Carbon border adjustments are known by many different names, including border carbon adjustments or border tax adjustments, but they all aim to achieve the same objectives: Address differences in the domestic climate policies, and the resulting emissions intensity of production, between trading partners. By accounting for these differences in climate ambition and emissions from the production of goods, carbon border adjustments are designed to protect industrial competitiveness and avoid shifting production — and emissions — to countries with dirtier processes or weaker environmental standards, which is known as carbon leakage.
Carbon leakage entails a geographic shift of production between countries without any net benefit to global greenhouse gas emissions, either through shifts in investment patterns, loss of market share for domestic industries to more emissions-intensive trading partners, or changes in energy markets that result in greater global emissions. To date, evidence on carbon leakage has been mixed. Most studies find little to no evidence of leakage occurring, though much of the existing research on carbon leakage was completed during periods of low carbon prices and significant sectoral exemptions from climate policies. Contrary to earlier research, a recent study found significant leakage rates, particularly in small, open economies such as individual European Union (EU) countries. Regardless of the uncertainty surrounding the impact of carbon leakage, it remains a concern of policymakers for some emissions-intensive industries in countries with ambitious climate policies, especially those with steadily rising carbon prices.
Carbon border adjustments apply fees on imported goods based on their emissions content and can also include rebates or exemptions from domestic policies for domestic producers that export their goods to markets abroad, especially to countries with laxer climate policies. Proposals for carbon border adjustments typically envision that the price an importer would pay would be aligned with a domestic carbon price. However, some discussions in the United States envision an implicit carbon price based on a range of regulatory and other policies.
Some observers have raised concerns that carbon border adjustments could amount to disguised protectionism; at a minimum, such policies involve unsettled issues of trade policy that have the potential to provoke disputes in the World Trade Organization (WTO). The WTO’s General Agreement on Tariffs and Trade (GATT) includes protections aimed at ensuring equal treatment of domestic and foreign-produced goods, which a border adjustment could violate if not carefully designed. While the GATT allows exceptions for certain policies on environmental grounds, it nonetheless prohibits any measure that amounts to arbitrary or unjustifiable discrimination against trading partners. As such, some observers conclude a border adjustment could be consistent with WTO rules or an allowable exception under GATT Article XX as long as domestic producers pay an equivalent fee. Recent research explores other alternative exceptions under WTO rules.
Carbon border adjustments are also sometimes criticized as incompatible with the United Nations Framework Convention on Climate Change (UNFCCC), particularly Article 3.5, which forbids measures that constitute “arbitrary or unjustifiable discrimination” or serve as a “disguised restriction on international trade.” International observers have also expressed concerns that border adjustments can stifle multilateral climate efforts through the UNFCCC.
As of December 2023, the EU is the only jurisdiction that has implemented a carbon border adjustment, but there is growing interest. Canada and the UK have separately concluded a consultation process on such a policy, and other countries are starting to consider similar policies in response to the EU CBAM. Some observers note that California was the first to implement a border adjustment, but the mechanism is a limited measure that covers only imported electricity under its cap-and-trade program.
In July 2021, the European Commission released a package of proposals to help the EU achieve its updated climate targets of reducing net greenhouse gas emissions 55 percent below 1990 levels by 2030 and becoming carbon neutral by 2050. The proposals include establishing a CBAM that would put a carbon price on imports of covered goods to ensure that ambitious climate action in Europe does not lead to carbon leakage. The CBAM is intended to serve as an alternative to distributing free emissions allowances to industrial sectors, which serves as the current leakage protection mechanism under the EU Emission Trading System (ETS) but is seen as unsustainable and ineffective as a decarbonization strategy. It also aims to encourage industry outside the EU to take steps in the same direction to reduce emissions. Revenues from the CBAM would go toward the EU’s general budget.
The EU enacted the CBAM legislation in May 2023 and released implementing regulation in August 2023 for a transitional phase from 2023 to 2025. During this period, which started in October 2023, a reporting system applies to importers of covered goods to facilitate a smooth rollout of the program, gather data, and to facilitate dialogue with non-EU countries. Starting in 2026, the CBAM will become fully operational, and importers will start paying a financial adjustment. The goal is to transition from a system of free allowances to the CBAM so EU producers will be incentivized to reduce emissions through exposure to the carbon price while still maintaining leakage protections. During this period, the CBAM fee that importers face will be reduced to reflect the value of free allowances until the phaseout is completed.
The CBAM will initially cover goods mostly from sectors at significant risk of carbon leakage: cement, iron and steel, aluminum, fertilizers, and hydrogen. The CBAM also covers electricity generation, given increasing interconnectivity with the EU’s more emissions-intensive neighbors, such Ukraine, Turkey, and countries in North Africa and the Balkans. Before the end of the transitional period, the CBAM could be extended to cover other goods, such as chemicals and refinery fuels. Other sectors that are officially considered at risk of carbon leakage (e.g., paper, glass, ceramics) in the EU ETS are also likely additions to the CBAM at some point as the EU phases out free allowances.
Under the program, importers will be required to purchase certificates equal to the total embedded emissions of the covered good each year. The price of the CBAM certificate will be based on the weekly average auction price of EU ETS allowances. If a non-EU producer can show that they already paid a price for carbon emitted during production of the imported good, then that price can be deducted from the CBAM fee paid by the importer.
Proposals for border adjustments have traditionally been paired with carbon pricing policies and framed as a means of addressing concerns around emissions leakage resulting from a carbon price. Partly prompted by the EU’s proposed CBAM, however, there is nascent interest among U.S. policymakers—both on Capitol Hill and in the Biden administration—in implementing a carbon border adjustment without an explicit domestic carbon price. There are varying reasons why Democrats and Republicans are interested in a standalone carbon border adjustment mechanism, but the overlapping consideration is economic competitiveness.
U.S. manufacturers are able to produce the same goods with a lower overall carbon intensity than many other countries, giving the United States a clear “carbon advantage.” A 2020 study found U.S. manufacturing to be 40 percent more carbon-efficient than the world average. However, a recent study reinforces aspects of the carbon advantage finding but with more nuanced conclusions: the United States is significantly less carbon intensive than large developing countries but is generally more carbon intensive than advanced economies like EU member states and Japan.
Growing attention on embodied emissions of globally traded goods has underscored another finding — nearly a quarter of global carbon dioxide emissions in 2019 are embedded in imported goods. For the United States, that amounted to about 1.26 gigatons of embedded carbon emissions in imported goods. Closing this “carbon loophole” whereby countries are able to reduce their direct emissions by importing emissions-intensive goods represents a significant opportunity to reduce emissions.
In the current 118th Congress (2023–2024), there is growing interest in standalone border adjustment proposals or bills that lay the groundwork for a standalone border adjustment. As of April 2024, five CBAM-related proposals have been introduced: two bipartisan proposals, two Democratic proposals, and one Republican proposal.
There is bipartisan interest in this topic. Five carbon border adjustment proposals have been introduced so far in the 118th Congress:
In the U.S. context, a key design issue concerns whether and how a border adjustment could be implemented in the absence of a federal price on carbon. The Biden administration has acknowledged the difficulty in calculating the environmental cost without an explicit carbon price. A related issue is whether a border adjustment could be implemented in the absence of any associated federal policies to directly address domestic emissions. Some observers argue that a carbon tariff could be based purely on differences in emission intensity. However, some policymakers and analysts raise concerns that such an approach, in the absence of regulatory policies to justify it, would be seen as protectionist and as an arbitrary and impermissible violation of the core WTO principles of nondiscrimination and national treatment.
In April 2024, John Podesta, senior advisor to President Biden for international climate policy, spoke about the need for “a global trading system that slashes pollution, creates a fair and level playing field, protects against carbon dumping, supports good manufacturing jobs and economic opportunity, and rewards every country that’s doing the right thing—no matter their stage of development.” To accelerate the transition toward climate-smart trade and policies, the Biden administration announced the formation of a new White House Climate and Trade Task Force. This task force will have three priorities: