USING TARIFFS TO TARGET CARBON EMISSIONS: ANALYZING THE LEGAL AND ECONOMIC JUSTIFICATIONS FOR A BORDER CARBON ADJUSTMENT MECHANISM IN CANADA.

• Author: Mcalister, Kyra

INTRODUCTION 226 I OVERVIEW OF BORDER CARBON ADJUSTMENT MECHANISMS 228 A. European Union BCAM 229 B. Current Canadian Carbon Regulations 232 II DOMESTIC JURISDICTION TO IMPLEMENT A BCAM 234 A. Sufficient Concern to Canada as a Whole 236 B. Singleness, Distinctiveness, and Indivisibility 237 C. Scale of Impact 239 III INTERNATIONAL LEGALITY: THE GATT & THE WTO 241 A. The Most Favoured Nation and National Treatment Principles 241 B. The GATT Article XX Exception 245 C. Designing a BCAM That is Not Arbitrary or Unjustifably Discriminatory 251 IV INTERNATIONAL LEGALITY: CUSMA 257 V POLICY EFFECTIVENESS 259 A. Comparison to OBPS 259 B. Additional Economic Effects 261 VI CONCLUSION 262 INTRODUCTION

In the last century, carbon dioxide levels in the atmosphere have risen by approximately 40%, causing temperatures to rise and threatening the Earth's natural balance. (1) To prevent irreversible damage, countries must significantly reduce carbon emissions by 2030. (2) However, global carbon emissions reached a record high in 2021 and progress towards the 2030 goal has been slow. (3) The latest round of climate negotiations at the 2021 Glasgow Climate Summit resulted in inadequate agreements that are not expected to sufficiently reduce carbon emissions. (4) If countries are to reach their climate goals, they must rapidly adopt domestic environmental policies instead of relying on multilateral efforts.

A Border Carbon Adjustment Mechanism ("BCAM") is one domestic policy tool available to address carbon emissions. It imposes a tax on imports at the border based on the carbon emissions released during production of the good being imported. Implementing a BCAM can help reduce both domestic and foreign carbon emissions. This is because a BCAM enables a country to pursue stricter domestic carbon regulations without compromising the competitiveness of domestic goods against cheaper, more polluting imports. (5)

This article examines a potential BCAM within the legal and economic context of Canada, adding to the extensive international literature debating the benefits and potential drawbacks of BCAMs. Based on this analysis, the article argues that Canada should adopt a BCAM as part of its efforts to reduce carbon emissions.

The analysis is divided into five sections. In the first section, the article introduces the concept of a BCAM. It also examines the current federal carbon regulation backstop and the proposed European Union (EU) BCAM.

In the second section, the article examines the legality of a BCAM domestically. Here, the article argues that the federal government likely has jurisdiction to implement a BCAM under both the national concern doctrine and the federal trade and commerce power. However, it may be strategically important to justify the BCAM under the national concern doctrine instead of the trade and commerce power.

In the third section, the article analyzes the BCAM's legality under General Agreement on Tariffs and Trade (GATT) and World Trade Organization (WTO) principles, arguing that a well-structured BCAM is likely to comply with Canada's international legal obligations. This section also discusses the specific design characteristics necessary to satisfy the relevant legal principles.

In the fourth section, the article moves beyond the GATT and briefly considers a Canadian BCAM's international legality in light of Canada's free trade agreement with the United States and Mexico.

Finally, in the fifth section, the article compares the policy effectiveness of a BCAM to the current Canadian carbon regulatory scheme. It concludes that a BCAM ultimately results in more significant emissions reductions. These reductions will likely come at increased costs for industries and consumers but will alter incentives to properly account for the harm created by carbon emissions. Given the rapid and substantial changes that Canada must make to meet its 2030 carbon emission reductions goals, these findings suggest that Canada should swiftly adopt a BCAM.

I OVERVIEW OF BORDER CARBON ADJUSTMENT MECHANISMS

A BCAM is a policy that imposes a tax on goods at the border based on their carbon emissions during production. (6) These external-facing tariffs work in conjunction with a domestic carbon tax by complementing internal carbon reduction goals. (7) A BCAM is generally only applied to imports from countries without similar carbon pricing policies, not to imports from countries with equivalent domestic carbon taxes. (8)

Unlike traditional tariffs, a BCAM is not intended to collect revenue or limit imports. (9) Instead, it is designed to achieve two primary goals: preventing carbon leakage (10) and encouraging carbon pricing in other countries. (11) Carbon leakage occurs when production and demand shift to jurisdictions with less stringent carbon policies, undermining domestic carbon regulations. (12) This can happen when a firm moves production to a different jurisdiction to avoid paying a domestic carbon tax. (13) It can also happen when a domestic carbon tax makes domestic goods more expensive compared to international competition, leading consumers to switch to the cheaper internationally produced good. (14) In both cases, carbon leakage relocates rather than reduces carbon emissions and undermines domestic carbon reduction efforts.

The intensity at which carbon leakage occurs depends on the industry and the timeframe being considered. Carbon leakage is more likely to occur in trade-ex- posed industries. (15) It is also a greater risk in the long term, as capital becomes more fluid allowing firms to relocate production to less expensive jurisdictions.

Beyond addressing carbon leakage, a BCAM can also encourage other countries to adopt carbon pricing or equivalent schemes. (16) Without BCAMs, there is little incentive for a foreign country to reduce its carbon emissions. This is because a country may freely benefit from the reduction efforts of other countries without incurring the costs, since reduction efforts by any country will improve global conditions. (17) This is known as the free-rider problem.

A BCAM can mitigate the incentive to free ride. Since BCAMs typically only apply to products from countries without equivalent carbon pricing schemes, a country with a BCAM can collect significant tax revenue from the producers of countries without such schemes. This creates an incentive for other countries to adopt equivalent carbon pricing schemes, as this would exempt their producers from the BCAM and redirect any revenue that the BCAM might collect from these producers back to their own country. In other words, a country's decision to adopt carbon pricing becomes a choice between allowing its producers to be taxed by the country with a BCAM or implementing a domestic carbon pricing scheme and collecting taxes from these producers itself.

In addition, there is a political effect: BCAMs may reduce foreign producers' opposition to the adoption of carbon pricing schemes in their countries. Ordinarily, these producers may lobby against local carbon pricing schemes because they would be worse off under a carbon price compared to no carbon price. But when a BCAM is implemented in a country they trade with, the producers would face carbon costs regardless of whether their products are taxed through the BCAM or through a domestic carbon pricing scheme. Accordingly, they would have less incentive to lobby against the domestic scheme.

The cumulative effect of implementing a BCAM on foreign countries is to alter the incentives for both foreign governments and foreign producers. A BCAM reduces the political barriers to adopting a carbon tax and lessens the benefits of free riding. As a result, more countries are likely to implement their own carbon pricing schemes if their trading partners implement BCAMs.

1. EUROPEAN UNION BCAM

   The European Union (EU) was the third-largest carbon emitter in 2019, behind only China and the United States (US). (18) In July 2021, the EU proposed a BCAM as part of its ambitious climate package, becoming the first international player to introduce such a policy. (19) Highly profitable and highly controversial, estimates suggest the EU BCAM could generate 9.1 billion euros in 2030. (20) Any revenue raised from the BCAM will go towards its administration costs and the EU budget more generally. (21)

   The BCAM will be implemented in 2023 and take full effect by 2026. (22) It will initially apply only to high-risk emission-intensive trade-exposed (EITE) industries, including iron and steel, cement, fertilizer, aluminum, and electricity industries. (23) These industries account for 94% of the EU's industrial carbon emissions. (24)

   EITE industries are particularly vulnerable to carbon leakage under a domestic carbon pricing scheme. Their production processes produce high emissions that are costly to reduce, and their products experience significant competition from imports. (25) These factors create competitive pressures that can make it difficult for firms in these industries to introduce costly changes that reduce carbon emissions. If they raise prices to cover these costs, the firms risk losing market shares to international competitors. If they do not raise prices, they risk being unprofitable. In the past, the EU has offered significant exemptions to its EITE industries to address these pressures and reduce the risk of carbon leakage. (26) However, these exemptions also reduced the overall effectiveness of the EU's carbon pricing scheme. (27) By introducing a BCAM, the EU will be able to reduce the exemptions granted to EITE industries without increasing the competitive pressures faced by domestic firms in these industries or the risk of carbon leakage.

   The EU BCAM will operate through a certificate system that mirrors the cap-and-trade system already in place within the EU. (28) Importers will be required to declare the annual level of embedded emissions of their imports and surrender...