The goal of tariffs must be to cut carbon content of imports

Since 1990, for example, US production-based emissions have increased by 3 per cent, while the country’s consumption-based emissions rose by 14 per cent over the same period.

Taxing the carbon content of imports, as the European Union plans to do and US President Joe Biden’s administration is considering, can help to dent the rising trend in global greenhouse-gas emissions. But policymakers must implement such levies in the right way.

By focusing on emissions linked to consumption, rather than just domestic production, such taxes would target the roughly one-fifth of import-related emissions usually excluded from calculations of countries’ nationally determined contributions under the 2015 Paris climate agreement. They would also be timely, given the growing divergence between consumption- and production-based emissions.

Since 1990, for example, US production-based emissions have increased by 3 per cent, while the country’s consumption-based emissions rose by 14 per cent over the same period.

Carbon tariffs are not protectionist trade measures; the goal is to reduce the carbon content of imports. But the trajectory of climate change leaves no room for error in emission-reduction policies. The success of initial EU and US steps to introduce carbon border taxes is therefore crucial, because these measures will serve as a model for others. In particular, policymakers must heed some essential principles that should govern such levies.

For starters, a carbon border tariff should be driven by the benefit-cost calculus in favour of pricing the negative “externality”, or spillover harm — namely, the carbon content — into the production of imported goods. Generally, import levies to protect domestic industries raise the cost of production, and hurt consumers’ welfare. In contrast, import tariffs that reduce carbon dioxide emissions would improve global welfare, with these gains exceeding the losses from trade inhibition. Carbon tariffs must not be perceived as constituting part of a trade war, but rather as contributing to collaborative pricing of a socially harmful activity.

That means that policymakers must keep an eye on these levies’ primary purpose. They must design tariffs to regulate the carbon content of imported goods, rather than to protect domestic industries or provide them with an implicit subsidy. Tariffs should focus on the emissions embodied in the imports, not on domestic industry’s cost disadvantage or the likelihood of production moving abroad.

That is why governments should never use carbon tariffs as blunt instruments to hit imports. For example, blocking steel imports from China or India is a crude and costly way to reduce those countries’ emissions compared to a carbon-related tariff that motivates exporters to switch to less-polluting production methods.

The effect of the carbon tariff on emissions in the exporting country depends on that country’s ability to divert its exports to other markets. To maximise the global environmental gains, therefore, it is vital that as many countries as possible are part of the new tariff regime. Because some importing countries like Germany and Canada, as well as some US states, have domestic carbon taxes or carbon-trading systems, the goal could be to align carbon import tariffs with these carbon-pricing instruments.