What the 1987 Montreal Protocol Teaches Us About Carbon Border Taxes
By Tarun Gopalakrishnan
The pressure to enact ambitious climate policy is higher than ever, as the IPCC clarifies the urgency of the challenge, and key global summits draw closer. In addition to emissions reduction targets and investment in green infrastructure, political leadership in the European Union and the United States are considering a “carbon border tax.” This is a duty on imported goods, determined based on the carbon (or greenhouse) footprint of the process used to manufacture the good in the country of origin. These are attempts to mimic the “climate club” approach of the Montreal Protocol, but need to pay much closer attention to the details of that agreement. In this blog, I explain why.
The EU draft legislation identifies iron and steel, refineries, cement, organic basic chemicals, and fertilisers as targets of a border tax; the US proposal is less specific, but expected to have a similar focus on industrial and manufacturing competitiveness. Such carbon tax or “border adjustment” proposals have been around in the US since at least the bipartisan Waxman-Markey climate bill of 2009.
Apart from protecting domestic industry, border taxes theoretically create “climate clubs” where groups of the willing use tariffs to widen the scope for climate actions beyond their borders. In their current form, however, they are counter-productive for a number of substantial reasons. They are not meaningfully linked to domestic policies. They undermine common-but-differentiated-responsibility – a key tenet of climate law and policy. They ignore key features of previous successes in planetary policy-making, such as the provision of reliable and sufficient finance.
“Climate club” proposals arise from the views of Nobel prize-winning economist William Nordhaus and others who argue that attempting universal agreement on emissions reduction through the multilateral diplomatic process is futile. The economically “efficient” alternative suggested is for a few key political units to mutually agree on their own level of ambition, and then offer carrots or sticks to other less amenable actors to join the “club.”
The idea of such clubs is drawn from the relatively successful effort to avert a different planetary crisis - ozone-layer depletion. The Montreal Protocol of 1987 resulted in almost complete replacement of ozone-depleting chlorofluorocarbons; the Kigali Amendment of 2015 has now laid out a path to the next generation of ozone-neutral chemicals. Countries that ratified the Protocol were prohibited from importing or exporting ozone-depleting technology, even to or from countries which had not ratified the Protocol. These trade measures operated as a multiplier to expand the Montreal club – every additional country joining tangibly raised the cost of holding out.
Weak link with domestic policies
To implement the Montreal Protocol, the US enacted a domestic-plus-import tax on imports of Ozone Depleting Chemicals (ODS) in 1989. In addition, Title VI of the Clean Air Act laid out ambitious time-bound national targets. The strong domestic tax and targets shrunk the national ODS market and contributed significantly to the long-term effectiveness of trade restrictions as a consensus-expanding measure.
The current border taxes are part of larger “Green New Deals”. The Green Deal legislation endorsed by the European Parliament in June sets an emission reduction target of 55% by 2030. The American Green New Deal bill targets decarbonization of the electricity sector by 2030. In April, President Biden announced a 52% reduction in greenhouse emissions below 2005 levels by 2030.
These are complex multi-sector proposals, but they are similar in one important element - their focus is on spending and not regulation. The EU plans on over a trillion euros of new or re-oriented green spending over the coming decade. The US will likely commit on a comparable scale, if steadily developing infrastructure and budget reconciliation bills containing significant climate-relevant investments are enacted into law.
Once thought politically infeasible, such spending now represents a re-imagination of what it means to invest in communities, businesses, public goods and social safety nets – a course correction in economies where vulnerability has spread beyond the margins and into the mainstream. This is partly why, unlike with previous climate debates, there is less talk of domestic taxation on energy or carbon.
The old theory was that such “sticks” and revenue-raising measures were a necessary part of the policy package. The new theory focuses on the rapidly falling price of green technologies, and banks on government spending to “crowd in” investments that drive these prices further downward. There are domestic carbon tax proposals, such as the Energy Innovation and Carbon Dividend Bill of 2019, but these are far from achieving broad consensus.
The European Union has an emissions trading system (ETS) which covers electricity and key industrial sub-sectors like energy production, cement and steel. The ETS is an ambitious mechanism but – as the Climate Policy Lab’s work shows – it has some distance to go in finding an effective and stable price for carbon. Apart from design difficulties, the fatal flaw in the EU ETS is the allocation of free emissions allowances to European industry. This is defended citing international competitiveness (with, for example, cement and steel manufacturers in China or India).
The lack of a strong (or any) domestic carbon tax on industry is a problem, because taxes at the border generally raise hackles at the World Trade Organization. The WTO Treaties prohibit import taxes beyond those specified in their annexures. There are exceptions – Article XX(g) of the General Agreement on Tariffs and Trade allows parties to implement policies contravening other Articles, if these are “relating to the conservation of exhaustible natural resources” and “if such measures are made effective in conjunction with restrictions on domestic production or consumption.” A tax on imported goods without a comparable domestic carbon price is a tough sell. It is why a former EU climate commissioner and a former WTO director-general co-authored a warning against “triggering a trade war that would also undermine the EU’s climate leadership.”
Without such domestic measures in the US and EU, the imposition of a carbon border tax becomes a different sort of policy. It challenges carbon-intensive industries in the rest of the world to slash their margins to lower pricing levels that incorporate the border tax to preserve market access. Given the current high cost for decarbonization of heavy industrial sectors like steel, only a very high border tax would convince developing country exporters to invest in green alternatives. More likely is that they will find other ways to lower costs and beat tariffs, such as reducing salaries or replacing human workers with automation.
Common but differentiated policy
The Montreal Protocol and Kigali Amendment laid out clear differentiated phaseout timelines for distinct categories of economies. The Paris Agreement allows countries to set their own emissions reduction targets, while setting a global aim of limiting warming to 2 degrees Celsius and as close as possible to 1.5C by the end of the century. The EU and US’ self-determined targets are unlikely to keep warming under 2C, and definitely insufficient to keep warming under 1.5C.
While China’s domestic targets are arguably even less ambitious, India and other developing economies’ targets are compatible with the temperature thresholds specified in the Paris Agreement. The EU and US imposing border measures without sufficiently ambitious domestic targets raises questions around common but differentiated responsibility, a key principle of climate law and policy.
In 2011, the EU tried to extend its emissions market to include international aviation, effectively imposing a border tax on airlines headquartered outside its borders. That move was met with widespread opposition, including a suit filed by American airline companies in a European court. The policy was withdrawn, and the court found – in the abstract, without reference to a specific policy – that the EU could enact regulations which have an effect on aviation beyond its borders. It did not indicate design principles for such a policy.
Presented with a specific carbon tax regulation, a national court would likely wade into the details. European courts have used the principle of common but differentiated responsibility in their decisions. In 2015, for example, a Dutch court found that the Netherlands’ climate target was insufficient, partly on the basis that “[the] state should not hide behind the argument that the solution to the global climate problem does not depend solely on Dutch efforts. […] as a developed country the Netherlands should take the lead in this.”
The issue is not that there may be legal challenges; it is that a legally controversial measure needs a strong policy rationale. Not only can such a rationale make a marginal-but-important difference to a court’s assessment, it can justify incurring the costs of litigation and policy uncertainty in the short term. As we outlined earlier, a border tax without strong domestic targets is unlikely to significantly change the carbon-intensity of imports. That gap in policy thinking makes a carbon border tax vulnerable in the courts.
No taxation without investment
A key feature of the Montreal Protocol was the Multilateral Fund, which covered incremental costs of technology transition. The adequacy of finance disbursed by the MF was contested, but ultimately did have a positive effect. At present, the landscape of finance for industrial decarbonization leaves much to be desired. At Paris in 2015, a commitment was made to mobilise $100 billion each year by 2020. The UNFCCC’s Standing Committee on Finance found that public finance flows from developed to developing countries totalled around $38 billion in 2016, the last year for which UN data is available.
This was a point of significant contention at the G7 ministerial this June. The situation has been described by Rachel Kyte, dean of the Fletcher School (and former World Bank Group Vice President and Special Envoy for Climate Change), as “diplomatic ineptitude amongst the rich countries, because $100 billion really in the scale of things is not an extraordinary amount of money, and it is not beyond our capability to meet that promise, keep it, and then extend it”. Even as the current target has not been met, countries still have to agree on a new target to take us to 2030 and beyond.
Finance so far has been overwhelmingly focused on decarbonising electricity. This has partially succeeded – renewable electricity is now the cheapest alternative in most large economies, including China and India. Finance for renewable energy access in the developing world must continue as a priority. However, the next stage for climate finance is the decarbonisation of industry, particularly steel, cement and chemicals – the exact sectors which are being targeted by the proposed border carbon taxes.
The majority of investment in these sectors is occurring in the developing world. Unlike with electricity, the technology options to decarbonise are still nascent and expensive. For example, substituting coal with hydrogen in steel manufacture would quintuple the cost of manufacture in China. For cement, replacing clinker with less carbon-intensive substitutes (assuming adequate supply of substitutes) makes sense in the long-term, but comes with high upfront costs in the billions. The technology with most transformative potential – carbon capture and storage – costs significantly more in most applications than any carbon price currently implemented.
Within existing amounts of climate finance, developing such transformative technologies in industry and manufacturing is among the lowest priorities. For example, multilateral development banks in 2018 allocated 30% of their finance to renewable energy and 18% to energy efficiency, but just 1% to low-carbon technologies. At the Green Climate Fund, the “buildings, cities, industry and appliances” sector receives $1.3 billion compared to $2.6 billion for energy generation and access. Nevertheless, manufacturers across the developing world are making attempts to decarbonise, through piloting technologies, setting company-wide decarbonisation targets, and forming global coalitions.
That ambition needs to be matched by a scaling up of the quantity and re-alignment of the priorities of international finance. President Biden recently announced a doubling of the US’ climate finance commitments. Given the US’ absence from climate finance between 2016 and 2020 - combined with the fact that many other countries already doubled their commitments in that time – that announcement is a step in the right direction, but far from enough. Without a sufficient scale up in finance, import taxation is a purely reactive, self-serving policy.
The success of the Montreal Protocol was also based on technology sharing institutions, including paying for public domain access to critical licenses. The climate technology space is much more complex. However, in the realm of trade, one straightforward policy shift is possible. Trade litigation around green technologies is proliferating, with problematic bipartisan support.
This includes the Biden administration supporting Trump-era solar panel import tariffs, and the EU continuing trade measures against solar glass imported from China. These disputes may satisfy domestic constituencies but - especially in combination with carbon border taxes - they are difficult to frame as responsible climate policy, much less as policies that would lay the groundwork for a “climate club.”
In sum, the US and EU carbon border tax proposals, as they currently stand, have substantial flaws and could prove counter-productive. A better takeaway from the Montreal Protocol is not that border taxes can have a multiplier effect, it is that for border taxes to have a multiplier effect, they must be accompanied by strict regulation of the pollution inside the countries where the tariffs will be cast in the first place and accompanied by sufficient global finance for technology transfer and adoption.
If carbon border taxes must be implemented to protect domestic industry, they should at least be automatically re-routed toward global climate finance. A legislation implementing a carbon tax at the US border should specify that the proceeds of such a tax would be directly transferred to the Green Climate Fund, the Adaptation Fund or other funds focused on climate responsible investments in developing countries.
Domestically, pooling fuel taxes into green funds is an increasingly useful policy tool to jumpstart transitions (although not a guarantee of long-term revenue). At the international level, the Adaptation Fund is partly raised through a levy on international carbon trading. These precedents indicate that an integrated global system of carbon-taxation-plus-equitable-green-investment is possible. This may be one of the few ways in which the US and EU could enact unilateral carbon border taxes which do not immediately draw counter-productive reactions. ∎
Tarun Gopalakrishnan is a junior fellow at The Fletcher School, Tufts University.