Putting progress over protectionism in climate policy

The COP28 climate summit in Dubai ended this month with a historic pledge to hasten the transition away from carbon emissions caused by fossil fuels. But that commitment is toothless without incentives and leadership to generate results. An efficient way for advanced countries to make progress towards the COP28 goal is Europe’s approach of tying carbon pricing to a carbon border adjustment mechanism (CBAM) that imposes a duty on carbon intensive imports. But that method has so far been politically impossible in the United States.

Yet there are mechanisms that could move the United States in that direction over time. For example, one approach is the proposed Clean Competition Act introduced in the House and Senate by Democrats. The legislation calls for a carbon price charged on US plants whose emissions are above some threshold, coupled with a CBAM on imports when their carbon emissions are above the same threshold. Unfortunately, while both this proposal and recent US legislation demonstrate policy commitment to emissions reductions in the years ahead, other recent US actions in this space risk undermining important progress abroad.

A global collective action problem

The Dubai gathering made clear that climate change is the world’s largest global collective action problem. But without coordination, countries may free ride on each other’s efforts, since the costs of policy action are borne at home, while the benefits are shared worldwide. So far, governments worldwide are falling short, raising the prospect that the world will substantially overshoot the goal of limiting global temperature increases to 1.5 degrees Celsius, embodied in the original Paris Agreement goal of 2015, even under the most optimistic scenarios. Creating incentives is essential, as discussed in a piece by the International Monetary Fund managing director, the European Commission president, and the World Trade Organization director-general.

The European approach does just that, pairing carbon pricing with a CBAM, which works much like a valued-added tax: It treats imported goods on a level with domestic production. The CBAM counteracts the competitive disadvantage to local firms from carbon pricing, avoiding the possibility that European consumers would choose lower cost dirty imports over cleaner domestic alternatives.

The European approach is already bearing fruit, increasing climate change mitigation incentives. Countries like the United Kingdom, Canada, and Australia are contemplating similar border adjustment measures. Since Europe's CBAM credits companies for any carbon price they have paid domestically, several countries (for example, Turkey, Indonesia, Vietnam, and Thailand) are considering carbon pricing regimes in response. As more countries join such efforts, the rest of the world has an incentive to adopt carbon pricing to avoid tariffs on their exports. Such reciprocity serves as a useful enforcement mechanism.

Carbon pricing generates many advantages. In addition to turning off CBAMs, carbon pricing can raise government revenues. Since carbon emissions typically rise with income in poorer countries, the rich will bear a disproportionate share of the burden, and the funds generated by carbon pricing can be used to offset any negative effects on the poor. It is also a highly cost-effective method for countries to address their emissions reduction goals. To help poorer countries, an international agreement could be pursued to allow countries to set different “minimum prices” required to avoid CBAMs on their exports, combined with granting such countries additional climate finance resources.

Can the United States join in?

Some will write off a price-based approach in the United States as a nonstarter. Yet there are mechanisms that could move the United States in that direction over time. For example, the proposed Clean Competition Act in Congress would treat domestic and foreign emissions similarly but only apply the carbon price and accompanying CBAM above a certain emissions threshold. The threshold is an important policy dial: As the threshold decreases (which happens over subsequent years in the legislation), the policy approaches a carbon price with an accompanying CBAM, aligning US efforts with those abroad. US industry would likely gain domestic market share relative to imports, since US production is cleaner than that of many trading partners.

Beyond that proposal, 2025 may provide an important moment for the United States to include carbon pricing because of the need to revisit the US tax code. Many tax cuts enacted in 2017 are scheduled to expire at the end of 2025. Extending those tax cuts would cost more than $3 trillion over a decade, yet policymakers on both sides of the aisle have expressed interest in at least a partial extension. This tax policy debate will occur in the context of rising deficits and debt, alongside higher federal interest expense in servicing the national debt. The looming insolvency of the Social Security and Medicare trust funds may also compel a search for revenue.

To be sure, the Inflation Reduction Act (IRA) of 2021 will drive important emissions reductions, but the United States is still forecast to fall short of its Paris emissions reduction commitments. The tax subsidies in the IRA pass cost-benefit tests, but the fiscal cost of these credits are likely far higher than originally budgeted. The Joint Committee on Taxation has already nearly doubled its estimate of the costs, and reputable outside estimates are even higher.

Carbon pricing may seem contradictory to the IRA, but it is actually complementary in several respects. Building clean energy infrastructure and capacity makes it easier for consumers and businesses to substitute clean energy for dirty energy when carbon pricing increases the price of dirty energy. Also, the IRA helps workers and communities hurt by the energy transition while building out job opportunities in clean energy industries. Further, it makes no sense to let polluters add CO2 to the atmosphere free of charge while providing tax credits when people remove CO2 from the atmosphere.

In a recent paper, one of us advocates enactment of a US corporate carbon fee. By exempting gasoline and home heating oil from the fee, the proposal would insulate households from cost increases, and revenues from this fee can either be recycled to households or used to reduce the federal deficit. We suggest a fee that would start at $15 per metric ton of carbon emissions, rising to $65 over ten years, levels that would still be lower than fees in Europe or Canada.

But beware protectionism in disguise

As of now, the United States is not pricing carbon at the federal level, and some US policy stances may even interfere with global convergence around carbon pricing. For example, during recent EU-US steel negotiations, the US government’s position—arguing that the two sides should grant each other mutually assured market access (despite the absence of a US carbon price), while tariffing dirty steel from outside the group—was incompatible with the logic of the European Union’s CBAM.

Other problematic US policy proposals include a proposed carbon tariff advanced by Senators Bill Cassidy (R-LA) and Lindsey Graham (R-SC), a “foreign pollution fee” based on the carbon intensity of imported goods, ostensibly to incentivize greater climate action abroad. Senator Cassidy recently contrasted his suggested approach with the European Union’s CBAM, which he labels as “protectionist.”

Unfortunately, Cassidy’s labels are exactly backward. His fee would be protectionist. The EU approach is nondiscriminatory, whereas the Cassidy measure would charge those selling imports into the United States for their carbon emissions even though no similar levy would affect US firms, which may even be subsidized under the IRA to reduce their carbon footprint. US industries would thus enjoy a competitive advantage over their foreign counterparts, the very definition of protectionism.

The Cassidy-Graham approach would also undermine the ability of the US government to require more decarbonization effort from industry, since it gives the American industrial sector something valuable (i.e., protection from carbon-intensive imports) without requiring them to commit to progress towards climate goals.

Their bill also risks undermining important work that the European Union and other countries have done on the CBAM; the CBAM asks Europe’s trading partners to bear the same costs that domestic companies face when serving the European market, following a nondiscriminatory approach. In contrast, exporting countries hit by the proposed “foreign polluter fee” may legitimately assert that the fee is discriminatory and retaliate, jeopardizing harmonization of climate-oriented policies and igniting trade disputes that harm the US economy.

The prospect of US protectionism without carbon pricing also risks undermining support for the EU CBAM and carbon pricing in the rest of the world. Affected industries in other countries may start lobbying for a similar approach from their governments. Carbon pricing will not and should not be the only approach the world takes to climate mitigation, but it is a tool that much of the rest of the world is leaning into, so reversing that momentum would have disastrous implications for worldwide emissions reductions.

Ways forward for US climate policy

Past efforts to pursue pricing in Congress have failed, including the BTU energy tax proposed in the 1990s and the cap-and-trade effort of the early Obama years. The IRA reflected the notion that subsidies for clean energy are much easier politically than taxes on dirty energy.

But 2025 will look very different from 1993 (before many voters were born) or 2009. The fiscal environment is far more dire, and we are literally living in a very different climate of extreme weather disasters, reminding us of the importance of global collective action for addressing global problems. The United States may realize that better aligning with policies abroad through carbon border adjustments and climate clubs is essential to the global climate effort.

There are other ways for global cooperation to serve climate policy action besides tariffs. In recent work, one of us suggests trade rule reforms to lessen conflicts over divergent climate policies, such as forging commitments that would ban export restrictions on climate-related goods or services, and avoid (or dismantle) national content provisions in green subsidies.

International cooperation can enhance access to green technologies through information sharing and by liberalizing trade and investment in clean energy goods and services. Further, international financial flows and multilateral development assistance are essential to facilitate the energy transition for poorer countries.

The US subsidy-based approach was the best we could do in 2022, but IRA investments, while increasingly expensive, will only get us part way to our Paris commitments. The United States should put climate progress over protectionism. This moment in history provides ample reminders that a world more reliant on clean energy would also be a safer world, making it harder for authoritarian governments in petrostates to turn energy revenues into weapons of war and reducing the stress from waves of climate refugees, to say nothing of avoiding human suffering. Climate change is moving swiftly, and so should US climate policy.

Kimberly A. Clausing is the Eric M. Zolt Professor of Tax Law and Policy at the UCLA School of Law and a nonresident senior fellow at the Peterson Institute for International Economics. Catherine Wolfram is the William F. Pounds Professor of Energy Economics and a professor of applied economics at the MIT Sloan School of Management.