p>At the heart of the international problem with border-tax adjustments for carbon emission controls is the concept of ‘common but differentiated responsibility‘ first invoked at the RIO Conference of UNEP in 1992. In brief, it means that developing countries, that in the past contributed less carbon to the atmosphere because they had smaller economies, will have a reduced responsibility for cleaning up the problem in the future. Whether this makes sense or not (considering some developing countries will be very big emitters in the future), it is certain that any international agreements to restrict carbon emissions will embody the concept, which is now said to be an established principle of international law. Article 10 of the Kyoto Protocol, for example, explicitly invokes the principle (as did Australia on its own behalf, before Kevin Rudd ratified Kyoto in 2008).
Border-tax adjustments work by levying a tax on imports equal to the difference between an indirect tax (e.g. a value-added or consumption tax) levied in the exporting country and the indirect tax that applies to the same product when produced (or consumed) in the importing country. This ‘equalizes’ the tax burden on all products, whether imported or of domestic origin, in the importing country. Typically, exporting countries levy zero indirect taxes on exports: the GATT long-ago established that countries were not obliged to tax exports at the same rate as other production.
Now let’s imagine that China, for example, is designated in a future international agreement on emission controls as having lesser responsibility for taxing emissions for whatever reason you like (the reasons are not likely to be explicit in the agreement). In this case, the application of a U.S. border tax adjustment to imports from China at the higher rate applied in the U.S. to production of the like product, will erode the principle of differentiation. We can expect to see a bitter struggle over this point—well in advance of any taxes actually being levied—that could easily put an end to any prospects of an international agreement on emission controls. Of course, the higher U.S. tax would also impose a burden on U.S. consumers of Chinese imports, robbing them of the gains from trade; in this case, the benefits of specialization in Chinese/U.S. trade. Furthermore, China would not be the only beneficiary of the ‘lesser responsibility’. The Kyoto protocol indicates that any country not listed in Annex B (a sub-set of OECD countries) should benefit from differentiated status.
A second major difficulty with carbon tax adjustments—that has not been a problem with other ‘indirect’ tax adjustments such as consumption taxes—will be the endless opportunity for discrimination and protectionist tax rates. Carbon taxes are most unlikely to apply, as a consumption tax applies, to products. Rather, they will be embodied taxes derived from the production methods or processing or manufacturing methods used for the product. So the estimation of the equivalent domestic tax rate will be a nightmare, made worse by the variable tax rates implied by various national schemes of ‘cap-and-trade’ restrictions that will contain some product exceptions, free distribution of emission rights for certain industries etc. etc.
There are other likely legal problems, too, because the GATT rules (applying to goods trade and border-tax adjustment) take account of so-called “production and processing methods” (PPM) to determine ‘like’ imported products only in very narrow circumstances: mostly in the case of ‘exceptional actions’ under Article XX. They have also been invoked in the WTO agreements on product standards. Carbon-tax adjustments will be whole new tangle.