WTO treatment of a carbon tax

In which I try briefly to describe the prac­ti­cal impact of WTO rules on the admin­is­tra­tion of a com­pen­sat­ed car­bon tax that is not levied on exports.

The huge vol­umes of recent com­men­tary on the inter­ac­tion of WTO rules and car­bon emis­sion tax­es or admin­is­tered mar­kets (“emis­sion trad­ing schemes”, ETS) con­tain a bewil­der­ing diver­si­ty of analy­sis. The mat­ter is so con­tentious that the 2010 Copen­hagen Accord of the UN Kyoto Pro­to­col omit­ted any men­tion of trade mea­sures that might be used to shore up domes­tic tax/ETS schemes if some large emit­ters (Chi­na, India, Japan) declined to make pro­por­tion­ate (or any) emis­sion cuts.

In the present state of WTO jurispru­dence the only thing we can say for sure is that any laws to levy a car­bon tax on imports or to remit a domes­tic car­bon tax on exports are like­ly to pro­voke nasty trade dis­putes; which is why the then-EC-Trade-Com­mis­sion­er, Peter Man­del­son, advised against putting any such bor­der tax­es on imports or tax-remis­sions on exports in place when the EU adopt­ed its own ETS in 2005.

Man­dleson’s advice has intu­itive appeal but it is lit­tle bet­ter than the advice of The Great Oz (“Ignore that man behind the cur­tain!”). Gov­ern­ments are bound to use these con­tentious trade mea­sures to deal with two fun­da­men­tal prob­lems of either a car­bon tax or an ETS that they adopt uni­lat­er­al­ly or, under any inter­na­tion­al agree­ment that attracts less than uni­ver­sal compliance:

  • First, a uni­lat­er­al tax that is not remit­ted on exports will hurt the export com­pet­i­tive­ness of an economy—its capac­i­ty to exploit its com­par­a­tive advan­tage in the pro­duc­tion or exploita­tion of car­bon-based ener­gy, for example
  • Sec­ond, an uncom­pen­sat­ed tax will lead to car­bon leak­age and pos­si­bly an increase in the glob­al amount of car­bon emis­sions as emis­sion-inten­sive indus­tries move off­shore to loca­tions where there are weak­er or no abate­ment mea­sures in place. 

If the Gillard gov­ern­ment suc­ceeds with its car­bon tax+ETS pro­pos­als, it will not be able to avoid remis­sion of the tax on exports because coal is our biggest export and because every extrac­tive (iron ore), man­u­fac­tured and farm prod­uct we export uses (tax­able) ener­gy input. The gov­ern­ment must off­set the impact on export com­pet­i­tive­ness or risk chok­ing the eco­nom­ic pros­per­i­ty that allows it even to con­sid­er this lux­u­ry-good (a “car­bon-con­science” to which few coun­tries aspire).

As for com­pen­sa­tion, the gov­ern­ment has already made that com­mit­ment to ener­gy pro­duc­ers and I expect it will be forced by the same log­ic to offer com­pen­sa­tion to man­u­fac­tures and farm­ers: although the “com­pen­sa­tion” across such a broad spec­trum of pro­duc­tion might be eas­i­est man­aged through a sub­sidy to con­sumers rather than to producers.

What then, are the WTO chal­lenges? WTO sub­sidy rules per­mit remis­sion of the tax on exports and on the tax­able (i.e. car­bon) inputs whol­ly incor­po­rat­ed into man­u­fac­tures or farm prod­ucts. This is a long-stand­ing rule apply­ing to indirect/product tax­es such as val­ue-added tax­es. It was adopt­ed as an inter­pre­ta­tion of the GATT sub­sidy rules in the mid-1970s in set­tle­ment of a trans-Atlantic dis­pute over the EC’s “des­ti­na­tion-based” VAT rules and has since been incor­po­rat­ed explic­it­ly in the WTO’s 1994 Agree­ment on Sub­si­dies and Coun­ter­vail­ing Mea­sures. But note, that the remis­sion on exports of the tax on the tax­able car­bon incor­po­rat­ed in either pri­ma­ry or processed prod­ucts must be no greater than the actu­al tax that would have been due on the incor­po­rat­ed car­bon on the domes­tic mar­ket. Any excess is an ‘action­able’ export sub­sidy that would attract either a WTO dis­pute or a “coun­ter­vail­ing” import duty in an export market.

The impo­si­tion of tax­es on the car­bon com­po­nent of imports from places where the equiv­a­lent car­bon tax has not been paid will be urged by busi­ness­es demand­ing “fair­ness” on the domes­tic mar­ket. In this light, the import duty is akin to an anti-dump­ing duty; good for import com­pet­ing indus­tries but bad for every­one else, espe­cial­ly con­sumers and, con­squent­ly, for eco­nom­ic growth. But there is an eco­nom­i­cal­ly plau­si­ble ratio­nale, too; with­out some equiv­a­lent tax­a­tion, emit­ters will have a strong rea­son to relo­cate pro­duc­tion to mar­kets where the emis­sion lim­its are weak or non-exis­tent. In oth­er words, the import duties will be a defence against car­bon-leak­age. Since a reduc­tion in glob­al emis­sions is the ulti­mate motive for the car­bon tax, any Gillard/Garnaut car­bon tax that has a mean­ing­ful impact on emis­sions will have to be but­tressed by these addi­tion­al import duties (in WTO jar­gon, “bor­der adjust­ment tax­es”, BAT) on the prod­ucts of all non-extrac­tive indus­tries that can switch to for­eign sources of sup­ply. This includes all man­u­fac­tur­ing and most farm products. 

Com­pen­sa­tion” for the new tax will be a hor­ri­ble tax-admin­is­tra­tion tan­gle, but it is less of a prob­lem from a WTO per­spec­tive. The log­ic of “com­pen­sa­tion” is the same as the log­ic of bor­der-adjust­ment tax­es. Pro­duc­ers who will find it dif­fi­cult to pass-on the full bur­den of the tax to con­sumers and who are wor­ried that, even so, con­sumer demand will slump if they do pass on the tax—at a guess, this group includes pro­duc­ers in every sec­tor oth­er than elec­tric­i­ty pro­duc­tion, fuel and services—will demand full com­pen­sa­tion for rea­sons of “fair­ness”. Again, the gov­ern­ment will be moti­vat­ed to com­pen­sate if it wants to ensure that the Aus­tralian tax leads to a reduc­tion in glob­al emis­sions and not just to car­bon-leak­age. But, from a WTO per­spec­tive com­pen­sa­tion is prob­lem­at­ic only if it over­shoots; in which case it is an action­able sub­sidy to domes­tic pro­duc­tion and coun­ter­vail­able in export mar­kets. But the Gillard/Garnaut pro­pos­als would fail if the com­pen­sa­tion over­shot because peo­ple would have lit­tle rea­son to switch to non-emis­sion-inten­sive goods (assum­ing there are any such alter­na­tives available).

For more read­ing (but not too much) I rec­om­mend two overview papers by Horn and Mavroidis and by Low, Marceau and Reineau.

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