Economics globalization Interviews

Discussing Carbon Pricing and Tariffs with CFR’s Jennifer Hillman – an Introduction

Nader Mehrdadi (top left) interviews Justice Jennifer Hillman, a senior fellow for trade and international political economy at the Council on Foreign Relations specializing in U.S. trade policy, the law and politics of the World Trade Organization, international organizations, and Brexit.

If current trends in population growth hold through 2050, the resources of three planet Earths are needed just to maintain current lifestyle consumption levels according to UNEP. Consumption levels are rising, global temperatures are rising, and technological advancements are rising. The warnings of the IPCC’s 2018 Special Report on what is truly at stake, should global temperatures continue to rise, are all too apparent at this point. Pairing this knowledge with ESG now standing at the forefront of social contracts and corporate mandates, we are fully informed as to what needs to be done to drive substantive, meaningful change: consume less, invest more. 

Graphic showing projected rise in global temperatures from the IPCC

Standing at the intersection of consuming less and investing more are Carbon Capture Utilization and Storage (CCUS) technologies such as Carbon Abatement Technologies (CATs), which are utilized in production-derived emissions, and Negative Emissions Technologies (NETs), which are used to capture emissions already discharged into the environment (otherwise known as carbon scrubbing technologies). For standalone dedicated CCUS facilities, there are only twenty-one worldwide, which have a combined capacity of 40 MtCO2 a year. To put that into perspective, 2019 saw a record high in CO2 emissions at 36.44 MtCO2 — in billions. This is why current efforts striving towards reform in the global energy sector (Accounting for 69% of CO2 emissions and 60% of other greenhouse gases) and in the industrial production of goods is  especially crucial: CCUS and CATs are simply immaterial at current levels.

Even if deployment of CCUS technologies were to scale at exuberant levels, they would virtually make no dent in mitigation without significant improvements in their levels of efficiency as well. 

This is why much of the conversation in meeting our climate needs revolves around mitigation at the point of generation. For continued brevity, as more efficient methods of energy generation, renewables, and their financing challenges are already highly developed areas of conversation, we will stick to discussing the lesser-focused carbon markets for the remainder of this article.

So what can serve as the catalyst in fostering more investments in CCUS?

In a 2016 report by the IEA, 20 Years of Carbon Capture and Storage, Olav Skalmerass of then Statoil (Now Equinor) noted Norway’s Sleipner carbon capture facility becoming commercially viable to produce following the country’s introduction of a carbon tax. 

You may ask, what is a carbon tax?

A tax on carbon is a method of abatement which works to price-in the cost of carbon. Therein lies the beginning of two challenges: (1) adequate Carbon Pricing and (2) the legal boundaries in enforcing and upholding carbon  taxes on the international level.

For Carbon Pricing, proposed taxes work to take into account the social costs imposed onto society derived from pollution, otherwise known as a Pigouvian Tax. An optimized level of taxation not only includes the monetary equivalent of the damages imposed onto society, but the costs of offsetting the damages as well. In a 2018 publication by the OECD, Effective Carbon Rates on Energy, it was found that across all OECD states plus Argentina, Brazil, China, India, Indonesia, Russia, and South Africa, that “90% of emissions are priced below the low end estimate of the climate cost of CO2 emissions, being EUR 30 per tonne.” It is important to note that the price of EUR30/MtCO2 is in fact on the lower end of the sufficient pricing spectrum. On January 4th of this year, the price of carbon on the European Union’s Emission Trading System (EU ETS) hit a record high of only EUR34.25/MtCO2 (USD41.37/MtCO2). The EU ETS has historically been cited as a model system in carbon markets, yet as the premier market for firms and traders in this space, this system is still coming short in pricing in the true cost of carbon emitted by operators in this space.

Graph representing the cost imposed on society by mispricing from Wikipedia

So what does it mean when the premier system is inadequately pricing carbon?

It means that we are insufficiently accounting for the true environmental costs of carbon emissions. To contextualize this, 2020’s emissions of 34.07 billion Mt/CO2 with the EU ETS all-time high price would set the value of global emissions at ≈ USD $1.41T for that static year. Additionally, please keep in mind the compounding effect that is had with how long particulates remain in the atmosphere. Meanwhile, the OECD estimates that USD $6.9T are needed year over year through 2030 to meet the climate and development targets of the Paris Agreement. For the United States, President Biden via Executive Order 13990, Protecting Public Health and the Environment and Restoring Schiece To Tackle the Climate Crisis, established an Interagency Working Group to measure the social costs of GHGs, with orders to present final price targets no later than January 2022. As of February, the working group has already put out guidance lowering the discount rate of carbon pricing from the last two administrations to 3%, a number that would place the current domestic price of carbon at ≈ USD51/MtCO2. 

Chart taken from “Technical Support Document: Social Cost of Carbon, Methane, and Nitrous Oxide Interim Estimates under Executive Order 13990”

Is this still sufficient in the long-term? No.

In August 2020’s A Near-Term to Net Zero Alternative to the Social Cost of Carbon for Setting Carbon Prices, researchers estimated forward guidance of carbon pricing to be USD124/MtCO2 by 2030. Of the study, Dr. Noah Kaufman of Columbia University’s Center on Global Energy Policy was recently appointed to be a Senior Economist on President Biden’s Council of Economic Advisors, this being notable in that this may signal what type of further direction towards progress the administration will follow.

Now that Carbon Pricing and its critical importance in achieving our climate goals is understood, we can look towards the challenges in regards to implementation.. While appropriating a cost on carbon within an economy’s domestic production is easier said than done, it is significantly more difficult when international trade comes into play. 

This is where Border Tax Adjustments (BTAs) fall in.

A BTA on GHGs is a Pigouvian tax added onto imported goods pegged to thee value of production-derived emissions. This is simple in theory: we are applying the same standards on imported goods as we apply to our domestic producers, are we not? No.

The challenges are multi-faceted in regards to keeping in accordance with international trade guidelines, and there being opportunities to falsify reportings by emitters. For GHG BTAs to maintain compliance with the World Trade Organization’s rules against import tax discrimination regarding Most-Favoured-Nations treatment and unequal status of imported goods against the same goods produced domestically, they must fall under internationally recognized standards of GHG indexing. Countries’ domestic industries would have to self-report their own emissions to the international community so that their goods can be appropriately taxed, should their production be dirtier than the global standards. 

Herein lies the ultimate challenge, what is stopping foreign producers from lying about their emissions? There isn’t a way we as outside entities can audit these producers. So what can possibly be done besides estimating as best we can?

This method of self-reporting was recently explored in the publication, Framework Proposal for a US Upstream GHG Tax with WTO-Compliant Border Adjustments: 2020 Update. The publication discusses avoiding of gaming GHG indexing systems in applying a BTA on an imported good based off of the average GHG index standard for the production of said good based off of its sector’s country of origin, or, apply a tariff on the imported good based off of the average emissions of the company that produced the good if such information is made available by the company. This leaves one potential loophole: for producers that have a higher carbon output than their home country’s industry average, it may be beneficial to withhold fully reporting their carbon emissions so that their goods would receive the lower BTA that their industry as a whole receives.

I went on to discuss this scenario and what the Biden administration may do going forward with one of the authors of the publication, former WTO Appellate Court Justice & Senior Fellow for Trade and International Political Economy at the Council on Foreign Relations, Jennifer Hillman.

Justice Hillman did note that for applying BTAs based on corporate averages, such information may not be sufficiently available and that GHG indexing standards may be needed to be implemented based on country-wide standards as a fallback since the work of IGOs, like the OECD, do approximate such numbers themselves. In these scenarios we would elect to apply a BTA based on  the country’s average emissions to avoid individual gaming by companies under a system where tariffs are applied based on foreign sectors’ emissions averages. Justice Hilman stated that this is a last resort method of application that would fall within the WTO’s guidelines: applying the average rating of the home country’s emissions as the tax on imported goods.

For example: think about the tax on emissions for goods such as steel and glass produced within the United States. Now apply those taxes on the same goods being imported from China. But as Justice Hillman stated, this is something we do not want to do because our production averages are likely to be cleaner and that by applying our tax on their goods, we would still not be capturing the entirety of the externality of those imported goods.

However, should we elect to use the methods highlighted by Justice Hillman, she emphasized that the critical thing for being legal and consistent with the WTO is that whatever average you produce, you have to give an individual company the opportunity to prove that they are cleaner than the average, and therefore can be taxed less.

If they are in fact cleaner, we can tax their goods at the lower amount sufficient for their specific emission levels. Going forward, sufficient carbon pricing and taxation relies on the integrity of host countries in holding their industries to international emission standards, and in access to accurate data over time in order to optimally, and timely, adjust pricing levels accordingly to meet the levels put out by international guidance.

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By Nader Mehrdadi

Nader Mehrdadi studies Economics at Columbia University, class of 2021. He is researching sustainable energy technologies and the role capital markets play in fostering their developments. He volunteers as an Assistant Director with the National Model United Nations program, and work in the industrials group at an investment boutique.

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