Climate Change: EU and Proposed U.S. Approaches to Carbon Leakage and WTO Implications

Larry Parker
Specialist in Energy and Environmental Policy

Jeanne J. Grimmett
Legislative Attorney

The United States has proposed, and the European Union (EU) developed, policies to mitigate the potential economic and environmental (i.e., "carbon leakage") impacts of carbon policies on energy- or greenhouse gas-intensive, trade-exposed industries. While studies have found little effect of carbon policies on EU competitiveness in the present, the EU decision to move toward auctioning of allowances in the future has spurred development of criteria to extend potential availability of free allowances to exposed industries to 2020. In a December 2009 decision, the European Commission (EC) listed 164 industrial sectors and subsectors deemed exposed sectors under appropriate European Parliament and Council directives. 

H.R. 2454, which passed the House on June 26, 2009, includes two strategies to address these concerns: (1) free allocation of allowances (similar to that of the EU), and (2) an international reserve allowance (IRA) scheme. Studies have suggested that a free allowance scheme appears effective in mitigating the trade-related impact of the carbon program on energy-intensive, tradeexposed industries. However, production cost for those industries (along with other industries) could increase because of the potential pass-through of compliance-related costs by upstream producers of various inputs into their manufacturing processes. Whether these costs would become significant would depend on the ability of upstream suppliers to pass on the costs, and the ability of the downstream industries to respond by increasing the efficiency of their operations or by substituting other, less-costly inputs into their processes. There are questions about whether the allowances provided by H.R. 2454's allocation scheme are sufficient. If the Environmental Protection Agency's estimates are correct, the allocation would appear sufficient. If industry estimates are correct, or if individual showings of eligibility prove significant, the pool of allowances provided by the bill would appear inadequate under the assumptions used here. Also, the data and administrative resources necessary to implement the program would be substantial. 

Although H.R. 2454 as passed would require EPA to establish an IRA program consistent with U.S. international agreements, questions may be raised as to whether proposed Part IV and its application would fully comply with U.S. international trade obligations. The distribution of free allowances may constitute actionable subsidies for purposes of the World Trade Organization (WTO) Agreement on Subsidies and Countervailing Measures by possibly qualifying as "foregone revenue" when auctioning of allowances would also be permitted. In addition, the requirement that importers purchase IRAs to accompany particular imports might be found to constitute a prohibited import surcharge or, if the product may not otherwise enter the United States, a prohibited quantitative restriction under the General Agreement on Tariffs and Trade (GATT) 1994. While the IRA program might be provisionally justified under GATT general exceptions for health protection or resource conservation, the GATT also requires that it not be applied "in a manner that would constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade." Whether an IRA program can be applied consistently with these requirements may depend on the type of program that may be crafted by EPA under the proposed legislation—that is, on the elements that would be required under the bill and the administrative possibilities inherent in its discretionary authorities. Absent an international consensus on the types of trade-related measures that may be applied as part of a domestic climate change regime, adversely affected countries may seek to challenge these measures under WTO dispute settlement provisions. Since neither the distribution of emission allowances nor border restrictions imposed as part of a domestic greenhouse gas-reduction program have yet come before WTO dispute settlement panels, WTO obligations and exceptions remain untested in this complex regulatory environment.


Date of Report: January 28, 2010
Number of Pages: 71
Order Number: R40914
Price: $29.95