6 - Border Adjustments for Carbon Taxes and the Cost of Emissions Permits

Summary

Introduction

Under the Kyoto Protocol, most advanced countries other than the United States committed to reduce emissions of CO₂ occurring within their boundaries, on average, to 95 percent of their 1990 levels between 2008 and 2012. By comparison, the protocol exempted developing countries from the requirement to reduce CO₂ emissions. Although the protocol does not prescribe the means to be employed to achieve this target, it is anticipated that either carbon taxes or cap-and-trade systems – hereafter referred to as carbon pricing – will play an important role. The first carbon pricing systems to be implemented rely on what, in the tax literature, would be called origin-based systems for pricing carbon embedded in internationally traded products.

For example, under the European Union's Emissions Trading System (ETS), by far the most important extant system for pricing carbon, emissions permits are required to engage in production in a member state that entails emissions of CO₂. Exports are not exempt from the requirement to hold permits, and the cost of permits for carbon emissions embedded in the cost of exports is not rebated when products are exported. Conversely, it is not necessary to hold CO₂ emissions permits of EU members of destination to import into the EU products that would be subject to the requirement for emissions permits if produced within the EU. The first column of Table 6.1 describes the treatment of international trade under an origin-based system, for both carbon taxes and a cap-and-trade system.