As more and more countries consider adopting border carbon adjustment (BCA) instruments, the need for international cooperation is becoming increasingly urgent. However, the prospects for such cooperation are dimmed by the sensitive nature of some of the issues involved. What are the most difficult issues to overcome, and what steps can we take toward resolving them?

In a recent article, we outlined three main reasons why international cooperation is crucial as interest in BCAs rises. The article explored five technical areas that are candidates for early cooperative discussions.

This article picks up where the first left off: it unpacks four challenging design elements of BCA, which can only be resolved through international political dialogue and broad engagement. Despite their “tough” status, none of these issues is intractable. Understanding the inherent tensions that make them difficult is a first step in exploring how they might be resolved.

The four tough BCA issues that are particularly difficult for cooperative discussions

Should a BCA exempt certain jurisdictions from coverage?

There are a number of possible reasons that a BCA regime might be pressured to exempt some jurisdictions from coverage. The most straightforward might be in cases where the exporting jurisdiction has a binding national emissions cap (meaning there is no chance of carbon leakage) or an emissions trading system (ETS) that is linked to the ETS of the importing jurisdiction.

It has been argued that least developed countries (LDCs) should be exempted from BCA coverage. These countries, as a rule, have contributed the least to the climate change crisis, have the least means to support the decarbonization of their energy-intensive industries, and are most in need of the poverty alleviation that can come from exports. As such, it can be argued that their firms should be shielded from the costs of compliance with a BCA. Doing so would undoubtedly blunt some of the criticism any BCA would face from developing countries.

There are practical and legal challenges with such exemptions, however (discussed below), so it bears asking whether the benefits are worth the costs. If we consider the coverage of the European Union’s (EU’s) Carbon Border Adjustment Mechanism as an indicator, there is only one low-income country with a value of covered exports to the EU that exceeds 0.005% of GDP (2022 trade data from the UN COMTRADE database)—Mozambique has substantial covered aluminum exports to the EU, valued at over 10% of GDP. There is a clear need to accommodate the producer involved. But the fact that there is only one low-income country with significant impacts seems to argue for a bilateral approach to the problem, rather than a general LDC exception.

The more politically charged question is the treatment of middle-income countries. If they were to be exempted, it should probably be based on more nuanced criteria than simply income levels, including such relevant variables as historic contributions to climate change and fiscal capacity to support the decarbonization of their heavy industries.

However, applying any sort of criteria for exemption and decisions on the threshold cut-off levels raises questions of legitimacy. Should it be the prerogative of any nation to unilaterally decide which economies are poor enough and have contributed little enough to climate change to be exempt from carbon pricing? On the other hand, is it realistic to hope for a timely international accord on such questions? One alternative is for the jurisdiction implementing BCA to implement a program of assistance to affected exporters and their home states in lieu of exemptions.  

Another challenge would be the risk of the trans-shipment of goods through exempt countries. In a similar vein, there is the risk that such exemptions might incentivize high-carbon investment in the exempt countries, not only circumventing the aims of the measure but also locking the host countries into export patterns replete with goods that will eventually suffer in global markets that increasingly account for embodied carbon.

Trade law would also be a challenge—any country-based exemptions risk violating the General Agreement on Tariffs and Trade (GATT) Article I’s most-favoured-nation provisions. If the exemption favoured all developing countries, it could be argued that the GATT’s Enabling Clause could “save” it, but that is not a legal certainty.

Should a BCA recycle revenue back to exporters?

There are strong arguments in favour of recycling BCA revenue back to the affected countries or exporters. Doing so is one way of acknowledging and addressing the fact that BCAs will have impacts on exporters in ways that frustrate internationally agreed-upon objectives to pursue poverty alleviation and other development goals.

There are limited ways in which the United Nations Framework Convention on Climate Change principle of common but differentiated responsibility and respective capabilities could be built into a BCA, particularly if exemptions are rejected, but recycling revenues is one. There are several approaches to recycling revenues, from support programs for impacted governments to multilateral funds—which could be another way to replenish much-needed international climate finance and scale up annual climate finance flows in line with a New Collective Quantified Goal on Climate Finance. Revenue recycling to affected exporters would also likely assist in the defence of a BCA as an environmental—as opposed to protectionist—measure under the chapeau of GATT Article XX.

On the other hand, there will be strong political pressure not to send revenues abroad. BCAs are an accompaniment to domestic carbon pricing and are meant to ensure that a high carbon price is actually felt by domestic producers and consumers. Faced with higher costs and prices, they will argue that they are the ones paying the carbon price, and so they should be the ones benefiting from revenue recycling. Domestic firms will argue further that a high domestic carbon price needs to be accompanied by industrial policy support in order to make the carbon price effective—and that BCA revenues are an ideal revenue source for such support.

Should a BCA grant credits for non-price-based climate policies?

If a BCA grants credits for an explicit carbon price paid in the country of export (as it should), will it also grant credits for non-price-based climate policy costs?

Countries that do not have carbon pricing but have costly climate policies argue that only crediting for explicit carbon pricing amounts to dictating how countries should achieve their nationally determined contributions (NDCs) under the Paris Agreement. That is, if a country chooses to decarbonize its industrial sectors by means of (costly) regulations, it should not be punished relative to countries that achieved the same degree of decarbonization via carbon pricing. This, they argue, runs counter to the spirit of the Paris Agreement, which allows each party to choose its own mode of achieving its NDCs.

There are, however, challenges to crediting for non-price-based climate policies. First, it must somehow define which sort of domestic regulations count as climate policies. Do air pollution regulations count, for example? It would seem inappropriate for the BCA-implementing jurisdiction to unilaterally decide that question about exporting country policies; however, if the exporters were to decide, the list would undoubtedly be over-inclusive. Second, it is methodologically difficult to translate regulatory policies into a carbon price equivalent. Among other things, the costs of any regulation will vary significantly from firm to firm. Third, it can be argued that any BCA that bases its charges on actual emissions already credits for regulatory costs to some extent. If those regulations result in lower emissions, then they will also result in lower BCA charges. Finally, if such credits were granted, the importing country would, by the same principle, have to increase the border charge to account for the non-price-based regulatory costs faced by domestic producers. Such a feature would be highly controversial and very likely illegal under trade law.

Should a BCA cover only imports or also exports? 

A fundamental design question is whether the BCA will apply only to imports or will also cover exports by granting some sort of rebate of the carbon price paid by domestic producers at the point of export. The import charge would aim to protect against carbon leakage in the domestic market, ensuring that a lack of carbon price in other countries does not confer an advantage on foreign producers. But it would do nothing to protect against leakage in a country’s export markets. If the domestic carbon price were significant and there were no rebates of carbon prices on export, it could mean essentially losing the covered firms’ export markets. As such, there will be strong pressure on policy-makers from export-oriented domestic firms concerned not only about leakage but about the loss of competitiveness, which translates into jobs and votes; they will want export coverage.

There are, however, several challenges to the proposition of export coverage. First is legality under trade rules. If the domestic carbon price takes the form of a tax, then there may be scope under the World Trade Organization’s Agreement on Subsidies and Countervailing Duties (ASCM) for a rebate of the tax at the point of export in a manner similar to the allowance for a rebate of a value-added tax (VAT). To be clear, it is not certain that a carbon tax would qualify for this exemption. The carbon tax would have to be deemed an indirect tax imposed on products—like a VAT—and that is not a given. 

But if the domestic carbon price is a regulatory requirement, such as a requirement to purchase allowances under an ETS, then it could be argued that a rebate of those regulatory costs at the point of export was a prohibited export subsidy under the ASCM. As of September 2024, there was almost an even split between jurisdictions worldwide, at the national or subnational level, that had applied carbon pricing in the form of a carbon tax (39) and those that had applied it in the form of an ETS (36).

The second challenge with export rebates is environmental—rebating the cost of carbon at the point of export sends goods into the global market completely unburdened by a carbon price. This could lead to carbon leakage in other jurisdictions that have carbon pricing but do not have a BCA. It could also reduce the effectiveness of carbon pricing in the jurisdiction applying the rebate; the most carbon-intensive firms would have incentives to export their goods rather than decarbonize. These environmental challenges circle back to become trade law challenges (but not the subsidy-law type described above). Any design feature that reduces the environmental effectiveness of a BCA makes it less likely that the regime could be “saved” by a GATT Article XX exception.

A way forward?

The urgent need for international cooperation on BCAs need not necessarily be frustrated by the fact that some aspects of international cooperation are politically charged. The aim of unpacking those here is to lay the foundation for eventual discussion and agreement on how they might best be approached in the implementation and elaboration of BCAs. While those conversations might sound challenging, the implications of no agreement or coordination will be even more challenging, especially for the most vulnerable participants of the global trading system. It is important to start those exchanges now.