\nof Why Nations Fail: The Origins of Power, Prosperity and Poverty
\nand The Narrow Corridor: States, Societies, and the Fate of Liberty<\/p>\n
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Environmental tariffs may be humanity\u2019s last hope for mitigating climate change, which is on course to become increasingly devastating if we do not curb our greenhouse-gas (GHG) emissions.<\/p>\n
The most straightforward way to confront this unprecedented global threat is through a multilateral agreement that locks in a \u2018green transition\u2019 in all (or most) countries. The key is to boost renewable-energy production while significantly reducing fossil-fuel consumption, a process that calls for coordinated policies on three fronts: regulation, subsidies for cleaner technologies (including renewables), and carbon taxes.<\/p>\n
Unfortunately, this type of global agreement seems out of reach, both because the fossilfuel industry remains politically powerful, and because some of the world\u2019s biggest emitters, including the United States, China, and India, are not adopting the necessary policies.<\/p>\n
Although regulation and subsidies are essential to achieve an effective energy transition, the carbon tax is the bedrock, because that is what will increase the costs of emitting carbon dioxide, methane, and other GHGs. Several countries have already adopted such taxes, including Sweden, which has the world\u2019s highest carbon tax (approximately $117 per ton). But many others, including the US and China, have not followed suit.<\/p>\n
This lack of consistency gives rise to \u2018carbon leakage\u2019. High-emissions activities tend to move away from countries with carbon taxes to those without. While a country that unilaterally adopts a higher carbon tax benefits everyone (by reducing its own GHG emissions), it also unwittingly encourages others to do less. Or, as an economist would put it, one should expect that unilateral climate-mitigation policies function as \u2018strategic substitutes\u2019 across countries: The higher one country\u2019s carbon tax, the less other countries will do for mitigation. A high carbon tax creates an opportunity for \u2018carbon arbitrage\u2019. Since the steel industry emits 1.85 tons of carbon for every ton of steel produced, Sweden\u2019s carbon tax increases the cost of its steel production by about $210 per ton, which in turn makes Chinese steel imports much more attractive for steel-users and their customers.<\/p>\n
Worse, Chinese authorities have an incentive to maintain this arrangement. Without a Chinese carbon tax, Chinese steel exports will thrive, and that will help Chinese industry, workers, and politicians (who can claim credit for generating an economic boom). Even if they recognize the need to combat climate change, Chinese authorities may end up doing less than they might have done without Sweden\u2019s carbon tax.<\/p>\n
Hence the need for environmental tariffs, which would reverse this logic by imposing a carbon tax on imports. Sweden would apply a border tax adjustment equivalent to the difference between its carbon tax and the carbon tax of the exporting country, multiplied by the tonnage of the CO2 emissions generated in the production of the imported products.<\/p>\n
An environmental tariff\u2019s most obvious benefit is that it reduces carbon leakage. By nullifying the artificial cost advantage of imports from low-carbon-tax countries, it encourages steel consumption to shift toward cleaner domestic sources or less-polluting exporters.<\/p>\n
But an environmental tariff\u2019s indirect effects may be even more important. Most importantly, a tariff makes climate-change mitigation policies \u2018strategic complements\u2019 rather than strategic substitutes; this means that Swedish carbon taxes will encourage, rather than discourage, other countries to adopt similar policies of their own.<\/p>\n
The logic is simple. Without environmental tariffs, Sweden\u2019s carbon tax gives Chinese steel producers an arbitrage opportunity. But once more countries have begun to apply border adjustments on imports, the Chinese authorities will want to help China\u2019s steel exporters clean up their operations. Regardless of whether they do this through carbon taxes, regulations, or subsidies for clean energy, Chinese CO2 emissions will decline. And once Chinese producers start meaningfully reducing their emissions, China\u2019s authorities will have an incentive to introduce environmental tariffs of their own.<\/p>\n
For the most part, what is standing in the way of aggressive environmental tariffs are excuses and misleading arguments. The fossilfuel industry and major polluters, including China, are dead set against environmental tariffs and have been campaigning aggressively to block them. But this position is wholly selfish and thus should be disregarded.<\/p>\n
A second argument is that environmental tariffs are protectionist measures, and that we should not \u2018risk giving protectionists another opening\u2019, as The Economist puts it. This claim does not hold water. Because carbon tariffs level the playing field, they do not function like traditional protectionist measures. Moreover, the classic theory of trade does not imply that arbitraging domestic policies produces welfare gains \u2014 especially considering that such policies are essential for combating climate change.<\/p>\n
A third objection is that environmental tariffs may not be legal under World Trade Organization rules. In fact, a straightforward reading of the General Agreement on Tariffs and Trade (GATT) suggests that they are indeed legal. Article III allows for environmental taxes, stating that \u201c[imported products] shall not be subject, directly or indirectly, to internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to like domestic products.\u201d It follows that if a country has a domestic carbon tax on \u2018like domestic products\u2019, it is permitted to apply the same tax to imports through border adjustments.<\/p>\n
This rule has long provided the basis for border adjustments on value-added taxes, and it was also the reasoning behind a GATT panel\u2019s 1987 ruling (in United States \u2013 Taxes on Petroleum and Certain Important Substances) that border tax adjustments could be applied to chemicals. Furthermore, Article XX of the GATT provides additional exemptions for trade restrictions \u201cnecessary to protect human, animal or plant life or health,\u201d and there is now a strong scientific case that carbon taxes meet that criteria. Finally, some commentators worry that in a \u2018liberal international order\u2019, important global policy decisions should be pursued primarily through multilateral cooperation. That may well be true. But the fact is that multilateral agreements are not going to work fast enough to keep the world anywhere close to the Paris climate agreement\u2019s 1.5\u00b0 Celsius warming pathway. We cannot allow faith in multilateralism to become an alibi for inaction. Environmental tariffs could create a positive cascade of climate-mitigation policies around the world. There should be no delay in implementing them.<\/p>\n