Incentivizing Carbon Taxation Using Border Carbon Adjustments: Tax Rebating Versus Carbon Crediting

Border carbon adjustments (BCA) imply that high-income (H) countries set taxes on carbon-intensive imports proportional to the carbon content of these imports, to match their own carbon taxes. This paper considers the use of BCA policies to incentivize carbon taxation in low-income exporter countries, many of which have no or very low carbon taxes today. We first assume that the importer allows the exporter’s border tax to be reduced by the exporter’s own comprehensive carbon tax (“tax rebating”). We find that the exporter is then incentivized to set its own comprehensive carbon tax at the same rate as the border tax, up to a maximal rate. When the border tax is higher, the exporter instead gradually reduces its carbon tax. Border tax revenues of the H country can be returned to incentivize higher carbon taxes in the exporting countries (“carbon crediting”). When tax rebating is not allowed but tax revenues are fully returned, even higher comprehensive carbon taxes can be incentivized in exporter countries, up to $60 per ton CO2 in our numerical examples. Border taxation can give rise to export diversion away from BCA-setting countries, which reduces the scope for incentivizing carbon taxes in exporting countries.