The incoming Trump administration is signaling it could withdraw from the new multilateral climate accord (known as the Paris Agreement) that entered into force on November 4, 2016. Under Paris, 192 parties, including the U.S., agreed to “strengthen the global response to the threat of climate change by keeping a global temperature rise this century well below 2 degrees Celsius above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5 degrees Celsius.”
To reach these targets, most parties submitted voluntary nationally-determined contributions (NDC). These NDCs varied from nation to nation and comprise some form of domestic regulation of greenhouse gas (GHG) emissions or subsidization for sustainable development and resilient infrastructure. However, the NDCs are not enforceable because the Paris Agreement lacks a binding enforcement mechanism. Instead, parties intend to rely on each other to promulgate their own domestic rules every few years and self-regulate achievement of their NDC goals.
If the U.S. withdraws from the Paris Agreement or chooses to ignore its submitted NDC, other countries have limited direct means to stop it from doing so. However, countries are contemplating an indirect economic challenge – the creation and application of climate-related trade tariffs, taxes or duties (known as border adjustments). In fact, the French government has already stated publicly that it would immediately pursue an EU directive to impose carbon tariffs on U.S. goods coming into the European Union if the United States were to withdraw.
In theory, border adjustments of this kind would be applied to imports from any country that does not have or enforce GHG regulations or restrictions deemed commensurate with the importing nation. The intent would be to preserve a level playing field between domestic goods produced subject to GHG restrictions or taxes on emissions, and U.S. or other goods that would not similarly be burdened or economically affected.
The salient question, however, is whether application of such carbon tariff border adjustments is legal and WTO-consistent. To the extent these border adjustments would consist simply of applying a tax or duty on imports equal to the measured cost incurred by domestic companies, border adjustments would appear at first glance as being unlikely to contravene the multilateral WTO Agreement. However, the devil will always be in the details for any border adjustment measures ultimately devised and imposed. The reason is mainly the obvious concern that border adjustments would be nothing more than disguised protectionism. A second concern would be the application of carbon tariffs on some, but not all, countries (i.e., only applied to those countries deemed not to have commensurate GHG regulations in place). There are other uncertainties as well. In fact, the legality of carbon tariffs has never been tested before a WTO Dispute Settlement Panel.
To be WTO-compliant, border adjustments will conceptually depend on proper design, scope, and connection to domestic environmental conservation efforts. There are several provisions within the WTO Agreements that could arguably permit border adjustments, however each available provision has drawbacks to legality. For example, both Articles II.2 and III.2 of the General Agreement on Tariffs and Trade (GATT) permit countries to impose taxes or charges on imports, provided those taxes are imposed on products that are “like” the domestic products that are subject to the domestic tax (i.e., GHG regulation) and the amount of the tax imposed on the imports does not exceed the amount of the internal tax on the “like” products. A country that levies a $10 carbon tax on domestically produced steel, in other words, would have to apply a $10 tax on imported steel, regardless of the carbon content differences between the two like products.
Article XX of the GATT provides the most flexibility for countries seeking to implement border adjustments because it allows WTO members to apply otherwise discriminatory restrictions on imports in certain circumstances. Under Articles XX(b) and XX(g), WTO members can adopt policies inconsistent with international trade legal principles if such policies are “necessary to protect human, animal, or plant life or health” or which “relate to the conservation of exhaustible natural resources” (in the case of carbon tariffs, the exhaustible resource would be a livable climate).
The EU, for example, would need to show that the EU Emissions Trading Scheme and the corresponding border adjustment fall under the exemptions provided by Article XX. However, the exemption is not absolute. Any EU border adjustment scheme would have to be deemed as not applied in a manner that constitutes a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or as a disguised restriction on international trade. However, the propensity of any tariffs or adjustments to serve as a means of protectionism means that the degree of “equivalence” between the border adjustment and the domestically applied GHG restrictions will be the primary focus of any trade litigation. For these and other reasons, it will ultimately be for the WTO Appellate Body to settle the issue.
Even though border adjustment schemes will be complex and challenged, several parties to the Paris Agreement, not just the EU, will be seriously considering developing carbon tariffs if the U.S. withdraws from its NDC. Climate may turn out to be one of potentially several trade battles to come over the next few years. U.S. companies should therefore begin considering if there would be potential cost impacts on their exports based on their carbon-intensity.