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Don’t Be Fooled: The Carbon-Import Tax Is Just a Tariff

Posted on Mar. 16, 2023

It’s rare to find a Republican lawmaker who thinks highly of a new federal tax proposal. Enter Lindsey Graham from South Carolina. In recent days, the fourth-term senator has hinted that he may introduce a carbon-import tax. The proposal is billed as a clever way to stick it to Chinese polluters. According to some sources, the measure might be assigned a title that avoids using the word “tax.” OK, fine. Call it a something less provocative . . . a carbon-import levy, or a carbon-import fee. What’s in a name?

The same concept is being considered by several foreign governments. The European Union has already adopted a version of the plan, known as the carbon border adjustment mechanism (CBAM), scheduled to take effect in 2026. Yikes! It sounds like Graham is both an environmentalist and a proponent of higher taxes. Not so fast. The reality is more complicated.

The gist of the proposal is that it would be helpful for the U.S. government to encourage consumers to select greener alternatives when faced with purchasing decisions. If a special tax were applied to environmentally unfriendly imports, it would drive up their retail price — making it less likely that people would buy them. Because the special tax would apply only to specified imports, it would need to be administered by U.S. customs officials, not the IRS. Functionally, it’s no different from a tariff.

Moreover, there’s a massive difference between a genuine carbon tax (which includes a border adjustment mechanism) and the idea that’s being floated on Capitol Hill (which is only the border adjustment piece). A true-to-form carbon tax would be neutral as to source. That is, it would apply to all carbon-intensive goods, irrespective of where they were made. It would hit domestic production as well as imports. Politically, that’s a hard sell. Economists cherish the concept of neutrality; politicians, not so much.

Other countries’ carbon taxes feature border adjustments for the same reason their VAT regimes do. Both are destination-based charges. A carbon-intensive product that is exported should receive a rebate, knowing that it will pick up the appropriate charge once it enters the destination jurisdiction. This avoids duplication. In fact, the overall design of the CBAM loosely resembles a VAT regime, except that the tax base is narrower — it relates to a good’s carbon footprint rather than the incremental value added through each stage of production.

The problem for policy wonks is that what’s being discussed in Washington leaves out the carbon tax itself. That’s a heck of an omission. For something to qualify as a legitimate border adjustment, there needs to be a domestic carbon tax structure behind it. That’s noticeably lacking here.

Advocates of the measure claim that it can be justified because of the costly array of environmental regulations that U.S. manufacturers must contend with — and which are absent in lightly regulated places such as China. What the United States lacks in a domestic carbon tax is effectively made up for by regulatory compliance costs. This conflates tax costs with nontax costs in a way that our trade partners will not appreciate. In this sense, the thing that our border adjustment would be compensating for is that other countries' producers aren’t subject to Environmental Protection Agency regulations.

That’s a stretch. Again, the carbon border adjustment is just a tariff, plain and simple. And it might violate WTO obligations depending on how it’s structured.

That being said, a lot of people would argue that there’s a rational place for tariffs in a country’s trade policy. And if Congress eventually chooses to go the route of more tariffs aimed at China, that’s its prerogative. But let’s not mislabel our tariffs in the hope that people will think they’re something they’re not.

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