Border carbon adjustments in international trade law an approach for the implementation through regional trade agreements

Climate Change and the Issue of Carbon Leakage

The risk of climate change

Between 2000 and 2010, greenhouse gas (GHG) emissions surpassed the total emissions of the previous three decades, according to the Intergovernmental Panel on Climate Change (IPCC) This surge contributed to a global temperature increase of 0.85°C from 1880 to 2012 and a rise in sea levels of 19 cm from 1901 to 2000 The consequences of climate change extend beyond extreme weather events, impacting agricultural trade, food security, public health, and leading to the extinction of various plant and animal species Scientists attribute the rise in temperatures to unprecedented increases in atmospheric concentrations of greenhouse gases.

The 2013 Summary for Policymakers by the Intergovernmental Panel on Climate Change (IPCC) emphasizes the critical findings of the Fifth Assessment Report, focusing on the physical science basis of climate change This report, contributed by Working Group I, highlights the urgent need for action to address the impacts of climate change.

Greenhouse gases (GHGs) such as carbon dioxide, methane, and nitrous oxide are primarily generated from industrial processes and human activities, particularly the combustion of fossil fuels Since the industrial revolution, GHG concentrations have risen by 40% compared to pre-industrial levels Scientific consensus indicates that without a significant reduction in GHG emissions, global warming and climate system changes will worsen Therefore, it is essential to reduce GHG emissions to mitigate climate change.

In order to avoid irreversible damage with catastrophic consequences, states, international organizations and industries must ensure that effective policies are developed to address climate change

Climate change presents significant challenges for the international community, hindering the establishment of effective global agreements The current international climate framework lacks robust mechanisms for ensuring participation and compliance, relying mainly on non-binding statements and legal principles Three key factors contribute to this issue: first, climate change impacts various sectors of a state's policies, including energy, agriculture, transportation, urban planning, and the economy, complicating domestic political landscapes Second, the multifaceted nature of climate change makes it difficult for nations to address the issue cohesively.

10 Stern and Treasury, The Economics of Climate Change, 7–10

In the 2013 report by the Intergovernmental Panel on Climate Change (IPCC), titled "Climate Change 2013: The Physical Science Basis," significant findings were presented by Working Group I, emphasizing the urgent need for policymakers to address climate change This summary highlights the critical scientific evidence regarding the physical impacts of climate change, underscoring the necessity for immediate action to mitigate its effects.

12 See generally Scott Barrett, Environment and Statecraft: The Strategy of Environmental Treaty-Making: The Strategy of Environmental Treaty-Making (OUP Oxford, 2003)

In the United States, both major political parties often challenge the validity of climate change science, creating significant barriers to participating in international agreements aimed at addressing the issue This trend is highlighted in the article "The Anti-Science Climate Denier Caucus: 114th Congress Edition" by Tiffany Germain, Kristen Ellingboe, and Kiley Kroh, published in January 2015.

Addressing climate change requires significant long-term efforts from countries, yet many governments prioritize immediate issues such as poverty, energy access, and economic development There is a disparity in interests and capabilities among states; those most responsible for climate change often do not face its worst impacts For instance, small island nations are motivated to act but their efforts alone are insufficient to mitigate the severe consequences of global warming Conversely, developed and large developing nations may remain reliant on fossil fuels and may not alter their short-term energy policies Consequently, the international response to climate change has achieved only limited success thus far.

International response to climate change

The urgency to address climate change is clear, yet nations exhibit diverse approaches to tackling this global challenge These varying perspectives significantly influence their contributions to international climate policies For instance, European countries and small island states perceive climate change primarily as an environmental crisis, leading them to advocate for international policies aimed at mitigating its harmful impacts.

14 Kelly Levin et al., “Playing It Forward: Path Dependency, Progressive Incrementalism, and the

‘Super Wicked’ Problem of Global Climate Change,” in International Studies Association 48th Annual

The effectiveness of policies aimed at reducing greenhouse gas (GHG) emissions relies on the stringency of emissions reduction commitments, the extent of state participation, and the compliance of these states.

Developed countries, including the U.S., view climate change primarily as an economic issue, aiming for cost-effective climate policies that equalize compliance costs They often implement market mechanisms like emissions trading schemes to lower greenhouse gas emissions efficiently In scenarios where future emissions reduction costs are lower than current ones, and disparities exist between countries, it may be more advantageous to defer emissions reduction efforts or transfer them to nations with less stringent climate regulations However, this strategy has faced criticism from environmentalists who argue it could weaken the overall effectiveness of climate policies.

Many developing countries view climate change as an ethical issue, attributing its historical causes to developed nations, which have been responsible for the majority of greenhouse gas emissions since the nineteenth century Consequently, they argue that developed countries should take the lead in combating climate change and provide financial and technical assistance to developing nations However, this perspective becomes less compelling as large developing countries, particularly China, have recently surpassed many developed nations in emissions.

16 See Barrett, Environment and Statecraft, 155–59

17 Bodansky, Brunnée, and Rajamani, International Climate Change Law, 190

18 Slobodan Perdan and Adisa Azapagic, “Carbon Trading: Current Schemes and Future Developments,” Energy Policy 39, no 10 (2011): 6040–6054

Developed countries continue to have significantly higher greenhouse gas (GHG) emissions per person compared to developing nations, as highlighted by the Intergovernmental Panel on Climate Change (IPCC) This disparity raises complex challenges regarding the equitable reduction of emissions, as countries are less likely to accept international climate policies that are perceived as unfair.

Scholars categorize the global response to climate change into four distinct phases The initial phase, known as "agenda setting," occurred from 1985 to 1990, during which the climate change issue gained traction among scientists and various stakeholders.

The "constitutional phase" from 1991 to 1994 marked the negotiation and implementation of the United Nations Framework Convention on Climate Change (UNFCCC) This was followed by the "regulatory phase" from 1995 to 2005, which emphasized the development and operationalization of the Kyoto Protocol Since 2005, the focus has shifted to the "negotiation of future regime," addressing the establishment of a new climate framework beyond the initial commitment period of the Kyoto Protocol.

The concept of the greenhouse effect was initially introduced by Swedish scientist Svante Arrhenius in the 19th century However, concerns regarding ozone layer depletion due to human greenhouse gas emissions emerged in the 1970s The first World Climate Conference, organized by the World Meteorological Organization in 1979, aimed to evaluate climate studies and their implications for human society It wasn't until the 1980s that an international framework to tackle climate change began to take shape, highlighting the growing recognition of climate change as a critical issue.

In 2015, China was responsible for 29% of global emissions, while the United States and the European Union contributed 14% and 10%, respectively, highlighting the significant disparity in emissions among major economies.

21 Bodansky, Brunnée, and Rajamani, International Climate Change Law (Oxford University Press,

2017), 96 primarily by non-governmental actors including environmental-oriented scientists However, the “agenda setting” phase marked the more active participation of governments, 22 perhaps because of the following three factors

First, a group of scientists from developed countries performed as

Knowledge brokers play a crucial role in translating and disseminating emerging scientific knowledge about climate change to the general public and policymakers Notable scientists, such as Ber Bolin, the first chair of the Intergovernmental Panel on Climate Change (IPCC), and James Hansen from NASA, have actively engaged in raising awareness through congressional reports in the late 1980s The 1985 discovery of the Antarctic ozone hole, linked to chlorofluorocarbon (CFC) emissions, heightened public concern regarding global warming and ozone depletion, leading to significant agreements like the Montreal Protocol in 1987 and the UN Conference on Environment and Development in 1992 Additionally, the severe heat wave and drought in North America in 1988 intensified public and governmental apprehension about global warming, culminating in the establishment of the IPCC by the United Nations Environment Programme (UNEP) and the World Meteorological Organization.

Prominent scientists, including Bor Bolin from Sweden, the first chair of the Intergovernmental Panel on Climate Change (IPCC), and James Hansen from NASA, have played crucial roles in addressing climate change by presenting significant reports to U.S Congressional committees.

1987 and 1988 See ibid at 98 with the endorsement by the UN General Assembly 24

The IPCC's first Assessment Report highlighted that rising greenhouse gas emissions were significantly altering the Earth's atmosphere, primarily due to industrial emissions and deforestation It forecasted more severe storms, extreme weather events, negative effects on ecosystems and biodiversity, and potential sea level rise However, it was not until the Third and Fourth Assessment Reports in 2001 and 2007 that the IPCC conclusively attributed these issues to human activities.

The process of creating a framework convention on climate change began in

In 1990, the UN General Assembly proposed a convention during the preparations for the upcoming UN Conference on Environment and Development An Intergovernmental Negotiating Committee (INC) was established to create an effective framework convention on climate change with suitable commitments The INC conducted five sessions from early 1991 to mid-1992, culminating in the adoption of the United Nations Framework Convention on Climate Change (UNFCCC) on May 9, 1992.

During UNFCCC negotiations, significant divisions arose between developed and developing nations, as well as among developed countries themselves Developing nations emphasized that climate change should not be considered solely an environmental issue, highlighting the broader implications it has on social and economic factors.

25 IPCC, First Assessment Report: Overview and Policymaker Summaries and 1992 IPPC Supplement,

1992, 11 Accessed on July 20, 2019 https://www.ipcc.ch/site/assets/uploads/2018/05/ipcc_90_92_assessments_far_full_report.pdf

26 Navraj Singh Ghaleigh, “Science and Climate Change Law - The Role of the IPCC in International Decision-making,” in The Oxford Handbook of International Climate Change Law, ed Cinnamon P

The article emphasizes that climate change is fundamentally a development issue, arguing that measures to address it should not hinder economic growth in developing nations, which are not primarily responsible for the problem The UNFCCC asserts that developed countries must lead in combating climate change, highlighting the principle of "common but differentiated responsibilities and respective capabilities" (Article 3.1) Furthermore, it establishes distinct commitments for developed and developing nations, imposing stricter reporting and review obligations on developed countries (Article 4.1 and 12.2).

Bottom-up approach to deal with climate change

Despite the international community's efforts to establish a multilateral climate change agreement, challenges in participation, burden-sharing, and compliance persist Consequently, some countries have begun implementing unilateral national measures to combat climate change These voluntary actions taken at national and subnational levels are referred to as the "bottom-up approach." Many scholars argue that this approach can effectively complement ongoing negotiations.

42 Victoria Johnson, “The Politics of Climate Change,” AL JAZEERA, December 2, 2015 Accessed on

The evolution of climate policies has transitioned from bilateral and regional frameworks to comprehensive international agreements This shift is characterized by three primary bottom-up approaches: emission trading schemes (ETS), carbon taxes, and command-and-control measures, which collectively aim to address climate change effectively.

The emissions trading scheme (ETS) allows 44 states and companies to buy and sell emissions rights to meet their reduction commitments Compliance options include purchasing allowances in the market when emissions exceed targets or selling excess allowances when emissions are below caps This market mechanism creates economic opportunities, making it more cost-effective for states and companies with higher greenhouse gas emissions to manage their compliance Ultimately, the ETS serves as a national policy for climate change mitigation.

EU, Switzerland and New Zealand, a voluntary basis in Japan or a state-level scheme

43 Carlo Carraro and Christian Egenhofer, Climate and Trade Policy: Bottom-up Approaches Towards

Global Agreement (Edward Elgar Publishing, 2007), 42–43

The journey from economic theory to practical implementation of emissions trading systems (ETS) has been extensive, as highlighted by Robert Baldwin in his work on "Regulation Lite: The Rise of Emissions Trading." Additionally, Jan-Peter Voss discusses the innovation processes in governance that have influenced the development of these systems.

In the article "Emissions Trading as a New Policy Instrument," published in Science and Public Policy, economists from the 1960s proposed that well-regulated property rights and the elimination of transaction costs can effectively address externalities By granting property rights to environmental resources and establishing markets for trading these rights, states can achieve certain environmental protections at the lowest possible cost, as discussed by John Harkness Dales in his work, "Pollution, Property & Prices."

Essay in Policy-Making and Economics (Edward Elgar Publishing, 2002); When the U.S amended the

The Clean Air Act of 1990 introduced the "acid rain program," marking the United States as the first country to implement an emissions trading scheme specifically for sulfur dioxide This innovative approach aimed to reduce acid rain by allowing companies to buy and sell emission allowances, thereby promoting cost-effective pollution control For further insights, refer to A Denny Ellerman's book, "Markets for Clean Air: The US Acid Rain Program," published by Cambridge University Press in 2000.

In his 2007 report, Robert J Shapiro discusses the effectiveness of emissions caps and tradable permits versus carbon taxes in addressing climate change risks He emphasizes the importance of balancing environmental effectiveness with economic efficiency to create sustainable solutions in the U.S.

A carbon tax is an effective price-based approach to reducing greenhouse gas (GHG) emissions, distinct from market-based mechanisms like emissions trading systems (ETS) As more governments consider implementing carbon taxes, these taxes not only generate revenue for state income but also support the development of green technologies and aid economically vulnerable consumers and adaptation programs in developing countries While carbon taxes offer economic advantages such as price stability and flexibility, they may face opposition from business sectors concerned about competitiveness Typically, states utilize carbon taxes as a tool for emissions reduction in energy sectors and high-emission industries, imposing taxes based on the carbon footprint of fossil fuel combustion and emissions from production processes like steel and cement manufacturing.

46 The Low-Carbon Fuel Standard (LCFS) in California combines a technical norm of emission trading when there is a deficiency of a federal emissions trading scheme at the federal level

47 See Keith Kendall, “Carbon Taxes and the WTO: A Carbon Charge without Trade Concerns,” Ariz J

Int’l & Comp L 29 (2012): 52–54; See also Thomas Cottier and Nashina Shariff, “International Trade and Climate Change,” in Research Handbook on Environment, Health and the WTO, ed Geert Van

Calster and Denise Prévost (Edward Elgar Publishing, 2013), 413–47

48 Kendall, “Carbon Taxes and the WTO,” 51–54

49 Erich Vranes, “Carbon Taxes, PPMs and the GATT,” in Research Handbook on Climate Change and

Trade Law, ed Panagiotis Delimatsis (Edward Elgar Publishing, 2016), 77

50 WTO and UNEP, Trade and Climate Change: A Report by the United Nations Environment Programme and the World Trade Organization (UNEP/Earthprint, 2009), 90

1.3.3 Command-and-control climate measures

A command-and-control system implemented by governments establishes emission standards along with monitoring and enforcement mechanisms to ensure compliance This system can include performance-based standards that set allowable emissions for producers or products, as well as technology-based standards that specify both emissions limits and required production technologies If a producer fails to meet these climate standards, their product sales may be restricted in the market Unlike market-based mechanisms, which offer compliance flexibility through the purchase or sale of emission allowances, the command-and-control approach mandates strict adherence to regulations Although it may be less cost-effective than market-based alternatives, this system remains the preferred choice for both developed and developing nations, having been adopted earlier than market-based schemes Typically, command-and-control systems focus on carbon-related standards and labeling requirements for high-emission products, which will be explored in detail in the following sections.

The concept of implementing mandatory regulations for producers and products emerged in the 1980s to enhance energy efficiency in vehicles and household appliances Consequently, climate-related standards have generated tensions among regulators.

51 Adam B Jaffe, Richard G Newell, and Robert N Stavins, “Environmental Policy and Technological Change,” Environmental and Resource Economics 22, no 1–2 (2002): 50

Countries are increasingly implementing emission-intensive standards, particularly in the transportation sector, with nations like Brazil, India, the EU, and the U.S establishing technical requirements for biofuels Japan mandates emission-combustive firms to utilize energy-efficient equipment in their production processes Climate standards often take the form of performance-based regulations, enforcing maximum greenhouse gas emissions and minimum fuel economy The EU's Fuel Quality Directive, adopted in 2009, aimed to reduce life-cycle GHG emissions from fuel suppliers by 10% per energy unit by the end of 2020 Similarly, the U.S has set climate standards for transportation fuels through the Corporate Average Fuel Economy Standards, targeting a reduction of nearly 1 billion metric tons of GHG emissions and 1.8 billion barrels of oil combustion by 2027 for medium- and heavy-duty vehicle producers.

Similar to mandatory energy efficiency labels applying on household

54 Philipp Aerni et al., “Climate Change and International Law: Exploring the Linkages between Human Rights, Environment, Trade and Investment,” German YB Int’l L 53 (2010): 166–67

55 WTO and UNEP, “Trade and Climate Change,” 119

The Directive 2009/30/EC, adopted by the European Parliament and Council on April 23, 2009, amends Directive 98/70/EC to establish specifications for petrol, diesel, and gas-oil, while also introducing a mechanism aimed at monitoring and reducing greenhouse gas emissions Additionally, it revises Council Directive 1999/32/EC concerning fuel specifications for inland waterway vessels and repeals Directive 93/12/EEC.

The National Highway Traffic Safety Administration (NHTSA) has implemented Phase 2 regulations from 2018 to 2027 to enhance fuel efficiency and reduce greenhouse gas (GHG) emissions from heavy-duty trucks Carbon emission labels are designed to inform consumers about the total GHG emissions produced throughout a product's life cycle, including its production, distribution, and usage This initiative aims to raise awareness of climate change and guide consumers in making informed choices about emission-intensive products Regulators believe that such labeling can drive market innovation in energy-efficient products, serving as a market-friendly approach to addressing climate change, in contrast to traditional regulatory methods However, climate labels primarily influence consumer behavior for finished goods like food and appliances, as manufacturers of primary products—such as steel and cement—may not prioritize climate considerations in their purchasing decisions.

The carbon labeling scheme is increasingly adopted worldwide as an effective strategy to combat climate change, with many countries implementing these measures across various sectors While most OECD countries have utilized carbon labeling for several years, non-OECD nations are also beginning to embrace this practice Australia has been a leader in this initiative, requiring new vehicles to display labels on their windscreens that provide crucial information about fuel consumption and carbon dioxide emissions.

EU, new cars also require labels that display levels of carbon dioxide emissions in

59 Steve Charnovitz, “The Law of Environmental PPMs in the WTO: Debunking the Myth of Illegality,” Yale J Int’l L 27 (2002): 109

60 WTO and UNEP, “Trade and Climate Change,” 120

61 Kateryna Holzer, Carbon-Related Border Adjustment and WTO Law (Edward Elgar Publishing,

2014), 29 units of grams per kilometer 62

Carbon leakage and policy options to address this issue

Pricing emissions is widely regarded as an effective strategy to combat climate change, as it encourages market stakeholders to transition from inefficient production methods to environmentally friendly practices However, this approach may impose significant costs on industries, including investments in low-emission technologies and shifts in consumer spending towards less carbon-intensive products The current commitment to greenhouse gas (GHG) emission reduction remains voluntary, leading to varying emission levels between developed and developing nations, which creates unequal competition for domestic and foreign producers and raises concerns about carbon leakage To address these challenges, measures can be categorized into three main types: those that increase costs through global or sectoral agreements, and those that aim to lower carbon costs.

62 WTO and UNEP, “Trade and Climate Change,” 121

63 Stern and Treasury, The Economics of Climate Change, xviii

64 Susanne Drửge et al., “Tackling Leakage in a World of Unequal Carbon Prices,” Climate Strategies 1 (2009): 11, http://climatestrategies.org/wp-content/uploads/2009/10/cs-leakage-final-230909.pdf

65 Jean Charles Hourcade et al., Differentiation and Dynamics of EU ETS Industrial Competitiveness

Impacts: Final Report, (May 2014); and Verena Graichen et al., “Impacts of the EU Emissions Trading

Scheme on the Industrial Competitiveness in Germany,” Berlin: German Federal Environment Agency, 2008; and Julia Reinaud, “Issues behind Competitiveness and Carbon Leakage,” Focus on Heavy

In the context of international competition and climate policy, key studies highlight the importance of addressing competitiveness issues The International Energy Agency (IEA) underscores these challenges in its 2008 information paper, which discusses the implications of emissions trading and market dynamics Additionally, Trevor Houser's work emphasizes the need for equitable climate policy design to level the playing field for U.S industries Furthermore, research by Karsten Neuhoff and colleagues explores the critical role of auctions in emissions trading systems, suggesting that effective auction mechanisms can enhance market efficiency and fairness.

Climate Strategies Report Cambridge, 2008, http://climatestrategies.org/wp-content/uploads/2008/10/role-of-auctions-09-oct-08final.pdf supporting the domestic industry (1.4.2) and measures at the border implementing flexible adjustments (1.4.3)

1.4.1 A global agreement for a cost adjustment of GHG emissions

A global climate agreement is essential for effectively tackling carbon leakage by establishing uniform carbon pricing and binding emissions reduction commitments across participating nations This approach can minimize disputes between countries and prevent industries from relocating based on varying carbon costs In the long run, it can also attract investors seeking countries with stable and predictable climate policies, contrasting with those that opt out of such agreements.

To encourage countries to join climate agreements, substantial incentives are essential, particularly for developing nations that require significant financial support from developed countries The top ten carbon-emitting nations, responsible for two-thirds of global greenhouse gas emissions, are unlikely to commit to emissions reduction in the near future Additionally, developing countries face the challenge of balancing national legislative autonomy with the influence of supranational authorities on fiscal policy.

66 van Asselt and Brewer, “Addressing Competitiveness and Leakage Concerns in Climate Policy,” 43

67 Michel Colombier and Karsten Neuhoff, “Sectoral Emission Agreements Regional Affairs,” Envtl Pol’y & L 38 (2008): 164

The top ten countries contributing to CO2 emissions include China, the United States, India, Russia, Japan, Germany, South Korea, Canada, Iran, and the United Kingdom A comprehensive analysis of energy consumption and emissions in the residential sector can be found in the study by Payam Nejat et al., titled “A Global Review of Energy Consumption, CO2 Emissions and Policy in the Residential Sector.”

Sustainable Energy Reviews highlights ongoing controversies surrounding climate change commitments, suggesting that countries may struggle to make effective pledges for mitigation This uncertainty contributes to the persistent issue of carbon leakage, which remains a significant challenge in the fight against climate change.

Support measures aim to mitigate the negative impacts of greenhouse gas (GHG) emissions reduction on domestic producers These measures often include free allowances under an emissions trading scheme (ETS), which is recognized as an effective approach to combat climate change To avoid carbon leakage, countries can allocate a specific quantity of free allowances to domestic industries, allowing them to offset potential economic losses without purchasing allowances for all emissions The number of free allowances can be adjusted to match current emissions levels, enabling producers to pay for allowances only when their emissions exceed this threshold Additionally, domestic producers can profit by reducing their emissions and selling any surplus allowances in the market, even if they initially received these allowances at no cost.

Financial support for domestic companies addressing climate change mitigation seeks to offset the adverse economic impacts of emissions reduction policies Nonetheless, these assistance measures may inadvertently limit the motivation for firms to reduce their emissions effectively.

69 Gary Clyde Hufbauer and Jisun Kim, “Climate Change and Trade: Searching for Ways to Avoid a Train Wreck,” TAIT second conference “Climate Change, Trade and Competitiveness: Issues for the

WTO”, Geneva, June 2010, 24, http://www.wto.int/english/res_e/reser_e/climate_jun10_e/background_paper7_e.pdf

70 Bodansky, Brunnée, and Rajamani, International Climate Change Law, 10

Governments can implement various supporting measures to prevent carbon leakage, including the "Safety-valves" policy This policy allows domestic producers to avoid exorbitant allowance prices by setting a maximum trading price for emission permits.

The concepts of "cross subsidization" and "carbon offsets" are not covered in this paper, which emphasizes that firms’ profits rely more on their influence over government allocation decisions than on competitive performance Measures aimed at safeguarding the profits of domestic producers may hinder the transition to low greenhouse gas emissions products and erode the trust essential for future global cooperation, leading to skepticism about their effectiveness in preventing carbon leakage.

1.4.3 Flexible adjustments through border adjustments

A state can combat carbon leakage by implementing border adjustments on imports and exports from countries without comparable greenhouse gas (GHG) emissions reduction systems This strategy differs from other measures as it allows for immediate action against carbon leakage Border Carbon Adjustments (BCAs) can encompass tariffs, taxes, subsidies, or technical regulations, effectively balancing GHG emissions costs in both directions.

BCAs, or Border Carbon Adjustments, mitigate the risk of carbon leakage by implementing trade restrictions on carbon-intensive imports while offsetting emissions costs for domestic exporters Recently, this approach has garnered support from both policymakers and scholars, leading to increased interest in national climate policies that incorporate BCA provisions The subsequent sections will delve deeper into these measures.

First, international reserve allowances were proposed as a U.S climate change

72 Drửge et al., “Tackling Leakage in a World of Unequal Carbon Prices,” 48–49

The examination of energy-intensive industries affected by carbon pricing reveals that trade flows are the primary driver of emission leakage in the short term, while capital flows play a supplementary role in the medium to long term, as highlighted by Drửge et al in their study on addressing leakage in a landscape of unequal carbon prices.

To address competitiveness and leakage concerns in climate policy, products seeking access to a specific market must either originate from a country with an equivalent emissions control program or submit allowances that cover their greenhouse gas emissions These allowances can be obtained by purchasing carbon credits from an established emissions trading scheme or a special international reserve Without the submission of these allowances, imported products will be denied entry.

A carbon tax, also known as a Border Tax Adjustment (BTA), is a price-based measure that imposes a duty, charge, or tax on carbon-intensive products based on their greenhouse gas (GHG) emissions during manufacturing This tax applies to both domestic and imported goods, affecting consumers and producers alike However, many countries primarily implement this carbon tax by levying a duty on fuel consumption for consumers.

The prospects to the use of Border Carbon Adjustments

Many studies consider Border Carbon Adjustments as a useful policy tool to offset carbon leakage and deal with climate change in the forms of carbon taxation and

78 For an example, see The U.S House of Representatives Committee on Energy and Commerce,

Climate Change Legislation Design White Paper: Competitiveness Concerns/Engaging Developing Countries, (2008), 10–11

A proposed "carbon passport" aims to indicate the carbon footprint of products, providing essential information for calculating border adjustments in emissions trading systems (ETS) or carbon tax frameworks This initiative is discussed in the work of Gary Clyde Hufbauer, Steve Charnovitz, and Jisun Kim in their book, "Global Warming and the World Trading System" (Columbia University Press, 2009).

The French government has proposed that 2% of the total greenhouse gas (GHG) emissions allowances from the third phase of the EU Emissions Trading System (ETS) be allocated as rebates for EU exporters.

The implementation of Border Carbon Adjustments (BCAs) is a significant focus in various national climate policies, including the EU's Emission Trading System (ETS), proposed U.S federal climate legislation, and China's anticipated national carbon market Economic studies indicate that the negative impacts of carbon leakage can outweigh the benefits of domestic climate initiatives, with simulations revealing that unilateral climate measures in EU countries could lead to emissions increases in non-EU regions by 5 to 30 percent These findings highlight the urgent need to address carbon leakage risks, particularly as countries present more ambitious Nationally Determined Contributions (NDCs) under the Paris Agreement compared to previous commitments made in the Kyoto Protocol.

Recent studies highlight that Border Carbon Adjustments (BCAs) could effectively mitigate carbon leakage and tackle climate change while maintaining competitive market conditions Specifically, BCAs are designed to decrease the incidence of carbon leakage significantly.

81 Proposals of the U.S and the EU will be discussed in Section 2.1 See also M Mehling et al.,

“Designing Border Carbon Adjustments for Enhanced Climate Action,” Climate Strategies, 2017, 41; and Holzer, Carbon-Related Border Adjustment and WTO Law, 2014, 55

82 Mehling et al., “Designing Border Carbon Adjustments for Enhanced Climate Action,” 41

83 Cary Coglianese and Jocelyn D’Ambrosio, “Policymaking under Pressure: The Perils of Incremental Responses to Climate Change,” Conn L Rev 40 (2007): 1411

Rahel Aichele and Gabriel Felbermayr's study in "The Review of Economics and Statistics" explores carbon leakage related to bilateral trade, while Bửhringer, Balistreri, and Rutherford's research in "Energy Economics" discusses the significance of border carbon adjustments in unilateral climate policy Additionally, Garsous and Kozluk examine the connection between foreign direct investment and the pollution haven hypothesis in their 2017 analysis.

85 C Fisher and A K Fox, “Comparing Policies to Combat Emissions Leakage: Border Carbon Adjustment versus Rebate,” Journal of Environmental Economics and Management 64, no 2 (2012):

Border Carbon Adjustments (BCAs) have the potential to significantly reduce greenhouse gas emissions by approximately 6% compared to scenarios without such adjustments They can also mitigate carbon leakage, leading to production losses in energy-intensive and trade-exposed industries being reduced from 2.8% to 1% BCAs are often more effective than duty exemptions and output-based abatements, as they influence consumer preferences through price incentives However, their effectiveness is most pronounced when applied to critical sectors such as cement, aluminum, steel, and electricity.

While numerous studies support the implementation of Border Carbon Adjustments (BCAs), many scholars express skepticism regarding their effectiveness in climate policies Critics highlight potential environmental, political, and legal ramifications, arguing that foreign producers in countries with lax greenhouse gas (GHG) regulations may focus on adapting to carbon adjustments instead of transitioning to sustainable technologies Additionally, the role of BCAs in encouraging developing countries to engage in global GHG emission reduction efforts remains unclear, as these measures must address significant volumes of emissions.

The concept of Border Carbon Adjustment (BCA) is critical in the context of unilateral climate policies, as explored in various studies Notably, Kuik and Hofkes (2010) analyze BCA's implications for the European Emissions Trading System, focusing on its effects on competitiveness and the risk of carbon leakage Additionally, Winchester, Paltsev, and Reilly (2011) investigate the effectiveness of BCA in mitigating these challenges Collectively, these works underscore the importance of implementing BCA as a strategic tool to balance environmental goals with economic stability in international trade.

87 Branger and Quirion, “Would Border Carbon Adjustments Prevent Carbon Leakage and Heavy Industry Competitiveness Losses?,” 16

88 Bửhringer, Balistreri, and Rutherford, “The Role of Border Carbon Adjustment in Unilateral Climate Policy,” 102

89 Ibid at 105; and Stéphanie Monjon and Philippe Quirion, “A Border Adjustment for the EU ETS: Reconciling WTO Rules and Capacity to Tackle Carbon Leakage,” Climate Policy 11, no 5 (September

Imported products can play a crucial role in encouraging exporting countries to implement stricter climate policies However, various economic analyses indicate that the application of border carbon adjustments should be limited to specific carbon-intensive and trade-exposed sectors This limitation is due to considerations of administrative feasibility and the technical capacity required, particularly concerning industries such as fossil fuels, cement, steel, and aluminum.

Several scholars argue that the implementation of Border Carbon Adjustments (BCAs) may violate WTO law Despite theoretical concerns and limited practical experience, BCAs have emerged as a viable policy option in both developed and developing nations to enhance climate mitigation efforts where global cooperation has fallen short Increasingly, researchers view BCAs as promising tools that can mitigate the economic impacts of ambitious climate policies while incentivizing other countries to bolster their climate initiatives.

The relationship between climate change policy and international trade rules 31

Trade significantly influences greenhouse gas (GHG) emissions and climate change Every business activity impacts the environment, particularly as global energy needs rely heavily on fossil fuels The rising global population further escalates energy demands, resulting in increased GHG emissions Countries pursuing economic development without strategic planning are likely to exacerbate these emissions While many nations adopt a liberalized trade approach, it presents both advantages and disadvantages for environmental sustainability.

91 Weber, “Border Tax Adjustment – Legal Perspective,” 407–8

92 Mehling et al., “Designing Border Carbon Adjustments for Enhanced Climate Action,” 16

93 Cottier and Shariff, “International Trade and Climate Change,” 417 emission 94

Trade liberalization fosters the advancement of clean technologies, which can counterbalance the emissions associated with economic growth Increased participation in the global economy enhances a country's access to research and development, including technology transfer from other nations Furthermore, as citizens achieve higher income levels, their environmental awareness grows, leading to a shift in consumer behavior towards more environmentally friendly products.

Climate change significantly impacts sustainable economic development by altering countries' comparative advantages, particularly in agriculture It poses risks to agricultural productivity, potentially leading to reduced exports of key products Moreover, extreme weather events associated with climate change can severely disrupt supply, transportation, and distribution networks.

Cole and Elliott's research indicates that greater trade openness is likely to lead to increased CO2 emissions Their analysis of data from 32 developed and developing countries between 1975 and 1995 reveals that for every 1 percent increase in trade, per capita CO2 emissions rise by 0.04 percent This study highlights the significant impact of trade on environmental outcomes, emphasizing the need for careful consideration of trade policies in relation to environmental regulations.

95 Margareta Tợmbur, “International Trade Development - Risks for the Environment?,” Economy Transdisciplinarity Cognition; Bacau 13, no 2 (2010): 6–22

The Environmental Kuznets Curve suggests that as a country's income per capita increases, environmental degradation initially worsens until a certain income threshold is reached, after which there is a greater concern for environmental quality However, the applicability of the Kuznets Curve to greenhouse gas emissions remains a topic of debate, with some studies indicating that this hypothesis is primarily relevant to OECD member countries Notable research, such as the work by Rachel S Franklin and Matthias Ruth, highlights these dynamics in the context of environmental geography and development.

Climate Change: A Report by the United Nations Environment Programme and the World Trade Organization (UNEP/Earthprint, 2009), 53

97 Cottier and Shariff, “International Trade and Climate Change,” 418

98 Intergovernmental Panel on Climate (IPCC), Climate Change 2014, 3:368

Economists regard climate as a public good, highlighting that industries have not fully accounted for their environmental impact, with climate change seen as a major market failure Experts like Stern and Treasury advocate for carbon pricing through taxes, trading, or regulations to encourage a shift away from high-carbon goods and services National trade measures, such as tariffs and subsidies, can support climate objectives by discouraging emission-intensive products and promoting a low-carbon economy However, the World Trade Organization (WTO) aims to prevent countries from using environmental policies as a guise for protectionism, necessitating a balance between climate policies and international trade regulations This balance is crucial to avoid conflicts between WTO obligations and national climate measures, particularly concerning carbon leakage, which will be further explored in Chapter 2.

Conclusion to Chapter 1

Climate change is one of the most severe challenge for international

99 Stern and Treasury, The Economics of Climate Change, 25; See also Brian Andrew, “Market Failure, Government Failure and Externalities in Climate Change Mitigation: The Case for a Carbon Tax,”

Public Admin Dev 28, no 5 (December 1, 2008): 394

100 Stern and Treasury, The Economics of Climate Change, xviii

The need for a significant shift in global socio-economic production and consumption patterns to address climate change cannot be achieved by individual countries alone; it necessitates a multinational framework Despite over two decades of negotiations, international cooperation on climate change mitigation has seen little progress In response, some nations have implemented national measures to promote climate change mitigation and prevent carbon leakage, including Border Carbon Adjustments, which have garnered support from scholars and policymakers However, the compatibility of these measures with WTO law remains a contentious issue.

Border Carbon Adjustments in Practice and Their Compatibility with

Past proposals and limitations concerning Border Carbon Adjustments

For over twenty years, countries have suggested implementing border carbon adjustments (BCAs), yet these measures have seldom been adopted by governments Recently, however, there has been an increased willingness to introduce BCAs as a policy option in developed nations like the U.S and the EU, while some developing countries are also considering them This article will analyze the context and substance of past proposals from the EU and the U.S., highlighting the rising policy expectations for decisive climate action.

In 2005, the European Union initiated the first Emissions Trading System

102 Mexico committed an emissions reduction of 40 percent, subject to include BCAs in its NDC See Mexico Government, “Intended Nationally Determined Contribution (INDC) for the Paris Agreement,” March 30, 2015, 2

The EU Emissions Trading System (ETS), operational from 2005 to 2030, aimed to fulfill the EU's Kyoto Protocol commitments by capping greenhouse gas emissions from energy-intensive industries Under Directive 2003/87/EC, firms received emissions allowances through a set allocation process, allowing them the flexibility to invest in climate-friendly technologies or utilize their allowances as needed Each year, companies submitted their emissions data to the ETS regulator, enabling them to choose the most economically efficient method for reducing emissions.

The allocation of emission allowances has evolved through three trading phases, each with distinct approaches In the initial phase (2005-2007), free emission allowances were distributed by the regulator The second phase (2008-2012) introduced auctioning for a small portion of these allowances Currently, in the trading phase from 2013 to 2020, numerous modifications have been implemented to stabilize the carbon market and maintain elevated prices for emissions allowances These recent changes signify a notable advancement in the allocation process, sparking intense debate over carbon leakage and the potential for border measures.

The 2003 Directive 2003/87/EC, established by the European Parliament and Council on October 13, 2003, creates a framework for trading greenhouse gas emission allowances within the European Community, while also amending Council Directive 96/61/EC This legislation aims to enhance environmental protection by regulating emissions and promoting sustainable practices across member states.

104 Mikael Skou Andersen, “Border Adjustment with Taxes or Allowances to Level The Price of Carbon: Maket-Based Perspectives,” in Innovation Addressing Climate Change Challenge, ed Mona

Hymel et al., vol XX, Critical Issues in Environmental Taxation (Edward Elgar Publishing, 2018), 20–

In early 2018, the EU updated its legislative goals for the Emissions Trading System (ETS) as part of its commitment to the Paris Agreement, introducing the "2030 Climate Change Energy Policy Framework." This revision aimed to reduce allowances for EU manufacturers to enhance market stability while preserving free allowances to protect the international competitiveness of industries at risk of carbon leakage.

Between 2007 and 2016, the European Commission and its member states proposed various border adjustment measures to combat carbon leakage The initial proposal, known as the "Future Allowance Import Requirement" (FAIR), was introduced in 2007 as part of an unpublished draft for a revised ETS Directive This proposal mandated that importers provide emissions allowances at the border based on a specific formula estimating a product's potential emissions The regulation targeted products deemed at risk for carbon leakage, which could lead to unfair international competition Although the EU did not fully adopt the FAIR proposal, some concepts related to border carbon adjustments were eventually incorporated into Article 10 of the revised ETS Directive.

The Italian Senate has urged the EU to explore an "addendum tax" aimed at equalizing energy and environmental costs of goods according to their carbon intensity, which could negatively impact the economy To mitigate these adverse effects, adjustments to Value Added Taxation (VAT) rates are proposed However, due to the proposal's vague details regarding policy design, including timelines and Border Carbon Adjustment (BCA) levels, it will not be discussed further.

EU to Introduce Carbon Border Adjustment to Protect Industry,” Carbon Pulse, July 20, 2017

The formula used to calculate emissions for a specific product in the EU involves determining the average emissions, subtracting the free allocation allowances for production, and multiplying the result by the quantity of the actual imported product.

The European Commission's proposal, COM (2008) 30 final, seeks to amend Directive 2003/87/EC to enhance and expand the Community's Greenhouse Gas Emission Allowances Trading System established in 2008 This initiative aims to improve the efficiency and effectiveness of emissions trading, contributing to the European Union's climate goals.

The 2009/29/EC article marked a significant shift by allowing border carbon adjustments to address carbon leakage Key policy options for implementing these adjustments included the free allocation of allowances, the inclusion of importers in the EU Emissions Trading System (ETS), and targeted measures to identify leakage specifically within the electricity sector.

Later, the French government launched a second proposal which attempted to include importers of goods manufactured outside Europe into the EU ETS through the

In 2009, the "Carbon Inclusion Mechanism" (CIM) proposed two options for the EU regarding the purchase of allowances by importers: one for countries not participating in international climate agreements and another for targeted goods from nations lacking comparable carbon-pricing programs The proposal aimed to calculate allowances based on the average carbon content of similar goods produced within the EU, adjusting for free allocations based on product benchmarks Ultimately, the EU rejected this proposal, believing it would complicate discussions on Border Carbon Adjustments (BCAs) and hinder negotiations on future climate agreements.

Following the establishment of the Paris Agreement, an unofficial document from the French government proposed an alternative Carbon Intensity Measure (CIM) This paper recommended that the European Union Emissions Trading System (EU ETS) take into account multiple criteria when implementing Border Carbon Adjustments (BCAs) for imported goods.

The 110 Directive 2009/29/EC, enacted by the European Parliament and Council on April 23, 2009, amends Directive 2003/87/EC to enhance and expand the Community's greenhouse gas emission allowance trading scheme, ensuring its relevance within the European Economic Area (EEA).

111 Mehling et al., “Designing Border Carbon Adjustments for Enhanced Climate Action,” 27

The article discusses the significant role of high carbon concentration products, particularly in the cement industry, in contributing to total greenhouse gas emissions in Europe It highlights the need for a feasible carbon footprint assessment and suggests that a Carbon Import Measure (CIM) could effectively address issues related to imports and prevent windfall profits from free allowances under the EU Emissions Trading System (ETS) In December 2016, the Committee on Environment, Public Health and Food Safety adopted a proposal for the fourth trading phase of the EU ETS (2021-2030), aiming to align with the EU's commitments under the Paris Agreement However, this proposal was ultimately rejected by the European Parliament in February 2017.

In the United States, administrations have expressed concerns about international climate actions, fearing they may impact the domestic economy Specifically, there is apprehension that global climate initiatives could lead to inconsistencies affecting American manufacturing, particularly regarding emissions reduction disputes This concern prompted the Senate to pass a unanimous resolution addressing these issues.

1997 proclaiming that the U.S should not participate any climate agreement that would

“result in serious harm to the U.S economy” or impose limits on GHG emissions

Border adjustment measures in international trade

2.2.1 The history and evolution of the border adjustment practices

In international trade, governments utilize border adjustments to enhance the competitive edge of domestic producers and boost revenue According to a GATT Working Party, "Border Tax Adjustments" (BTAs) refer to fiscal measures that implement the destination principle This principle allows exported goods to be exempted from some or all taxes imposed in the exporting country, similar to domestic products sold locally Conversely, it also permits the taxation of imported goods in the importing country, aligning them with domestic products.

Border Tax Adjustments (BTAs) are applied to imported goods, aligning them with taxes imposed on similar domestic products They can lead to exemptions or refunds of previously paid charges or taxes for domestic producers when exporting their products The primary goal of BTAs is to ensure trade neutrality in domestic taxation and to prevent competitive distortions between domestic and imported goods due to varying tax systems across countries By implementing BTAs, the risk of double taxation or non-taxation is mitigated.

In addition to fiscal measures, border adjustments can also take the form of domestic regulations such as standards, requirements that set conditions for the entry

119 WTO and UNEP, “Trade and Climate Change,” 100

120 GATT Working Parties, Report by the Working Party on Border Tax Adjustment, L/3464, para.4

Border Tax Adjustments (BTAs) have a historical precedent dating back to the 18th century, when countries first implemented them as "excise taxes" on imports such as alcohol, cigarettes, and fuel In the 19th century, bilateral trade agreements began to incorporate regulations on BTAs, particularly regarding Value Added Tax (VAT) and excise duties, to prevent double taxation These practices have persisted and evolved over time, maintaining their relevance in contemporary trade discussions.

BTAs have faced resistance from various countries, particularly highlighted by the European Community's (EC) adoption of export rebates on VAT in the 1960s This move raised concerns about competitive pressures between European and U.S producers in third-country markets Critics argued that the EC's policy failed to provide meaningful protection, as shifting from an origin to a destination basis in VAT did not yield significant trade advantages for the EC when coupled with a destination-based duty.

Border adjustment measures, originally designed to enhance the competitiveness of domestic producers, have been repurposed by some countries to address additional goals like environmental protection A prime example of this is the U.S Superfund Amendments and Reauthorization Act of 1986, which aimed to fund the disposal of hazardous wastes and toxic chemicals through the imposition of border tax adjustments on specific substances.

122 Holzer, Carbon-Related Border Adjustment and WTO Law, 2014, 64

123 Frank Biermann and Rainer Brohm, “Implementing the Kyoto Protocol without the USA: The Strategic Role of Energy Tax Adjustments at the Border,” Climate Policy 4, no 3 (2004): 289–302

In their article, Ben Lockwood and John Whalley discuss the implications of carbon-motivated border tax adjustments, questioning whether these measures are truly innovative or simply a rebranding of existing practices They highlight that certain inputs for chemical derivatives used in fertilizer production were affected by these adjustments Despite challenges from Canada, the European Community, and Mexico, a GATT panel concluded that the Act was consistent with GATT rules, as the duties imposed were comparable to those on similar domestically produced substances.

In 1989, the U.S enacted the Omnibus Budget Reconciliation Act, which introduced an excise tax on ozone-depleting chemicals (ODCs) to align with the Montreal Protocol's goals of phasing out these harmful substances This ODCs tax imposed a charge on imports equivalent to the domestic tax, while allowing rebates for domestically produced ODCs that were exported The border adjustment related to ODCs was designed to safeguard domestic producers and ensure compliance with international commitments to eliminate ozone-depleting substances.

The U.S Acts introduce border adjustment measures for imported and exported products, focusing on environmental policies and the greenhouse gas (GHG) emissions associated with production processes Unlike traditional border tax adjustments, these climate-related measures prioritize the carbon footprint of products rather than their inputs As previously discussed, beyond ensuring fair competition between domestic and imported goods, climate-related border adjustments can also serve more ambitious goals, such as mitigating climate change impacts.

126 C C H Editors, U.S Master Excise Tax Guide (CCH, 2008)

127 United States - Taxes on Petroleum and Certain Imported Substances, L/6175-34S/136, para.5.2.7-10 (GATT Panel Report June 17, 1987)

128 Sara P Boroshok, “Environmental Excise Taxes, Focusing on Ozone-Depleting Chemicals, 1993,” accessed April 2, 2018 https://www.irs.gov/pub/irs-soi/93exenviro.pdf

Biermann and Brohm emphasize the complexities of implementing the Kyoto Protocol, particularly in light of the USA's absence, highlighting issues like carbon leakage and the need to internationalize the social costs of carbon reduction They note that political sensitivities make border carbon adjustments significantly more contentious than traditional border adjustments concerning their compatibility with WTO regulations.

2.2.2 WTO legal framework concerning border carbon adjustments

Scholars are divided on the effectiveness of market mechanisms in addressing climate change and carbon leakage While some advocate for universal emission taxes or cap-and-trade systems as superior to unilateral greenhouse gas (GHG) emission reduction measures, others warn that unilateral border carbon adjustments (BCAs) may hinder future global cooperation on climate agreements Nevertheless, given the stagnation in global progress, many argue that individual actions, even if not perfect, are significantly better than inaction.

BCAs, as outlined in Chapter 1, encompass both price-based and non-price-based restrictions Price-based measures include carbon taxes on imports, international reverse allowances for importers, and export tax rebates for domestic producers Meanwhile, non-price-based measures consist of specific standards or requirements regarding the greenhouse gas emissions levels of imported products.

130 Holzer, Carbon-Related Border Adjustment and WTO Law, 2014, 258

131 James R Markusen, “International Externalities and Optimal Tax Structures,” Journal of International Economics 5, no 1 (1975): 15–29

132 Trevor Houser, Leveling the Carbon Playing Field: International Competition and US Climate Policy Design (Peterson Institute, 2008); and S Drửge et al., “Tackling Leakage in a World of Unequal

133 Madison Condon and Ada Ignaciuk, Border Carbon Adjustment and International Trade: A Literature Review, Paris, France, OECD Trade and Environment Working Papers (Paris, France:

Organisation for Economic Cooperation and Development (OECD), October 31, 2013), 5

134 Gabrielle Marceau, “The Interface Between the Trade Rules and Climate Change Actions,” in Legal

Issues on Climate Change and International Trade Law, ed Deok-Young Park (Springer, 2016), 5–6

Border Carbon Adjustments (BCAs) may be governed by GATT/WTO law, with certain WTO Agreement provisions applicable to both import and export adjustments Import border adjustments must comply with non-discrimination rules, including most-favoured-nation treatment and national treatment principles as outlined in Articles I and III of GATT 1994 Conversely, export border adjustments are subject to WTO subsidy regulations under GATT 1994 and the Agreement on Subsidies and Countervailing Measures (SCM Agreement) Additionally, the Agreement on Technical Barriers to Trade (TBT Agreement) may apply when border adjustments relate to product characteristics.

The World Trade Organization (WTO) Agreements were not originally designed to address climate change, leading to complex legal issues at the intersection of trade rules and domestic climate policies Non-discrimination principles emphasize fair treatment of imported and domestic products, yet climate policies aimed at reducing greenhouse gas (GHG) emissions often focus on production processes rather than the products themselves Additionally, defining comparable climate policies and their effects across different countries poses significant challenges, particularly in relation to Article provisions.

XX of GATT and the TBT Agreement

Border adjustments on exports, such as Border Carbon Adjustments (BCA), can involve financial aid and tax rebates aimed at particular producers, industries, or countries These measures may raise concerns regarding their compliance with the General Agreement on Tariffs and Trade (GATT) and the Subsidies and Countervailing Measures (SCM) Agreement Although the World Trade Organization (WTO) permits its members to rebate or remit taxes, the implications of such adjustments warrant careful examination.

The imposition of carbon leakage measures and border tax adjustments, as discussed by Joost Pauwelyn and Reinhard Quick, is a critical issue under WTO law These measures, particularly in the context of emission trading, raise concerns about climate protection potentially veering into protectionism Notably, the regulations prohibit applying such measures to firms or industries intended for exportation, ensuring that international trade remains unaffected Further elaboration on these complex issues will follow.

The eligibility of price-based climate measure for border adjustment

The legality of a price-based climate measure, such as a carbon tax or international reverse allowance, hinges on its eligibility for border adjustment Only indirect taxes, which are applied to products, can be adjusted at the border, while direct taxes imposed on producers cannot If a price-based Border Carbon Adjustment (BCA) is classified as an indirect tax, it would fall under Article I and III:2 of GATT as an internal tax Conversely, if deemed a direct tax or tariff, it would be governed by Article II.

Article II of the GATT mandates that tariffs on imported goods at borders must be strictly limited to specified rates, prohibiting countries from raising these tariffs without renegotiating market access commitments According to Article II:1(b), imported products listed in a tariff concession schedule are exempt from any ordinary customs duties beyond those outlined in the schedule and are also free from additional duties or charges exceeding those in effect at the time of the Agreement.

Article II:2(a) of the WTO agreements permits member countries to impose charges on imported products that are equivalent to internal taxes applied to similar domestic goods This provision ensures that imports are subject to the same financial obligations as local products, promoting fair competition within the market.

136 Cosbey et al., “A Guide for the Concerned.”

137 Jochem Wiers, Trade and Environment in the EC and the WTO: A Legal Analysis (Europa Law

The GATT Working Party in 1970 clarified that price-based measures, aside from tariffs, can be implemented at borders, provided they impose charges equivalent to internal taxes This exception is rooted in the destination principle, which asserts that products should only be taxed in the country where they are consumed.

There is a consensus that indirect taxes, such as specific excise duties, sales taxes, cascade taxes, and value-added tax, qualify for tax adjustments.

The Working Party determined a consensus that certain indirect taxes, specifically direct taxes not imposed on products, are ineligible for tax adjustment Notable examples include social security contributions and payroll taxes.

The GATT Working Party differentiated between "indirect taxes" on products and "direct taxes" on producers, noting that only indirect taxes can be adjusted at the border Indirect taxes are considered equivalent to internal taxes, while other taxes that are not directly levied on products typically do not qualify for such adjustments.

Article II:2(b) defines a charge similar to an internal tax that aligns with Article III's provisions regarding domestic products or articles from which imported goods are made Additionally, Article II outlines various price-based measures, such as anti-dumping and countervailing duties, as well as service charges In relation to climate change, countervailing measures may be applied by states on subsidized imports, a topic further explored in Section 6 of this chapter.

When Border Carbon Adjustments (BCAs) take the form of carbon taxes on imports or international reverse allowances, a key consideration is the classification of these measures as either direct or indirect taxes, in accordance with the requirements outlined in Article II:1(b).

Some scholars argue that border tax adjustments should be based exclusively on the destination principle of indirect taxes, as tariffs and customs duties directly impose tax costs on producers This approach allows consumption taxes to pass costs onto consumers, creating a level playing field between domestic and imported goods without additional burdens on producers This perspective highlights the difference between consumer taxation and foreign producer taxation Conversely, others believe that both indirect and direct taxes, such as fuel and payroll taxes, can influence product prices since they are imposed on inputs and reflected in final prices They suggest that the distinction between direct and indirect taxes may stem from administrative feasibility, as taxes on imports or consumers are easier to trace than those on foreign producers.

There is currently a lack of clear guidance regarding the classification of taxes eligible for border adjustment under Article II:2 of the GATT Some experts propose that direct taxes could be applicable to production factors, including labor.

142 Wiers, Trade and Environment in the EC and the WTO, 22

The interface between trade and climate change regimes presents significant challenges, as highlighted by Holzer's analysis of carbon-related border adjustments and their implications under WTO law Additionally, the work of Low, Marceau, and Reinaud emphasizes the need to explore the complexities of these issues in the context of global trade dynamics.

144 Paul Demaret and Raoul Stewardson, “Border Tax Adjustment Under GATT and EC Law and General Implications for Environmental Taxes,” J World Trade 28 (1994): 15

The Appellate Body in the China-Auto Parts case (2009) clarified that a border duty on imports could violate Article II:1 if it exceeds the established tariff schedule Additionally, an internal tax is permissible under Article III:2, provided it is non-discriminatory.

For a charge to constitute an ordinary customs duty [subject to

Article II] the obligation to pay it must accrue at the moment and by virtue of or, in the words of Article II:1(b), “on,” importation

On the other hand, charges falling within the scope of Article III are charges that are imposed on goods that have already been

“imported,” and that the obligation to pay them is triggered by an

“internal” factor, something that takes place within the customs territory 148

The Appellate Body determined that China's border duties on auto parts are classified as "internal charges" rather than customs duties, as these charges arise from internal factors and are assessed only after the motor vehicles are completed, not at the time of importation This ruling suggests that if a duty is triggered by internal events like distribution, sale, use, or transportation of an imported product, it falls under Article III as an "internal charge." Conversely, if the duty is imposed solely upon importation, independent of domestic market distribution, it is considered a border measure governed by Article II.

147 Low, Marceau, and Reinaud, “Interface between the Trade and Climate Change Regimes,” 10

148 China - Measures Affecting Imports of Automobile Parts, WT/DS339,340,342/AB/R, para.158 (WTO Appellate Body Report January 12, 2009)

In the case of India-Additional Import Duties (2008), the Appellate Body evaluated the U.S complaint regarding India's import taxes, which were claimed to violate Article II:1 due to exceeding tariff-binding rates India contended that Article III and II:2(a) were applicable, arguing that the duties were imposed as substitutes for state excise taxes on similar domestic alcoholic beverages and aimed to offset local taxes However, the Appellate Body determined that these duties violated the national treatment principle outlined in Article III:2, as they did not apply equivalent charges on domestic products Furthermore, the measure was found to breach the tariff binding commitment under Article II:1(b).

The Appellate Body also stated the relationship between border measures qualified as border tax adjustments under Article II:2(a) and border measures entitled custom duties under Article II:1(b), as follows:

The chapeau of Article II:2 … connects Articles II:1(b) and II:2(a) and indicates that the two provisions are inter-related Article

Non-discrimination principles

2.4.1 The debate concerning the Product and Production Method

The compatibility of non-physical product characteristics with WTO law has sparked considerable debate While the term "processes and production methods" (PPMs) is not explicitly defined in the WTO Agreement, certain provisions do make reference to it.

The OECD defines Production and Process Methods (PPM) as the techniques used in manufacturing products and extracting natural resources Trade measures associated with PPM, known as PPM measures, are designed to promote public goods, including environmental protection, human health improvement, and climate change mitigation.

PPMs can be categorized into product-related and non-product-related measures Product-related PPMs directly affect the final product and address consumption externalities, including food safety standards and pesticide residues in agricultural goods Conversely, non-product-related PPMs, such as import bans on fish products harvested using harmful environmental practices, focus on production externalities, which pertain to the environmental impact of production methods rather than the later stages of a product's lifecycle.

The debate over PPM measures originated from GATT Panel findings in two US-Tuna cases In the early 1990s, the U.S enforced an embargo on Mexican tuna due to methods that resulted in incidental dolphin deaths This was followed by a second embargo targeting countries that did not treat Mexican tuna similarly Mexico contested the first embargo in the US-Tuna I (Mexico) case, citing Articles XI, XIII, and III of GATT, while the EEC challenged the second embargo.

The SPS Agreement's Annex A, Paragraph 1, along with Paragraphs 1 and 2 of Annex 1 of the TBT Agreement, Paragraph 12 of Annex 2 of the Agreement on Agriculture, and Article 51 of the TRIPS Agreement, collectively outline critical provisions that govern international trade regulations.

164 OECD, Processes and Production Methods (PPMs): Conceptual Framework and Considerations on

Use of PPM-Based Trade Measures, OCDE/GD(97)137, (1997), 7, fn.30

The interplay between environmental processes and production methods (PPMs) in international trade law, particularly within the WTO framework, is critically analyzed in works by Charnovitz and Gaines These studies emphasize the necessity of developing sound policies that incorporate environmental considerations into trade measures, highlighting the complexities of balancing trade and sustainability Additionally, Wiers explores the implications of these issues within the context of the European Community and the WTO, underscoring the importance of aligning trade practices with environmental protection goals.

166 United States - Restrictions on Imports of Tuna, DS21/R unadopted (GATT Panel Report September

3, 1991) in US-Tuna I (EEC) based on Articles XI and III of the GATT 167

The GATT Panels determined that the U.S PPM measures could hinder market access for exporting members and violate the non-discrimination principle, despite their goal of environmental protection They concluded that differences in production methods did not impact the likeness test when products were physically identical or similar Additionally, the panels ruled that these measures could not be justified under Article XX if they aimed to protect environmental resources outside the jurisdiction of the importing states The panels expressed concerns that allowing such measures could undermine the GATT's function, as it would jeopardize the multilateral trade framework and legal security Consequently, the GATT Panels in the US-Tuna cases declared that distinctions based on PPM characteristics are inherently illegal.

Critics of the GATT panel's findings contend that these rulings may hinder GATT Members from achieving their environmental goals and preserving their sovereignty Furthermore, such decisions could alienate the WTO from pressing global issues like environmental protection and climate change, particularly when panels deem PPM measures illegal Conversely, recognizing the legitimacy of the PPM characteristic could pave the way for more environmentally conscious trade practices.

167 United States - Restrictions on Imports of Tuna, DS29/R unadopted (GATT Panel Report June 16,

169 US-Tuna I (Mexico), para.5.26-7 (GATT Panel Report September 3, 1991)

Charnovitz discusses the legal implications of environmental product and process methods (PPMs) within the WTO framework, while Vranes examines the relationship between carbon taxes, PPMs, and GATT regulations Additionally, Matsushita et al provide comprehensive insights into the WTO's laws, practices, and policies, highlighting the intersection of trade and environmental standards.

171 Robert E Hudec, “GATT/WTO Constraints on National Regulation: Requiem for an Aim and Effects Test,” in Int’l L., vol 32 (HeinOnline, 1998), 11–12; Charnovitz, “The Law of Environmental

The likeness test in the WTO may encourage unilateral actions against imports from countries with differing domestic policies, potentially undermining trade liberalization objectives Additionally, the WTO agreements address only a limited number of provisions concerning Product and Process Methods (PPMs), while numerous trade disputes arise from non-trade issues, particularly environmental concerns As there is currently no international body like the WTO dedicated to environmental protection, the frequency of disputes regarding the tension between trade development and environmental sustainability is expected to rise, prompting further discussions on PPMs.

Commentators frequently analyze the reasoning of GATT Panels in the US-Tuna cases by referencing the foundational principles established in the 1947 GATT preamble, which highlights one of its key objectives.

The focus of trade and economic relations should be on improving living standards, achieving full employment, and increasing real income and effective demand This involves maximizing the world's resources and enhancing the production and exchange of goods.

The drafters of GATT, therefore, insisted that trade development be its main purpose However, the preamble of the WTO Agreement, adopted in 1994, is slightly

172 Aaron Cosbey, “Achieving Consensus: Multilateral Trade Measures in Post-2012 Scenarios,”

Climate and Trade, 2009, 130; John H Jackson, “World Trade Rules and Environmental Policies:

Congruence or Conflict,” Wash & Lee L Rev 49 (1992): 11

The GATT lacks a specific provision addressing PPM measures, while the TBT Agreement includes them as "technical regulations" that define product characteristics However, this definition excludes PPM measures that do not affect the physical attributes of products These topics will be explored in detail in the subsequent sections.

174 David Sifonios, Environmental Process and Production Methods (PPMs) in WTO Law (Springer,

175 The Preamble of the GATT 1947 different from that of the GATT The preamble states:

Countries aim to enhance trade and economic relations to improve living standards, achieve full employment, and increase real income and effective demand They focus on expanding the production and trade of goods and services while optimizing global resource use for sustainable development This approach seeks to protect the environment and enhance preservation efforts, considering the diverse needs and concerns associated with varying levels of economic development.

The preamble of the WTO Agreement emphasizes sustainable development, highlighting the importance of balancing economic growth with environmental conservation, rather than merely focusing on trade expansion This shift has significantly influenced the interpretation of relevant GATT provisions.

Justifications under Article XX of the GATT 1994

A measure that contravenes a GATT provision can be allowed if it meets the conditions outlined in Article XX of the GATT In the case of US-Gasoline, the Appellate Body utilized a two-tier test to assess whether the measure could be justified under Article XX.

XX 229 First, the measure must fall within one of the exceptions under sub-paragraphs (a) to (j) Among the exceptions, sub-paragraphs (b) and (g) are particularly important in the case of climate measures Sub-paragraph (b) allows exceptions for measures that are “necessary” to protect human, animal, plant life, or health and sub-paragraph (g) allows exceptions for measures relating to the conservation of exhaustible natural resources Second, it must also satisfy the chapeau of the article

2.5.1 Article XX(b) – Measures necessary for the protection of health

To assess if the measure in question is "necessary" for achieving the goal outlined in sub-paragraph (b), the Appellate Body in the Korea-Beef case utilized a necessity test that involved a "weighing and balancing" of the relevant values However, in the Brazil-Retreated case, the approach may differ.

228 European Communities - Measures Affecting the Approval and Marketing of Biotech Products, WT/DS291/R; WT/DS292/R; WT/DS293/R, para.7.2514 (WTO Panel Report November 21, 2006)

229 United States - Standards for Reformulated and Conventional Gasoline, WT/DS2/AB/R, para.22 (WTO Appellate Body Report May 20, 1996)

230 Korea - Measures Affecting Imports of Fresh, Chilled and Frozen Beef, WT/DS161/AB/R, WT/DS169/AB/R, para.161–164 (WTO Appellate Body Report January 10, 2001)

In the case of Tyres, the Appellate Body evaluated the material contribution of the measure to its objectives by applying a three-step test This test assessed the significance of the objective, the measure's contribution to achieving that objective, and its trade restrictiveness, while also considering less trade-restrictive alternatives that could still fulfill the original goal.

In the Brazil-Retreated Tyres case, the Appellate Body highlighted that for a measure to be justified, its contribution to the intended objective must be substantial and demonstrate a genuine connection between the objective and the means employed.

An import ban or other trade-restrictive measures can be justified under Article XX(b) even if their immediate effects are not apparent Addressing complex environmental issues often requires a comprehensive policy that includes multiple interconnected measures The effectiveness of actions aimed at mitigating global warming and climate change can only be assessed over time.

The Appellate Body evaluates the role of a Border Carbon Adjustment (BCA) in meeting climate-policy goals with a more lenient approach compared to other contexts This suggests that the assessment of BCAs may prioritize environmental objectives over strict regulatory compliance.

231 Brazil - Measures Affecting Imports of Retreaded Tyres, WT/DS332/AB/R, para.151 (WTO Appellate Body Report December 3, 2007)

Border Carbon Adjustments (BCAs), including carbon taxes and climate-related regulations, aim to reduce emissions by addressing carbon leakage and ensuring a level playing field for businesses However, it remains uncertain whether the World Trade Organization (WTO) will recognize the connection between BCAs and their intended environmental objectives.

The third step in challenging the legality of a Border Carbon Adjustment (BCA) under WTO rules requires the member to demonstrate the availability of less trade-restrictive alternatives To meet this criterion, the primary objective of implementing BCAs must focus on their effectiveness in reducing global emissions, rather than merely addressing competitiveness issues for domestic industries against imports However, studies indicate that WTO panels and the Appellate Body have historically interpreted these justifications narrowly, primarily accepting those related to human, animal, or plant health As a result, several commentators suggest that BCAs may struggle to satisfy this critical requirement.

2.5.2 Article XX(g) – Measures relating to the conservation of exhaustible natural resources

Sub-paragraph (g) focuses on measures related to the conservation of exhaustible natural resources, contrasting with sub-paragraph (b), which permits exceptions necessary for human health protection The WTO panels and the Appellate Body have defined "exhaustible resources" to include species such as tuna, sea turtles, and dolphins.

The Appellate Body initially mandated that a country invoking an exception must demonstrate the absence of alternatives; however, it later determined that the country only needs to establish the necessity of the measure Consequently, the burden of proof shifts to the complaining country, as outlined in the WTO Appellate Body Report on the United States' measures affecting the cross-border supply of gambling and betting services (WT/DS285/AB/R, para 309, April 20, 2005).

236 Weber, “Border Tax Adjustment – Legal Perspective,” 415

237 Monjon and Quirion, “A Border Adjustment for the EU ETS,” 1212–25

238 United States - Prohibition of Imports of Tuna and Tuna products from Canada, L/5198-29S/91 (GATT Panel Report February 22, 1982)

The WTO Appellate Body Report on the United States' import prohibition of certain shrimp and shrimp products highlights the relationship between greenhouse gas (GHG) emissions and natural resources GHG emissions can be considered an exhaustible natural resource, akin to clean air, as their levels impact atmospheric quality over time Border carbon adjustments (BCAs) aimed at reducing GHG emissions are crucial, as climate change depletes other vital natural resources, including forests, fisheries, and biodiversity.

The term "relating to" in sub-paragraph (g) emphasizes the necessity of a close relationship between the structure of a measure and its carbon emissions reduction goals, as established by the Appellate Body in US-Shrimp (1998) To meet this criterion, a Border Carbon Adjustment (BCA) should focus on mitigating carbon leakage and lowering emissions rather than merely enhancing the competitiveness of domestic producers Additionally, it is argued that this term mandates fair domestic policies to achieve public policy objectives, although it does not require identical treatment for domestic and imported products Consequently, the effectiveness of a BCA that treats domestic and imported products differently based on environmental impacts remains uncertain.

240 United States - Restrictions on Imports of Tuna, DS21/R unadopted (GATT Panel Report September

241 Canada - Measures Affecting Exports of Unprocessed Salmon and Herring, L/6268-35S/98 (GATT Panel Report March 22, 1988)

242 United States - Standards for Reformulated and Conventional Gasoline, No WT/DS2/AB/R (World Trade Organization Appellate Body Report May 20, 1996)

243 Bradly J Condon, “Climate Change and Unresolved Issues in WTO Law,” J Int Economic Law 12, no 4 (December 1, 2009): 895–926

244 United States - Import Prohibition of Certain Shrimp and Shrimp Products, WT/DS58/AB/R, para.128–131 (WTO Appellate Body Report November 6, 1998)

245 James Bacchus, “Questions in Search of Answers: Trade, Climate Change, and the Rule of Law,” in

Keynote Address to the Conference on “Climate Change, Trade and Competitiveness: Issues for the WTO”, Geneva, vol 16, 2010, 13

246 Condon, “Climate Change and Unresolved Issues in WTO Law,” December 1, 2009, 912–13 could qualify under this requirement

2.5.3 The chapeau of Article XX – The good-faith test

Sub-paragraph (b) and (g) must be interpreted alongside the chapeau of Article

XX mandates that measures must not lead to "arbitrary or unjustifiable discrimination" or act as "disguised restrictions on international trade." In the context of climate change, countries may need to show genuine efforts to achieve international consensus before implementing Border Carbon Adjustments (BCAs) Despite international agreements like the Kyoto Protocol and the Paris Agreement setting emission-reduction targets, they lack enforcement mechanisms for compliance Consequently, it remains uncertain whether a WTO Member imposing BCAs on countries that do not meet their climate commitments would be deemed as engaging in "arbitrary or unjustified discrimination" or creating "disguised restrictions on trade."

The Appellate Body emphasized that discrimination among countries under similar conditions is both arbitrary and unjustifiable, especially when such discrimination lacks a reasonable connection to the intended objective or contradicts it In the context of climate change, a WTO Member implementing Border Carbon Adjustments (BCAs) may impose restrictions not only on imports but also on other related aspects.

Technical barriers to trade

Border Carbon Adjustments, including carbon standards and labeling requirements, must meet the criteria of likeness, necessity, and international standards as outlined in Articles 2.1, 2.2, and 2.4 of the TBT Agreement Additionally, the process and production methods (PPM) associated with these measures may be assessed early on to determine their coverage under the TBT Agreement.

2.6.1 Border Carbon Adjustments and coverage of the Agreement on Technical Barriers to Trade

The TBT Agreement provides a framework for the application of technical regulations and standards that contain requirements related to product characteristics

In the context of climate change, the TBT Agreement raises the question of whether a Border Carbon Adjustment (BCA) can impose a mandatory ceiling on greenhouse gas emissions for market entry According to Annex 1.1 of the TBT Agreement, for a measure to be classified as a “technical regulation,” it must define specific product characteristics or related processes and production methods, be mandatory, and apply to identifiable products or groups of products.

The definition of “technical regulation” in the first sentence of Annex 1.1 of the

TBT Agreement indicates “product characteristics or their related process and

Annex 1.1 of the TBT Agreement defines a document that specifies mandatory product characteristics and related production processes, including necessary administrative provisions This document may also focus exclusively on terminology, symbols, packaging, marking, or labeling requirements relevant to the product or its production methods.

Technical regulations encompass terminology, symbols, packaging, marking, and labeling requirements associated with a product, process, or production method While the TBT Agreement is widely acknowledged to address product-related production and processing methods (PPMs), there remains some ambiguity regarding the interpretation of "related" and its applicability to non-product-related PPMs.

The WTO's adjudicative bodies first addressed process and production methods (PPMs) in the EC-Seal Products case, where specific seal products faced market entry restrictions based on various criteria, including the hunter's identity and the hunting method The panel initially determined that the TBT Agreement applied to a non-product-related PPM measure due to its influence on product characteristics However, the Appellate Body overturned this decision, clarifying that the product's characteristics did not include these distinctions and that the panel needed to assess the relationship between the PPM measure and the product's characteristics.

The Appellate Body determined that only product-related process and production methods (PPMs) are covered by the TBT Agreement, yet it failed to clarify the specific characteristics of these measures Analysts suggest that this interpretation by the Appellate Body limits the classification of PPMs to those that can be traced in the final product.

259 Sifonios, Environmental Process and Production Methods (PPMs) in WTO Law, 225

The WTO Panel Report dated November 25, 2013, and the subsequent Appellate Body Report on May 22, 2014, address the European Communities' measures that prohibit the importation and marketing of seal products These reports, identified as WT/DS400/R and WT/DS401/R for the panel, and WT/DS400/AB/R and WT/DS401/AB/R for the appellate body, evaluate the legality and implications of these trade restrictions within the context of international trade law.

261 EC - Seal Products (Panel Report), para.7.109

262 EC - Seal Products (Appellate Body Report), para.5.12

Most PPMs aimed at combating climate change will not be covered by the TBT Agreement, as they focus on industries or producers instead of specific products While non-product-related PPMs fall outside the TBT Agreement, they are not inherently inconsistent with WTO law Instead, these measures will be evaluated under the GATT, particularly Articles III and XX.

Recent WTO jurisprudence indicates that carbon-footprint labeling requirements clearly fall under the TBT Agreement In cases such as US-Tuna II and US-COOL, the U.S acknowledged the applicability of the TBT Agreement to these labeling measures The panel in US-Tuna II determined that the TBT Agreement encompasses dolphin-safe labeling because it pertains to a specific product, like tuna Consequently, the TBT Agreement is applicable not only to labeling related to product characteristics but also to non-product-related PPM labeling requirements.

If a Border Carbon Adjustment falls within the scope of the TBT Agreement, it

263 Marceau, “The Interface Between the Trade Rules and Climate Change Actions,” 26; Holzer,

Carbon-Related Border Adjustment and WTO Law, 2014, 141

264 Matsushita et al., The World Trade Organization, 732; and Andreas R Ziegler and David Sifonios,

“The Assessment of Environmental Risks and the Regulation of Process and Production Methods (PPMs) in International Trade Law,” Risk and the Regulation of Uncertainty in International Law, 2017, 219–236

265 United States - Measures Concerning the Importation, Marketing and Sale of Tuna and Tuna Product, WT/DS381/AB/R (WTO Appellate Body Report May 16, 2012)

266 United States - Certain Country of Origin Labelling (COOL) Requirements, WT/DS384/AB/R, para.314–315 (WTO Appellate Body Report July 23, 2012)

267 United States - Restrictions on Imports of Tuna, DS29/R unadopted, para.7.62, 7.78 (GATT Panel Report June 16, 1994)

268 Marceau, “The Interface Between the Trade Rules and Climate Change Actions,” 29–30; Holzer,

The Carbon-Related Border Adjustment must adhere to the Most-Favored-Nation (MFN) and National Treatment (NT) principles outlined in Article 2.1 of WTO law In the cases of US-Tuna II and US-Clove Cigarettes, the Appellate Body evaluated three key elements to determine if a regulation contravenes these principles.

The TBT Agreement defines "technical regulation" and stipulates that imported products must be treated equally to domestic products Specifically, it addresses situations where imported goods are given less favorable treatment compared to domestic counterparts This evaluation, outlined in Article 2.1 of the TBT Agreement, parallels the criteria found in Article III:4 of the GATT, as both articles reference "like products" and "less favorable treatment."

In the US-Clove Cigarettes case, the panel initially determined that the assessment of product likeness should focus on legitimate public policy objectives rather than competitive dynamics However, the Appellate Body overturned this conclusion, aligning the likeness test under Article 2.1 of the TBT Agreement with that of Article III:4 of the GATT This alignment emphasizes the need to balance trade liberalization with health protection Consequently, when applying climate standards or carbon-footprint labels to imported and domestic products with similar physical characteristics, these products may not pass the likeness test under Article 2.1 of the TBT Agreement if their climate-friendly attributes influence consumer preferences or competitive market conditions.

The Appellate Body highlighted the lack of a provision in the TBT Agreement that is similar to Article XX of the GATT, a point it revisited in the case of US-Tuna II (Mexico).

269 United States - Measures Affecting the Production and Sale of Clove Cigarettes, WT/DS406/AB/R, para.216 (WTO Appellate Body Report April 4, 2012)

Under Article 2.1 of the TBT Agreement, the complainant must demonstrate that imported products receive "less favorable" treatment compared to similar domestic or foreign products If the complainant provides sufficient evidence to indicate that the measure is not applied equally, it may indicate a violation of Article 2.1.

The Appellate Body suggests that Article 2.1 of the TBT Agreement includes a requirement similar to Article XX of the GATT, implying that labeling requirements for climate standards may not violate the non-discrimination principle if the negative impacts on imported products arise from legitimate regulatory distinctions However, previous measures have not been justified under the TBT Agreement's exceptions to trade liberalization, indicating that WTO adjudicative bodies need to clarify the criteria for a measure to meet the even-handed test in future disputes.

Subsidies

Border Carbon Adjustments (BCAs) can include export rebates of carbon taxes or emission allowances to ensure fair competition for domestic producers in international markets A key consideration is whether these BCAs align with World Trade Organization (WTO) regulations, particularly the Agreement on Subsidies and Countervailing Measures (SCM Agreement).

The SCM Agreement defines a "subsidy" as a "financial contribution" from a government or public body that provides a "benefit" (Article 1.1), and such a subsidy must be "specific" (Article 1.2) In the context of climate change, the free allocation of emissions allowances can be considered a "subsidy" since it represents a "revenue … foregone" by the government, thereby benefiting particular companies or industries that receive these allocations.

Not all measures classified as "subsidies" violate WTO law; only those contingent on export performance or import substitution are deemed illegal under Article 3 of the SCM Agreement Some scholars argue that Border Carbon Adjustments (BCAs), which aim to exempt exporters from tax duties, may qualify as export subsidies However, if carbon taxes and charges under emissions allowance requirements are considered indirect taxes, they can be permissible for export rebates According to Footnote 1 of the SCM Agreement, which elaborates on Article VI:4 of the GATT, exemptions or remissions of duties or taxes on exported products are allowed, provided they do not exceed the amounts applicable to similar products intended for domestic consumption.

278 Weber, “Border Tax Adjustment – Legal Perspective,” 415 which have accrued, shall not be deemed to be a subsidy

Likewise, paragraph (g) of Annex I of the SCM Agreement regulates export subsidy as follows:

Exported products benefit from an exemption or remission of indirect taxes that exceed those imposed on similar products sold for domestic consumption.

In the case of US-FSC, the Appellate Body determined that the U.S foreign sales corporations' exemption from income tax constitutes a prohibited subsidy as outlined in Article 3.1 of the SCM Agreement.

The tax measures identified in footnote 1 as not constituting a

“subsidy” involve the exemption of exported products from product-based consumption taxes The tax exemptions under the

FSC measure relate to the taxation of corporations and not products

Footnote 1, therefore, does not cover measures such as the FSC measure 281

Products exported from countries with specific climate regimes may qualify for exemptions from carbon taxes or emission allowances equivalent to the duties that would have been imposed if sold domestically Additionally, paragraph (g) of Annex I of the SCM Agreement stipulates that any exemption or reduction of indirect taxes on exported goods must not exceed the duties that would normally apply.

The WTO Panel Report on the United States' tax treatment for Foreign Sales Corporations (WT/DS108/R) was issued on October 8, 1999, followed by the WTO Appellate Body Report on the same matter (WT/DS108/AB/R) on February 24, 2000.

280 US – FSC (Panel Report), para.7.108, 7.131

According to the Appellate Body Report in 281 US – FSC, export rebates for "like products" in the domestic market are not classified as export subsidies However, this raises concerns regarding the definition of "like products," particularly since carbon-intensive and climate-friendly products may be subject to different taxation in the domestic market, despite being considered "like" products.

A "prohibited subsidy" is considered specific and can be contested by other WTO Members, while an "actionable subsidy" can only be challenged if it meets the "specific" criteria and demonstrates an "adverse effect" on international trade.

The "specific" test mandates that a subsidy must be allocated to "certain enterprises," as outlined in Article 2.1 of the SCM Agreement, which refers to particular enterprises or industries within the jurisdiction of the granting authority However, the provision does not specify the exact number of enterprises or industries required for a measure to be classified as specific In WTO case law, the majority of the subsidies under review have been deemed specific.

Panels in US-Upland Cotton and US-Lumber IV determined that subsidies aimed at a wide array of products within an industry are considered specific Importantly, the evaluation of specificity extends beyond a de jure analysis to include de facto considerations Scholars emphasize that even if a subsidy is not overtly restricted to particular enterprises, it is crucial to assess its predominant or disproportionate beneficiaries, reflecting the complexities of a diversified economy.

282 Part II of the SCM Agreement

283 Part III of the SCM Agreement

284 Article 5 of the SCM Agreement

285 United States - Subsidies on Upland Cotton, WT/DS267/R, para.7.1150 (WTO Panel Report September 8, 2004)

The WTO Panel Report on the United States' Final Countervailing Duty Determination regarding certain Softwood Lumber imports from Canada (WT/DS257/R, para 7.120, August 29, 2003) highlights that the determination of specificity is ultimately made by WTO adjudicative bodies or investigating authorities on a case-by-case basis, as regulated under Article 2.1(c).

In the realm of climate policies, when a government provides export rebates or tax exemptions to specific sectors, particularly those most exposed to trade, a domestic emissions trading system (ETS) or carbon tax may lack the necessary specificity Consequently, an importing member state may impose countervailing measures unilaterally if its domestic industry suffers due to these subsidies, rather than pursuing multilateral dispute resolution Additionally, Condon suggests that Article XX of GATT 1994 could be invoked to justify prohibited or actionable subsidies and countervailing measures, potentially allowing climate change mitigation subsidies that comply with Article XX to be exempt from dispute settlements and countervailing actions by affected members However, this interpretation remains uncertain and requires further clarification in future legal cases.

Policy options for the implementation of Border Carbon Adjustments within

Disputes targeting domestic measures related to clean energy, causing to potential contradictions between trade regime and climate action has been increasing

287 Thomas Cottier, Olga Nartova, and Sadeq Z Bigdeli, International Trade Regulation and the Mitigation of Climate Change: World Trade Forum (Cambridge University Press, 2009), 180

288 United States - Subsidies on Upland Cotton, WT/DS267/R, para.7.1142 (WTO Panel Report September 8, 2004)

Climate change poses significant challenges that necessitate effective negotiations among WTO Members rather than relying solely on WTO panel rulings A case-by-case dispute resolution is inadequate for implementing border carbon adjustments, highlighting the need for legal reforms within the WTO to better address climate change mitigation This article explores various proposals put forth by scholars aimed at enhancing WTO law to accommodate these pressing environmental issues.

2.8.1 Amending WTO trade rules in favor of unilateral climate policies

Amending WTO rules could alleviate the uncertainty surrounding Border Carbon Adjustments that has arisen from case-by-case dispute resolutions Many scholars argue that this approach would not only ease the pressure on the WTO dispute settlement system but also create a more coherent connection between trade and climate policies.

Recent disputes in renewable energy have emerged globally, including Canada's case (DS412) regarding Ontario’s feed-in-tariff program, China's issue (DS419) related to its Special Fund for Wind Power Equipment Manufacturing, and the United States' countervailing duty measures (DS437) targeting pricing investigations of Chinese solar panels and wind energy products Additionally, the European Union and certain Member States (DS452) are involved in disputes concerning various feed-in-tariff programs affecting the renewable energy generation sector.

The dispute cases DS456 and DS510 highlight the local content requirements imposed by India and the United States, respectively, on solar cells and modules within their renewable energy sectors These measures raise concerns about the implications for international trade and competition, as they involve specific regulations and subsidies aimed at promoting domestic production in the solar industry.

U.S states imposed Another challenged climate-related policy is the favouring of biofuels Argentina and Indonesia have raised four cases against the EU’s regulations on local content requirements and antidumping duties

(https://www.ictsd.org/sites/default/files/downloads/2012/02/biofuels-subsidies-and-the-law-of-the-wto. pdf, accessed on 15 January 2019)

James Bacchus discusses the importance of establishing global rules that harmonize trade and climate policies in his policy option paper for the ICTSD and World Economic Forum He emphasizes the need for mutually supportive frameworks that address climate change while facilitating international trade, highlighting the critical intersection of these two domains for sustainable development Bacchus advocates for coordinated efforts to create effective measures that can balance economic growth with environmental protection.

292 Kasturi Das et al., Making the International Trade System Work for Climate Change: Assessing the

According to Article X of the WTO Agreement, amendments can be proposed by WTO Members or specialized Councils, with the Ministerial Conference having 90 days to respond Some advocate for amending Article XX of the GATT to explicitly include climate change measures, while others suggest changes to the SCM Agreement to allow export rebates for carbon taxes However, the precise amendments needed to balance trade and climate objectives are yet to be determined It's important to note that amendments affecting WTO Members' rights and obligations are only binding for those who accept them, meaning non-accepting Members can still challenge the compatibility of border carbon adjustments or climate measures with WTO law The amendment approval process within WTO law is complex, with only one amendment successfully agreed upon to date.

In light of the current WTO landscape and the U.S stance under the Trump administration, there is a proposal for amending WTO rules that may require consensus If consensus cannot be reached, the Ministerial Conference could opt for a two-thirds majority vote among members to proceed with the proposed amendment Once at least two-thirds of members ratify the proposal, it will take effect, although specific provisions necessitate acceptance from all members This amendment could alter the obligations of WTO members and alleviate legal barriers related to climate policies and Border Carbon Adjustments (BCAs), addressing the case-by-case nature of the organization's dispute settlement mechanism Many scholars argue that this approach would ease the burden on the WTO's dispute resolution system while fostering a stronger connection between trade and climate initiatives.

294 International Bar Association, “Climate Change Justice and Human Rights Task Force Report,”

Achieving Justice and Human Rights in an Era of Climate Disruption, 2014, 166–67

295 Amelia Porges and Thomas L Brewer, “Climate Change and a Renewable Energy Scale-up: Responding to Challenges Posed to the WTO” (by International Centre for Trade and Sustainable Development (ICTSD) 7 …, 2014), 1

296 This amendment concerns the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) regarding a compulsory licensing provision related to public health and it became into force in

2017 See https://www.wto.org/english/news_e/news17_e/trip_23jan17_e.htm, accessed on 15 January

2.8.2 The waiver of specific WTO obligations

A "waiver" under Article IX:3 of the WTO Agreement allows member countries to be exempt from specific obligations under exceptional circumstances and for a limited time, as determined by the Ministerial Conference This provision enables WTO Members to prioritize non-trade interests, such as climate-related issues, while maintaining the WTO's jurisdiction and legitimacy in relation to other international laws Since a waiver does not create or modify existing obligations, it is a more feasible option than amending the agreement Numerous countries have utilized waivers, including the 2003 Kimberly Waiver addressing "conflict diamonds," which are linked to financing rebel activities.

297 Phil Levy, “What’s Next For The World Trade Organization?,” Forbes https://www.forbes.com/sites/phillevy/2018/10/31/whats-next-for-the-world-trade-organization/ accessed on 15 January 2019

Article IX:3 of GATT allows the Ministerial Conference to waive obligations imposed on a Member by the Agreement or any Multilateral Trade Agreements under exceptional circumstances Such decisions require the approval of three-fourths of the Members, unless specified otherwise in this paragraph.

Requests for waivers related to this Agreement must be submitted to the Ministerial Conference, which operates on a consensus decision-making basis The Conference will allocate a maximum of 90 days to review the request If consensus is not achieved within this timeframe, a waiver may be granted with the approval of three-fourths of the Members.

A waiver request related to the Multilateral Trade Agreements outlined in Annexes 1A, 1B, or 1C must first be directed to the appropriate Council—either the Council for Trade in Goods, the Council for Trade in Services, or the Council for TRIPS This request will be reviewed within a maximum timeframe of 90 days, after which the relevant Council is required to present a report to the Ministerial Conference.

299 Isabel Feichtner, “The Waiver Power of the WTO: Opening the WTO for Political Debate on the Reconciliation of Competing Interests,” European Journal of International Law 20, no 3 (2009): 645

Hufbauer and Kim discuss the implications of climate change on trade, highlighting that a waiver previously allowed members to bypass certain GATT provisions to restrict trade with specific diamonds Some experts propose that WTO Members could pursue a similar waiver for Border Carbon Adjustments (BCAs), enabling a limited harmonization of measures across various countries.

Under Article IX:3 of the WTO Agreement, waivers can only be invoked by a Member in exceptional circumstances and for a limited duration as defined by the Ministerial Conference's decision These waivers serve as a temporary suspension of existing obligations Furthermore, Articles IX:3 and IX:4 stipulate that the Ministerial Conference must conduct an annual review for any waiver exceeding one year, assessing the exceptional circumstances justifying the waiver and the compliance with its specified terms and conditions.

A waiver is an unstable solution to the WTO incompatibility of Border Carbon Adjustments (BCAs), failing to address the long-term conflicts between trade and climate regimes Additionally, it remains vulnerable to challenges from other Members under non-violation claims related to nullification and impairment of rights as outlined in Article XXIII:1(b) of the GATT Due to these limitations, a waiver is not a viable option for resolving these issues.

301 “Conflict diamonds” mean diamonds which are used to finance rebels against the legitimate governments See https://www.wto.org/english/news_e/news03_e/goods_council_26fev03_e.htm, accessed on 15 January 2019

303 See Feichtner, “The Waiver Power of the WTO”; and Hufbauer and Kim, “Climate Change and Trade.”

Conclusion to Chapter 2

Border Carbon Adjustments (BCAs) are not inherently illegal under WTO law, but must adhere to eligibility criteria for border adjustments and align with non-discrimination principles for imports If BCAs conflict with WTO regulations, they must comply with Article XX of GATT, particularly regarding public health and environmental policies The justification for import BCAs relies on passing the "good faith" test outlined in Article XX For exports, BCAs must follow WTO subsidy rules, facing legal uncertainties as export rebates on carbon taxes and emissions allowances may be deemed prohibited subsidies, complicating justifications under Article XX The legality of BCAs under WTO law remains uncertain, and there is a significant risk of disputes arising in the WTO dispute settlement system.

Negotiated solutions are essential to establish legal certainty regarding Border Carbon Adjustments (BCAs) Proposed changes at the WTO include amending existing trade rules, waiving certain obligations, providing authoritative interpretations of provisions, and creating a plurilateral trade and climate agreement However, the feasibility of these solutions within the WTO remains questionable.

320 Jeff Swartz, “Are We Heading towards a Climate Change Trade War? | International Centre for Trade and Sustainable Development,” Opinion and Analysis from ICTSD’s Network of Experts, June 29,

2018 effectiveness at least in the short and medium term Thus, such shortcomings of multilateral fora call for a more appealing approach for the negotiation of implementing BCAs in practice.

An Approach to Implementing Border Carbon Adjustments under