Carbon leakage measures and border tax adjustments under WTO law

Abstract

One of the major obstacles toward the adoption of mandatory limits on greenhouse gas emissions is the impact of such limits on the international competitiveness of domestic firms. Limits on greenhouse gas emissions – be they in the form of regulation, a carbon tax or a cap-and-trade system – may impose extra costs on domestic industries. Where foreign firms do not bear similar costs, domestic firms may lose their competitive edge. In particular, with a domestic climate policy in place, imports from countries without mandatory carbon restrictions may gain a price advantage over domestic goods. It is exactly this asymmetry that led the US Senate to reject the Kyoto Protocol , an international agreement that did not require emission cuts from developing countries. The competitiveness impact of climate change policy may play out both at home (on the domestic market) and abroad (on world markets). It can be particularly acute for energy-intensive manufacturers such as the iron and steel, aluminium, cement, glass, chemicals and pulp and paper industries.This paper examines the extent to which domestic climate policy could alleviate this competitiveness concern. More particularly, the paper assesses the limits imposed by World Trade Organization (‘WTO’) agreements on possible competitiveness provisions in climate legislation. Such competitiveness provisions would essentially aim at leveling the playing field by imposing the same or similar costs on imports, as domestic climate policy imposes on domestic production. To level the playing field on world markets, exports could also be exempted from domestic climate restrictions. As WTO Members are internationally bound by WTO law, any competitiveness provision that violates WTO agreements risks a challenge by trading partners before the WTO dispute settlement body. If competitiveness provisions were to be used as a sweetener to enable the adoption of domestic climate legislation, the WTO consistency of such provisions is, therefore, crucial.Section 2 briefly examines the policy reasons for and against competitiveness provisions in climate legislation and discusses recent initiatives to this effect. Section 3 explains how competitiveness provisions can take the form of trade measures, but that non-trade alternatives are also available. Section 4 elaborates on the types of trade restrictions that would most likely not pass WTO muster (import bans, punitive tariffs, anti-dumping duties and countervailing (anti-subsidy) duties). Finally, Sections 5 and 6 provide alternatives that the WTO would most likely accept. First, a carbon tax or emission allowance requirement on imports could be framed as WTO permissible ‘border adjustment’ of a domestic carbon tax or cap-and-trade system (Section 5). Crucially, if such ‘border adjustment’ does not discriminate imports as against domestic products (national treatment), and does not discriminate some imports as against others (most-favoured nation treatment), this type of competitiveness provision could pass WTO scrutiny without any reference to the environmental exceptions in Article XX of the General Agreement on Tariffs and Trade (‘GATT’). Second, even if ‘border adjustment’ would not be permitted for process-based measures such as a domestic carbon tax, regulation or cap-and-trade system imposed on producers, and/or such ‘border adjustment’ would be found to be discriminatory, the resulting GATT violation may still be justified by the environmental exceptions in GATT Article XX (Section 6). Such justification would then most likely centre on whether, under the introductory phrase of GATT Article XX, a carbon tax, emission allowance requirement or other regulation on imports is applied on a variable scale that takes account of local conditions in foreign countries, including their own efforts to fight global warming and the level of economic development in developing countries.