Is the Foreign Pollution Fee Act a Carbon Price?

A national-level carbon price—a taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. or cap-and-trade scheme placed on CO2 or other greenhouse gases—may seem distant in the U.S., especially since the InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. Reduction Act, which included major climate policy, omitted one. However, policymakers on both sides of the aisle have been nibbling around the edges of carbon taxes.

Most recently, Senators Bill Cassidy (R-LA) and Lindsey Graham (R-SC) have proposed a fee on some emissions-intensive imports in the Foreign Pollution Fee Act of 2023 (FPFA). While The Wall Street Journal editorial board critiqued the proposal in an editorial titled “Republicans for a Carbon TaxA carbon tax is levied on the carbon content of fossil fuels. The term can also refer to taxing other types of greenhouse gas emissions, such as methane. A carbon tax puts a price on those emissions to encourage consumers, businesses, and governments to produce less of them. ,” and carbon tax advocates have been friendly to the bill, it is not a carbon tax—or even a carbon tariffTariffs are taxes imposed by one country on goods or services imported from another country. Tariffs are trade barriers that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers. .

What’s in the Bill?

The FPFA proposes a multi-tiered tariff that would place taxes on categories of imported goods (including a series of energy and industrial products, such as petrochemicals, iron and steel, and lithium-ion batteries) as long as imports in the specific product category are more than 10 percent more emissions-intensive than domestically produced equivalents. Categories of imported goods would face different tax rates according to a schedule based on the emissions intensity of imported goods relative to domestically produced alternatives.

The bill does not specify rates to accompany the emissions intensity schedule. Instead, it delegates responsibility for setting tariff rates to the Treasury Department, with specific targets for reductions in emissions content of the import categories over time. The tariffs would be ad valorem taxes, based on the value of a particular good (like a sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. or a typical tariff), rather than based on its emissions content, though the rates would vary by relative emissions.

Countries with free trade agreements would be exempted from the tariffs, provided the emissions intensity of their products is no more than 50 percent greater than that of the United States. Additionally, products can be excluded from the tariff schedule if domestic production is insufficient or for national security purposes like fulfilling a Department of Defense contract. Another option would be for countries to enter into an international partnership agreement with the United States, whereby they impose tariffs on high emissions-content imports from third-party countries and remove any tariffs on U.S. exports of the covered goods.

Why the Foreign Pollution Fee Act Is Not a Carbon Tax

To understand the FPFA, one must consider the difference between production-based and consumption-based emissions. Production-based emissions are relatively straightforward, consisting of emissions generated within a jurisdiction. Consumption-based emissions are more complicated; they include foreign emissions generated from producing imported goods but exclude domestic emissions generated from producing exported goods to count emissions in the goods and services consumed in a jurisdiction.

Typically, developed countries have higher consumption-based emissions than production-based emissions, as they import goods from developing countries with high-emissions production processes. Overall, though, the gap between production-based and consumption-based emissions is not particularly large. In 2021, the U.S. was a net importer of emissions, with production-based emissions of 1.4 billion tons of carbon compared to consumption-based emissions of 1.5 billion tons of carbon (a ton of carbon is equivalent to 3.664 tons of CO2).

The distinction between production-based and consumption-based emissions has implications for designing a carbon tax. Taxing production-based emissions alone would put domestic producers at a disadvantage in domestic and foreign markets relative to foreign producers. As a result, it makes sense to border-adjust a carbon tax, excluding exporters and taxing importers. Effectively, a border adjustment shifts the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. from domestic production to domestic consumption.

On these grounds, we can contrast the FPFA with the EU’s approach. The EU’s carbon border adjustment mechanism (CBAM) is not a true border adjustment because it does not feature an exemption for exporters. Instead, CBAM is a tariff the EU has imposed on the carbon content of certain emissions-intensive products at the level of the EU’s emissions trading system (ETS) price. The tax on importers is at least consistent with a border adjustment framework: it is levied according to carbon content consistent with the domestic ETS price, but it still lacks the exporter exemption.

The foreign pollution fee as proposed in the Cassidy-Graham bill is further abstracted from the carbon content of a particular import. Instead of basing the tax on a good’s carbon intensity in the country of origin, the foreign pollution fee would tax goods based on the average carbon intensity of the particular import category, regardless of country of origin.

Even more importantly, the U.S. imposes no matching domestic carbon price. Because the tax is based on the value of a good, and not its carbon content directly, it isn’t technically a carbon price either. As is, it would only cover a narrow sliver of U.S. emissions given that imported emissions are only about 20 percent of total consumption emissions, and a large share of that subset would likely be excluded.

Another downside of the policy is devolving rate-setting responsibility to the Treasury Department. Stability and certainty are core principles of sound tax policy; a variable fee creates uncertainty for businesses and negative economic consequences beyond the typical costs of tariffs, like increased consumer prices and intermediate input costs.

Now, the elephant in the room is China. While the People’s Republic of China is not mentioned in the bill text, one argument for the bill is pressing China. The idea of international partnership agreements, in effect, creating some form of low-carbon free trade zone, could have merit. However, as with recent rounds of tariffs targeting China, this proposal would likely result in retaliatory measures that reduce demand for U.S. exports and reduce trade.

Setting geopolitical arguments aside, the FPFA is not a particularly well-designed tax policy, nor would it create a carbon price for the United States.

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