A key aspect of the political balance that allowed H.R. 2454-the American Clean Energy and Security Act of 2009 (ACESA)-to pass in the U.S. House of Representatives was its “border adjustment” provisions designed to safeguard the competitiveness of U.S. manufacturing industries facing foreign competitors not subject to comparable emissions regulation.  Now that the Senate has begun deliberations on a companion bill, the debate about the optimal form of border adjustment measures, as well as their legality under international trade rules, has begun anew against a backdrop of heightened criticism from U.S. trading partners. 

H.R. 2454 sets forth a two-phased approach.  First, under Title IV, Part F, subpart 1, the bill would establish an “Emission Allowance Rebate Program” under which domestic industrial sectors shown to be vulnerable to “carbon leakage” (the transfer of emissions-intensive manufacturing to jurisdictions with lesser emissions restrictions) would recover a specified level of the costs of compliance with ACESA’s emissions caps.  Eligibility would be determined on a sector-specific basis through formulae measuring each sector’s energy-, greenhouse gas-, and trade-intensity.

In the second phase, under subpart 2, entitled “Promoting International Reductions in Industrial Emissions,” the President could, as of 2020, impose on importers a requirement to submit emissions allowances.  The President would be required to do so if, by 2018, there is no international agreement to ensure globally coordinated reduction of greenhouse gas emissions.  In the absence of an international agreement, the importer allowance requirement could be waived only if the President determines that the requirement would not be in the national economic or environmental interest and if Congress passes a joint resolution approving the President’s determination.  No importer allowance requirement would be imposed, however, for any sector for which the President determines that over 85% of global production meets specified emissions reduction criteria.  Further, imports from individual countries that have met the same emissions reduction criteria, or other specified de minimis criteria, would be exempted from the importer allowance requirement.

Key Senators have stated, however, that they cannot accept the balance struck in the House bill on border adjustment measures.  According to Sen. Barbara Boxer (D-CA), who chairs the Environment and Public Works Committee, H.R. 2454 would irritate U.S. trading partners and undermine U.S. efforts to negotiate a comprehensive U.N. climate accord to replace the Kyoto Protocol, which expires in 2012.  Sen. Max Baucus (D-MT), Chair of the Finance Committee, reportedly shares Sen. Boxer’s concerns.  So too does Sen. John Kerry (D-MA), who stated at a recent Finance Committee hearing that the President must be afforded more discretion than exists in H.R. 2454 to determine when border adjustment measures may be warranted.  At the same time, another group of Democratic Senators representing Midwest states where emissions-intensive manufacturing is concentrated, such as Sherrod Brown (D-OH), are conditioning their support for the bill on tough border adjustment measures.

As Congress continues its work to strike the right balance between the interests of domestic manufacturing industries and harmony with U.S. trading partners, the Obama Administration faces its own challenges to sell U.S. climate change legislation on the international stage.  Shortly after the passage of H.R. 2454, President Obama told the press that, in light of the continuing global recession and a drop in international trade flows, the United States should be “very careful about sending any protectionist signals.”  The President made his comments amid mounting global concerns about new protectionist tendencies, including repeated warnings by the Director-General of the WTO, Pascal Lamy, that border measures designed to stem carbon leakage could trigger retaliatory actions among trading partners and burden the WTO’s dispute settlement system.

Such warnings find support in a recent joint report of the WTO and the U.N. Environment Program describing the technical challenge of devising border measures that impose a fair cost for the greenhouse gas emissions associated with the production of an imported product and the potential difficulties of sustaining such measures under the WTO’s trade rules if challenged.  The recent comments of India’s Environment Minister Jairam Ramesh to visiting U.S. Secretary of State Hillary Clinton, who stated that India faces “the threat of carbon tariffs on our exports to countries such as yours,” underscore the diplomatic challenges triggered by ACESA’s border adjustment measures.

ClimateIntel has previously discussed the WTO rules implicated by border adjustment measures.  As discussed in relation to earlier U.S. bills, the outcome of a WTO challenge to any final U.S. climate change law would likely depend in large part on the application of GATT Article XX, which can excuse discriminatory trade practices that are “necessary to protect human, animal or plant life or health,” or that relate to “the conservation of exhaustible natural resources.”   Article XX requires and WTO jurisprudence clarifies, however, that trade restrictions for ostensible environmental purposes may not be used to shield arbitrary discrimination.

The more immediate challenge under WTO rules may focus on the first phase of ACESA’s border adjustment construct-rebates to domestic industries found to be vulnerable to carbon leakage.  Article 3 of the WTO Agreement on Subsidies and Countervailing Measures prohibits subsidies contingent upon export performance.  Under WTO subsidy rules, subsidies intended to spur exports are subject to the tightest disciplines.  Experts on WTO subsidy rules do not agree on whether ACESA’s rebate provisions run afoul of the Article 3 prohibition.  Because ACESA determines eligibility for rebates in part on a formula taking into account the applicable sector’s exports, however, such a challenge cannot be ruled out.

ACESA’s many complexities, combined with a clogged legislative calendar, suggest that it will not be easy for the House and Senate to find common ground on border adjustment measures.

For further information about this topic, please contact Akin Gump.