July 1, 2009

Carbon Tariffs

So a last-minute amendment to the Waxman-Markey bill passed last Friday would require the President, by 2020, to impose a tariff on imports from countries that do not regulate their greenhouse gas emissions. Such a provision has long been controversial (see Tyler Cowen's objection, for one), but as we get closer to actually enacting climate change regulation in this country, I think a carbon tariff needs to be seriously considered.

To begin with, Paul Krugman flags some potentially game-changing news on this front:
There was some question about how the WTO would handle cap-and-trade — whether it would accept the need for carbon tariffs, if some countries (cough China cough) drag their feet, or whether it would adopt a purist free-trade rule. The answer seems to be in — the WTO is going to treat cap-and-trade the same way it treats VATs, with border taxes allowed if they can be seen as reducing distortions.
If you believe, as I do, that international negotiations over climate change can be modeled as an iterated form of the prisoner's dilemma, then a key tool for getting the major polluting countries to cooperate on reducing carbon emissions has to include both positive and negative incentives for compliance — with carbon tariffs being, obviously, a form of the latter. So the WTO ruling is, at first glance, good news.

Having said that, just because something is permissible does not mean that it is necessarily advisable. Even with the WTO's blessing, a trade war with China could easily break out if the US slaps a border tax on carbon-intensive imports. And it's not only US-China relations that we should worry about: Imagine if Waxman-Markey were to fail, support for climate change regulation collapses à la health care reform in 1994, and the EU decides to punish our recalcitrance with a carbon tariff on American exports. It'd be like the just-averted Roquefort War earlier this year, but not nearly as funny.

Some other thoughts:
  • Returning to the WTO ruling, a key consideration about a carbon tariff will be one of intent: Is it meant, as Krugman suggests above (and elaborates on here), to merely prevent unfairly privileging carbon-intensive goods — in the same way that a border tax in countries with a VAT prevents unfairly privileging foreign-made goods? Or is it meant to punish non-cooperation, according to the prisoner's dilemma framework? That will likely come down to the size of the tariff: To be simply anti-distortionary, it would have to be set at a rate that restores the trade status quo prior to the implementation of climate change regulation. Of course, that implies that it would have be constantly adjusted to account for non-climate-related changes in the balance of trade. Whether that can be done, and whether the process of setting and adjusting a carbon tariff rate can avoid being abused (as a back-door to protectionism, say), is an open question.

  • It goes without saying that a carbon tariff shouldn't be a measure of first resort. It would be best for the US and China to agree on a path to developing a cleaner energy regime, rather than coercing each other into doing so. I'm no China expert, but it seems that a trade war could be as bad for the Chinese as it would be for Americans: They depend on us buying their exports as much as we depend on them buying our Treasury bills.

  • Following on that point, one major objection to a carbon tariff (see Cowen again) is that we cannot credibly threaten to use it. That is, one rationale for a carbon tariff is that it would function as a kind of nuclear option for climate change negotiators — a peaceable solution is more likely if the possibility of a destructive trade war looms in the background. Indeed, according to Brad Plumer at the TNR link above, the threat of a US carbon tariff may be prodding the Chinese to the bargaining table. The problem, however, is that, given the trade dynamic with China I just mentioned, can we really risk provoking a fiscal crisis over even something as portentous as climate change? The Chinese face a similar predicament, of course; despite some rumblings about moving away from dependence on the dollar, it's unlikely they can afford to do it — at least in the near term. Getting our trade deficit down to a manageable level will be just as difficult, if not more so.

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