Border Carbon Adjustments: Rationale, Design and Impact

IMF Working Papers, September 27, 2021

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This paper assesses the rationale, design, and impacts of border carbon adjustments (BCAs).
Large disparities in carbon pricing between countries raise concerns about competitiveness and emissions leakage.
BCAs are potentially the most effective domestic instrument for addressing these challenges—but design details are critical.
BCAs alone do not solve the free-rider problem in carbon pricing, but might be a step to an effective international carbon price floor.

Large carbon price differentials can create competitiveness pressures and emissions leakage.
Limiting coverage of the BCA to energy-intensive, trade-exposed industries facilitates administration.
Initially benchmarking BCAs on domestic emissions intensities would ease the transition for trading partners with emission-intensive production.
It is important to consider how to apply BCAs across countries with different approaches to emissions mitigation.

Coverage: Focusing on energy-intensive, trade-exposed (EITE) industries to reduce administrative complexity.
Benchmarking: Using domestic emissions intensities as an initial benchmark to smooth transition for trading partners.
Cross-country application: Need to account for heterogeneous mitigation approaches across countries when applying BCAs.
Legal and trade compatibility: Design choices should consider World Trade Organization rules and tariff implications.

Effectiveness: BCAs can address competitiveness and leakage concerns domestically if carefully designed.
Limits: BCAs do not by themselves resolve the international free-rider problem in carbon pricing.
Role in international coordination: BCAs could be a stepping stone toward an international carbon price floor.

Target initial BCA coverage on energy-intensive, trade-exposed industries to facilitate administration.
Use domestic emissions-intensity benchmarks initially to reduce disruption for emission-intensive trading partners.
Design BCAs with attention to differing national mitigation approaches to maintain fairness and effectiveness.
View BCAs as part of a broader strategy that may include steps toward coordinated international carbon pricing.