This is a guest post from trade lawyer Bernard O'Connor:
Reinhard Quick has written a blogpost questioning the idea of a border carbon adjustment. He raises some very good points.
It goes without saying that a border adjustment for internal direct taxes must be trade neutral and must normally be rebated on exports as well as charged on imports. But as Reinhard rightly says rebating internal carbon costs on export would undermine the EU’s carbon reduction strategy. So, if there is to be a border measure to address the carbon footprint of imports with no rebate on exports, it is right to question its classification as a Border Tax Adjustment (BTA). In law, it is likely to be something else and EU policy makers are simply lazy in cloaking their thoughts in BTA.
If, as seems likely, the border measure would have, as one of its elements, a charge applicable to imports only, should it be considered a climate tax? Again, Reinhard makes a good point that internal environmental costs are indirect and cannot be offset at the border. Thus, if the measure is only a charge or tax it is likely to fall foul of GATT II.
Much debate has been about avoiding discrimination within GATT Article III when converting an internal EU cost imposed on companies into a product specific cost to be charged at the border. Reinhard is right to make the point that this is a herculean task and will run into all sorts of problems particularly in relation to imports from countries where different conditions prevail. The object must be to avoid discrimination but facts will determine if that object is reached.
Given these difficulties, Reinhard suggests two solutions. It seems to me neither do the trick. The idea of increasing VAT by 2% and dedicating the revenues to climate purposes could well run foul of the Agreement on Subsidies and Countervailing measures. The idea of getting outline agreement on border charges in a Paris type agreement and then seeking a WTO waiver is ambitious and ultimately unrealistic. Paris itself does not seek to limit carbon but rather temperature, and WTO waivers need a two thirds majority.
Whatever measure the EU imposes at the border it cannot be either a simple tax or a BTA if it is to make EU’s internal regime effective. Thus, to question its legality on the basis of the nature of these two instruments misses the point. The border measure, most likely made up of many elements, will form an integral part of the EU’s system to reduce the EU’s overall carbon footprint through costing carbon and reducing emissions.
It is fundamental to the WTO that Members are sovereign and retain the right to adopt whatever measure they consider appropriate for their polity. The object of the WTO is not to negate that right but to ensure that it is exercised according to certain criteria that, in the view of the WTO, least restrict trade. This underlying right is reflected in the provisions of GATT Article XX. This Article must be kept in mind from the beginning in designing, and determining the WTO compatibility of, the climate border measure.
Article XX does not provide that a border measure must be exactly the same as the domestic measure or that it must be non-discriminatory. The chapeau refers to ‘measures’ in the abstract and not ‘identical’ measures. Paragraph (g) states that the measures must ‘relate to’ the conservation of natural resources helping to ‘make effective’ the domestic measures. Paragraph (b) refers again to ‘measures (from the chapeau) ‘necessary to protect’. Again, this is in the abstract. The primary test of GATT XX is coherence in achieving the objective of the internal measure by whatever means are appropriate for that objective. The Chapeau is secondary.
In imposing emission reductions, the EU has determined that cost alone is not a sufficient means to achieve its climate objectives. Planned and mandatory reduction is also needed. This leads to the conclusion that the EU would be entitled to impose, at the border and as part of a legitimate domestic objective, a requirement that imports demonstrate a contribution to the reduction objective. In the absence of a reduction element, it cannot be argued that the border measure is ‘necessary’ or ‘contributes to’ the declared objective of reduction.
The very idea of the border measure serves as a third core element of the EU’s carbon reduction policy, namely carbon leakage. Carbon leakage is that part of the policy that seeks to avoid achieving reductions in EU emissions simply by moving production out of the EU or closing down EU production tout court and replacing that production with imports made using processes that do not consider the climate consequences. EU policy seeks to avoid cleaning up at home while exporting the cleaned-up emissions abroad.
Like Reinhard, I will suggest a solution. I start with the climate objective rather than with the potential WTO pitfalls in existing border instruments. The new EU border climate measure should be made up of a number of elements to reflect, contribute to, make effective, and be necessary for the ambitious domestic objective of making the EU carbon neutral by 2050 without carbon leakage.
The three core elements of the EU’s domestic climate policy, mandated reductions, carbon costing and avoidance of carbon leakage, are necessary to achieve a high level of climate ambition. A border measure based on these three elements fits squarely within the rights WTO members to determine policy and, if it must come down to it in dispute settlement, fully within the scope of GATT Article XX.
The border measure would be as follows:
• The EU imposes a charge on the import of goods based on the carbon footprint. This charge should be set at the level of the cost of carbon in the EU (at the moment of import) multiplied by the amount of the most carbon emitting process that can be used for the production of the good in question. This element of the border measure would reflect a high level of ambition.
• A review mechanism would allow the importer to show that the company, or group of companies, producing the product in question produces with a lower carbon footprint or has already incurred costs that should be deducted from the charge. This element of the border measure would address GATT Article III as well as the chapeau of GATT XX to show that the objective of the border measure is not to hit trade or discriminate in favour of domestic producers but to set costs at an equivalent level.
• The review mechanism must be designed in such a way as to avoid ‘source shuffling’ or the idea of one manufacturing company or group of companies sending low carbon footprint products to the EU and higher carbon footprint like-products to other markets including the domestic market.
• To be able to invoke the carbon cost review mechanism, the importer would have to demonstrate that the product’s production is subject to a carbon reduction mechanism. In other words, participation in a system, public or private, to reduce emissions equivalent to the EU mandated reductions would be a precondition to making a claim that costs have already been incurred and should be deducted. This element reflects a core element of the EU’s ETS system which is to reduce emissions.
This combination of elements makes the border measure something different from a tax or a border carbon adjustment (this name deceptively harks back to the border tax adjustment idea and should be avoided), or a scramble to devise a measure to address GATT Article III type concerns. Rather it recognises that the EU has a high level of ambition for its carbon policy and needs a special complex border measure to ensure that the high level of ambition is achieved.
A border measure, such as the one outlined here, that seeks to set the cost of carbon and to limit emissions in amounts equivalent to domestic EU producers may well already pass muster within GATT Articles I, II and III. But it would clearly meet the test of GATT XX and its chapeau. It is not designed as a disguised restriction on trade and it allows for the differences that prevail in exporting countries.
The precondition of demonstrating participation in a reduction mechanism has nothing to do with Paris because Paris does not require reductions. Mandated reductions in carbon emissions is a core of domestic EU policy, not the Paris Agreement, and it is therefore logical and necessary that the EU border measure has a reduction element as well. Compliance with Paris by the exporting country is therefore irrelevant for this purpose. If third countries impose costs on their producers to comply with Paris this may become relevant in determine what costs the exported good should pay at the EU border but nothing else. It is therefore a red herring to invoke Paris as a limitation on what the EU can do.
A consequence of this solution is that the EU is de facto imposing its climate policy, not on third countries, but on producers wishing to export to the EU. Carbon costing, reduction and leakage avoidance become the standard. There is nothing unusual in this. EU food and chemical standards are already imposed or ‘exported’ to any third country producer wishing to export products to the EU. Like for food and chemicals the EU would not be questioning the right of third countries to set their own standards or climate ambitions (in this way the EU would respect the flexibility of Paris). Rather the EU would only be setting climate conditions that producers have to respect to enter the EU market. Conditions similar to those imposed on EU producers.
I am not aware of any questioning of the legitimacy of the EU’s ambition to achieve carbon neutrality by 2050. If that, in itself, is legitimate, a complex border measure that reflects that ambition, is equally legitimate.
