The EU’s Carbon Border Adjustment Mechanism is reshaping global trade and climate policies. Will the US follow suit, or chart its own course? Here are potential paths forward and what’s at stake for transatlantic climate cooperation.
While the idea of carbon border tariffs is not new, the European Union set a powerful precedent with the announcement of its Carbon-Border-Adjustment-Mechanism (CBAM) last year, utilizing a policy tool once considered too politically disruptive to be feasible to improve competitiveness and shape global carbon trading dynamics. The Mechanism, which represents an extension of the EU Emission Trading System (ETS), is part of the Fit-for-55 reform package of the EU that aims to expand the ETS’s scope and most importantly, phase out free emission allowances. While it is far from settled how the transatlantic carbon pricing dynamics will play out once CBAM moves out of its transitional period in December 2025, it is clear that, as with so many global affairs, how the US reacts will ripple across the globe.
Before looking at the impact CBAM made on the US and analyzing how the country could move forward, the intricacies of Carbon Border Adjustments warrant elaboration: Carbon Border adjustment (CBA) mechanisms are a form of environmental trade policy, existing in the absence of a global, harmonized carbon pricing policy and international agreements on how to deal with these issues. CBAs operate according to the polluter-pays-principle: “putting a price on the carbon created by goods that cross the border as an adjustment to put imported goods on a level playing field with domestic goods subject to a carbon price”. At the core such border adjustments aim to minimize the risk of carbon leakage, a shift in emissions to regions either without or less ambitious carbon mitigation policies, undercutting the effectiveness of domestic efforts. CBAs, so the argument goes, encourage trading partners to install their own carbon pricing strategies because it allows exports to minimize their CBA fee, only paying the difference to avoid double taxation. Ultimately, CBAs are one, but by no means the only, way to approach carbon pricing of imports and can have a variety of forms and shapes as demonstrated below.
Transatlantic Trading Dynamics & what CBAM means across the Atlantic
The announcement of the CBAM triggered a pronounced concern amongst Europe's key trading partners as to the future of their bilateral trade relations and its impact on their domestic economies. Its most crucial ally, the US, received the news critically across the Atlantic. The Biden Administration diplomatically applauded the EU’s net-zero efforts after repeatedly urging the EU to postpone the launch of its Border Adjustment. Nevertheless, the figures show that de facto only 15 percent of total US exports are delivered to the EU and the economic impact will thus be considerably weaker than the press has depicted in recent months. Experts share this assessment and predict that a shift in US carbon policy will be considerably based on domestic political considerations such as the health of the United States’ biggest climate bill, the Inflation Reduction Act (IRA), and the popularity of its tax credits. More fundamentally, the US is thought to have an “inward-facing moment” with respect to its trade policy (Prof. Emily Lydgate). This shift is obvious on the federal level, as discussions on carbon pricing and related policies are increasingly gaining traction and related legislative efforts demonstrate growing bipartisan interest (Cy McGeady, CSIS). This is a change from a few years ago and can be linked to conversations on the European implementation of CBAM.
Historically, the regulatory relationship between the European Union and the United States has been a ‘push-pull: between competition and cooperation’ (Lydgate), amplified by tremendous difficulties coming together on regulatory matters as both superpowers are not used to being imposed on.
These long-standing difficulties continued in the ongoing introductory phase of CBAM, leading to increased tension between the two partners and their respective approaches: the US is at this stage not eligible to benefit from the CBAM provision allowing for a reduced import fee as it presupposes the existence of a national CO2 pricing mechanism in the exporting country. On the EU’s part, little accommodations can be made to smooth the waves with the United States without seriously compromising the credibility of their long-planned and laboriously negotiated CBAM.
Essentially, what matters is not so much what approach the respective countries chose to follow but rather to ensure transatlantic climate coordination and leadership remains a central pillar of any undertaking. Even more so since climate change has transcended from an environmental issue to a geo-economic one with cross-sectoral repercussions on matters such as national security and supply chain resilience.
Possible US Policy Reactions to CBAM
Based on consultations with experts, the US domestic context, and policy proposals on the matter of handling carbon pricing, the future actions of the US can be broken down into the following three scenarios: A Carbon Club as a form of CBA, the introduction of a domestic carbon tariff with a CBA and the instalment of a CBA without a domestic counterpart. As debates in the US government intensify and a number of compelling proposals are on the table, covering the scenarios mentioned above, let’s have a closer look closer at their applicability and context.
Scenario 1: A Carbon Club
The creation of a Carbon Club is based on the idea that states with higher emission reduction standards voluntarily band together to give each other benefits (such as no CBAM charges) to entice other states to join this high-ambition coalition. Carbon Clubs present an opportunity to jointly establish international minimum standards through a common technopolitical dialogue, building upon existing frameworks such as VCM standards and ultimately easing compliance with CBAM and future US regulations. In practice, the establishment of such a Club requires the cooperation & alignment of the US with its industrial policy approach, the EU with its ETS & CBAM, and the objectives of low & middle-income countries like India. Many experts, such as Shuting Pomerleau, argue this would be a road to messy geopolitics exacerbated through lacking binding regulation and accountability mechanisms. Nonetheless, its establishment offers an approach with greater flexibility for regulatory superpowers such (such as the US and EU) to come together and find an internationally applicable agreement which takes into account longstanding, unique diplomatic relationships.
Scenario 2: A US Carbon Border Tariff without a Domestic Component
An alternative idea that has gained momentum in the context of CBAM, is the idea of a carbon tariff on imports without a domestic counterweight currently proposed in the shape of the Republican Foreign Pollution Fee Act (FPFA). First introduced last November by Senators Cassidy & Graham, the bill would establish a solely outward-oriented carbon tax complemented by an extensive section on international agreements and partnerships that can be characterized as clubs.
This scenario is worrisome to many because it is based on American superiority, the assumption that production in the US is inherently cleaner and less carbon intensive than (most of ) its trading partners. This concept, also known as carbon advantage, upon closer examination, crystallizes as the foundation of all proposed regulatory emission initiatives in the 118th Congress and sends the signal that the US “has already done enough to decarbonize” (Pomerleau). However recent studies show that the United States is performing average globally, being more carbon-intensive than the EU or United Kingdom but holding a definitive carbon advantage over countries such as China and Russia. This easily makes the introduction of a CBA without a domestic tariff seem more like an international power play than an action taken out of environmental concern.
The realization of this scenario poses three major difficulties. First, the development of a CBA requires a variety of new data forms defining the amount of GHG in individual products (compared to existing data on facilities and companies). Second, determining a tariff and agreeing on a 'price' will not only be challenging in the absence of comparable domestic data, but it will prove even more difficult to pitch this price to US trading partners convincingly. Unlike the EU, which is introducing its Carbon Border Adjustment Mechanism to prevent carbon leakage with the phase-out of its free emission allowances under the longstanding EU ETS, a US scenario is anticipated to lead to varying degrees of diplomatic backlash. The introduction of a border tariff without a domestic component will likely be perceived as protectionist by US trading partners. Thirdly, this scenario represents a potential violation of the World Trade Organization’s (WTO) core principles of nondiscrimination and national treatment, legal exposure that disgruntled trading partners are likely to leverage. Although the extent to which the US would feel threatened by this course of action is debatable based on the fact that the WTO’s Appellate Body has been rendered dysfunctional as the appointment and reappointment of judges has been blocked for years, a paralysis to which the US has significantly contributed in the last Administrations.
Scenario 3: the Renewal of the US Tax Code
The adoption of a domestic carbon tariff in the near future through policy initiatives such as the Democratic Clean Competition Act (CCA) is considered rather unlikely by experts after similar motions (e.g. the Waxman-Markey Bill) repeatedly failed in Congress in the past years and the United States is presently focusing on an industrial policy approach through its Inflation Reduction Act. However, policy viability isn’t static and various factors can bring about changes to the status quo.
Perhaps the most anticipated impact in the foreseeable future, beyond the presidential election, will be the renewal of the US Tax Code. The upcoming renewal promises to become an extraordinary round of fiscal policy battles in 2025 while simultaneously offering an enormous opportunity to rethink the complex interplay of political options and legislative strategies behind US taxation. The 2017 Tax Cuts and Jobs Act (TCJA) made significant changes to the taxation of individuals and corporations, many of which are slated to expire at the end of December 2025. The TCJA’s future shape is constrained by the Byrd Rule, which requires all legislation passed via reconciliation to be exclusively budget-related and forbids bills to increase the deficit outside the 10-year budget window.
How a renewal might look like will largely depend on the government’s composition post-election but both Republicans and Democrats aim to extend key provisions of the TCJA without increasing the deficit. Trump has shown interest in making his tax rules permanent and pledged to expand them while Democrats will likely only preserve tax cuts benefitting households making less than $400,000 per year. However, an extension of the expiring provisions is estimated to cost an extra $3 trillion over the next decade. This would lead to a record-setting federal debt of 211% of GDP by 2054, roughly doubling it.
In order to uphold and maintain the TCJA provisions post-2025, green policies such as carbon pricing become an effective tool to positively shape the federal debt and create additional revenues for the US government which will be needed to pay off and further fund the $1.5 trillion tax cuts agreed to in 2017, its long-term interest payments and, especially, a possible extension of the Act.
Therefore, perhaps the bill worth following closest in Congress is the bipartisan PROVE IT ACTintroduced in June 2023 by Senators Coons (D-Delaware) and Cramer (R-North Dakota). The Providing Reliable, Objective, Verifiable Emissions Intensity and Transparency Act requires the Department of Energy to determine within 2 years the average emissions intensity of each category of covered products (as defined in the Act). While the PROVE IT ACT itself does not create a domestic carbon tariff, its contents serve as an essential base for quality emission measurements, necessary to follow through on any more concrete carbon-pricing plans. Based on the past failed attempts at introducing domestic carbon pricing, the acquirement of quality emission measurements might be the most realistic win to hope for with the ongoing tensions between Republicans and Democrats on the handling of carbon emissions at this point in time.
An Outlook into the Future
Looking ahead, the upcoming presidential elections in the United States and the control of Congress in 2025 will be a decisive factor in what direction US climate policy takes in the next four years. A Republican victory in the elections will come alongside a potential shift away from any kind of climate legislation in addition to reducing the states’ abilities to regulate climate issues on their own as described in Project 2025.
Conversely, a Harris’ win would presumably bring more robust federal action. The Biden-Harris administration’s formation of a new White House Climate & Trade Task Force, with states filling in gaps as necessary regarding climate ambitions, is indicative. Nonetheless, policy viability is ever-evolving and variables such as changes in leadership, national restructuring, or the geopolitical shifts touched upon above constantly influence the likelihood of bills passing Congress. Just as the EU CBAM was once considered impossible, it is entirely likely that a large shift – both towards more climate protections and away from them – could happen in the near future.
Finally, the perception of climate change is rapidly evolving from a purely environmental challenge to one affecting a variety of critical sectors such as national security and supply chain resilience. On the one hand, that means that policy makers might no longer have the luxury of picking and choosing what methods to employ, but rather should explore them all, while on the other, this emphasizes the strategic importance of transatlantic cooperation to overcoming global threats.
Many thanks to Cy McGeady from CSIS, Alex Muresianu from the Tax Foundation, Milan Elkerbout and Molly Roberston from Resources for the Future for their valuable and insightful input that has informed this publication.