In the context of climate policy, a border adjustment is usually discussed as a component of a carbon tax. A carbon tax is a “source-based” tax that applies to carbon-intensive goods produced in the United States, regardless of where they are ultimately sold. A border adjustment shifts a carbon tax from a source-based tax to a “destination-based” tax, which applies to all goods consumed in the United States. As such, a border-adjusted carbon tax applies to both domestically produced and imported carbon-intensive goods. Carbon-intensive goods produced for export receive a rebate and are excluded from the base of the tax.
A typical concern with a non-border-adjusted carbon tax is that the additional burden on US production will encourage companies to shift economic activity overseas. Offshoring productive economic activity could also increase carbon emissions, causing what is called “leakage.” A border adjustment alleviates these concerns as the tax burden on goods is based on where consumers are located. A company cannot reduce its tax burden by shifting production out of the United States.
The Democrats’ proposal would seek to apply the advantages of a border adjustment to current US climate policy. Carbon emissions in the United States are discouraged by a mix of federal, state, and local regulations, taxes, and standards. These include federal EPA regulations and fuel efficiency standards for vehicles, state-level cap and trade policies, excise taxes on fuel, and renewable energy portfolio standards. The Senate proposal would attempt to convert the costs of complying with many of these policies into a tax and apply them to imported goods.
Leaving aside some potentially significant administrative and legal issues, one problem with this proposal is that it would not actually enact a border adjustment. The Democrats’ proposal would enact a tariff as it does not include an export rebate. Without a rebate on exports, the policy would not fully offset the incentive to shift production overseas. A company that produces goods for export would face an incentive to produce in the market in which they sell their goods if the cost of production in that market is lower.
A border adjustment, in the context of a carbon tax, can reduce the incentive for companies to shift production overseas and avoid carbon leakage. Democratic lawmakers are considering a proposal to apply the advantages of a border adjustment to current climate policy. The import tax lawmakers are considering, however, is not a border adjustment — it is a tariff.
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