Carbon taxes and tariffs

First, some background. British Columbia is part of the Western Climate Initiative, a group of U.S. states and Canadian provinces that have the goal of reducing GHGs through market-based mechanisms such as cap-and-trade systems. The Western Climate Initiative is, in turn, a member of the International Carbon Action Partnership, a group of developed countries and regions that have implemented or are actively pursuing the implementation of carbon markets through mandatory cap-and-trade systems.

Cap-and-trade systems have been promoted as being highly effective at controlling GHG emissions. Cap-and-trade systems work by placing a cap or ceiling on the amount of GHGs that large final emitters (LFE) are allowed to emit; the aggregate cap on emissions is then the sum of all the individual LFE caps. A company that wants to emit more GHGs than allowed under its cap will have to purchase - in a carbon market - carbon reductions that other companies create. Cap-and-trade systems thus achieve a limit on GHG emissions; they also create an incentive for firms to develop new technologies for reducing GHG emissions.

One of the weaknesses of cap-and-trade systems is that they put companies that have to comply with such regulations at a cost disadvantage relative to companies that do not have to comply. One way to ensure that firms are not put at a cost disadvantage is to have a number of different countries/regions all introduce cap-and-trade systems at the same time - in this way all firms in these countries have to incur the cost of reducing GHGs and none are disadvantaged. Thus, it is not surprising that British Columbia is part of the Western Climate Initiative, which in turn is part of the International Carbon Action Partnership. One reason these groups have been created is to solve the coordination problem inherent in getting firms to reduce GHGs.

While these regional and international collaborations can ensure that companies operating in developed countries will be required to comply with GHG reductions, they do not address the problem of non-compliance by companies operating in developing countries. One way that has been suggested to address this latter problem is for countries with cap-and-trade (or carbon taxes) in place to levy carbon tariffs on imported goods that have not been subject to such policies (see Joseph Stiglitz (2006) "A New Agenda for Global Warming," The Economists' Voice: 3(7)). The carbon tariff means that companies operating under a cap-and-trade system are not at a cost disadvantage to those operating in countries where such systems are not in place.

With this as background, consider what might occur in the United States over the next year or so. Faced with a growing deficit and trade imbalance, there is a reasonable chance that the next U.S. administration could introduce a carbon tax (and/or carbon market) coupled with a carbon tariff. A carbon tax, in particular, would both raise government revenue and decrease energy use (thus reducing somewhat the United States' dependence on imported oil), while a carbon tariff would give U.S. manufacturing firms a competitive leg up on their developing world counterparts, attract some firms home from abroad (particularly heavy energy users), and raise tariff revenues (see report by Jeff Rubin, CIBC World Markets). Other developed countries can be expected to follow suit immediately, since doing so would allow them to continue their trade with the United States and give them a competitive advantage vis-à-vis developing countries.