The Role of Border Carbon Adjustments in a U.S. Carbon Tax

Abstract

This paper examines carbon tax design options in the United States using an intertemporal computable general equilibrium model of the world economy called G-Cubed. In this paper, we discuss four policy scenarios that explore two overarching issues: (1) the effects of a carbon tax under alternative assumptions about the use of the resulting revenue, and (2) the effects of a system of import charges on carbon-intensive goods ("border carbon adjustments" or BCAs). Consistent with earlier studies, we find that the carbon tax raises considerable revenue and reduces CO2 emissions significantly relative to baseline, no matter how the revenue is used. Gross annual revenue from the carbon tax with lump sum rebating and no BCA begins at 110 billion in 2020 and rises gradually to 170 billion in 2040. By 2040, annual CO2 emissions fall from 5.5 billion metric tons (BMT) under the baseline to 2.4 BMT, a decline of 3.1 BMT, or 57%. Cumulative emissions over 2020 to 2040 fall by 48 BMT. Also consistent with earlier studies, we find that the carbon tax has very small overall impacts on gross domestic product (GDP), wages, employment, and consumption. Different uses of the revenue from the carbon tax result in slightly different levels and compositions of GDP across consumption, investment and net exports. Overall, using carbon tax revenue to reduce the capital income tax rate results in better macroeconomic outcomes than using the revenue for lump sum transfers. Counter to their purported purpose of protecting U.S. trade strength, for a given revenue policy, BCAs tend to produce lower net exports than the carbon taxes alone. This is generally because the BCAs raise the value of the dollar relative to other currencies, thus lowering exports more than they lower imports. This is consistent with standard results in the international trade literature on the effects of import tariffs and export subsidies on real exchange rates, a result that is often overlooked in the discussion of domestic carbon policy. In a finding new to the literature, our results show that BCAs can have strikingly different effects depending on the use of the revenue. Under a lump sum rebate, BCAs exacerbate the impact of the carbon tax by lowering domestic output further than it would fall under the carbon tax alone. Under a capital tax swap, however, BCAs have a moderating effect: they reduce the impact of the tax on most industries. Show more