In this week’s episode, host Kristin Hayes talks with Brian Flannery, a visiting fellow at Resources for the Future and an expert on international climate policy. Flannery describes how border carbon adjustments—essentially taxes imposed on goods from countries with relatively less ambitious climate standards—are gaining traction, with proposals circulating in the United States and the European Union. However, Flannery cautions that these policy tools will confront a number of challenges before they can be implemented, including backlash from countries that could be negatively affected and the need to abide by World Trade Organization rules.
Listen to the Podcast
- Border adjustments help level the playing field: “The difficulty is that nations with stronger climate policies have legitimate concerns that energy-intensive, trade-exposed industries—steel, cement, et cetera—might shift their production to nations with less ambitious policies. Border adjustments … are a procedure that would put a charge on imports coming in to reflect the fact that where they were manufactured, they didn’t face a stiffer climate policy.” (4:14)
- Border adjustments face complex challenges: “What are the big challenges? The first one is political. But after that, there are legal, technical, and administrative challenges … There are literally thousands of greenhouse gas–intensive products traded in the international markets and hundreds of nations. And the rules keep changing, the policies keep changing, markets evolve. So any system you impose will have some serious administrative challenges.” (12:00)
- World Trade Organization rules are shaping negotiations: “The EU proposal is far more advanced and developed at this point [than any US plans], but they’ve had lots of discussions. One thing I’d point out is that both [the EU proposal and the Coons-Peters bill] apply only to import charges. They do not provide export rebates. I think I know why: the rules under which they’re proposing them would be based on the environmental exceptions—Article 20—which most people would say applies to imports but not necessarily to exports.” (22:39)
Top of the Stack
- “Policy Guidance for US GHG Tax Legislation and Regulation: Border Tax Adjustments for Products of Energy-Intensive, Trade-Exposed and Other Industries” by Brian Flannery, Jennifer A. Hillman, Jan Mares, and Matthew C. Porterfield;
- “Framework Proposal for a US Upstream GHG Tax with WTO-Compliant Border Adjustments: 2020 Update” by Brian Flannery, Jennifer A. Hillman, Jan Mares, and Matthew C. Porterfield;
- “Implementing a Framework for Border Tax Adjustments in US Greenhouse Gas Tax Legislation and Regulations” by Brian Flannery;
- Transcript of an oral evidence session in the House of Lords for the inquiry into Ofgem and net zero, with Sir Dieter Helm
The Full Transcript
Kristin Hayes: Hello, and welcome to Resources Radio, a weekly podcast from Resources for the Future. I'm your host, Kristin Hayes. My guest today is Brian Flannery, who joined Resources for the Future as a visiting fellow in 2012. Brian has long been engaged in the complicated world of international climate negotiations, attending nearly all Conference of the Parties, or COP, meetings, and other related sessions over the years. Fully understanding both the structures and the outcomes of these international negotiating sessions is no easy feat. And RFF is fortunate to have benefited from Brian's expertise and experience in this area.
Given his interest and background in international climate policy, along with some of the research that he and others at RFF and elsewhere have been doing, Brian is a great candidate to talk with me today about one of the hot topics in the trans-border climate dialogue, which is border carbon adjustments. We'll be talking about what they are, what challenges they face, and what proposals have recently been emerging in the European Union, the United States, and elsewhere. Stay with us. Brian, welcome to Resources Radio. It's great to talk with you today.
Brian Flannery: Hi, Kristin. Good to talk with you, too.
Kristin Hayes: So you've been connected to RFF for a number of years, but you come from a different kind of research background. So can you say just a little bit more about your own professional history, and in particular, how you came to work on climate change?
Brian Flannery: Sure. I pursued a career in astrophysics for over a decade. My work involved theoretical modeling of a sort that's not unlike what's done in climate models. And in fact, my undergraduate thesis at Princeton in 1969 and 1970 was on the CO₂ greenhouse in the atmosphere of Venus. It isn't just the international negotiations, it's the broader set of issues, like science, technology, economics, and policy. But, RFF, who I had worked with—I thought it would be a great place to continue to work on subjects of interest to me. So that's how I ended up at RFF.
Kristin Hayes: Great. Okay. We're tackling a complicated subject today, and so I'm grateful that you're going to talk us through all the bits and pieces. So we're going to be talking about border adjustments, or border tax adjustments, or border carbon adjustments, or carbon border adjustment mechanisms … There are a lot of evolving terms here. And so I guess I wanted to start with the basics. What are we talking about, generally, when we talk about border adjustments in the context of climate policy? And what do all these differences in terminology that our listeners might have heard of, what do all those differences in terminology actually signify?
Brian Flannery: Well, partly, they signify experts’ knowledge of what terms might work or not work with what they're proposing to do. I refer to them generically as border adjustments. Ever since the climate issue began seriously in terms of being a public policy issue, I'd say even in the 1970s, it was clear that there would be a confrontation between climate and trade. Not just the issues, but the institutions—the World Trade Organization (WTO), and what later became the UN Framework Convention on Climate Change.
The difficulty is that nations with stronger climate policies have legitimate concerns that what are often called energy-intensive, trade-exposed industries—steel, cement, et cetera—might shift their production to nations with less ambitious policies. So, the idea of border adjustments, which exist in other settings—including, in particular, the value-added tax setting—are a procedure that would put a charge on imports coming in to reflect the fact that, where they were manufactured, they didn't face a stiffer climate policy. And in general, it would also provide an export rebate to domestic manufacturers sending goods abroad, in order to create a level playing field for greenhouse gas–intensive goods.
In general, it’s export rebates and import charges; we'll get into that more later. But there are questions: What mechanism do you use to set the price? If it's a tax, as in the framework we proposed, we would call it a border tax adjustment. And the WTO is very familiar with border tax adjustments because of the words I just mentioned—value-added tax—where an appropriately designed tax can be legally subject to border tax adjustments under the WTO. If you use other procedures—such as the European Union's Emissions Trading System (ETS) or the Coons-Peters proposals, it's not clear—but they would face much bigger challenges.
So the words are often used to couch a direction to maybe make it more or less acceptable to WTO, the World Trade Organization. Of course, in some cases, people say, “Well so what, about WTO? Let's get on with dealing with climate.” And that's a separate discussion. But these are all wound up in this process. And the vocabulary is tough, because we use common words that have specific meanings, and sometimes they're not the same in trade discussions as they are in climate discussions. So your question is a good one.
Kristin Hayes: So, why are border adjustments getting so much attention right now? It's not that they haven't been discussed for years, or decades. As you've mentioned, there are parallels with things like the value-added tax. And yet, I feel like they're also having a bit of a moment. So, can you explain to our listeners why they're increasing in prominence in the dialogue right now?
Brian Flannery: Yes. If I had to guess, I would say this will be, some might say, an unwelcome addition to the discussions going on at COP26 in Glasgow now. Why are they important now? And as you say, Jan Mares and I and our colleagues have been working on these issues for four or five years to a small set of experts. There are two reasons: the Paris Agreement put in place vastly different levels of ambition, and vastly different policy portfolios in different countries.
A study I've seen working with a group that RFF works with in an international collaboration estimated, by a simple way of doing it, the costs in countries like Switzerland and Japan would be over $300 a ton to meet their 2030 pledge. In India and China, the costs would be zero. Not small—zero. They would achieve those targets without having to do anything more than what they were currently doing and putting in place. So first, you have—I call it a mosaic world—interlocked nations, but with vastly different ambitions and sets of policies.
Then you have the European Union, which is working. And, thank you to them, they're working hard to see how they would actually implement an ambitious policy, not just pledge, in 2030. The more they look at it, the more they see that they may be faced with a challenge for the domestic industry. They tend to phrase it in terms of an environmental outcome, greenhouse gas leakage, but they feel they have to address it now. And that's been uncomfortable for some countries. I think even in the United States, John Kerry has suggested that this isn't the time to implement this, and we should talk about it first.
Now, countries like China, India, Australia, New Zealand, and others have said, “We don't want to go along with this; we think this is wrong.” So, there are big differences, there’s attention on what it will actually take to achieve the policy, and now the European Union is coming forward with a specific plan. And now, in the United States, there is the Coons-Peters proposal, and I suspect there may be more policies. So, we're seeing a real intense set of discussions about: What are these? Should we be doing them? How would they work? Will they be legal?
Kristin Hayes: This is a huge question, but I'm going to ask it in this massive scale here. These are complicated instruments. You've mentioned that they intersect with the World Trade Organization rules and regulations, which are their own set of very complicated instruments. So, what are the challenges to designing and implementing a border adjustment like the one that the European Union has proposed?
Brian Flannery: Yeah. Or like the one that Jan Mares, Jennifer Hillman, Matt Porterfield, and I have proposed with a tax. They're the same sets of issues, but they play out differently, depending on the policy. So first, let's say, for sure the world has had over two decades of experience determining and reporting greenhouse gas emissions from facilities. A steel plant or an operation, let's say an oil field using tertiary oil recovery to produce crude oil, those are the rules for which they're reporting obligations.
In the United States, any operation that produces more than 25,000 tons of greenhouse gas emissions a year has to report their emissions in some detail. In the European Union, the Emissions Trading System applies to facilities. So we have a lot of experience with facilities. But border adjustments don't apply to facilities. They don't apply to sectors. They apply to products crossing the border. To give you an example: Steel. Steel that looks the same could be produced with a blast oxygen furnace or an electric arc furnace. The first generates three times as much emissions as the second, and it's the same product.
It also depends on whether they're recycling scrap steel. So, it depends on the facility, what raw materials, what technology, what processes, whether they're recycling, what the emissions would be. So, there's a big challenge to go from facilities to products. And that's what most of the work that our team was involved in was really focused on. But there are two major items to be settled in border adjustments.
First, what is the price per ton of greenhouse gas emissions? $50, $100 a ton CO₂. And that if it's a tax, you know what it is—the tax was 20. That's my price. But if it's the European Union ETS, it's a permit on a facility. And the permit price goes up and down all the time. And the European Union awards free allowances to many sectors. We can get into this in a moment, but you need to know the price on a product, and that's where the WTO rules come in. So first, what's the price per ton of emissions? And second, how do I calculate the emissions associated with greenhouse gas–intensive products that the facility creates? Those are the two issues we have to address.
What are the big challenges? The first one is political: there is a big pushback on doing it. But after that, there are legal, technical, and administrative challenges. Now, these aren't political; these are, how the heck do you do it? Legal mostly applies to the WTO. Technical applies to this issue of allocating emissions to facilities, accounting for the facility's emissions, and the emissions that were required to produce the products you purchased in the supply chain. Every sector uses electricity, every sector uses commercial fuels, and you have to account for those two.
And last, there's an administrative issue. There are literally thousands of greenhouse gas–intensive products traded in the international markets and hundreds of nations. And the rules keep changing; the policies keep changing; markets evolve. So, any system you impose will have some serious administrative challenges. But the big one is, Do we know even how to do it to create the emissions associated with products? So, there's a nest of these, and they're different with different policies.
Kristin Hayes: Great. So, you and, as you mentioned, Jan Mares and some colleagues at Georgetown—Jennifer Hillman and others—have been thinking about a framework that would actually pull all these threads together and address the challenges that you just mentioned. So, tell us a little bit about that specific framework and how you see it addressing those challenges.
Brian Flannery: Okay. So, a first remark: Jan and I both would love to see an appropriately designed greenhouse gas tax—a carbon tax. And whether Congress will give us one or not is another issue. It seems like they're going in other directions. But it was our view—and this is cemented in discussions with over a dozen trade associations and experts on all sides—we probably can't pass a greenhouse gas tax in the United States without border adjustments. It may not be such a big deal for the United States, for the economy as a whole, or for greenhouse gas leakage, but the effects will be concentrated.
Pittsburgh is Steel City, Detroit was Auto City. So, you have a big effect in important cities—and even regions—because these major industries are often the linchpin for a whole regional economy. And it's not just business, it's actually organized labor who are quite adamant about the need for border adjustments. And then the communities where these industries operate, for the supply chains, for the grocery stores, for the hairdressers, for the restaurants—it's a big deal.
So, how do you do this? The team we assembled consists of two good trade lawyers from Georgetown: Jennifer Hillman, who is actually a judge on the appellate court of the WTO and has had senior US positions; Matt Porterfield is a good academic trade analyst; and then Jan and I, who have experience with business—me more on the international side, and Jan on the domestic side. To be clear, we aren't looking at the economics of border adjustments. We aren't looking at their impact on greenhouse gas emissions. We asked a different question: Can we create feasible WTO-compatible border adjustments?
And the answer we've come up with is: Yes, in the context of a greenhouse gas tax. The reason we can is that WTO allows the value-added tax to be rebated on exports and imposed on imports. In large measure, that's because, for many nations, the value-added tax is a primary source of national revenue. So, we modeled our approach to analysis on the value-added tax, using a concept that we created, and it also becomes an administrative index called the Greenhouse Gas Index, the GGI.
So what is GGI? Its units are tons of CO₂ equivalent per ton of product. So, if you manufacture a ton of steel, did you emit two tons of CO₂ or half a ton of CO₂? And similarly for any other product. Jan and I—me, especially, I think—have worked very hard within industry groups about these methods to measure emissions from facilities. We've been doing it for decades now. We know how to do it. But the challenge is to allocate it to products. I won't go into it too much now. But what are the major criteria to comply with WTO?
You need an objective methodology to determine the border adjustment. And if it's a tax, that's straightforward, and we've defined the allocation procedures. There are international standards for these, and we've modeled ours after that. Second, there are two clauses that deal with the price you assign to the product. If it's not based on a tax, then you've got to base it on some equivalent price, like, what's the price of an emissions permit? Well, it goes up and down. What's the price of a CAFE [Corporate Average Fuel Economy] standard, which is in the Coons-Peters bill? I don't know how you would determine that.
But there are two key issues. One, the import charge cannot exceed the charge on an alike domestic product. If you're taxing the steel, you can't put a bigger charge than you do on domestic steel. That seems reasonable in terms of fair trade. And the export rebate cannot exceed the tax paid on the product. Otherwise, it would be deemed an illegal subsidy. “Thanks for the $10—we're giving you $20 back. Go out there and sell your steel.” Finally—and this one is somewhat controversial, but—we heard this from most WTO lawyers we talked with. The “most-favored-nation principle” implies you cannot provide a credit to firms that export to the United States for the domestic policies they face.
That's to say, if it were VAT [value-added tax], you can't say, “Well, our VAT is $20, the United States doesn't have one, and yours is $10, so we only have to charge you $10 more.” Now, with VAT, if you remove it on exports, we'll impose it on imports. Let the consumer pay the tax. Well, those four criteria, we've worked them through—and we have a WTO-compatible technique for a carbon tax. For all of these other proposals, people have talked about what the price would be. Well, it's the permit price.
But what about those free allowances and the fact that it goes up and down from month to month? Okay, we'll try to figure out a way to deal with that. Or portfolio policies like CAFE standards, and the Regional Greenhouse Gas Initiative and whatnot. Well, how do you define an objective methodology for a regulatory standard to compute what the price is? And not just the price, which many people are trying to do, but the price on a product. Would it be different on steel than electricity? Which could well be subject to this, too, in parts of the United States and Canada, and certainly in Europe. So, these are tricky criteria, and these are the challenges when you have a different policy than a carbon tax or greenhouse gas tax.
Kristin Hayes: As you mentioned, even in the European Union, where they do have a price on carbon, it's through a trading system, and therefore, the price fluctuates. How do these work, given that they're so much easier to design and implement in the presence of this explicit tax, as opposed to other frameworks? How do you get around that?
Brian Flannery: Kristin, the short answer is: I don't know. I am trying to think about it. And there's a lot of work going on to try to assess, what is the greenhouse gas price, in dollars per ton of CO₂ or euros per ton of CO₂? But there's the related question: How much of that price do I assign to a particular product? And as I just said, for instance, for steel, electric arc furnace steel made from scrap has far lower emissions than steel made from a blast oxygen furnace—so much so that it really makes a huge difference for that and a number of other products.
So, I think people are trying to assess what the price might be. But again, like in Europe, the permit price is something you can buy, and then they want to assign it on a monthly basis and charge. Europe will collect the money for the CO₂ at the price of the EU ETS permit in that month. But how much do they apply to a particular product? This question of how many tons of CO₂ per ton of product—I don't know the answer to that. And the allocation of free allowances could be different in different sectors.
I think they're proposing to phase out free allowances, but all that's part of the development of the actual final rules and laws. So, I think it'll be a big challenge. And again, I think it's not just what is the national price, but how do I assign it to products under these different sets of policies? At least we can say we have a proof that you can do it with a greenhouse gas tax—an appropriately designed one. I keep mentioning that.
Kristin Hayes: Okay. So actually, it'd be great to dive a little bit more deeply into some of those specific policy proposals that have been emerging both here in the United States and in Europe. And maybe we can talk a little bit about how those might differ from what you and your colleagues have been proposing, and we can compare and contrast a little bit. But there is, as you mentioned right at the outset—there's some proposals coming out of Europe. I believe the acronym that people are using is “CBAM,”—the carbon border adjustment mechanism. And there's also a bill in the Senate that has some proposals for the United States. So, can you say a little bit more about how those look and how they're different or the same as what you've just talked us through?
Brian Flannery: Yeah. I think I've been talking about the generic issues that apply to both of them. The EU proposal is, I think, far more advanced and developed at this point, but they've had lots of discussions. One thing I'd point out is that both of them apply only to import charges. They do not provide export rebates. I think I know why. The rules under which they're proposing them (probably to look at WTO) would be based on the environmental exceptions—Article 20—which appears to apply, most people would say, to imports but not necessarily to exports.
Whereas the framework proposal we developed goes through the front door of the WTO. It relies on Articles 2 and 3 and the agreement on subsidies and countervailing measurements. And in that setting, it's okay to say we're doing this for economic reasons. Whereas when you're dealing with the environmental exceptions, you really have to lean more heavily on the greenhouse gas leakage issues than the competitiveness losses. But the United States competes with, let's say, China, in developing countries. It's not “us versus China.” It's us and China competing, and—I'm making this up—Nigeria for a contract. Well, in that case, without an export rebate, the US manufacturers would be at a big disadvantage.
I think it's pretty clear US manufacturers would want to see. I mean, I've heard the labor unions say this, and some of the trade associations would want export rebates, as well—would insist on them. In Europe, I'm not sure what the situation will be. So, that's a difference with respect to what we proposed. But neither is based on a specific tax. So, we have this question of what is the amount, and how do I determine it in general? And how do I determine it for specific products?
Now, our proposal is applied to a broad set of sectors that produce what we call greenhouse gas–intensive products, actually based on their GGI. Any product that would emit more than half a ton of CO₂ per ton of product we would cover, and it would be eligible for export rebates and imports would be subject to charges. The EU proposal is limited to a handful of sectors at this time, and so is the Coons-Peters FAIR Transition and Competition Act. The European Union applies to the emissions trading system. So, that's pretty clear.
Coons-Peters applies to, as I read it, US regulations, federal regulations, state regulations, local regulations—including those in place now and those that might come into effect later. They mentioned things like a clean energy standard, the Corporate Average Fuel Economy standard. I guess I can't see a way to translate some of those policies into a price, and greenhouse gases in an objective way, without the possibility of assumptions that might advantage some folks and disadvantage others in a way that looked like an illegal restraint on trade.
I'm not saying they would be trying to do it that way—I just don't see how you do it. And it's not just for one or the other; it's for all of them. So it instructs, I think, the Secretary of Treasury to determine an equivalent price. But it doesn't offer insight into how, and it could be a very challenging issue. And if it's not objective, it could be challenged in the WTO.
Kristin Hayes: Interesting. Okay. Well, Brian, I understand that you also have some new work coming out on this topic pretty soon. So, can you share a little bit more of how you've been extending your work on border adjustments in the recent months, and what our listeners should be on the lookout for on the RFF website?
Brian Flannery: Many people asked us if we would give examples of how you actually compute GGI, the Greenhouse Gas Index, in various sectors, and we've been working on that. And we've looked at two different settings: One for export rebates. We believe that the information is known or knowable for US companies to be able to file for export rebates when the program starts. They already report greenhouse gas emissions from facilities, they know what products they buy from electricity providers and fuel providers, they know what products they make, and we've designed allocation procedures.
One is based on the carbon content of products that derive from produced fossil resources. And from what they produce, feedstocks of naphtha that are cracked to produce other petrochemicals, and so on. So, that's allocation by carbon content. The second for commodity inorganic products is based on what we call the fraction by weight of a core product on raw aluminum or raw steel. We provide different examples. We've shown how to do that with hypothetical examples—hypothetical, because right now, Jan and I don't know what the emissions are for a particular facility. But we made up some that look like what they would be and showed here's how you turn the crank.
And the conclusion we've come to after lots of work is really—and I use this word advisedly—it's simply a matter of accounting for known information. The information is known or knowable. Under the framework, it would be required to be sure it was known. Suppliers would have to tell their customers if they have covered products, what the GGI was for their electricity—which varies depending on the electricity—and so on. So, the facilities report says, “Here's how you do it.”
The second report is called estimates and methods. And it would apply initially under a regulatory authority in the United States to determine import charges from other nations. We would allow them to do it the way we do based on facilities. But in many nations, they do not currently have robust reporting procedures. In that case, these methods are based on known public information and use national sectoral averages. Rather than saying, “What was the electricity in your facility?” We say, “What's the average emissions for electricity in your country?” And that's provided by the International Energy Agency. It may lag by a year; I've forgotten. But information is there.
So, that one allows us to inform people early on: here's what GGI values look like. We call them indicative, representative values. They're indicative because we don't know it for the specific facilities, and they’re representative because they deal with products in about three dozen sectors. So, these show you: Here's how you do it. Unknown or unknowable information. But all that would have to be translated through the regulatory authority into authorized procedures for import charges and export rebates.
I think that crosses the bridge to say, “Going from the theory, here's how you do it,” and identifies major issues. The latter, we have a to-do list of a whole bunch of issues that require further work, and we'll be working with our colleagues at Georgetown and the Council on Foreign Relations and others to define them. There are a number of them, like: How do you treat biofuels? How do you deal with timing questions? A nasty problem which occurs all the time in trade: What's the country of origin of the goods? Were they actually manufactured in China and shipped through Vietnam?—I'm making up an example. I have no idea of a particular product—and Vietnam qualifies for a lower rate than China, but it's actually a Chinese product.
But there are tools to deal with these, but we want to deepen the dialogue. A new dialogue is to look at what the administrative procedures and the legalities would be under US law to actually implement this with appropriate legal guardrails on the way they're being done. So, those are all whatever seems hottest and most interesting at the time. We'll work on some of those next.
Kristin Hayes: Okay. Well, that sounds great. And you certainly are right at the heart of the dialogue now, which is a great place to be—to have your work really be squarely in the center of decisions that are happening. There is no shortage of further things to study. But also, it sounds like the work that you've done to date is already a real contribution to the conversation.
Brian Flannery: Well, thanks for that. I think in part, that's because we've assembled a really good team of people who each bring different but complementary expertise to look at: Can you design a legal, administratively feasible, technically feasible procedure to do it? And there's a lot there, as well as in the economics and climate issues.
Kristin Hayes: Great. Well, Brian, thank you so much for introducing us to this framework. As you noted, there will be more information coming on RFF's website related to your particular research. There is other research up, as you also noted, recently related to border adjustments. And so RFF is hopefully going to be a great repository for lots of this thinking. But we've reached the time for our closing feature, Top of the Stack. And I think everyone's familiar at this point with what Top of the Stack entails. But Brian, let me ask you, what would you recommend to our listeners? What's on the top of your stack?
Brian Flannery: Just a week or so ago, I read some excellent testimony given in the UK House of Lords with regard to their 2050 net-zero approach. And the question really was, Does the United Kingdom have a good system in place to achieve its net-zero 2050 goals? And the expert they asked to testify (and what I'm going to suggest is the transcript of his testimony) is quite good. His name is Dieter Helm, who is a professor of energy policy at the University of Oxford. I think it's very sobering to read it.
Kristin Hayes: We will take that link and we will actually post it alongside this recording. Well, thanks, Brian. It's been a pleasure. And I'm sure we'll talk again soon.
Brian Flannery: Thank you.
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