rules depends on the usual arcane complexities and uncertainties of international trade law. Some precedent was set by a celebrated case between several Asian countries and the US over American laws banning shrimp caught without special nets that allowed sea-turtles to escape – hence the protesting environmentalists in turtle costumes at the disastrous WTO meeting in Seattle in 1999. The ruling established the principle that imports can be restricted if their production harms exhaustible natural resources and the same rules are applied to domestic producers. In theory, this could be applied to imports from countries without carbon taxes. But it remains a moot point whether such a tariff would be a levy on the producer of the good, which would be illegal under WTO laws, or on the product itself, which would be permitted.

Joost Pauwelyn, a Geneva-based academic who advises the law firm King & Spalding and helped to draft the US Senate proposals, thinks it would be politically explosive for a WTO dispute resolution panel to stand in the way. “I would have a really hard time imagining the WTO saying that the US is allowed to worry about turtles in Thailand but not about the atmosphere of the planet,” he says.

But even supporters of the Senate proposals, including Prof Pauwelyn, accept that such a high-stakes policy, with trade worth trillions of dollars potentially at stake, is likely to provoke litigation from affected countries such as China or India. Such import restrictions must take into account differences in enforcement and regulatory capability in different countries – a requirement that can get officials deeply enmeshed in thickets of impenetrable administrative detail. Greg Mastel, former chief economist at the Senate finance committee, now at the law firm Akin Gump in Washington, says: “Creating parallel systems that meet WTO rules by imposing the same burden in different countries will be very difficult.”

As Susan Schwab, US trade representative, warned fellow trade ministers at the international meeting in Bali in December – a caution she repeated this week in Brussels – such legislation could easily provoke escalating retaliation. “Restricting imports easily leads to covert protectionism, undermining both environment and economic objectives,” she said. “Trade restrictions to seek to force action can backfire and lead to tit-for-tat.”

China, for example, might bring a case to the WTO on carbon border taxes, only for the EU or the US to hit back with fresh litigation or emergency tariffs aimed at Chinese energy subsidies.

Climate change has already started to provoke WTO legal cases and other disputes. Brazil, for example, has filed a complaint about the US tariffs and subsidies that keep out Brazilian sugarcane ethanol. Brasilia wants ethanol to be classified as an “environmental good” in the Doha round and hence subject to big cuts in tariff protection, a move blocked by the US and EU. An EU plan to ban imports of biofuels produced in environmentally destructive ways, though in theory also protected by the principle established in the shrimp-turtle case, may also be vulnerable to legal challenge.

A Chinese trade official says that, while China had not taken a formal view, his initial personal impression was that carbon border taxes would be legally complex and many WTO members would be concerned. “I doubt whether the measures taken in the name of the environment will always be applied to protect the environment and not to protect domestic industries,” he says. He adds that they could prove a double-edged sword. “If one takes per capita emissions of greenhouse gases rather than overall emissions, it will be the developed countries paying taxes on their exports.”

Whatever the legal implications, opponents of border taxes point out that implementing them fully would be immensely difficult. With the extended supply chains of the modern world economy, goods sold in the US may have components from dozens of countries, some with domestic carbon taxes and some without. Sorting out which part of the manufacturing process is responsible for what emissions is likely to be close to impossible.

The same applies even at a sub-national level. As EU officials sceptical about carbon border taxes point out, US exports made in, say, California have been produced under a strict emissions trading regime; those from some other states have not. As things stand, European customs officials would have to disaggregate imports from America state by state and tax them accordingly to be fair and consistent. In theory, this problem could be avoided by Californian companies being compensated by state-level rebates – Arnold Schwarzenegger, California’s governor, refunding their carbon taxes on any goods made for export. But that would merely create a perverse incentive for those companies to export to climate-unfriendly countries to avoid tax, further harming the environment.

The US Senate proposals skirt the complexities by covering only basic energy-intensive bulk input goods such as steel, cement, paper and glass. But to sceptics, that begins to look like targeted help to favoured companies in fiercely competitive global industries that already frequently demand protection against cheap imports – and have merely seized on climate change as a new excuse to do so. Jim Hunter, director of the utility department at the IBEW, denies such charges. “This is a global issue that we cannot address on our own,” he says. “We need something like this to get any cap-and-trade measure past the House and Senate.” American Electric Power denied the measure was a tax and said it would “equalise the conditions of global trade with regard to climate change and serve as a powerful impetus for other nations to join a new global emission-reduction initiative”.

Industries such as iron, steel and aluminium in the EU have lobbied vociferously against stricter emissions controls, arguing such legislation would drive them out of Europe. Expert opinion is divided. Research by the European Commission found significant losses in competitiveness by energy-intensive industries, while the World Bank has generally found little evidence of widespread carbon leakage from existing environmental taxes and regulations. The Carbon Trust, a government-funded UK body, recently said that the EU’s emissions trading scheme would seriously affect only UK businesses in a few energy-intensive sectors. As Prof Pauwelyn says: “There is a strong incentive for companies to exaggerate the extent of carbon leakage for protectionist reasons. Even if you make China internalise the cost of carbon emissions, it will still be competitive in a lot of these industries.”

Development campaigners, who have considerable influence on the public debate, particularly in Europe, find themselves in a quandary. Many have shifted their attention over the past year from aid and trade issues to climate change. So far they have concentrated fire on their familiar targets – rich countries – for failing to impose sufficiently stringent emissions controls and for introducing incentives to produce biofuels that encourage deforestation in developing countries. But carbon border taxes put the environment and the immediate economic interests of high-emitting developing countries at odds.

Jennifer Haverkamp, senior counsel at Environmental Defense, an influential US green campaign, says that her favoured bill in the Senate, which exempts the poorest countries, is best viewed as a means to bring emerging markets to the multilateral negotiating table. “With luck it will never have to kick in,” she says. “We see it as one element in a wider effort to help developing countries play their part in reducing emissions.”

Indeed, the most important role that carbon border taxes or their equivalents might play is as a threat to be kept in reserve. As one EU official says: “From a negotiating point of view it is useful to have this in our pocket as one of the bargaining chips.”

Either way, it is unlikely that the environmental costs of doing business can long evade international trade regulators. The EU official says: “I cannot imagine any international carbon agreement that will not deal with the issues of free-riders and trade.” It may also increasingly be the case that there are few international trade agreements that do not address the issue of carbon.

Additional reporting by Sheila McNulty

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