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Abstract

Carbon taxes are utilized as a tool to address the negative externalities of carbon emissions from production. However, as countries begin to price carbon and create additional policies that address environmental damage, the issue of “carbon leakage” has emerged. Instead of reducing pollution as intended, products produced domestically are instead replaced with more carbon intensive imports (European Commission Taxation and Customs Union, 2021). This essentially reduces the effect of carbon pricing and makes environmental regulations less effective. To combat this, the European Commission announced a proposal on July 14, 2021, to create a carbon border adjustment mechanism (CBAM). This carbon border tax aims to prevent carbon leakage and increase accountability worldwide for environmental degradation by equalizing the price of carbon in the EU (European Union) with that of imports. However, the potential outcome of this policy is a highly controversial topic among economists, policymakers, and environmentalists. Some economists assert that this border tax could disrupt global trade and potentially start trade wars, while others question the proposal’s legality under WTO (World Trade Organization) laws. Those in favor argue that this mechanism would prevent carbon leakage and would lead to additional environmental regulations worldwide. This paper argues that a carbon border tax is likely to succeed in the goal of reducing carbon emissions if regulated and enforced properly. However, some evidence demonstrates consumers and producers could face additional costs in the short term as a period of disruption could occur in the trade sector, while also shifting the carbon price burden onto developing countries. Therefore, the EU should continue with this program but ensure that a gradual transition occurs, giving manufacturers in other countries ample time to address additional costs and reduce emissions, while also ensuring that clean technology is accessible to developing countries. If successful, the EU should also advocate for other large importer countries, such as the US, to utilize a carbon border mechanism in order to increase the policy’s effectiveness. This paper will first discuss how carbon pricing aims to fix market failures that occur due to emissions in production before outlining the current system and proposal by the EU. The paper will then delve into a thorough literature review to illustrate the arguments from those in favor and against this proposal before offering the authors suggestions.

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