I’m getting lots of questions these days about “border carbon adjustments” (BCAs). After all, BCAs sit at the intersection of carbon policy and trade policy, and what wonk can resist that combination? So as we start to move toward broader carbon pricing policies in Canada, let’s take a closer look at BCAs in today’s blog.

What is a Border Carbon Adjustment?

Here at Ecofiscal, we’ve spent plenty of time talking about leakage and competitiveness pressures. When Canadian firms face a higher carbon price than their competitors in other jurisdictions, some production and investment might shift from Canada to jurisdictions with weaker policy, particularly in emissions-intensive and trade-exposed sectors. The result is lost economic activity. Leakage is the environmental side of the same coin: if economic activity simply relocates to other jurisdictions, the net impact of Canadian climate policy on global emissions could be negligible.

Border Carbon Adjustments are one potential solution to this problem. Two main kinds of BCAs are possible (they can also be combined):

• Import tariffs would try to address competitiveness issues in domestic markets by taxing imported goods based on the emissions associated with producing those goods. The tariff would only be applied to imports that come from a jurisdiction without comparable policy.
• Exports rebates would try to address the carbon disadvantage faced by Canadian exporters in international markets by providing a rebate to exporters on their carbon costs based on the goods exported.

The idea is to level the playing field to address competitiveness and leakage concerns, enabling domestic carbon pricing, while also creating incentives for other countries to implement carbon pricing of their own.

Sounds simple, right? Well, in practice, maybe not so much.

Are Border Carbon Adjustments legal?

First, consider two legal issues. (Important note: I am definitely not a lawyer, so I will not pretend to have expertise here. Follow the links for more details).

Internationally, Border Adjustments could be problematic under World Trade Organization (WTO) rules. Concerns around subsidizing exports and discriminating against imports based on their country-of-origin mean that a BCA might well be challenged. Still, some analysis suggests BCAs could survive a WTO challenge if carefully designed, though significant uncertainty remains.

Domestically, it’s not clear whether provincial governments have authority to implement trade measures. International trade is federal jurisdiction, and regulations that affect out-of-province pollution could be beyond provincial powers. If this is the case, and the federal government has the sole authority to implement BCAs, a harmonized Canadian carbon price might be a necessary first step. However, Canadian courts haven’t explicitly ruled on this issue, according to lawyers James Coleman and Martin Olszynksi.

Would border adjustments work?

Research provides mixed results on the efficacy of BCAs, depending on their design. This modelling analysis, for example, suggests that Canadian BCAs would significantly reduce leakage experienced under a Canadian carbon pricing policy. It also indicates that rebates on exports would be a larger driver of reduced leakage than an import tariff. Yet the modelling shows that providing free permits or rebates based on output also reduces leakage, particularly in manufacturing sectors.

Border adjustments also face practical concerns. Estimating the carbon embedded in traded goods is complex. And applying tariffs only to imports from jurisdictions without carbon policy of equivalent stringency further increases the complexity of designing such a policy. As a result, compromises are likely required between effectiveness and practicality for a real-world BCA.

What’s the bottom line?

For now, there are still more questions than answers on border carbon adjustments in Canada. That’s one of the reasons that providing transitional support to industry using output-based allocations or rebates is a simpler approach to addressing leakage concerns. That being said, as Canada moves toward a pan-Canadian carbon price, alternatives such as border adjustments might also be on the table.