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
November 4, 2009
Congressional Research Service
7-5700
www.crs.gov
R40914
CRS Report for Congress
P
repared for Members and Committees of Congress

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

Summary
Both the United States and the European Union (EU) have proposed 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 draft September 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, trade-
exposed 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 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.
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Contents
Introduction ................................................................................................................................ 1
Using Free Allocations under the EU-ETS: Results and Lessons Learned .................................... 2
Background on the European Union’s Emissions Trading Scheme (ETS)............................... 2
European Energy-Intensive, Trade-Exposed Industries .......................................................... 4
Background .................................................................................................................... 4
EC Draft Phase 3 Decision on Eligible Industries ............................................................ 5
Analysis of EU Approach............................................................................................................ 7
Effectiveness of Phase 1 Free Allowance Allocations ............................................................ 7
Current Attitude of Companies under ETS............................................................................. 8
Determining Eligibility for Phase 3: The EC’s Draft List ..................................................... 11
Criteria Used for EC Draft Eligibility List ..................................................................... 11
Data Sources Used for EC Draft Eligibility List ............................................................ 12
U.S Proposals to Address Carbon Leakage: H.R. 2454 .............................................................. 13
H.R. 2454, Title IV, Subpart 1: Free Allocation of Allowances................................................... 14
Description of Rebate Program............................................................................................ 14
Eligible Industries ............................................................................................................... 15
Proposed Funding ............................................................................................................... 18
Analysis.............................................................................................................................. 19
Adequacy of Allocation................................................................................................. 19
Effectiveness of Free Allowance Scheme ...................................................................... 21
Phase-Out Schedule ...................................................................................................... 22
H.R. 2454, Title IV, Subpart 2: International Reserve Allowance Scheme .................................. 23
Description of Program ....................................................................................................... 23
Overview ...................................................................................................................... 23
Initial Action: Section 765............................................................................................. 24
Further Requirements and Criteria: Section 767 ............................................................ 24
EPA Implementing Regulations: Section 768................................................................. 26
Decision-Making Process.............................................................................................. 27
Analysis.............................................................................................................................. 28
Potential Impact ............................................................................................................ 28
Data Needs ................................................................................................................... 29
Presidential Determination to Exclude a Sector ............................................................. 31
“Covered Goods” .......................................................................................................... 31
“Manufactured Items for Consumption” (Downstream Items) ....................................... 32
Emphasis on International Action.................................................................................. 33
Reactions from Other Countries: Defining “Comparable” Actions ................................. 35
Implications for International Trade Obligations........................................................................ 37
Distribution of Free Emission Allowances ........................................................................... 40
General Characteristics of Emission Allowances ........................................................... 40
WTO Agreement on Subsidies and Countervailing Measures (SCM)............................. 42
Free Allowances Under the SCM Agreement................................................................. 45
International Reserve Allowance (IRA) Program................................................................. 48
General Agreement on Tariffs and Trade (1994) ............................................................ 48
Border IRA Requirements under the GATT 1994........................................................... 51
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Figures
Figure 1. UK Manufacturing Activities Most Cost-sensitive to CO2 Pricing................................. 5
Figure 2. How Important Is the Long-Term Carbon Price for New Investments in Your
Industry?.................................................................................................................................. 9
Figure 3. Companies Response to Carbon Price......................................................................... 10
Figure 4. Carbon Trust Assessment of Exposure to Phase 3 Competitiveness Issues................... 11
Figure 5. U.S. Manufacturing Exposed to Carbon Leakage Risk................................................ 16
Figure 6. Presumptively Eligible Energy-Intensive, Trade-Exposed Industries ........................... 17
Figure 7. Direct and Indirect Allowance Allocations to Energy-Intensive, Trade-Exposed
Industries under H.R. 2454..................................................................................................... 18
Figure 8. Projected Allowance Need and Allocation to Eligible Industries ................................. 20
Figure 9. Industrial Impacts in the H.R. 2454 Basic Case, 2012-2030 ........................................ 22
Figure 10. Decision Tree for IRA Scheme ................................................................................. 28

Tables
Table 1. Direct and Indirect Emissions from Eligible Industries ................................................. 19
Table 2. Comparison of Top-20 Greenhouse Gas Emitting Countries ......................................... 36

Appendixes
Appendix. EC Draft List of Eligible Industries .......................................................................... 60

Contacts
Author Contact Information ...................................................................................................... 67

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Introduction
Congress is considering legislation to reduce emissions of greenhouse gases that may, depending
on the specifics of the final legislation, affect the competitiveness of energy- or greenhouse gas-
intensive industries. Competitiveness can be a rather abstract term for which any precise meaning
can be elusive.1 Competitiveness is a continuing phenomenon, with companies becoming more or
less competitive according to a host of factors, including productivity, market demand, resource
costs, labor costs, exchange rates, and the like. As stated by the Australian Government in its
Green Paper on carbon reduction schemes:
Changes in the cost structures of entities and industries are not unusual and occur
continuously in a market-based economy; nor is it unusual for Government policy to change
cost structures. For example, the adoption of high quality occupational health and safety
standards have affected the profitability of Australia’s labour-intensive traded industries,
making it more difficult for them to compete with foreign producers that are subject to lower
standards. Assistance is not usually provided to offset the impact of domestic policies on
traded industries, as those policies reflect the priorities and values of the Government and
community more generally.2
Most industries face a competitive market (sometimes international in scope) both in terms of
producers of the same products and producers of substitute products. Also, in some cases, an
industry may face a fairly elastic demand for its product. Thus, most industries are price sensitive,
and therefore any increase in manufacturing costs—as by a carbon emission reduction
requirement—hurts the competitiveness of a firm. This complex situation is further complicated
for energy-intensive industries as competitors within the same industry may experience different
energy price increases (particularly for electric power), depending on their individual energy
needs and power arrangements. For example, an aluminum plant receiving power from a hydro-
electric facility may not be affected the same way as a similar plant whose power contract is with
a coal-fired power supplier.
The addition of a carbon control regime to this competitive dynamic has raised concerns that, in
the absence of similar policies among competing nations, if the United States adopts a carbon
control policy, energy- or greenhouse gas-intensive, trade-exposed industries that must control
their emissions or that find their feedstock or energy bills rising because of costs passed-through
by suppliers may be less competitive and may lose global market share (and jobs) to competitors
in countries lacking comparable carbon policies. In addition, this potential shift in production
could result in some of the U.S. carbon reductions being undercut by increased production in less
regulated countries; this is commonly known as “carbon leakage.”
Greenhouse gas reduction legislation introduced over the last two Congresses has included
provisions to address carbon leakage and to mitigate the effect of carbon policies on U.S.
competitiveness. In general, two strategies have been proposed: (1) providing assistance to
greenhouse gas-intensive, trade-exposed industries; and (2) imposing tariffs on certain
greenhouse gas-intensive goods imported into the country from countries not implementing

1 For a further discussion, see CRS Report R40100, “Carbon Leakage” and Trade: Issues and Approaches, by Larry
Parker and John Blodgett.
2 Department of Climate Change, Commonwealth of Australia, Carbon Pollution Reduction Scheme: Green Paper
(July 2008), p. 292.
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comparable carbon policies. Such tariffs are frequently referred to as border measures. H.R. 2454,
as passed by the House, contains both of these strategies.3
This report examines the dynamics of this issue in three parts. First, the European Union (EU) has
been implementing a cap-and-trade program for four years, and has finalized a third reduction
phase that will run from 2013 through 2020. This report reviews and analyzes the experience of
the EU in addressing its concerns about energy-intensive, trade-exposed industries, and the
lessons those efforts may have for the United States. Second, the House-passed American Clean
Energy and Security Act of 2009 (H.R. 2454) contains both a free allocation scheme and a border
measure among its provisions to address the concerns of energy-intensive, trade-exposed
industries. This report reviews and analyzes these provisions. Third, these same provisions could
come under scrutiny under various U.S. trade agreements, particularly within the World Trade
Organization (WTO). Concerns have been expressed that the border measure contained in H.R.
2454 would be suspect under various provisos of the WTO. This report analyzes the potential
WTO implications of any attempt to implement a subsidy or a border measure under H.R. 2454.
Using Free Allocations under the EU-ETS: Results
and Lessons Learned
Background on the European Union’s Emissions Trading
Scheme (ETS)
The EU’s Emissions Trading System (ETS) covers more than 10,000 energy-intensive facilities
across the 27 EU Member countries, including oil refineries, powerplants over 20 megawatts
(MW) in capacity, coke ovens, and iron and steel plants, along with cement, glass, lime, brick,
ceramics, and pulp and paper installations. In addition, aviation is currently being phased into the
ETS. These covered entities emit about 40%-45% of the EU’s total greenhouse gas emissions,
and almost two-thirds of them are combustion installations. The trading program does not cover
either carbon dioxide (CO2) emissions from the transportation sector (except aviation), which
account for about 25% of the EU’s total greenhouse gas emissions, or emissions of non-CO2
greenhouse gases, which account for about 20% of the EU’s total greenhouse gas emissions. A
Phase 1 trading period ran between January 1, 2005, and December 31, 2007.4 A Phase 2 trading
period began January 1, 2008, covering the period of the Kyoto Protocol, and a Phase 3 has been
finalized to begin in 2013.5
Under the Kyoto Protocol, the then-existing 15 nations of the EU agreed to reduce their aggregate
annual average emissions for 2008-2012 by 8% from the Protocol’s baseline level (mostly 1990
levels) under a collective arrangement called a “bubble.” In light of the Kyoto Protocol targets,

3 For more information on trade and carbon leakage issues, see CRS Report R40100, “Carbon Leakage” and Trade:
Issues and Approaches, by Larry Parker and John Blodgett.
4 For further background on the ETS, see CRS Report RL34150, Climate Change and the EU Emissions Trading
Scheme (ETS): Kyoto and Beyond, by Larry Parker.
5 More information, including relevant directives, on the EU-ETS is available on the European Union’s website at
http://europa.eu.int/scadplus/leg/en/lvb/l28012.htm.
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the EU adopted a directive establishing the EU-ETS that entered into force October 13, 2003.6
One objective of the second phase of the ETS is to achieve 3.3 percentage points of the 8.0%
reduction required by the EU-15 under the Protocol.7
The importance of emissions trading was elevated by the accession of 12 additional central and
eastern European countries to EU membership from May 2004 through January 2007. For the
new EU-27, the overall emissions cap under the ETS is set at 2.08 billion metric tons of carbon
dioxide (CO2) for the Kyoto compliance period (2008-2012).
The second phase Kyoto compliance stage of the ETS is built on the experience the EU gained
from its preliminary Phase 1. The European Commission (EC) believes that the Phase 1 “learning
by doing” exercise prepared the community for the difficult task of achieving the reduction
requirements of the Kyoto Protocol. Several positives resulted from the Phase 1 experience that
assisted the ETS in making the Phase 2 process run smoothly, at least so far. First, Phase 1
established much of the critical infrastructure necessary for a functional emission market,
including emissions monitoring, registries, and inventories. Much of the publicized difficulties
the ETS experienced early in the first phase can be traced to inadequate emissions data
infrastructure.8 Phase 1 significantly improved those critical elements in preparation for Phase 2
implementation.
Second, the ETS helped jump-start the project-based mechanisms—Clean Development
Mechanism (CDM) and Joint Implementation (JI)—created under the Kyoto Protocol.9 As stated
by Ellerman and Buchner:
The access to external credits provided by the Linking Directive has had an invigorating
effect on the CDM and more generally on CO2 reduction projects in developing countries,
especially in China and India, the two major countries that will eventually have to become
part of a global climate regime if there is to be one.10
Third, according to the EC, a key result of Phase 1 was its effect on corporate behavior. An EC
survey of stakeholders indicated that many participants are incorporating the value of allowances
in making decisions, particularly in the electric utility sector, where 70% of firms stated they were
pricing the value of allowances into their daily operations, and 87% into future marginal pricing
decisions. All industries stated that it was a factor in long-term decision-making.11

6 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for
greenhouse gas emissions allowance trading within the Community and amending Council Directive 96/61/EC.
7 Commission of the European Communities, Communication from the Commission: Progress towards Achieving the
Kyoto Objectives (November 19, 2008).
8 A. Denny Ellerman and Barbara K. Buchner, “The European Union Emissions Trading Scheme: Origins, Allocations,
and Early Results,” Environmental Economics and Policy (Winter 2007), pp. 69-70; and International Emissions
Trading Association, “IETA Position Paper on EU ETS Marking Functioning,” (no date), p. 3.
9 For more on the effect of the ETS on Kyoto mechanisms, see A. Denny Ellerman and Barbara K. Buchner, “The
European Union Emissions Trading Scheme: Origins, Allocations, and Early Results,” Environmental Economics and
Policy (Winter 2007), p. 84; and International Emissions Trading Association, “IETA Position Paper on EU ETS
Market Functioning” (no date), p. 2. For more information on the Kyoto Protocol mechanisms, see CRS Report
RL33826, Climate Change: The Kyoto Protocol, Bali “Action Plan,” and International Actions, by Jane A. Leggett.
10 A Denny Ellerman and Barbara K. Buchner, “The European Union Emissions Trading Scheme: Origins, Allocations,
and Early Results,” Environmental Economics and Policy (Winter 2007), p. 84.
11 European Commission, Directorate General for Environment, Review of EU Emissions Trading Scheme: Survey
Highlights, (November 2005), pp. 5-7.
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European Energy-Intensive, Trade-Exposed Industries
Background
Figure 1 below indicates the cost sensitivity of various manufacturing activities in the United
Kingdom as determined by Climate Strategies.12 Cost sensitivity is measured as the percentage of
the activity’s current gross value added at stake from a 20 euro per metric ton carbon price.13 As
indicated by the bold, several of these industries are covered by the ETS, including lime, cement,
basic iron and steel, refined petroleum products, pulp, paper and paperboard, hollow glass, and
flat glass. The figure also indicates the direct and indirect cost components of implementing a
carbon pricing policy. The cost impact of a 20 euro carbon price from a manufacturing process
from direct emissions is indicated by the light blue versus the cost impact of indirect emissions
resulting from higher electricity prices, which is indicated by the dark blue. As shown, the
balance of direct and indirect costs differs substantially among the various sectors.

12 As published in Carbon Trust, EU ETS Impacts on Profitability and Trade (January 2008), p. 3.
13 The Value at Stake can be defined as the difference in costs between “business as usual” and reduced emissions
scenarios (based both on the impact of increasing energy process and the potential for reducing consumption). This
calculation includes both direct and indirect costs.
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Figure 1. UK Manufacturing Activities Most Cost-sensitive to CO2 Pricing

Source: Carbon Trust, EU ETS Impacts on Profitability and Trade (January 2008), Based on data in Climate
Strategies (2007).
Notes: Annex referenced in Figure 1 can be found on page 32 of source report.
EC Draft Phase 3 Decision on Eligible Industries
After nine eastern European Member States threatened to veto an initial proposal to auction 100%
of all allowances, the leaders of the European Union (EU) agreed to provide for some free
allocation of allowances during Phase 3 that will begin in 2013.14 In making changes for Phase 3,
the European Commission has identified three CO2 emitting sectors for inclusion under the ETS:

14 See Position of the European Parliament adopted at the first reading on 17 December 2008 with a view to the
adoption of Directive 2009/…/EC of the European Parliament and of the Council amending Directive 2003/87/EC so
as to improve and extend the greenhouse gas emission allowance trading system of the Community (December 17,
2008).
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petrochemicals, ammonia, and aluminum.15 The ETS would also expand beyond CO2 to include
nitrous oxide (N2O) emissions from nitric, adipic, and glyoxalic acid production, and
perfluorocarbon (PFC) emissions from the aluminum sector. These industries would be added to
those currently covered: oil refineries, powerplants over 20 MW in capacity, coke ovens, and iron
and steel plants, along with cement, glass, lime, brick, ceramics, and pulp and paper installations
(aviation is currently being incorporated into the system).
Most covered industries will be eligible for some free allocation of allowances to cover direct
emissions under the Phase 3 agreement. The schedule for most covered entities provides for
allowances to be auctioned increasingly in the future, reaching 70% of total allowances in 2020
and 100% in 2027. As stated by the European Parliament (EP):
For other sectors covered by the Community scheme, a transitional system should be
foreseen for which free allocation in 2013 would be 80% of the amount that corresponded to
the percentage of the overall Community-wide emissions throughout the period 2005 to 2007
that those installations emitted as a proportion of the annual Community-wide total quantity
of allowances. Thereafter, the free allocation should decrease each year by equal amounts
resulting in 30% free allocation in 2020, with a view to reaching no free allocation in 2027.
(paragraph 21)
For electric powerplants, most would receive no free allocation of allowances during Phase 3.
However, in a concession to certain eastern European Member States, an optional and temporary
derogation from the no-free-allocation requirement for powerplants is provided to countries that
meet specific energy and economic criteria. Under the optional allocation scheme, the Member
State can allocate allowances equal to 70% of the powerplant’s Phase 1 emissions free; this
allocation will decline in the out-years.
For energy-intensive, trade-exposed industries, Phase 3 has provisions to provide assistance to
eligible installations to address the direct and indirect impact of emissions control costs. With
respect to direct emissions costs, the European Commission will determine and publish a list of
installations exposed to a significant risk of carbon leakage by December 31, 2009. In September
2009, the EC released its draft decision on a list of sectors and subsectors which are deemed to be
exposed to a significant risk of carbon leakage. Subject to revision after the Copenhagen talks in
December, the draft lists 164 industrial sectors and subsectors deemed exposed sectors under the
appropriate European Parliament and Council directives.16 That list is provided in the Appendix.
Eligible installations will receive allowances sufficient to cover 100% of their direct emissions,
provided they are using the most efficient technology available. Subject to review when a
satisfactory international agreement is reached, allowances allocated to these industries would
decline annually in line with the emissions cap.
Assistance for the impact of indirect emissions control costs on exposed industries would be
determined by Member States. As stated by the EP:

15 See CRS Report RL34150, Climate Change and the EU Emissions Trading Scheme (ETS): Kyoto and Beyond, by
Larry Parker.
16 European Commission, Draft Commission Decision of determining, pursuant to Directive 2003/87/EC of the
European Parliament and of the Council, a list of sectors and subsectors which are deemed to be exposed to a
significant risk of carbon leakage (Brussels, 2009).
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Member States may deem it necessary to compensate temporarily certain installations which
have been determined to be exposed to a significant risk of carbon leakage related to
greenhouse gas emissions passed on in electricity prices for these costs. Such support should
only be granted where it is necessary and proportionate and should ensure that the
Community scheme incentives to save energy and to stimulate a shift in demand from grey
to green electricity are maintained. (paragraph 24)
Analysis of EU Approach
Effectiveness of Phase 1 Free Allowance Allocations
In general, allowances have been allocated free to participating entities under the ETS. During
Phase 1, the EU-ETS Directive allowed countries to auction up to 5% of allowance allocations,
rising to 10% under Phase 2.17 Under Phase 1, only four of 25 countries used auctions at all, and
only Denmark auctioned the full 5%. The political difficulty in instituting significant auctioning
into ETS allowance allocations is the almost universal agreement by covered entities in favor of
free allocation of allowances and opposition to auctions.18 Free allocation of allowances
represents a one-time transfer of wealth to the entities receiving them from the government
issuing them.19 The resulting transfer of wealth has been described by several analysts as
“windfall profits.”20 As summarized by Ellerman and Buchner: “Allocation in the EU-ETS
provides one more example that, notwithstanding the advice of economists, the free allocation of
allowances is not to be easily set aside.”21
Despite concerns about windfall profits and economic distortions resulting from the free
allocation of allowances, there is little change in basic allocation philosophy for Phase 2. No
country proposed auctioning the maximum percentage of allowances allowed (10%). Most do not
include auctions at all.22 The unwillingness of governments to employ auctions as an allocating
mechanism revolves around equity considerations, including (1) the inability of some covered
entities to pass through cost because of regulation or exposure to international competition; (2)
the potential drag on a sector’s economic performance from the up-front cost of auctioned
allowances; and (3) the potential that government will not recycle revenues to alleviate

17 For a further discussion of auctioning and the ETS, see Cameron Hepburn et. al., “Auctioning of EU ETS phase II
allowances: how and why?” Climate Policy (2006), pp. 137-160.
18 A Denny Ellerman and Barbara K. Buchner, “The European Union Emissions Trading Scheme: Origins, Allocations,
and Early Results,” Environmental Economics and Policy (Winter 2007), p. 73.
19 Joseph Kruger, Wallace E. Oates, and William A. Pizer, “Decentralization in the EU Emissions Trading Scheme and
Lessons for Global Policy,” Environmental Economics and Policy (Winter 2007), p. 114.
20 E.g., Deutsche Bank Research, EU Emission Trading: Allocation Battles Intensifying (March 6, 2007), pp. 2-3; and
Regina Betz and Misato Sato, “Emissions Trading: Lessons Learnt from the 1st Phase of the EU ETS and Prospects for
the 2nd Phase,” 6 Climate Policy (2006), p. 353.
21 A Denny Ellerman and Barbara K. Buchner, “The European Union Emissions Trading Scheme: Origins, Allocations,
and Early Results,” Environmental Economics and Policy (Winter 2007), p. 85.
22 For a review of proposed NAP 2 auction proposals as of January 12, 2007, see Karsten Neuhoff, EU ETS Auction
Workshop, (Cambridge, January 12, 2007), p. 26. NAP refers to the National Allocation Plans member countries
submitted to the European Commission during Phase 1 and Phase 2 to demonstrate how they were going to meet their
emissions target.
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compliance costs, international competitiveness impacts, or other equity concerns, resulting in the
auction costs being the same as a tax.23
Most studies of the competitiveness impacts of the ETS during Phase 1 have found no impact.
The International Energy Agency (IEA) cites several reasons for this situation:
Experience to date with the EU-ETS does not reveal leakage for the sectors concerned—
analysis of steel, cement, aluminum and refineries sectors reveals that no significant changes
in trade flows and production patterns were evident during the first phase (2005-2007) of the
EU-ETS. This is mostly due to the free allocation of allowances, sometimes in generous
quantities, and to the still functioning long-term electricity contracts, which softened the
blow of rising electricity prices. Further, the general boom in prices for most traded products
subject to carbon costs—whether direct or indirect—has blurred any effects of the latter.
Finally, the relatively short time span of these policies does not allow observation of the full
potential effects on industry via changes in investment location decisions.24
This conclusion is echoed by Carbon Trust, which states that currently, free allocation of
emissions allowances offset almost all of the additional costs of the ETS; and it is echoed by The
Climate Group for The German Marshall Fund, which states that companies surveyed found it
difficult to quantify effects on their bottom line in the first phase, or found no effect at all.25
Current Attitude of Companies under ETS
As noted earlier, the EC believes that one of the major positive outcomes of the ETS has been the
incorporation of carbon prices in EU corporate decision-making. A survey of EU-ETS companies
by Point Carbon suggests this assertion is true.26 As indicated in Figure 2, companies are
factoring the long-term price of carbon into their future investment decisions. According to Point
Carbon, it is the power sector and the pulp and paper sectors that appear to consider the carbon
price most decisive in their planning.

23 Martina Priebe, Distributional Effect of Carbon-Allowance Trading (Cambridge, January 12, 2007). Also, see
Eurochambres, Review of the EU Emission Trading System (June 2007), p. 5.
24 Julia Reinaud, Issues Behind Competitiveness and Carbon Leakage: Focus on Heavy Industry (October 2008), p. 6.
25 Carbon Trust, EU ETS Impacts on Profitability and Trade (January 2008), p. 4; and The Climate Group, The Effects
of EU Climate Legislation on Business Competitiveness; A Survey and Analysis (September 2009), p. 8.
26 Point Carbon, Carbon 2009 (2009), p. 10.
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Figure 2. How Important Is the Long-Term Carbon Price for New Investments
in Your Industry?

Source: Point Carbon, Carbon 2009, p. 10.
Notes: Long-term defined as 2020 in the questionnaire. A total of 301 companies affected by the EU-ETS were
surveyed by Point Carbon.
With respect to considering moving production to other countries because of carbon prices, the
Point Carbon survey of EU-ETS companies does not reveal a major trend yet. As indicated in
Figure 3, over 80% of companies surveyed have not considered moving production because of
carbon pricing; however, some of that includes companies, like power producers, that have
limited relocation opportunities. A more detailed look at the figure indicates that 44% of the
respondents in the metals, cement, lime, and glass sectors have at least thought about moving
production. This may be one reason the EU included provisions extending the free allocation of
allowances to such energy-intensive, trade-exposed sectors through Phase 3.
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Figure 3. Companies Response to Carbon Price

Source: Point Carbon, Carbon 2009, p. 12.
Notes: A total of 301 companies affected by the EU-ETS were surveyed by Point Carbon.
These findings by Point Carbon were generally confirmed by the survey and analysis conducted
by The Climate Group for The German Marshall Fund.27 Among that survey’s conclusions were
the following:
• Although costs for some firms are increasing, there is scant evidence of effects
on competitiveness—but concerns about the future persist, especially as the
number of free allowances decreases and CO2 costs are reflected in electricity
prices. The survey noted that aluminum smelters were particularly sensitive to
electricity costs and that the pass-through of CO2 costs may affect future
production decisions.
• Companies have not relocated their operations, reduced their workforce, or lost
market share as a result of carbon pricing to date.
• A market price for carbon has, to date, had a relatively low impact on how top
management runs their businesses. But companies are quick at internalizing the
EU-ETS into their strategic planning. Short-, medium-, and long-term effects of
carbon pricing on strategic planning vary.


27 The Climate Group, The Effects of EU Climate Legislation on Business Competitiveness; A Survey and Analysis,
(September 2009).
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Determining Eligibility for Phase 3: The EC’s Draft List
Criteria Used for EC Draft Eligibility List
Analysis indicates that there are industries that could be significantly impacted by the advent of
higher carbon prices under Phase 3. As indicated by Figure 4, the cement, steel, and aluminum
industries are considered by Carbon Trust to be the industries most exposed to higher carbon
prices. As indicated above, the EU policies being developed are to buy time for these industries
with free allowances while negotiating an international response that would level the playing field
for all companies within a sector.
Figure 4. Carbon Trust Assessment of Exposure to Phase 3 Competitiveness Issues
(for the United Kingdom manufacturing sector)

Source: Carbon Trust, EU ETS Impacts on Profitability and Trade (2008), p. 3.
Note: 159 manufacturing activities studied.
The list created by the EC suggest a more comprehensive view of potentially affected industries
than that suggested above. The EC used five different sets of criteria in compiling its list of 164
subsectors and sectors.
1. Paragraph 4: Significant risk of carbon leakage criteria based on a sector’s or
subsector’s ability to pass on the direct and indirect costs of control and
allowance costs into its product’s price without a significant loss of market share
to less carbon efficient installations outside the Community (in accordance with
Article 10a(14) of Directive 2003/87).
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2. Paragraph 5(a): Significant risk of carbon leakage criteria based on whether a
sector’s or subsector’s direct and indirect costs of control and allowance costs
would represent a substantial increase of production costs, calculated as a
proportion of the gross value added, of at least 5% and the intensity of trade with
third countries, defined as the ratio between the total value of exports to third
countries plus the value of imports from third countries and the total market size
for the Community (annual turnover plus total imports from third countries), is
above 10% (in accordance with Article 10a(15) of Directive 2003/87BC).
3. Paragraph 5(b): Significant risk of carbon leakage criteria based on whether a
sector’s or subsector’s direct and indirect costs of control and allowance costs
would represent a particularly high increase of production costs, calculated as a
proportion of the gross value added, of at least 30% (in accordance with Article
10a(16) of Directive 2003).
4. Paragraph 5(c): Significant risk of carbon leakage criteria based on a sector’s or
subsector’s intensity of trade with third countries, defined as the ratio between
the total value of exports to third countries plus the value of imports from third
countries and total market size for the Community (annual turnover plus total
imports from third countries), is above 30% (in accordance with Article 10a(16)
of Directive 2003).
5. Paragraph 14: Significant risk of carbon leakage criteria based on a qualitative
assessment of a sector or subsector; criteria may include increased production
costs, current and projected market characteristics, and profit margins (in
accordance with Article 10a(17) of Directive 2003/87/EC).
A company's ability to compete under a carbon policy depends on three primary factors: (1) the
greenhouse gas intensity of a company's products, which influences the company's profitability
and the products' cost; (2) the company's ability to pass on any increased costs to consumers
without losing market share or profitability; and (3) the company's ability to mitigate carbon
emissions, reducing the impact of the carbon policy on its operations and profitability.28
Interestingly, only the second set of criteria used by the EC seems to incorporate all three factors
in determining eligibility. Indeed, the fourth set of criteria used by the EC is based solely on
trade-exposure: the impact of carbon control is not included in the criteria. The expansive
eligibility requirements under the third and fourth sets of criteria results in 117 of the 164 sectors
and subsectors listed by the EC, and includes everything from the manufacturing of wines to
numerous textiles. While such sectors are trade-exposed, they are not generally considered to be
greenhouse-gas intensive, as indicated by the Carbon Trust analysis cited above.
Data Sources Used for EC Draft Eligibility List
The EC’s inclusion of a qualitative set of eligibility criteria is suggestive of the data difficulties in
setting up a comprehensive program to address carbon leakage. The EC’s discussion of a
qualitative analysis of the “Finishing of textiles” sector (Nomenclature des Activites
Economiques or NACE code 1730) presented in paragraph 17 of the draft decision is illustrative:

28 See CRS Report R40100, “Carbon Leakage” and Trade: Issues and Approaches, by Larry Parker and John Blodgett,
and Carbon Trust, The European Emissions Trading Scheme: Implications for Industrial Competitiveness (June 2004),
pp. 6-7.
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A qualitative assessment has been carried out on the sector of “Finishing of textiles” (NACE
code 1730), primarily due to the fact that no official trade data at the Community level is
available to assess trade intensity and that all other textile sectors are highly trade intensive.
The assessment demonstrated increased international competitive pressure, significant drop
in production in the Community over the last years and negative or only very modest profit
margins for the years evaluated, which limit the capacity of installations to invest and reduce
emissions. Based on the combined impacts of those factors, the sector should be deemed as
exposed to a significant risk of carbon leakage. (paragraph 17)
The “Finishing of textiles” sector is not covered by the ETS and, therefore, the EC’s concern
about the sector’s “very modest profit margins” that “limit the capacity of installations to invest
and reduce emissions” seems somewhat irrelevant, at least at the current time. The sector may be
trade-exposed; however, its primary impact from controlling greenhouse gas emissions is the
indirect effects of increased electricity generating costs. As indicated by Figure 1, this sector’s
indirect emissions account for less than 5% of its gross added value at stake. In its analysis of
affected industries, Carbon Trust notes that the UK textiles finishing sector is not trade-exposed;
“By far the most economically significant activities [within the UK textile industry], textiles
finishing (at 230 million pounds GVA) appears in the source data as trading only domestically.
Therefore, no major activities appear subject to significant carbon price impacts.”29
Data difficulties expand beyond determining eligibility of domestic industry sectors or subsectors.
As noted in paragraph 22 of the draft decision, the list is supposed to take into account the extent
to which third countries that represent a “decisive share of global production” in the sectors or
subsectors deemed exposed to carbon leakage (1) “firmly” commit to reducing greenhouse gas
emissions in those sectors or subsectors “to any extent comparable to that of the Community and
within the same time frame,” and (2) have installations located in their countries whose carbon
efficiency is “comparable” to that of the Community. However, with respect to the second factor,
the EC states:
As regards the carbon efficiency, the relevant data necessary for that assessment is not
available due to incomparability of statistical definitions and general lack of global data at
the required level of disaggregation and sectoral detail. Therefore, the criteria set out in
Article 10a(18) of Directive 2003/87/EC had no effect on the list of sectors and subsectors.
(paragraph 22)
U.S Proposals to Address Carbon Leakage: H.R. 2454
Greenhouse gas reduction legislation introduced over the last two Congresses has included
provisions to address carbon leakage. In general, two strategies have been employed: (1) free
allocation of allowances (similar to that of the EU); and (2) an international reserve allowance
(IRA) scheme. H.R. 2454, as passed by the House, contains both of these strategies.30
Title IV of H.R. 2454 would amend the bill’s new Title VII of the Clean Air Act by creating a new
Part F to address carbon leakage. The purpose of the new Part F is both environmental, in terms
of reducing potential carbon leakage resulting from potential shifts of production and investment

29 Carbon Trust, EU ETS Impacts on Profitability and Trade: A sector by sector analysis (2008), p. 29.
30 For more information on trade and carbon leakage issues, see CRS Report R40100, “Carbon Leakage” and Trade:
Issues and Approaches, by Larry Parker and John Blodgett.
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from the United States to countries without carbon controls, and economic, in terms of preventing
the associated job loss from such a shift. Specifically, the purposes of Part F as a whole would be
(1) “to promote a strong global effort to significantly reduce greenhouse gas emissions and,
through this global effort, stabilize greenhouse gas concentrations in the atmosphere at a level
that will prevent dangerous anthropogenic interference with the climate system,” and (2) “to
prevent an increase in greenhouse gas emissions in countries other than the United States as a
result of direct and indirect compliance costs incurred under” the new Title VIII.31
The free allocation scheme (subpart 1) would be further aimed at the following: (1) “to provide a
rebate to the owners of and operators of entities in domestic eligible industrial sectors for their
greenhouse gas emissions costs incurred under this title, but not for costs associated with other
related or unrelated market dynamics”; (2) “to design such rebates in a way that will prevent
carbon leakage while also rewarding innovations and facility-level investments in energy
efficiency performance improvements”; and (3) “to eliminate or reduce distribution of emission
allowances under subpart 1 when such distribution is no longer necessary to prevent carbon
leakage from eligible industrial sectors.”32
The IRA scheme (subpart 2) would have these additional purposes: (1) “to induce foreign
countries, and, in particular, fast-growing developing countries, to take substantial action with
respect to their greenhouse gas emissions consistent with the Bali Action Plan developed under
the United Nations Framework Convention on Climate Change” and (2) “to ensure that the
measures described in subpart 2 are designed and implemented consistent with applicable
international agreements to which the United States is a party.”33
H.R. 2454, Title IV, Subpart 1: Free Allocation
of Allowances
Description of Rebate Program
Subpart 1 of the new Part F would create a rebate program directed at energy/greenhouse gas-
intensive, trade-exposed industries harmed by the direct emissions reduction costs and indirect
increased energy input costs from implementing Title VII (the cap-and-trade provisions of H.R.
2454). The program would begin by requiring EPA to publish a list of eligible industrial sectors
and amount of allowances to be rebated per unit of production for the next two years by June 30,
2011 (revised every four years thereafter). Presumptively eligible industrial sectors would be
determined at the six-digit classification level in Codes 31-33 of the North American Industrial
Classification System of 2002 (NAICS).34 As determined by EPA, presumptively eligible sectors,
based on six-digit NAICS classification, are those that (1) meet energy or greenhouse gas
intensity criteria (specifically, that energy or greenhouse gas costs are at least 5% of the value of
their shipments) and trade exposure criteria (specifically, a trade intensity of at least 15%, based
on the value of a sector’s total imports and exports divided by the value of its shipments and

31 H.R. 2454, as passed, new section 761(a).
32 H.R. 2454, as passed, new section 761(b).
33 H.R. 2454, as passed, new section 761(c).
34 H.R. 2454, as passed, new section 763(b).
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imports); or (2) have very high energy or greenhouse gas intensity (at least 20%). The bill
specifies data sources to be used in these determinations and, specifically, annual average data for
2004-2006, unless unavailable. However, the bill provides that EPA shall determine additional
sectors to be eligible if they (1) meet the greenhouse gas or energy intensity criteria at the time
the rule is promulgated and (2) meet trade intensity criteria based on post-2006 data. The bill also
has provisions allowing individual entities to petition for inclusion of their subsector under the
program (Section 763).35 Potential coverage is focused on primary products, such as iron, steel,
aluminum, and cement. The bill expressly prohibits the petroleum refining sector from being
considered an “eligible industrial sector.”36
Based on the best data available, EPA is to provide the rebate to eligible companies based on a
two-part formula: (1) 100% of the industry’s annual average emissions per unit of output over the
most recent four years multiplied by the company’s annual average output over the preceding two
years (direct emissions); and (2) average emissions per kilowatt-hour of electricity purchased by
the company multiplied by the industry average electricity used per unit of output over the
preceding two years multiplied by an electricity efficiency factor to be determined by EPA
(indirect emissions). Entities not covered by Title VII are eligible for the indirect emissions
rebate. If these formulas result in more allowance needs than provided under the bill, the
allocations to entities would be reduced on a pro rata basis to match the allowances available
(Section 764)
Unless modified by the President, the allowance rebates are phased out over a 10-year period,
beginning in 2026. Facilities that ceased to engage in qualifying activities would lose their
allocations at the point they ceased those activities. As provided in Sec. 767, the President may
modify the phase-out schedule for a sector if 15% or more of U.S. imports for that sector is still
produced in countries with inadequate carbon policies.
Eligible Industries
The designation of six-digit NAICS codes for determining eligibility adds a level of precision to
the program that could make implementation more straightforward than would otherwise be the
case. While there are about 450 manufacturing sectors designated at this level within these three
codes,37 it is likely that less than 50 of these would be deemed presumptively eligible under the
detailed requirements set out in the bills. During deliberations on H.R. 2454, the Energy-Intensive
Manufacturers’ Working Group on Greenhouse Gas Regulation provided detailed testimony on
the energy intensity and trade intensity of the U.S. manufacturing sector.38 These data, based on
analysis done for the Working Group by FTI Consulting, are presented in Figure 5 and Figure 6.
According to the Working Group, 47 sectors are presumptively covered under subpart 1. This

35 The provision also provides that iron and steel made with different processes and metal, soda ash, or phosphate
production classified under more than one NAICS code be treated as different categories under the section; and that
differences in use of combined heat and power technologies be taken into account.
36 H.R. 2454, as passed, new section 763(b)(2)(C).
37 The NAICS codes are updated every five years. H.R. 2454 specifically defines NAICS codes as 2002 NAICS codes.
See 2002 NAICS Definition, 31-33, Manufacturing, at http://www.census.gov/cgi-bin/sssd/naics/naicsrch?chart_code=
31&search=2002%20NAICS%20Search.
38 Testimony of John McMackin for the Energy Intensive Manufacturers’ Working Group on Greenhouse Gas
Regulation before the House Committee on Ways and Means (March 24, 2009), available at
http://waysandmeans.house.gov/media/pdf/111/mcm.pdf.
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number is considerably less than the 164 sectors and subsectors potentially covered under the EC
draft decision. The primary reason for the difference is that the main set of criteria incorporated in
subpart 1 includes all three of the factors discussed earlier: (1) the greenhouse gas intensity of a
company's products which influences the company's profitability and the products' cost; (2) the
company's ability to pass on any increased costs to consumers without losing market share or
profitability; and (3) the company's ability to mitigate carbon emissions, reducing the impact of
the carbon policy on its operations and profitability.39
Figure 5. U.S. Manufacturing Exposed to Carbon Leakage Risk

Source: FTI, Greenhouse Gas Emissions Legislation: Leakage-Exposed Manufacturers: Briefing Book (June 2009).

39 The second set of criteria set up under Subpart 1 only adds one sector, lime manufacturing, to the list of
presumptively covered sectors.
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Figure 6. Presumptively Eligible Energy-Intensive, Trade-Exposed Industries

Source: FTI, Greenhouse Gas Emissions Legislation: Leakage-Exposed Manufacturers: Briefing Book (June 2009)
The EPA has also compiled a list of presumptively covered sectors; a list that is identical to that
above, with two exceptions: paperboard mills (322130) and beet sugar (311313) are not included
in the EPA list due to differences in data sources.40

40 U.S. Environmental Protection Agency, Comparison of FTI and EPA analyses of H.R. 2454, Title IV, Memorandum
to the House Energy and Commerce Committee Staff (June 10, 2009).
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Proposed Funding
Under H.R. 2454, energy-intensive, trade-exposed industries are allocated 2% of available
allowances in 2012 and 2013, 15% of available allowances in 2014, and 13.4% of available
allowances from 2015 through 2025. In addition, H.R. 2454 mandates that energy-intensive,
trade-exposed industries receive their share of allowance value provided local electric distribution
companies (LDCs) for electricity rebates. According to 2006 Bureau of Census data, the eligible
industries purchased between 295 billion (EPA list) and 315 billion (Working Group list)
kilowatt-hours of electricity.41 They represent between 29% and 31% of retail sales to the
industrial sector in 2006, or between 8% and 8.6% of total retail sales. Assuming a pass-through
of allowance value by the LDCs based on 2006 data, this would represent about 2.4% to 2.6% of
available allowances.
The allowances these allocations represent are presented in Figure 7. After 2025, the allocation to
energy-intensive, trade-exposed industries is phased-out over a 10-year period. The allocation to
LDC is phased-out over a five-year period, beginning after 2025.
Figure 7. Direct and Indirect Allowance Allocations to Energy-Intensive, Trade-
Exposed Industries under H.R. 2454
1000
900
800
)
s
700
on
li
il
600
m
(
s
500
e
c
n
a
400
w
llo
300
a
200
100
0
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
Direct
Indirect (EPA List)
Indirect (WG List)

Source: H.R. 2454 and CRS calculations.
Notes: See text.

41 The data for NAICS 212210 and 212234 are for 2007.
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Analysis
Adequacy of Allocation
Both EPA and FTI (for the Working Group) have estimated the required allowances to
compensate eligible industries for their direct and indirect greenhouse gas emissions. According
to EPA, the total is 738 million allowances annually from 2014 through 2025, or 14.5% of
available allowances; for the Working Group, the total is 828 million allowances. The differences
result from higher estimates by the Working Group for paperboard, cement, plastics, iron and
steel processes, and phosphates and soda ash. A breakdown of annual emissions by direct and
indirect sources is provided in Table 1. In addition, the Working Group recommends an
additional 10% be included as a reserve for individual showings of need and for methodological
uncertainty. These contingencies raise the Working Group’s estimate to 910 million allowances
annually, or 16.2% of available allowances.
Table 1. Direct and Indirect Emissions from Eligible Industries
(annually, in million metric tons of CO2 equivalent)
Direct Emissions
Indirect Emissions
Direct Emissions
from Industrial
from Electricity
Source
from Combustion
Processes
Consumption Total
EPA 383 173 183 738
FTI 413 198 216 828
Source: U.S. Environmental Protection Agency, Comparison of FTI and EPA analyses of H.R. 2454, Title IV,
Memorandum to the House Energy and Commerce Committee Staff (June 10, 2009).
Notes: EPA estimates are based on the average of 2004-2006 emissions, assuming no growth or efficiency
improvements through 2025. FTI estimates are based on 2007 emissions, assuming no growth or efficiency
improvements through 2005. Estimates do not include the reserve for individual showings of need and for
methodological uncertainty included in the Working Group estimate of 910 million metric tons of CO2
equivalent.
As noted above, after providing 15% of available allowances to energy-intensive, trade-exposed
industries in 2014, H.R. 2454 provides 13.4% from 2015 through 2025. This would compensate
between 82% and 92% of the industries projected direct and indirect costs. In addition, according
to H.R. 2454, all industry is eligible for the pass-through of allowance value provided via local
electric distribution companies (LDCs) (Sec. 783(b)(5)(D)). As noted above, based on Census
Bureau and Energy Information Administration (EIA) data, CRS calculates a “ballpark” estimate
of an additional 2.4% to 2.6% of available allowances being directed toward cost relief for
energy-intensive, trade-exposed industries.42 This estimate is considerably lower than the roughly
5% estimate provided to CRS by EPA. However, EPA notes that its numbers are overestimates of

42 This calculation mixes two data sets and, therefore, should be viewed as a ballpark estimate. The data on purchases
of electricity by the eligible sectors is from the U.S. Census Survey for 2006. The data for all retail sales is from the
Energy Information Administration (EIA) for 2006. Based on Census data, the eligible industries purchased between
295 (EPA's List) and 315 (Working Group list) billion Kwhs in 2006. Based on EIA data, that is equal to about 29%-
31% of industrial sector retail sales or between 8% and 8.6% of total retail sales in 2006. All else being equal, eligible
energy-intensive industry should get about 2.4% to 2.6% of total available allowances via the LDC pass-through (30%
LDC allocation times 8%-8.6%).
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actual amounts because their model’s (ADAGE) energy-intensive manufacturing sector is “much
larger” than the industries made eligible by the language in H.R. 2454.43
As indicated by Figure 8, H.R. 2454’s allocation scheme would appear to provide sufficient
allowances if EPA’s estimates are correct. If the Working Group’s estimates are correct, or if
individual showings of eligibility prove significant, the pool of allowances provided by the bill
would not be adequate under the assumptions used here.
Figure 8. Projected Allowance Need and Allocation to Eligible Industries
(average annual, 2014-2025)
1000
900
800
700
600
nces annually
500
a
400
300
million allow
200
100
0
EPA
WG w/o
WG w/
contingencies
contingencies
Allowances Needed
Allowances Allocated

Source: CRS calculations and U.S. Environmental Protection Agency, Comparison of FTI and EPA analyses of H.R.
2454, Title IV, Memorandum to the House Energy and Commerce Committee Staff (June 10, 2009).
Notes: EPA estimates are based on the average of 2004-2006 emissions, assuming no growth or efficiency
improvements through 2025. FTI estimates are based on 2007 emissions, assuming no growth or efficiency
improvements through 2005. The Working Group w/o contingencies estimates do not include the reserve for
individual showings of need and for methodological uncertainty included in the Working Group w/ contingencies
estimate.
Whether the individual state public utility commissions (PUCs) (or other responsible body in the
case of publicly owned utilities or cooperatives) would work to ensure that LDCs did return to
industry the share provided it in the bill or would attempt to tilt allocations in favor of residential
consumers is disputed. The language of H.R. 2454 is clear with respect to providing energy-
intensive, trade-exposed industries with their share of the electricity rebate (Sec. 783(b)(5)), and

43 Email correspondence from Jared Creason, Ph.D., Climate Economics Branch, U.S. Environmental Protection
Agency (September 30, 2009).
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each allowance misused by a state would be considered a separate violation of the Clean Air Act.
H.R. 2454 requires a representative sample of LDCs to submit an annual report on
implementation of the electricity rebate; this is to include how they are complying with the
requirement to provide allowance value to energy-intensive, trade-exposed industries. A question
is whether or not this reporting requirement, along with EPA implementation of the enforcement
provision, would sufficiently influence LDC and PUC decision-making.
The Working Group has expressed great skepticism about the states’ public utilities commissions’
willingness to pass through savings to industry instead of favoring residential consumers—a
decision over which Congress would have limited influence. This skepticism may not be
unfounded. In an October 28, 2009, letter to Chairman Boxer and Ranking Member Inhofe of the
Senate Environment and Public Works Committee, the National Association of Regulatory Utility
Commissioners (NARUC) urged the Senate to think carefully before “handcuffing” state
regulators. As stated in the letter:
NARUC understands the need for federal oversight of what will undoubtedly be a significant
amount of money flowing between LDCs and consumers. However, we also believe that
State commissions are far more accountable to ratepayers than distant bureaucracies in
Washington, and are far more efficient at developing innovative and entrepreneurial clean
energy programs. State commissions know their localities and constituents best, and we are
obligated to ensure fair, just and reasonable rates. The Senate should give States more
leeway in distributing allowance proceeds so consumers can truly benefit.44
Effectiveness of Free Allowance Scheme
Both the EPA and the Energy Information Administration (EIA) have explicitly examined the
impact of H.R. 2454’s free allowance allocation to energy-intensive, trade-exposed industries. In
the EPA/ADAGE analysis, energy-intensive manufacturing output is projected to decline by 0.3%
from base case levels in 2015 and by 0.7% in 2020 without H.R. 2454’s free allocation scheme.
With the free allocation scheme, energy intensive manufacturing output is projected to increase
by 0.04% from base case levels in 2015, and then decline by 0.3% from base case levels in
2020.45 The free allocation scheme phases out in the 2020s.
The EIA/NEMS analysis of energy-intensive, trade-exposed industries also indicates that the free
allocation to those industries reduces the impact of H.R. 2454 that they would otherwise bear. As
stated by EIA:
Receiving these permits ameliorates the impact of increased energy prices and therefore
industries face energy prices that are not impacted by the permit values. As a result, when
energy prices increase, the reductions in output of these trade- and energy-vulnerable
industries are less than overall manufacturing impacts and mirror the impacts (in terms of
percentage change from the Reference Case) of total industrial shipments. In past EIA
analysis of industrial impacts of energy price increases, these energy-intensive industries
typically experience larger losses compared to overall manufacturing. 46 [footnotes omitted]

44 Frederick F. Butler, President, National Association of Regulatory Utility Commissioners, Letter to Chairman Boxer
and Ranking Member Inhofe (October 28, 2009), p. 2.
45 U.S. Environmental Protection Agency, EPA Analysis of the American Clean Energy and Security Act of 2009: H.R.
2454 in the 111th Congress—Appendix (June 23, 2009), p. 42.
46 EIA, Energy Market and Economic Impacts of H.R. 2454, the American Clean Energy and Security Act of 2009
(continued...)
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The overall effect of the free allocation over time can been seen in Figure 9, from the EIA report.
As indicated, the impact on energy-intensive, trade-exposed industries is comparable to that on
industry as a whole, suggesting that the allowance allocation has a positive effect in alleviating
any disadvantage they may have from being exposed to international competition from countries
without comparable carbon policies.
Although the scheme would appear effective in mitigating the trade-related impact of the program
on energy-intensive, trade-exposed industries, 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 (e.g., feedstocks,
petroleum, etc.). Whether these costs would become significant would depend on the ability of
upstream suppliers to pass on those 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.
Figure 9. Industrial Impacts in the H.R. 2454 Basic Case, 2012-2030
(percent change from Reference Case)

Source: EIA, Energy Market and Economic Impacts of H.R. 2454, the American Clean Energy and Security Act of 2009
(August 2009), p. 45.
Phase-Out Schedule
H.R. 2454 provides that, unless modified by the President, the allowance rebates are phased out
over a 10-year period, beginning in 2026. In addition, the pass-through of allowance value from

(...continued)
(August 2009), p. 44.
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LDCs is also phased-out, but on a shorter schedule (beginning in 2026 and reaching zero in 2030)
As provided in Section 767, the President may modify the phase-out schedule for the direct rebate
for a sector if 15% or more of U.S. imports for that sector are still produced by countries with
inadequate carbon policies.47 There is no such authority for extending the pass-through received
via the LDCs. As suggested by Figure 9, the EIA analysis assumes the phase-out begins on
schedule in 2026 and the result is declining output for energy intensive, trade-exposed industries.
This raises questions about the timing of any phase-out, and the extent to which the possible
modification of the phase-out schedule introduces uncertainty in corporate decision-making.
H.R. 2454, Title IV, Subpart 2: International Reserve
Allowance Scheme
Description of Program
Overview
If implemented, Title IV, subpart 2 of H.R. 2454 would require EPA to establish an international
reserve allowance scheme that would essentially impose a shadow allowance requirement on
importers of greenhouse gas-intensive, trade-exposed products, creating a de facto tariff.
Basically, the scheme would require importers of energy-intensive products from countries with
insufficient carbon policies to submit a prescribed amount of “international reserve allowances,”
or IRAs, for their products to gain entry into the United States. Based on the greenhouse gas
emissions generated in the production process, IRAs would be submitted on a per-unit basis for
each category of covered goods from a covered country. Specifically, Section 768 requires EPA to
promulgate rules establishing an international reserve allowance system for covered goods from
the eligible industrial sector, including allowance trading, banking, pricing, and submission
requirements.
While subpart 1 would limit the distribution of emission allowances to eligible industrial sectors,
Part F’s definition of the term “covered goods,” a term used only in subpart 2, goes beyond goods
produced by eligible industrial sectors to include a “manufactured item for consumption” (i.e.,
finished goods, which could involve items ranging from aluminum cans to automobiles). 48
Allowances would potentially be required for importation into the United States of goods from a

47 More specifically, and as discussed later in this report, beginning June 30, 2018, and every four years thereafter, the
President would be required to determine for each eligible industrial sector whether more than 85% of U.S. imports for
that sector is from countries that are either (1) parties to international agreements requiring economy-wide binding
national commitments at least as stringent as those of the United States, (2) have annual energy or greenhouse gas
intensities for the sector comparable or better than the equivalent U.S. sector, or (3) parties to an international or
bilateral emission reduction agreement for that sector. If not, the President would be required, no later than June 30,
2018 (and every four years thereafter), to assess the effectiveness of subpart 1 rebates and the international reserve
allowance program in mitigating or potentially mitigating the carbon leakage in that sector, and respond by (1)
modifying the rebate formula under subpart 1, and (2) implementing (or continuing to implement) an international
reserve allowance program with respect to imports of covered goods from that sector.
48 Also, under subpart 2, iron and steel produced by different processes shall be considered as one eligible industrial
sector (Section 769). In contrast, subpart 1 would consider entities using different iron and steelmaking processes to be
in different industrial sectors (Section 764(d)).
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covered country that correspond to goods produced by U.S. eligible industrial sectors and, in
some cases, for the importation of manufactured items for consumption from such countries.
The program would need to be consistent with U.S. commitments under international agreements,
and in a manner that minimizes the likelihood of carbon leakage resulting from cost differentials
resulting from compliance by U.S. companies with the U.S. reduction program compared with
compliance by foreign companies with their nation’s reduction program. The EPA would be
required to adjust the international reserve allowance requirement based on the value of
allowances allocated free under subpart 1 and under Section 782(a) (electricity providers),
including reducing the requirement to zero. The international reserve allowances issued under this
program may not be used by covered entities to comply with the domestic emissions cap under
Title VII. Also, this program may not apply to imports entering the United States before January
1, 2020.
Initial Action: Section 765
Under Section 765, the President is required as soon as practicable after enactment to notify all
non-exempted countries that the United States (1) seeks international agreements that commit all
major emitting nations to contribute equitably to reducing greenhouse gas emissions; (2) requests
the country take appropriate measures to limit its greenhouse gas emissions, and (3) may apply
the international reserve requirements of this subpart to a covered good beginning on January 1,
2020. Exemptions are provided under section 768(a)(1)(E) for the (1) least developed countries,
(2) countries that emit less than 0.5% of global greenhouse gas emissions and have minimal
export trade with the United States in covered sectoral products, and (3) countries meeting the
comparability criteria of Section 767 (discussed below).
Section 766 states the environmental and economic elements the United States would seek in
negotiating an international greenhouse gas reduction agreement.
Further Requirements and Criteria: Section 767
The President is further required by January 1, 2017 (and biannually thereafter), to submit a
report to Congress on the effectiveness of the emission rebates under Subtitle 1 at mitigating
carbon leakage and recommendations on improving the subtitle’s purposes.49 The report must also
include an assessment, for each industrial sector receiving rebates, as to whether, and by how
much, the per unit cost of production has increased for the sector, taking into account the
provision of the rebates to the sector and the benefit received by the sector from the provision of
free allowances to electricity providers under new section 782(a). In addition, the report must
contain recommendations on improving the purposes of subpart 2, including an assessment of
whether an IRA program for the eligible industrial sector would be feasible and useful. Further, to
the extent that the President determines that an IRA program would not benefit a particular
eligible industrial sector because its exposure to carbon leakage is due to competition in third
country markets (i.e., occurs because of the sector’s export trade), the President would need to
identify alternative actions or programs consistent with the purposes of subpart 2. The President
could also determine in such a case that an IRA program will not apply to the sector, though the
determination must be approved by Congress (see below). Finally, the report must assess the

49 H.R. 2454, as passed, new section 767(a).
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amount and duration of assistance, including the distribution of free emission allowances, being
provided to industrial sectors in other developed countries to mitigate compliance costs for
domestic greenhouse gas (GHG)-reduction in those countries.
In addition, unless there is a multilateral agreement on reducing greenhouse gases in force for the
United States by January 1, 2018, the President would be required to establish an international
reserve allowance program for all eligible sectors unless the President determines, and the
Congress concurs, that a sector covered under the program, or inclusion of a sector within that
program, would not be in the nation’s economic or environmental interests.50 To become
effective, each such determination would need to be approved by both houses of Congress within
90 days after the President submitted his determination.51 Precisely when such a presidential
determination and congressional concurrence must occur is not explicitly stated; however, a strict
interpretation would suggest it must occur before the President is required to make his next
determination under the bill’s provisions on June 30, 2018.
Beginning June 30, 2018, and every four years thereafter, the President would be required to
determine for each eligible industrial sector whether more than 85% of U.S. imports of “covered
goods” for that sector are produced or manufactured in countries that meet one of these criteria:
(1) the country is party to “an international agreement to which the United States is a party
that includes a nationally enforceable and economy-wide greenhouse gas emissions
reduction commitment for that country that is at least as stringent as that of the United
States”;
(2) the country is a party to a multilateral or bilateral emission reduction agreement for that
sector to which the United States is a party; or
(3) the country has annual energy or GHG intensity for the sector comparable to or less than
the energy or GHG intensity for the sector in the United States for the most recent year for
which data are available.52
The bill does not appear to specify a time period within which the imports used in the calculation
must have entered the United States, nor does it specify whether the quantity of imports is to be
calculated on the basis of the value of the imports or on the basis of output (i.e., units imported).53
If the 85% threshold is not exceeded, the President would be required to assess the effectiveness
of both rebates (including the benefit that the sector receives from the provision of free

50 H.R. 2454, as passed, new section 767(b).
51 Any such joint resolution would be considered under an expedited legislative procedure set out in section 152 of the
Trade Act of 1974, 19 U.S.C. § 2191, providing for automatic discharge of the resolution from committee, a
prohibition on amendments, and limited floor debate in the House and Senate. H.R. 2454, as passed, new section 767
(b)(2)-(3).
52 H.R. 2454, as passed, new section 767(b)(1)(emphasis added). Although H.R. 2454 anticipates Senate or
congressional approval of a multilateral GHG-reduction agreement, it does not appear to indicate how a sectoral
agreement should be treated were such an agreement to be signed by the United States.
53 Note that, for purposes of determining whether an industrial sector is eligible for free allowances, EPA would
determine trade intensity by reference to the value of imports and exports (new section 763(b)(2)(A)(iii)).
See also the definition of “output” at H.R. 2454, as passed, new section 762(7) (“The term ‘output’ means the total
tonnage or other standard unit of production (as determined by the Administrator) produced by an entity in an industrial
sector).
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allowances to electricity providers) and an IRA program in addressing or mitigating, or
potentially addressing or mitigating, carbon leakage in that sector. The President would then need
to respond by (1) modifying the rebate formula and (2) implementing (or, in the case of future
determinations, continuing to implement) an IRA program for the sector.54 If the threshold is
exceeded, however, the President would be expressly prohibited from applying a sectoral IRA
program.55
Effectively, the international reserve allowance program would be established for all eligible
sectors unless the Congress (or the Senate, in the case of a treaty) approves a multilateral
agreement reducing greenhouse gases and the agreement enters into force for the United States, or
the Congress votes to concur with a Presidential determination that including an eligible sector
would not be in the nation’s economic or environmental interest. Further, once the program is
established for a sector, H.R. 2454 would not permit the President to determine, as a result of his
assessments, whether or not the rebate formula should be altered or an IRA program should be
applied. By not providing for this intermediate step, the bill would effectively make these two
actions mandatory once the President had determined that the 85% threshold had not been
exceeded for the sector involved. In the event a program is to be applied, the bill would prohibit
IRAs from being collected on goods imported into the United States before January 1, 2020.56
EPA Implementing Regulations: Section 768
If implemented, section 768 requires that the regulations that EPA issues for an IRA program for
an eligible industrial sector contain specific elements. The regulations must be issued with the
concurrence of U.S. Customs and Border Protection (CBP), which has general statutory
responsibility over the entry of goods into the United States, including the assessment and
collection of duties and fees on imported products. Such regulations must
• establish an IRA program for the sale, exchange, purchase, transfer, and banking of IRAs for
covered goods with respect to the sector;
• ensure that the price for purchasing IRAs from the United States on a particular day is
equivalent to the auction clearing price for emissions allowances [under the new cap-and-
trade provisions of Title VII] for the most recent emission allowance auction;
• establish a general methodology for calculating the quantity of IRAs that a U.S. importer of
any covered good must submit;
• require the submission of appropriate amounts of IRAs for covered goods with respect to the
eligible industrial sector that enter U.S. customs territory;
• specify the procedures that CBP will apply for the declaration and entry of the sector’s
covered goods into U.S. customs territory;

54 H.R. 2454, as passed, new section 767(d).
55 H.R. 2454, as passed, new section 767(d)(2).
56 H.R. 2454, as passed, new section 768(e).
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• establish procedures that prevent circumvention of the IRA requirement for covered goods
that are manufactured or processed in more than one foreign country. 57
In establishing a general methodology for calculating the required number of IRAs for a covered
good, EPA would be required to include an adjustment based on the value of rebates distributed to
the eligible industrial sector involved as well as the benefit received by the sector from free
allowances received by electricity providers under the bill.58 In applying such an adjustment, EPA
would be permitted to determine that the amount of IRAs for a given product should be zero.
In addition, in administering a sectoral IRA program, EPA would need to exempt goods
originating in three categories of countries from the border IRA requirement: (1) countries
meeting any of the three standards set out in the new Section 767 for determining if a country had
taken adequate action to reduce its GHG emissions for a sector, and ultimately, whether the
corresponding U.S. industrial sector merited further assistance (see below); (2) the least
developed of developing countries (LDDCs); and (3) countries that the United States determines
are de minimis emitters responsible for less than 0.5% of total global greenhouse gas emissions
and for less than 5% of U.S. imports of covered goods for an eligible industrial sector.59
The bill would also require the EPA to establish the IRA program “consistent with international
agreements to which the United States is a party.”60 Absent a limiting definition in the bills, this
requirement would seemingly encompass all U.S. international agreements, including both
environmental agreements and international trade agreements.
Decision-Making Process
Figure 10 is a flow chart that traces the decision-making process of the International Reserve
Allowance scheme created by the Center for Clean Air Policy.61

57 H.R. 2454, as passed, new section 768(a)(1)(A)-(D), (F)-(G).
58 H.R. 2454, as passed, new section 768(b).
59 H.R. 2454, as passed, new section 768(a)(1)(E).
60 H.R. 2454, as passed, new section 768(a)(2). As noted earlier, H.R. 2454 also sets out as one of the purposes of
subpart 2, “to ensure that the measures described in subpart 2 are designed and implemented in a manner consistent
with applicable international agreements to which the United States is a party.” H.R. 2454, as passed, new section
761(c)(2).
61 Center for Clean Air Policy, Summary of Provisions to Protect the Competitiveness of U.S. Industry in the American
Clean Energy and Security Act (July 23, 2009), p. 24.
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Figure 10. Decision Tree for IRA Scheme

Source: Center for Clean Air Policy, Summary of Provisions to Protect the Competitiveness of U.S. Industry in the
American Clean Energy and Security Act (July 23, 2009), p. 24.
Analysis
Potential Impact
No analysis of subpart 2 and its impact on trade has been conducted. Indeed, the only analysis of
an IRA scheme that has been done at all is one conducted by EPA (ADAGE) with respect to Title
VI of S. 2191, introduced in the 110th Congress.62 In that report, EPA’s sensitivity analysis
indicated that if countries without legally binding commitments to reduce greenhouse gases
commit to maintaining their 2015 levels beginning in the year 2025, and to returning their
emissions to 2000 levels by 2050, no international emission leakage occurred. Imports of energy-
intensive goods were projected to fall under this scenario, while exports expanded as developing
countries coped with their new emission limits.

62 EPA, EPA Analysis of the Lieberman-Warner Climate Security Act of 2008: S. 2191 in 110th Congress (March 14,
2008).
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In a worst case scenario, EPA’s 2008 sensitivity analysis looked at a no-international-actions-to-
2050 scenario. In this scenario, the International Reserve Allowance provisions of S. 2191 were
assumed to be triggered because of the lack of international action. Emissions from countries
without legally binding commitments were estimated to rise by 350 million metric tons of CO2e
by 2030 and 385 million metric tons by 2050—less than 1% of their base case levels under
ADAGE. It would have been equivalent to U.S. emission leakage rates of approximately 11% in
2030 and 8% in 2050. These emissions compared with increases of 361 million metric tons and
412 million metric tons for 2030 and 2050, respectively, if the IRA provisions were not
implemented. EPA described the impact of the IRA program on leakage as “minimal.”63
The projected impact on imports was more significant. Without the International Reserve
Allowance requirement, imports from countries without legally binding commitments were
projected to increase 5.4% in 2030, rising to 7% in 2050. In contrast, under the IRA provisions,
imports were estimated to increase about 1% in 2030 and decline about 5% in 2050. U.S. exports
declined in both cases as countries used more of their domestic manufacturing capacity.64
If the EPA projections for S. 2191 are transferable to H.R. 2454, the differential effect of IRA
provisions on trade versus emissions leakage could present problems if the scheme is brought
before the World Trade Organization (WTO).
In addition, this analysis does not fully account for the nature of international trade. Trade and
economics involve dynamic processes that can respond to public policy in unanticipated ways.
For example, trade sanctions based on primary goods, such as steel and aluminum, could have
impacts on domestic downstream industries. An increase in the cost of raw steel or aluminum
could drive up the costs of domestically manufactured finished products, such as automobiles,
and encourage foreign countries to export more finished products to the United States. Indeed, a
country could redirect its exports from primary goods to finished goods to avoid the trade
sanctions. For example, South Korea, which exports both raw steel and automobiles, could focus
its industrial policy toward automobile exports and away from raw steel exports. Thus,
downstream companies that use greenhouse gas-intensive goods could have their competitiveness
undermined by attempts to protect greenhouse gas-intensive, trade-exposed industries,
particularly if their goods do not meet the criteria for “items manufactured for consumption”
provided in the bill.
Data Needs
As noted earlier under the discussion of the EC’s draft list of eligibility, lack of data prevented the
EC from determining the carbon efficiency of installations in foreign countries (and thus their
comparability with installations within the EU) as part of the criteria set out in Article 10a(18) of
Directive 2003/87/EC. Instead, the EC chose to ignore the issue. This is not an option under
subpart 2.
While official emission data in the United States generally take about one to two years to be
collected, quality assured, and published, many other countries do not have the infrastructure to

63 EPA, EPA Analysis of the Lieberman-Warner Climate Security Act of 2008: S. 2191 in 110th Congress (March 14,
2008), p. 84.
64 EPA, EPA Analysis of the Lieberman-Warner Climate Security Act of 2008: S. 2191 in 110th Congress (March 14,
2008), p. 85.
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create emission data on a timely basis. Under the United Nations Framework Convention on
Climate Change (UNFCCC), the Amost recent year@ for emissions data for many countries is
1994. While U.S. emissions data are more reliable, the lack of equally reliable data for foreign
countries may well prevent the United States from adequately determining whether the same
conditions prevail in foreign countries and the United States (i.e., whether foreign GHG-reduction
programs are in fact comparable to the United States). Moreover, the lack of reliable data may
prevent the Executive Branch from properly determining whether the same conditions prevail in
foreign countries relative to each other, that is, determinations may be made on different
quantitative bases for different countries depending on data availability. The quality of data would
also be a factor in determining which countries are not high emitters and are thus excluded from
the import requirement altogether. Unreliable data may be particularly troublesome in
implementing a statutory cutoff point and countries may fall just above or below the threshold.
For example, China submitted its “Initial National Communication on Climate Change” to the
UNFCCC in October 2004.65 The emission inventory included in that submission was for 1994.
While China notes that its 1994 inventory was prepared in accordance with approved guidelines,
uncertainties remained. It provides two reasons for the uncertainties:
Firstly, as a developing country, China has a relatively weak position with regard to data, and
in particular has many difficulties in obtaining activity data for estimating GHG emissions;
Secondly, though sample surveys and on-the-spot examinations were carried out to some
extent in the energy, industrial processes, agriculture, land-use change and forestry, and
waste treatment sectors to collect the basic data for inventory development, the time span and
specific sample observation points may not be fully representative due to the constraints in
funding, time available and other factors.66
China is not alone. Emission data troubles exist for most Anon-Annex 1@ countries, that is,
countries that are not subject to legally binding emission reductions under the Kyoto Protocol to
the UNFCCC. As stated by the UNFCCC in its 2005 synthesis of initial national communications
from non-Annex 1 countries: “Most Parties [non-Annex 1 countries] reported difficulties in
preparing their GHG inventories, and indicated that their technical and institutional capacities
were inadequate to meet their reporting obligations under the Convention for both the preparation
and updating of national GHG inventories.”67
Other data-related aspects of subpart 2 may also raise implementation issues. For example, as
noted above, the most recent year for which official data on Chinese greenhouse gas emissions is
available is 1994. In contrast, the most recent calendar year for which official data of Chinese

65 The People's Republic of China, Initial National Communication on Climate Change (Beijing, October 2004).
66 Id. at 4. Continuing on page 33 of the document, China says specifically with respect to the energy inventory:
“Because existing statistical materials and data could not meet the needs for preparing the inventory, part of the activity
data could only be obtained by adopting the methods of investigation and experts' judgment. For example, activity data
by device in some important industries such as building material and metallurgy was based on experts judgment; owing
to the lack of the measured data on emission factors from coal combustion by sector and by device, the relevant
potential emission factors and oxidations rates could only be determined through case studies, questionnaires and
partial supplementary measurements; due to the lack of detailed measurement data, methane emissions under different
circumstances from different types of biomass stoves could only be estimated by using the same emissions factors. All
those would affect the accuracy of energy inventory.”
67 United Nations Framework Convention on Climate Change, Subsidiary Body for Implementation, Sixth compilation
and Synthesis of Initial National Communications for Parties not included in Annex I to the Convention: Addendum:
Inventories of anthropogenic emissions by sources and removals by sinks of greenhouse gases,
FCCC/SBI/2005/18/Add.2, (October 25, 2005), p. 10.
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production of major industrial goods (e.g., steel, iron, cement, etc.) are available is 2005.68 This
calculation may produce not only an uneven result for a particular country, but the results for
different countries may vary depending on the years for which data are available and thus provide
uneven results between countries. For example, in contrast to China's 1994 emissions inventory,
the latest submission to the UNFCCC by South Korea provides an emissions inventory for
2001.69 Multiply these differences between countries across affected sectors, subsectors, primary
goods, and “items manufactured for consumption,” and EPA’s ability to create the matrix of data
necessary to implement the scheme becomes problematic, at best.
Presidential Determination to Exclude a Sector
In the absence of a qualifying multilateral GHG-reduction agreement, H.R. 2454 would permit
the President to determine that an IRA program should not be established for an eligible industrial
sector because it would not be in the national economic or environmental interest of the United
States to do so. As evident from possible contents of the President’s initial report to Congress,
legislators would have contemplated that such determinations might involve eligible export-
dependent industrial sectors. The bill would not appear, however, to expressly preclude the
President from making such a determination regarding any sector that he saw fit to exclude.
Nevertheless, since Congress would have apparently distinguished between sectors depending on
whether their primary trade exposure from the U.S. cap-and-trade program is on the import or
export side, it may be more difficult to secure congressional approval for excluding a sector
whose primary concern is the adverse effect of imports into the United States from countries that
do not have GHG-reduction programs or have not made commitments to create them. This
outcome may be even more likely given that there does not appear to be authority in the bill for
the President to establish an IRA program for a sector once Congress has approved its exclusion.
Whether Congress would agree with a presidential request to exclude a sector could be a key
question for other countries engaged in negotiations on multilateral GHG-reduction agreements.
“Covered Goods”
An IRA program would apply to “covered goods” for an eligible industrial sector, defined in the
legislation as any good, as identified by EPA, that is produced by the relevant sector, as well as
any “manufactured item for consumption,” that is, a good that “includes in substantial amounts
one or more goods like the goods produced by an eligible industrial sector” (i.e., a downstream
item such as car or refrigerator in the case of steel products).70 Further, the bill appears to intend
that an IRA program be in effect for that eligible industrial sector and that the product or products
included in the downstream item be subject to IRA allowances greater than zero.71 In addition, the

68 National Bureau of Statistics of China, China Statistical YearbookC 2006, p. 14-24, available at
http://www.stats.gov.cn/tjsj/ndsj/2006/indexeh.htm.
69 See the UNFCCC website at http://unfccc.int/di/DetailedByParty/Event.do?event=go.
70 H.R. 2454, as passed, new section 762(2).
71 The definition of “manufactured item for consumption” lists several requirements that must be met for a product to
qualify as such, including that the good be one, “(ii) with respect to which an international reserve allowance program
pursuant to Subpart 2 is in effect with regard to the eligible industrial sector and the quantity of international reserve
allowances is not zero …” While the definition would make item (ii) applicable to the good for which the petition is
filed, it would appear that item (ii) could logically apply only to the goods that are contained in the manufactured item.
First, the producers filing the petition to include the particular “manufactured item for consumption” as a “covered
good” could not have been part of an eligible industrial sector with an IRA program since, if they were, their goods
would already have been at least potentially subject to IRAs. Second, the good for which the petition is filed could not
(continued...)
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industrial sector producing the good must have a trade intensity level of 15% or more and the
producers of the good must demonstrate, and EPA must determine, that applying IRAs to the
good is technically and administratively feasible and appropriate to achieve the purposes of Part
F, taking into account the energy and GHG intensity of the sector producing the good (as
determined under the formula that would be used to determine these levels for purposes of its
qualifying as an “eligible industrial sector”), the ability of these producers to pass on cost
increases, and “other appropriate factors.”
While the bill would require that the sector producing the good meet the same trade intensity
level needed to qualify as an eligible industrial sector, the bill appears to treat energy or GHG
intensity differently, making the producers’ existing levels, whatever they may be, a factor for the
EPA to consider in deciding whether IRAs are feasible and appropriate to apply. In other words,
in order to have their product be included as a “covered good,” petitioning producers may not
necessarily be expected to meet all the requirements for being deemed an “eligible industrial
sector” for purposes of Part F, whether presumptively or by petition.
“Manufactured Items for Consumption” (Downstream Items)
By including manufactured items for consumption, H.R. 2454 would allow a good that otherwise
would not be a product of a sector eligible for an IRA to be treated as if it were and the good
would thus be a covered good that might qualify for the IRA program. As explained earlier, we
are assuming that the legislation intends that an IRA program already be in effect for the eligible
industrial sector producing the “like” input or inputs into the manufactured item and that the IRA
requirement for the input or inputs is greater than zero. It is unclear, however, what the word
“like” means for purposes of this threshold requirement. While it could, but does not necessarily,
mean identical, how dissimilar the imported input or inputs could be from the goods that are
produced domestically is not specified.72
Whether such a manufactured good would qualify for inclusion would depend in part on the trade
intensity of the sector that produces the good. In addition, producers would seemingly need to
provide EPA with a strong factual and analytical basis to allow it to determine that applying IRAs
to the product would be technically and administratively feasible and appropriate in the
circumstances. As noted earlier, however, producers would not appear to be required to meet the
energy and GHG intensity standards needed to qualify as an “eligible industrial sector” in making
their case and, moreover, “other appropriate factors,” unidentified in the bill, could enter into
their argument and EPA’s ultimate determination. Overall, while the rationale for including goods
produced by an eligible industrial sector in an IRA program is clear, the application of an IRA
program to manufactured goods for consumption could be problematic in that it would extend the
benefits of an IRA program to an industry that would not have initially qualified as an eligible
industrial sector and may yet have difficulty doing so.

(...continued)
be one for which the quantity of IRAs is greater than zero, since the good would not yet be included in the sectoral
program.
72 The term “like product” is used in GATT obligations involving most-favored nation and national treatment, which
prohibit WTO Members from discriminating between like products imported from different countries or between like
imported and domestic items. “Likeness” is ordinarily determined by comparing products under four criteria: physical
properties, end-uses, consumer preferences, and tariff classification. See, generally, World Trade Organization, WTO
ANALYTICAL INDEX; GUIDE TO WTO LAW AND PRACTICE 145-48, 163-67 (2d ed. 2007).
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Emphasis on International Action
As noted above, subpart 2 states that its purpose would be best achieved through international
agreements negotiated by the United States and foreign countries and, to this end, states that it is
U.S. policy to “work proactively under the United Nations Framework Convention on Climate
Change, and in other appropriate fora, to establish binding agreements, including sectoral
agreements, committing all major greenhouse gas-emitting nations to contribute equitably to the
reduction of global greenhouse gas emissions.”73 The bill also sets out U.S. negotiating objectives
for the multilateral environmental negotiations contemplated in the bill. These are
to reach an “internationally binding” agreement in which all major GHG-emitting countries
“contribute equitably” to the reduction of global GHG emissions;
to include provisions “that recognize and address the competitive imbalances that lead to
carbon leakage and may be created between parties and non-parties to the agreement in
domestic and export markets” and not to prevent agreement parties from addressing “the
competitive imbalances that lead to carbon leakage and may be created by the agreement
among parties to the agreement in domestic and export markets”; and
to include “agreed remedies” for any agreement party that fails to meet its GHG reduction
obligations under the agreement.74
The bill also states that nothing in the negotiating objective involving competitive imbalances
may be construed to require the United States to alter provisions of new section 764, providing
for the distribution of emission allowance rebates.75
As discussed below, these objectives would be taken into account by the Senate or the Congress
when it considers whether to approve any resulting multilateral GHG-reduction agreement.76
Whether the United States is a party to such an agreement by January 1, 2018, would determine
whether the President must initially establish IRA programs for eligible industrial sectors.
Further, if such programs are established, the existence of a multilateral GHG-reduction
agreement would be a factor used by the President in determining whether an IRA program
should be applied with respect to a particular eligible sector for a given four-year period.
As noted above, the President would be required to establish an IRA program for each eligible
industrial sector if, by January 1, 2018, a multilateral GHG-reduction agreement consistent with
the bill’s negotiating objectives has not entered into force for the United States, unless Congress
has approved a Presidential determination to exclude a sector.77 H.R. 2454 would utilize the
legislative approval process for the contemplated international agreement as a vehicle for
Congress to indicate whether or not the agreement meets the legislative negotiating objectives
outlined above. Thus, if, in submitting an agreement to the Senate or the Congress, the Executive
Branch indicates that the agreement is consistent with these objectives, the agreement will be

73 H.R. 2454. as passed, new section 765(a)-(b).
74 H.R. 2454, as passed, new section 766(a).
75 H.R. 2454, as passed, new section 766(b).
76 The bill does not indicate how many countries other than the United States must be a party to the multilateral
agreement for it to be acceptable to the Senate or the Congress under these provisions. By definition, a multilateral
agreement qualifies as such so long as it has at least three parties.
77 H.R. 2454, as passed, new section 767(b)(1).
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considered to be consistent as of the date that the Senate consents to the agreement or “legislation
is enacted implementing such other agreement.” 78 The Senate or the Congress may state in any
such ratification or implementing measure, however, that the agreement should not be treated as
consistent with these objectives for purposes of the requirement to establish IRA programs and
for purposes of new section 768. It is under this section that EPA would issue regulations
implementing an IRA program for each eligible industrial sector in the event that a qualifying
agreement has not entered into force by January 1, 2018. As discussed below, any such
regulations must exclude goods originating in any country that is a party to an international
agreement to which the United States is also a party requiring a binding national GHG-reduction
commitment as stringent as that of the United States.
Even if the multilateral GHG reduction agreement, by virtue of its approval by the Senate as a
treaty or by the Congress as a congressional-executive agreement, were deemed to be consistent
with legislative negotiating objectives as of a date that meets the January 1, 2018, deadline, the
agreement would still need to meet the other requirement of new section 767(b)(1), namely, that
the agreement has entered into force for the United States. For this to occur, the agreement itself
would have to have entered into force, a situation that ordinarily occurs when an earlier agreed
upon number of countries have accepted or acceded to it, and the United States would need to
have deposited its instruments of ratification or accession with the entity designated under the
agreement to receive them (i.e., officially accept the treaty or agreement obligations as a matter of
international law and thereby become a party to it). This process raises the question of
implementing legislation since the United States might not accede to a treaty or international
agreement until any legislation needed to enable it to fully perform its treaty or agreement
obligations under domestic law is enacted.79 Thus, even though the bill, with its cap-and-trade
program and other GHG-reduction provisions, would have been enacted into law to arrive at this
point, further legislative action to implement the treaty or agreement could still conceivably be
needed, a requirement that may further delay its entry into force for the United States.80

78 H.R. 2454, as passed, new section 767(b)(4).
79 See Vienna Convention on the Law of Treaties art. 26 (“Every treaty in force is binding upon the parties to it and
must be performed by them in good faith”); id. art. 27 (“A party may not invoke the provisions of its internal law as
justification for its failure to perform a treaty”); and RESTATEMENT (THIRD) OF THE FOREIGN RELATIONS LAW OF THE
UNITED STATES § 111, reporters’ note h (1987).
Note, for example, the history of the multilateral Basel Convention on the Control of the Transboundary Movements of
Hazardous Wastes and their Disposal. When the President submitted the Convention to the Senate in 1991, the
accompanying transmittal notice stated that “[b]efore the United States can deposit its instrument of ratification,
changes in domestic law will be needed.” S. Treaty Doc. 102-5, at X (1991). While the Executive Branch proposed
implementing legislation to the Congress at the time and the Senate gave its consent to the Convention in August 1992,
138 Cong. Rec. 22,861 (1992), implementing legislation has not yet been enacted and the United States has not become
a Convention party. For additional background information on the deposit of instruments of ratification for a treaty or
international agreement, see, generally, Treaties and Other International Agreements: The Role of the United States
Senate; A Study Prepared for the Senate Committee on Foreign Relations by the Congressional Research Service 147-
50 (Jan. 2001)(S. Prt. 106-71).
Implementing legislation may also address other implementation issues, such as the relationship of the agreement to
federal and state law and whether private rights of action based on the agreement are allowed. See, for example,
Uruguay Round Agreements Act, P.L. 103-465, § 102, 19 U.S.C. § 3512.
80 It is unclear whether the implementing legislation referenced in new section 767(b)(4), the provision setting out how
consistency with U.S. negotiating objectives would be established for a congressional-executive agreement, would also
include provisions implementing the agreement as a matter of domestic law. Cf. Trade Act of 2002, § 2103(b)(3)(B), 19
U.S.C. § 2103(b)(3)(B), distinguishing between legislative provisions approving a trade agreement and provisions
making changes in domestic law to implement the agreement. Moreover, if the multilateral GHG-reduction agreement
is approved as a treaty, separate implementing legislation may still be needed.
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Some of these concerns may also arise with respect to the multilateral and bilateral sectoral
agreements whose existence would be a factor in the President’s determination as to whether the
85% import threshold is exceeded for an eligible industrial sector. The United States must be a
party to any such agreement, and thus questions related to approval and implementation may need
to be addressed. At the same time, H.R. 2454 is more lenient with respect to the elements of
sectoral agreements than it is with respect to the multilateral GHG-reduction agreement that
would moot the requirement that IRA programs be established or be taken into account in
determining whether the import threshold was met. H.R. 2454 places no requirements on the
content of a sectoral agreement, and thus the Executive Branch would seemingly have discretion
to agree to sectoral GHG-reduction commitments that are weaker than some would like. In such
case, increasing the percentage to be applied to the base figure (i.e., U.S. imports) in House-
passed H.R. 2454 may have been a way of making it more difficult to reach the threshold when
goods imported from one or more countries that are party to such sectoral agreements would be
included within the calculation.
Reactions from Other Countries: Defining “Comparable” Actions
There is a high probability of unintended consequences from subpart 2 as other countries react to
the threat of a tariff. One potential consequence of subpart 2 is that foreign countries with more
stringent carbon polices than those proposed in the United States could turn the tables and impose
their own tariffs on U.S. goods exported to them. As discussed earlier, the EU has already agreed
to a more stringent reduction program to the year 2020 than H.R. 2454 entails. Even if subpart 2
programs did not target the EU (because of the “comparable” provisions), it is conceivable that
the EU might target the United States because of the U.S. lack of a reduction target “comparable”
to that of the EU.
The argument about “comparability” could also extend to developing countries who are targeted
by subpart 2. Targeted foreign countries could take the subpart’s concept of comparability and
employ a different metric—a metric more favorable to their situation—than the standard that
subpart 2 would impose. For example, as illustrated in Table 2, developing countries could
attempt to define comparability in terms of per capita greenhouse gas emissions. By that metric,
China’s greenhouse gas emissions are only a quarter of those of the United States. For India, the
metric is even more favorable; its emissions are only 8% of those of the United States. Based on
this, or some other favorable metric, developing countries, such as China or India, could also turn
the tables on the United States and impose their own tariffs on U.S. goods.
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Table 2. Comparison of Top-20 Greenhouse Gas Emitting Countries
(2005 data)
2005
2005
Per Capita
GHG Emissions
GHG Emissions
2005 Rank
Country
Annex 1
MMTCE
(tons C/person)
1 China
No
1,970
1.5
2 United
States
Yes
1,901
6.4
[3] European
Union-27
Yesa 1,378
2.8
3 Russian
Federation
Yes
535
3.7
4 India
No
506
0.5
5 Japan
Yes
366
2.9
6 Brazil
No
277
1.5
7 Germany
Yes
267
3.2
8 Canada
Yes
200
6.2
9 United
Kingdom
Yes
175
2.9
10 Mexico
No
172
1.7
11 Indonesia
No
162
0.7
12 Iran
No
155
2.2
13 Italy
Yes
154
2.6
14 France
Yes
150
2.5
15 Korea
(South)
No
150
3.1
16 Australia
Yes
150
7.3
17 Ukraine
Yes
132
2.8
18 Spain
Yes
120
2.8
19
South
Africa No 115 2.5
20 Turkey
Yes
107
1.5
Totalb

7,764


WORLD
10,569
1.6
Source: Climate Analysis Indicators Tool (CAIT) Version 6.0. (Washington, DC: World Resources Institute,
2008).
a. The Kyoto Agreement gave explicit authority to the original 15-member European Union to meet its
obligations collectively; the EU has, in effect, expanded that authority as it has incorporated new members.
If the EU-27 were ranked in terms of its 2005 GHG emissions, it would place 3rd.
b. Totals are of the 20 individual nations; they do not include the European Union.
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Implications for International Trade Obligations81
Both vehicles in Title IV of H.R. 2454 aimed at competitiveness and leakage concerns—the
granting of free emission allowances to domestic firms and the imposition of border measures on
imported products—raise issues involving U.S. obligations under World Trade Organization
(WTO) agreements.82 Legislation providing free emission allowances to carbon/energy-intensive
trade-exposed industries may arguably confer a subsidy for purposes of the WTO Agreement on
Subsidies and Countervailing Measures. Although the bill would require EPA to establish a
border measure (IRA) program consistent with U.S. international agreements, a category that
would include U.S. trade agreements,83 a requirement that importers purchase IRAs to accompany
particular imports might nonetheless 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 1994 (GATT).84 If so, the requirement would need to
be justified under a GATT exception to survive a WTO challenge. It is important to emphasize
that while earlier GATT and WTO cases may provide a guide to the types of issues that may
concern a WTO panel applying and interpreting GATT exceptions, measures are judged on a
case-by-case basis. Thus, earlier decisions may not be fully predictive where a Member seeks to
justify a novel and complex measure that affects a broad range of imported products, production
processes, sources of manufacture, and trading partners.
Since the negotiating objectives set out in H.R. 2454 contemplate that a multilateral GHG-
reduction agreement may include provisions permitting, or at least not prohibiting, individual
parties to address trade-related “competitive imbalances that lead to carbon leakage,” it is
possible that such an agreement could establish a set of principles or rights and obligations among
the parties that address the allocation of emission allowances by WTO Member countries in the
context of WTO subsidy obligations, provide scope for Members to impose border measures, or
both.85 A provision limiting the initiation of disputes for a defined period, a so-called “peace

81 The discussion here is restricted to provisions of H.R. 2454 and does not explicitly address the program developed by
the EU, although there may be some similarities.
82 The WTO-consistency of such measures, particularly border requirements, has been the subject of considerable legal
commentary, including discussion in a 2009 report prepared jointly by the United Nations Environment Program
(UNEP) and the World Trade Organization. See Trade and Climate Change; A report by the United Nations
Environment Programme and the World Trade Organization 90-110 (2009), at http://www.wto.org/english/res_e/
booksp_e/trade_climate_change_e.pdf. A number of these commentaries are referenced in the UNEP/WTO report.
83 The United States is also party to number of bilateral and regional free trade agreements (FTAs), including the North
American Free Trade Agreement (NAFTA) and the Central America-Dominican Republic-United States Free Trade
Agreement (DR-CAFTA), and bilateral agreements with such countries as Australia and Chile. These agreements
incorporate certain GATT rights and obligations, such as national treatment of imported goods, a prohibition on
quantitative restrictions, and general exceptions for measures that are inconsistent with agreement obligations, but also
contain, among other things, their own tariff obligations, rules of origin, and dispute settlement procedures and, for the
NAFTA, a chapter on energy trade. While the requirements of these agreements are not addressed in this report, it is
important to note that two of the largest U.S. trading partners, Canada and Mexico, are parties to the NAFTA. To the
extent that these countries are exporters of the types of products that are likely to be produced by eligible industrial
sectors or later determined to be remediable “manufactured items for consumption,” relevant NAFTA obligations may
also need to be considered by EPA in applying an IRA program to Canadian or Mexican goods.
84 The General Agreement on Tariffs and Trade 1994 (GATT 1994), which consists of the GATT, as originally adopted
in 1947 (GATT 1947) as well as subsequent GATT decisions, waivers, and other provisions, may be accessed at
http://www.wto.org/english/docs_e/legal_e/06-gatt.pdf, and http://www.wto.org/english/docs_e/legal_e/gatt47_e.pdf.
85 See, for example, Elements of a Trade and Climate Code, in Gary Clyde Hufbauer, Steve Charnovitz, and Jisun Kim,
GLOBAL WARMING AND THE WORLD TRADING SYSTEM 103-110 (2009). Note also the now-expired Article 8.2(c) of the
(continued...)
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clause,” might also be included.86 Such an agreement might also be negotiated separate from
multilateral climate change negotiations. WTO Members could obtain a WTO waiver for the
provisions of such an agreement, incorporate binding commitments into WTO law by amending
the relevant WTO agreements, or adopt separately negotiated principles or guidelines in a WTO
decision.87 Agreement on a binding WTO-related climate change accord is far from certain,
however,88 and thus, absent such an agreement or broad adherence thereto by WTO Members,89
the WTO dispute settlement process may ultimately serve as the main forum for resolving WTO
legal issues involving problematic trade-related climate change measures.
Disputes arising under WTO agreements are heard under the terms of the Understanding on Rules
and Procedures Governing the Settlement of Disputes (Dispute Settlement Understanding or
DSU).90 Other WTO agreements, such as the WTO Agreement on Subsidies and Countervailing
Measures, while providing for dispute settlement under the DSU rules and procedures, contain
certain special and additional rules, which prevail over those in the DSU in the event of
differences between the two. Dispute settlement is administered by the WTO Dispute Settlement
Body (DSB), consisting of all WTO Members.
WTO dispute settlement may be characterized as a three-stage process, consisting of (1)
consultations; (2) panel and possibly Appellate Body proceedings; and (3), if a WTO decision is

(...continued)
WTO Agreement on Subsidies and Countervailing Measures (SCM Agreement) exempting from WTO challenge
certain “assistance to promote adaptation of existing facilities to new environmental requirements imposed by law
and/or regulations which result in greater constraints and financial burden on firms,” so long as the assistance did not
constitute a prohibited subsidy, in other words, an export subsidy or a subsidy contingent on the use of domestic over
imported products. Assistance was exempted under this provision even though it may have been specific to an industry
or group of industries, a condition that would ordinarily make a non-prohibited subsidy actionable. The SCM
Agreement may be accessed at http://www.wto.org/english/docs_e/legal_e/24-scm.pdf.
86 See, for example, WTO Agreement on Agriculture art. 13 (making certain domestic agricultural support and
agricultural export subsidies exempt from WTO dispute settlement actions for the initial nine years of the Agreement);
Agreement on Trade-Related Aspects of Intellectual Property Rights art. 64.2 (exempting non-violation claims—claims
based only on trade injury and not on violations of the Agreement—from WTO dispute settlement for the initial five
years of the Agreement; moratorium since extended). The Agreement on Agriculture may be accessed at
http://www.wto.org/english/docs_e/legal_e/14-ag.pdf; the Agreement on Trade-Related Aspects of Intellectual
Property Rights (TRIPS) may be accessed at http://www.wto.org/english/docs_e/legal_e/27-trips.pdf.
87 Note, for example, WTO, Kimberley Process Certification Scheme for Rough Diamonds; Decision of 15 May 2003,
WT/L/518 (May 27, 2003) (WTO waiver through December 31, 2006, for certain actions taken by WTO Members to
control diamond trade pursuant to international agreement); WTO, Kimberley Process Certification Scheme for Rough
Diamonds; Decision of 15 December 2006, WT/L/676 (December 19, 2006) (extension of waiver through December
31, 2012); WTO, Amendment of the TRIPS Agreement; Decision of 6 December 2005, WT/L/641 (December 8, 2005)
(amendment of Agreement on Trade-Related Intellectual Property Rights to permit exporting Members to require
compulsory licensing for the production of pharmaceutical products and to export such products to eligible importing
Members). See also WTO Members Agree to Further Extension of TRIPS/Medicines Ratification Deadline, 26 Int’l
Trade Rep. (BNA) 1497 (November 5, 2009).
88 See, for example, Pascal Lamy, Director-General, WTO, Climate First, Trade Second—GATTzilla is Long Gone,
Address at Carleton University, Ottawa, Canada (November 2, 2009), at http://www.wto.org/english/news_e/sppl_e/
sppl140_e.htm.
89 In the event that not all WTO Members were party to a WTO-related segment of a multilateral GHG agreement or to
a separate international agreement providing for measures to address competitiveness and leakage issues, the legal
situation of non-party WTO Members would need to be addressed.
90 For additional information on WTO dispute settlement, see CRS Report RS20088, Dispute Settlement in the World
Trade Organization (WTO): An Overview, by Jeanne J. Grimmett, and the WTO website at http://www.wto.org/
english/tratop_e/dispu_e/dispu_e.htm. The WTO Dispute Settlement Understanding may be accessed at
http://www.wto.org/english/docs_e/legal_e/28-dsu.pdf.
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adverse to the defending Member, implementation. Once the DSB adopts panel and any Appellate
Body reports finding that the defending Member has violated a WTO obligation, the defending
Member would ordinarily be expected to withdraw the violative measure. 91 If the Member could
not comply immediately, it would be given a reasonable period of time to do so. In the event that
the defending Member fails to comply by the end of the established compliance period, the
complaining Member may seek compensation from the defending Member or request
authorization from the WTO to impose countermeasures (i.e., to suspend WTO concessions or
other obligations owed the defending Member, usually, to place additional tariffs on selected
products imported from the Member).92 The DSU treats countermeasures as measures of “last
resort,” however, and permits them to be applied only as long as the measure found to violate
WTO obligations remains in place or until the disputing parties settle their dispute in a mutually
satisfactory way.
Certain actions by the DSB—namely, establishing a dispute settlement panel, adopting panel and
Appellate Body reports, and authorizing a WTO Member to impose countermeasures—are
virtually automatic; that is, the action will be taken unless all Members present at the DSB
meeting agree not to do so (“reverse consensus” rule). The DSU contains an aspirational timeline
of 18 months from the date a panel is established to the date a compliance period is determined.
Complex cases are likely to require additional time, however, particularly at the panel stage.
Dispute settlement is generally Member-driven, so that it is up to the parties to a dispute to decide
whether or not to take particular actions available to them (e.g., to request a panel, to request
authorization to take countermeasures against a non-complying Member, or to apply such
measures even if the WTO has authorized them). While the possibility of paying compensation or
suffering the effects of retaliatory action may exert a degree of pressure on defending Members to
comply with WTO decisions, and while DSU provisions indicate an overall intent that Members
comply, the inclusion of compensation or retaliation as remedies, albeit temporary ones,
recognizes that WTO Members may not always do so. In practice, Members have managed
disputes at the implementation stage in a variety of ways short of taking retaliatory action.
Under GATT and now WTO dispute settlement practice, a WTO Member may challenge a
measure of another Member “as such,” “as applied,” or both.93 An “as such” claim challenges the
measure as violative of a WTO agreement independent of its application in a specific situation
and, as described by the WTO Appellate Body, seeks to prevent the defending Member from
engaging in identified conduct before the fact.94 Panels in past “as such” challenges have used an

91 Under U.S. law, a WTO decision finding that a federal law is inconsistent with a WTO obligation cannot be
implemented unless Congress amends or repeals the statute, as the case may be. WTO decisions faulting a U.S. agency
regulation or practice may be implemented through administrative action under existing authorities, provided that
procedures set out in § 123(g) of the Uruguay Round Agreements Act, 19 U.S.C. § 3533(g), are followed. For further
discussion, see CRS Report RS22154, World Trade Organization (WTO) Decisions and Their Effect in U.S. Law, by
Jeanne J. Grimmett, and CRS Report RL32014, WTO Dispute Settlement: Status of U.S. Compliance in Pending Cases,
by Jeanne J. Grimmett.
92 A disputing party may also request that a compliance panel be established to determine whether the defending
Member has complied with a WTO ruling.
93 Appellate Body Report, United States—Anti-dumping Act of 1916, paras. 60-61, WT/DS136/AB/R,
WT/DS162/AB/R (August 28, 2000).
94 Appellate Body Report, United States—Sunset Review of Anti-Dumping Measures on Oil Country Tubular Goods
from Argentina, para. 172, WT/DS268/AB/R (November 29, 2004). The Appellate Body further described “as such”
claims as follows: “By definition, an ‘as such’ claim challenges laws, regulations, or other instruments of a Member
that have general and prospective application, asserting that a Member’s conduct—not only in a particular instance that
(continued...)
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analytical tool known as the “mandatory/discretionary distinction,” under which a law or
regulation was considered not to violate a GATT or WTO obligation if it did not mandate a WTO-
inconsistent outcome or, in other words, could be applied in a WTO-consistent fashion.95 If found
to be discretionary under this analysis, the measure would need to be challenged “as applied.” At
the same time, the WTO Appellate Body, without examining the role of the distinction in a
comprehensive way, has stated that the distinction should not be applied in a “mechanistic
fashion,”96 and thus the existence of discretionary elements in a statute or regulation may not
necessarily shield it from an “as such” challenge.
Distribution of Free Emission Allowances
General Characteristics of Emission Allowances
An emission allowance may be defined as governmental permission to emit one ton of carbon
dioxide or carbon dioxide-equivalent.97 In a cap and trade system, recipients of emission
allowances would include entities subject to emission caps and possibly other industrial entities
that emit GHG gases directly in production processes and indirectly through the use of carbon-
intensive fuels, as well as a broader array of entities that may be adversely affected by higher fuel
prices resulting from compliance costs borne by capped fuel producers. The government may
allocate allowances free of charge, require that they be obtained through an auction, or operate a
mixed system incorporating both approaches.
Depending on its individual situation, a capped entity would use all of its allowances to cover
emissions up to its annual cap; purchase additional allowances if it exceeded its cap and did not
hold sufficient allowances to account for these excess emissions; or, in the event its annual
emissions fell below the cap, sell unused allowances to other capped entities that need allowances
to cover emissions that exceed their cap or bank them for future use or sale. Non-capped entities
would either sell their allowances to capped entities or trade them in carbon markets. Thus, the
situation of the recipient may differ depending on whether it is a capped or non-capped entity,
and, if capped, whether the original allocation of allowances is sufficient, insufficient, or over-
generous.
Emission allowances have been recently characterized by the Congressional Budget Office
(CBO) as “‘cash-like’ in nature” because they may be traded “in a large and liquid secondary

(...continued)
has occurred, but in future situation as well—will necessarily be inconsistent with that Member’s WTO obligations. In
essence, complaining parties bringing ‘as such’ challenges seek to prevent Members ex ante from engaging in certain
conduct. The implications of such challenges are obviously more far-reaching than ‘as applied’ claims.” Id.
95 See cases cited in Panel Report, United States—Laws, Regulations and Methodology for Calculating Dumping
Margins (“Zeroing”), para. 7.55, n.158, WT/DS294.R (October 31, 2005).
96 Appellate Body Report, United States—Sunset Review of Anti-Dumping Duties on Corrosion-Resistant Carbon Steel
Flat Products from Japan, para. 93, WT/DS244/AB/R (December 15, 2003). Note also Panel Report, United States—
Sections 301-310 of the Trade Act of 1974, WTO/DS152/R (December 22, 1999) (legislation granting discretionary
powers may be found to be inconsistent “as such” if it does not create a strong legal basis for WTO-consistent action).
97 An “allowance” is defined in H.R. 2454, as passed, as “a limited authorization to emit, or have attributable
greenhouse gas emissions in an amount of, 1 ton of carbon dioxide equivalent of a greenhouse gas in accordance with
this title. Such term includes an emission allowance …” H.R. 2454, section 321, as passed, adding new section 700(5).
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market.”98 Moreover, in assessing the budgetary treatment of distributed allowances in a system
where the government determines the scope of covered emissions and the number of allowances
to be issued, CBO concluded that:
the distribution by the federal government would be essentially equivalent to the distribution
of cash grants, so CBO believes that such distributions should be treated as outlays. At the
same time, allowances in a cap-and-trade system would be valuable financial instruments, so
CBO thinks that the creation of allowances by the federal government should be recorded as
revenues.
That logic does not hinge on whether the government sells or, instead, gives away the
allowances. Allowances would have significant value even if given away because the
recipients could sell them, or if they are carbon dioxide emitters, use them to avoid incurring
the cost of purchasing allowances or investing in costly emission mitigation mechanisms.
Therefore, selling allowances and giving entities cash, and giving entities the allowances
themselves and letting the entities realize their value, are essentially the same transaction.
Sound budgeting requires that the budget treat equivalent transactions in the same way. 99
In explaining its approach, CBO considers that the government grant of an allowance to a firm,
business, or other recipient that would sell the allowance to a capped entity is a transaction that is
“equivalent” to the government’s taxing the capped firm or selling it an allowance and
subsequently giving the proceeds from the transaction to the recipient.100
The Joint Committee on Taxation has added that considering emission allowances to be tradable,
and thus “cash-like,” makes them similar to commodities, noting that sulfur dioxide and nitrogen
oxide emission allowances created by the Clean Air Act and various types of carbon credits and
their derivatives are already traded on commodities markets.101 At the same time, the Committee
found that allowances also “bear some resemblance to licenses that the government grants in
other contexts, e.g., television broadcast licenses granted by the Federal Communication
Commissions, liquor licenses granted by State and local governments, and certain agricultural
production quotas.”102 As with these licenses, “emission allowances are transferable, intangible
assets, the useful life of which can be limited by statute.”103 The Committee continued:
The application of different analogies can lead to very different answers to the most basic tax
questions presented by cap and trade. For example, whereas allocations of certain licenses by
the government have been deemed to be nonrecognition events (i.e. , no tax is imposed at the
time the license is granted), few would argue that a government distribution of a commodity,
such as gold, oil, or pork bellies, should not be taxable to the recipient.104

98 Letter of Douglas W. Elmendorf, Director, Congressional Budget Office, to Hon. Henry A. Waxman, Chairman,
House Committee on Energy and Commerce, May 15, 2009, at [1], at http://www.cbo.gov/ftpdocs/102xx/doc10232/5-
15-WaxmanLetter.pdf, (hereinafter, CBO letter).
99 Id. at [1]-2.
100 Id. at 2.
101 Joint Committee on Taxation, Climate Change Legislation: Tax Considerations; Scheduled for a Public Hearing
Before the Senate Committee on Finance on June 16, 2009, at 5-6 (June 12, 2009), at http://www.jct.gov/
publications.html?func=startdown&id=3559.
102 Id. at 6.
103 Id.
104 Id.
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The Committee identified three alternatives for taxing allocated emission allowances, based on
whether and when there would be an accession to wealth: (1) including them in income upon
receipt, (2) including them in income when first available for use, and (3) excluding them from
income.105
It is clear that in providing emission allowances to domestic entities, the federal government
would provide the recipient with a vehicle for the receipt of a monetary benefit, and thus it may
be viewed in a broad sense as providing a subsidy to the recipient entity. As explained below,
however, for the provision of emission allowances to constitute a subsidy in WTO terms, the
government activity or practice must first qualify as a “financial contribution” or “an income or
price support” as those terms are understood under WTO agreements. To date, neither GATT nor
WTO jurisprudence has addressed this type of instrument in light of WTO subsidy obligations.
WTO Agreement on Subsidies and Countervailing Measures (SCM)
The provision of subsidies by WTO Members is governed by the WTO Agreement on Subsidies
and Countervailing Measures (SCM Agreement), which elaborates upon and expands subsidy
obligations contained in Article XVI of the GATT 1994 and contains detailed obligations
involving the imposition of countervailing duties permitted under GATT Article VI. WTO
Members may impose countervailing duties on imported products that are found to be subsidized
by an exporting WTO Member and cause or threaten material injury to (or materially retard the
establishment of) a domestic industry.106 A subsidy meeting the WTO definition may be
challenged in a WTO dispute settlement proceeding or may be remedied by the imposition of
countervailing duties on the subsidized product in an amount that does not exceed the subsidy
conferred. While the GATT 1994 contains general public policy-related exceptions that may be
invoked to justify GATT-inconsistent measures, the SCM Agreement does not contain a separate
set of exceptions that would permit WTO Members to deviate from agreement obligations.107
For purposes of the SCM Agreement, the term subsidy is defined as a “financial contribution by a
government or any public body within the territory of a Member,” or an income or price support
in the sense of Article XVI of the GATT 1994 that confers a benefit.108 A financial contribution
will be found where:
(i) a government practice involves a direct transfer of funds (e.g., grants, loans, and equity
infusion), potential direct transfer of funds or liabilities (e.g., loan guarantees);

105 Id. at 7-11
106 GATT 1994 art. VI:5:6(a). The GATT 1994 and the SCM Agreement define a countervailing duty as “a special duty
levied for the purpose of offsetting any subsidy bestowed directly or indirectly upon the manufacture, production or
export of any merchandise.” GATT art. VI:3; SCM Agreement art. 10, n.36.
107 WTO panels have not yet addressed whether, or the extent to which, GATT Article XX exceptions may be linked
and applied to obligations in other WTO agreements. See Panel Report, China—Measures Affecting Trading Rights
and Distribution Services for Certain Publications and Audiovisual Entertainment Products, paras. 7.708-7.863,
WT/DS363/R (August 12, 2009) (panel determined that China did not make case that measures found to be inconsistent
with its WTO Accession Protocol fell within the scope of GATT Article XX(a) without panel first determining whether
Article XX(a) applied to the Accession Protocol); see also Notification of an Appeal by China, China—Measures
Affecting Trading Rights and Distribution Services for Certain Publications and Audiovisual Entertainment Products,
at 2, WT/DS363/10 (September 23, 2009).
108 SCM Agreement art. 1.1(a)(1), (a)(2).
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(ii) government revenue that is otherwise due is foregone or not collected (e.g., fiscal
incentives such as tax credits);
(iii) a government provides goods or services other than general infrastructure, or purchases
goods;
(iv) a government makes payments to a funding mechanism, or entrusts or directs a private
body to carry out one or more of the functions illustrated in (i) to (iii) above which would
normally be vested in the government and the practice, in no real sense, differs from
practices normally followed by governments.109
While an income or price support may constitute the requisite governmental involvement for
purposes of the SCM Agreement, this provision has not been cited to any great extent in GATT or
WTO jurisprudence.110 With respect to the second prong of the WTO definition, that is, the
conferral of a benefit, a financial contribution will be found to do so if it places the recipient in a
more advantageous situation than would have been the case absent the contribution.111
To be challenged in a WTO dispute settlement proceeding or to be subject to countervailing
duties, the subsidy must be specific to an industry or enterprise or a group of industries or
enterprises.112 Prohibited subsidies, as described below, are considered to be specific per se.113
Subsidies may be specific in law, that is, they may be explicitly limited to certain enterprises and
not be administered under objective criteria or conditions, or they may be specific in fact.114
Regarding the rules under which the program operates, the SCM Agreement provides that
specificity will not exist where legislation, or the granting authority operating under it,
“establishes objective criteria or conditions governing the eligibility for, and the amount of, a
subsidy ... provided that the eligibility is automatic and that such criteria and conditions are
strictly adhered to.”115 Objective criteria or conditions mean those “which are neutral, which do
not favour certain enterprises over others, and which are economic in nature and horizontal in
application, such as number of employees or size of enterprise.”116
The SCM Agreement divides subsidies into two categories: prohibited and actionable. Two types
of subsidies are prohibited: (1) subsidies “contingent, in law or in fact … upon export
performance” and (2) subsidies “contingent ... upon the use of domestic over imported products”

109 SCM Agreement art. 1.1(a)(1).
110 See, generally, World Trade Organization, GUIDE TO GATT LAW AND PRACTICE; ANALYTICAL INDEX 445-48
(updated 6th ed. 1995).
111 Appellate Body Report, Canada—Measures Affecting the Export of Civilian Aircraft, paras. 149-157,
WT/DS70/AB/R (August 2, 1999) (hereinafter, Canada Aircraft AB Report).
112 SCM Agreement arts. 1.2.
113 SCM Agreement art. 2.3.
114 SCM Agreement arts. 21.(a), (c).
115 SCM Agreement art. 2.1(b)(footnote omitted).
116 SCM Agreement. art. 2.1(b), n.2.
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(also referred to as “import substitution” subsidies).117 The mere fact that a subsidy is granted to a
firm that exports is not enough to render it an export subsidy for purposes of the Agreement.118
Subsidies fitting the WTO definition that are not prohibited are considered “actionable,” that is,
they may be challenged in a WTO dispute settlement proceeding if they cause “adverse effects”
to the interests of another WTO Member.119 Under Article 5 of the Agreement, adverse effects
may take any of three forms: (1) injury to the domestic industry of another Member, as this
concept is used in countervailing duty proceedings (a standard that focuses on the effect of the
subsidized goods in the domestic market of the complaining Member); (2) nullification or
impairment of another Member’s WTO benefits, generally tariff concessions on a given product;
and (3) serious prejudice to the Member’s interests.
As set out in Article 6.3 of the SCM Agreement, serious prejudice occurs when the effect of the
subsidy is (1) to displace imports of a like product of the complaining Member into the market of
the subsidizing Member; (2) to displace or impede the exports of a like product of the
complaining Member from a third country market; (3) significant price undercutting by the
subsidized product as compared with the price of a like product of the complaining Member in
the same market, or significant price suppression, price depression, or lost sales in the same
market; and (4) an increase in the world market share of the subsidizing Member in a particular
subsidized primary product or commodity as compared to the average share that the subsidizing
Member had during the previous period three-year period and the increase follows a consistent
trend over a period when subsidies have been granted.120 In any such case, defining the nature of
the “like product” and the affected market would be important components in determining if
serious prejudice exists.121
Under special dispute settlement rules for the SCM Agreement, if the WTO Dispute Settlement
Body adopts a panel or Appellate Body report finding that a subsidy has resulted in adverse
effects to another Member, the subsidizing Member “shall take appropriate steps to remove the
adverse effects or shall withdraw the subsidy.”122 If the Member has not done so within six
months after adoption, and absent an agreement on compensation, the Dispute Settlement Body is
to authorize the complaining Member to take countermeasures, “commensurate with the degree
and nature of the adverse effects determined to exist,” unless the Dispute Settlement Body
decides by consensus to reject the complaining Member’s request to impose such measures.123
This time period may be extended by mutual agreement of the disputing parties.124

117 SCM Agreement art. 3.1(a), (b). The WTO Appellate Body has determined that import substitution subsidies may
be contingent in law or “in fact,” notwithstanding that the prohibition does not contain the quoted language. Appellate
Body Report, Canada—Certain Measures Affecting the Automotive Industry, paras. 137-43, WT/DS139/AB/R,
WT/DS142/AB/R (May 31, 2000) (hereinafter, Canada Autos AB Report).
118 SCM Agreement art 3.1(a), n.4.
119 SCM Agreement art. 5.
120 See Articles 6.4 and 6.5 of the SCM Agreement for further explanation of the terms used in Article 6.3.
121 The SCM Agreement states that, for purposes of the Agreement, the term “like product” means “a product which is
identical, i.e. alike in all respects to the product under consideration [i.e. the subsidized product], or in the absence of
such a product, another product which, although not alike in all respects, has characteristics closely resembling those of
the product under consideration.” SCM Agreement art. 15.1, n.46.
122 SCM Agreement art. 7.8.
123 SCM Agreement art. 7.9.
124 SCM agreement, art. 7.4, n.20.
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Free Allowances Under the SCM Agreement
For the provision of emission allowances to fit within the SCM Agreement’s definition of a
governmental financial contribution, the action would need to constitute (1) an actual or potential
direct transfer of funds, (2) the foregoing of revenue otherwise due, or (3) the provision of a good
or service other than general infrastructure. Because WTO panels have not had to deal with an
instrument of this type, it is unclear how it would or should be characterized under this definition.
It is also unclear how domestic tax or budgetary treatment of an allowance might affect this
characterization.125 The precise nature of an allowance is elusive for these purposes, and thus a
variety of scenarios can be contemplated. This report addresses some of the more salient subsidy
issues that may arise in this context.
While emissions have been characterized as “cash-like” in nature and would clearly constitute a
valuable instrument from the point of view of the recipient, to the extent that an allowance is
intended to be sold or traded, the allowance would in and of itself constitute a vehicle for a
financial contribution by private parties, that is, the ultimate transfer of funds would be effected
by the purchasers of the emission allowance rather than by the government. In such case, the
transfer may not be the type of “direct transfer” of funds by the government that is generally
contemplated by the first type of financial contribution listed above.126

125 As discussed earlier, CBO has stated that, for budgetary purposes, distributed allowances should be recorded as
outlays and the creation of emission allowances as revenues. CBO Letter, supra note 98, at [1]. Note also that the WTO
Agreement on Agriculture treats “budgetary outlays” as subsidies for purposes of calculating a WTO Member’s
aggregate domestic support for agricultural products, Agreement on Agriculture annex 3, para. 2, and that the SCM
Agreement includes, as the last item in its Illustrative List of Export Subsidies, “[a]ny other charge on the public
account constituting an export subsidy in the sense of Article XVI of GATT 1994.” SCM Agreement annex I, para. (l)
(emphasis added). Discussion of domestic budgetary treatment of emission allowances for purposes of the WTO
subsidy definition is beyond the scope of this report.
126 The role of private payments in a subsidy scheme was addressed in Canada— Measures Affecting the Importation of
Milk and the Exportation of Dairy Products (WT/DS103), where the WTO Appellate Body upheld a WTO panel
finding that producer-financed payments to support the export of dairy products were covered by commitments to
reduce export subsidies contained in WTO Agreement on Agriculture. Article 9.1(c) of the Agreement provides that
reduction commitments apply to listed export subsidies, including “payments on the export of an agricultural product
that are financed by virtue of governmental action, whether or not a charge on the public account is involved….” The
Appellate Body first upheld the panel’s finding that the provision of milk at discounted prices to processors for export
under the challenged program constituted payments, though in a form other than money, within the meaning of the
Article 9.1(c). Appellate Body Report, Canada—Measures Affecting the Importation of Milk and the Exportation of
Dairy Products, paras. 113, WT/DS103/AB/R, WTO/DS113/AB/R (October 13, 1999). The Appellate Body then
upheld the panel’s finding that producer-financed payments fell within the scope of the Article, provided they were
“financed by virtue of governmental action.” In upholding the panel, the Appellate Body stated that it was appropriate
to look at governmental action as a whole in the payment system at issue and found that although the “‘cost of selling
milk at a reduced price for export is not borne by the government’, ‘governmental action’ is, in our view, indispensible
to the transfer of resources that take place at as a result of the operation” of the program. Id. paras. 119-120. The
Appellate Body found that governmental action was involved at every stage of the program and that, in the regulatory
framework involved, “‘government agencies’ stand so completely between the producers of the milk and the processors
or the exporter that we have not doubt that the transfer of resources takes place, by virtue of governmental action.” Id.
para. 120. While the SCM Agreement does not contain language stating that subsidies include “payments … that are
financed by virtue of governmental action, whether or not a charge on the public account is involved,” the existence of
such language in another WTO agreement addressing subsidization may indicate that WTO Members generally
contemplate that the level of governmental involvement in the actual realization of wealth by the beneficiary of a
government program would exceed the mere allocation of an economic instrument to that beneficiary. Note also Panel
Report, Japan—Measures Affecting Consumer Photographic Film and Paper, para. 10.49, WT/DS44/R (March 31,
1998) (“non-binding [governmental] actions, which include sufficient incentives or disincentives for private parties to
act in a particular manner, can potentially have adverse effects on competitive conditions of market access” so as to
nullify or impair legitimately expected WTO benefits for purposes of filing a non-violation complaint—a challenge to a
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As an emission allowance has also been characterized as a license and a commodity, one might
alternatively argue that the provision of an allowance constitutes the provision of a good. While
the WTO Appellate Body has confirmed that the granting of a government license may constitute
the provision of goods to a recipient, its finding would appear to have limited utility in the current
context. Because the license at issue permitted recipients to harvest standing timber on
government lands, the government grant of a license was thus found to constitute the provision of
timber, a potentially tradable product.127 In contrast, the provision of a free allowance would
represent permission or authority to emit a defined amount of carbon dioxide or a carbon dioxide
equivalent, a substance that would not be a salable good in the same sense as timber was in the
above-cited example. Thus, if a similar analysis is applied to emission allowances, this category
of government financial contribution is not likely to apply.128 Further, unlike commodities that are
in and of themselves tradable goods, the item that is being traded here would essentially be a right
to take a particular action rather than a tangible product.129
A case for a subsidy may be made, however, once emission allowances are subject to government
auction, an event contemplated by H.R. 2454 to begin in 2012. Under the SCM Agreement, the
concept of revenue that is “otherwise due” requires an ascertainable standard against which a tax
or other exemption is measured. As described by the WTO, this portion of the subsidy definition
implies “an understanding that (i) ‘a financial contribution’ does not arise simply because a
government does not raise revenue which it could have raised; and (ii) the term ‘otherwise due’
implies a comparison with a ‘defined normative benchmark.’”130 In such case, the provision of an
allowance without charge to a U.S. firm may arguably constitute the foregoing by the government
of revenue that would otherwise be due, the specifics of the government auction serving as the
applicable norm. It is also possible that the future tax treatment of distributed allowances may
itself result in such foregone revenue. Although WTO jurisprudence on this portion of the subsidy
definition most often focuses on tax measures,131 the provision itself is generally written and is
not limited to the tax area.132
In the event that the provision of free allowances or the tax rules that applied to them were found
to qualify as foregone revenue, the existence of a benefit may, in some situations, not be difficult
to discern. In past cases, WTO panels, in determinations not subsequently appealed, have found
that the tax exemptions were virtually coterminous with the existence of a benefit.133 For

(...continued)
non-violative measure of another Member on the grounds that it causes WTO-related trade injury).
127 Appellate Body Report, Countervailing Duty Determination with Respect to Certain Softwood Lumber from
Canada, para. 75, WT/DS257/AB/R (January 19, 2004).
128 See, for example, Javier de Cendra, Can Emissions Trading Schemes be Coupled with Border Tax Adjustment? An
Analysis vis à vis WTO Law, 15 RECIEL 131, 137 (2006); Jacob Werksman, Greenhouse Gas Emissions and the WTO,
8 RECIEL 251, 255 (1999).
129 Note, for example, the definition of a “commodity” in IRS Regulation section 1.954.1(f)(2)(i) as “tangible personal
property of a kind that is actively traded or with respect to which the contractual interests are actively traded.” See,
generally, Matthew P. Haskins, Green Trading in Carbon Emission Rights, 122 TAX NOTES 387-88 (2009).
130 World Trade Organization, WTO ANALYTICAL INDEX; GUIDE TO WTO LAW AND PRACTICE 755 (2d ed. 2007)
(hereinafter, WTO ANALYTICAL INDEX).
131 Id. at 754-57.
132 See Canada Autos AB Report, supra note 117, paras. 87-94 (import duty exemption treated as foregoing of revenue
that is otherwise due).
133 In determining whether a benefit exists in cases involving the granting of loans or loan guarantees or the provision
of goods or services, panels will examine whether the terms placed on the transaction by the government are more
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example, in a report involving tax exemptions under the U.S. Foreign Sales Corporation (FSC)
statute, the panel stated that, in its view, “the financial contribution clearly confers a benefit, in as
much as both FSCs and their parents need not pay certain taxes that would otherwise be due,”
noting further that the United States had not raised any contrary arguments regarding the benefit
issue.134 Similarly, in a subsequent case that involved a statute that repealed the FSC statute and
established a replacement tax regime permitting the exclusion from taxation of certain income,
the panel stated that under the new statute:
a taxpayer involved in a qualifying transaction may exclude qualifying foreign trade income
from its gross income and therefore need not pay a certain amount of tax that it would
otherwise have to pay to the United States government. It is therefore “better off” than it
would have been absent the contribution, that is, if had been in another situation, where the
conditions for obtaining the tax treatment under the Act were not fulfilled and it was
therefore subject to otherwise applicable US taxation rules. We are of the view that the tax
treatment in the Act confers a benefit.135
Similarly, in a case involving whether an exemption from an import duty constituted a subsidy,
the WTO panel, having determined that the exemption qualified as revenue foregone, easily
found that it conferred a benefit since “the fact that manufacturer beneficiaries need not pay
customs duties that would otherwise be due—and that would be paid by non-qualifying
manufacturers—constitutes … an advantage” of the type that the Appellate Body had found in an
earlier case.136
In an assessment of whether a benefit is conferred, panels must focus on the recipient of the
financial contribution rather than on the granting authority and the cost to the granting
government.137 Because of the various situations of recipients of free allowances and because
there may be particular legislative requirements or conditions accompanying their receipt, the
existence or nature of the benefit, that is, whether a particular recipient is “better off,” may vary
with respect to the recipient involved. Since WTO panels have not yet dealt with such an
instrument, this remains a matter for further development by WTO panels and the WTO Appellate
Body.
Were the provision of free allowances to constitute a subsidy for purposes of the SCM
Agreement, the subsidy would not be prohibited under the Agreement so long as provision of the
allowances was not contingent in law or in fact on export performance or on the use of domestic
over imported products. Nevertheless, the subsidy would potentially be actionable, and thus

(...continued)
favorable than those available to the recipient in the marketplace. See, generally, WTO ANALYTICAL INDEX, supra note
130, at 761-73. See also Article 14 of the SCM Agreement, which sets out rules for calculating the benefit to a recipient
where the governmental financial contribution consists of a equity capital, a loan, a loan guarantee, the provision of
goods or services, or the purchase of goods.
134 Panel Report, United States—Tax Treatment for “Foreign Sales Corporations,” para 7.103, WT/DS108/R (October
8, 1999).
135 Panel Report, United States—Tax Treatment for “Foreign Sales Corporations”; Recourse to Article 21.5 of the
DSU by the European Communities, para 8.46, WT/DS108/RW (August 20, 2001). As the United States had focused
its arguments on the existence, or not, of a financial contribution, it again did not contest that a benefit would be
conferred were the requisite financial contribution to be found. Id. para 8.47.
136 Panel Report, Canada—Certain Measures Affecting the Automotive Industry, para. 10.165, WT/DS139/AB/R,
WT/DS142/AB/R (February 11, 2000).
137 Canada Aircraft AB Report, supra note 111, paras. 153-156.
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subject to challenge if a complaining WTO Member could show that it had suffered one of the
adverse effects set out in Article 5 of the Agreement. The complaining Member would also need
to show that the subsidy was specific in law or fact to an industry or group of industries before
proceeding with its showing of trade injury. While free allowances may be available to entities in
a broad range of economic sectors and might be viewed as not limited by statute to “certain
enterprises,” determining whether “objective criteria and conditions” governing the eligibility for,
and the amount of, the subsidy exist would appear to be an important area of inquiry in
determining if specificity is present.
International Reserve Allowance (IRA) Program
H.R. 2454, as passed, would also require that, if the President established an IRA program for an
eligible domestic industrial sector and once he determines that the 85% import threshold for the
sector is not exceeded, importers of products corresponding to those produced by the sector
submit emission credits upon the entry of these products into the United States. The requirement
would apply to a particular importation unless EPA has adjusted the border allowance
requirement to zero for the product or the product is imported from a statutorily exempted
country. In addition, “manufactured items for consumption,” that is, downstream products
containing inputs that are subject to sectoral IRA requirements, may also be covered by border
IRA requirements. Exemptions would apply to products imported from countries that have
entered into acceptable multilateral or bilateral GHG-reduction agreements or whose annual
energy or GHG-intensity for the sector is equal to or less than that of the United States. Also
exempted would be products imported from the least developed of developing countries and from
countries that are de minimis emitters and are the source of less than 5% of U.S. imports of
covered goods for a sector. In issuing regulations establishing the program, EPA , with the
concurrence of U.S. Customs and Border Protection, would incorporate certain statutory
requirements, but would also be given discretion to establish a general methodology for
calculating the quantity of IRAs that a U.S. importer of any covered good must submit and would
be authorized to adjust IRA requirements based on emission allowances distributed to eligible
industrial sectors and to reduce the amount to zero. The IRA requirements would not apply to
goods that enter the United States before January 1, 2020, the earliest date for application
specified in the statute.
General Agreement on Tariffs and Trade (1994)
Article I, the general most-favored-nation (MFN) obligation of the GATT, requires that certain
trade-related benefits that a WTO Member grants to the products of any country must be granted
“immediately and unconditionally” to like products of all WTO Members. The obligation applies
to any advantage involving customs duties and charges of any kind imposed on importation or
exportation, the method of levying such duties, all rules and formalities connected with
importation and exportation, and all matters related to internal taxation and regulation, that is,
matters covered by the GATT national treatment article.
Article II, which generally prohibits tariff surcharges and border fees on imports, is aimed at
ensuring that tariff concessions negotiated by WTO Members are maintained at negotiated rates.
Each Member’s tariff commitments are set out in a Schedule which lists the highest rate that a
Member may impose on a given product, also known as the “bound” rate. Article II:1(b) provides
that products imported from other WTO Members are to be exempt from ordinary customs duties
in excess of those set out in the importing Member’s Schedule and from “all other duties and
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charges of any kind imposed on or in connection with importation in excess of those imposed” on
April 15, 1994, the date the WTO agreements were concluded. At the same time, Article II:2(a)
provides that Article II does not prevent a WTO Member from imposing specific types of charges
on bound items, including “a charge equivalent to an internal tax imposed consistently with the
provisions” of the GATT national treatment article “in respect of the like domestic product or in
respect of an article from which the imported product has been manufactured or produced in
whole or in part.”
Article III, the GATT national treatment article, prohibits WTO Members from discriminating
between like domestic and imported products when imposing internal taxes and regulations.
Where an internal tax or regulation is enforced at the border with regard to an imported product,
the tax or regulation will be considered an internal measure and, as such, subject to Article III.
Article III:1 of the GATT 1994, which generally informs Article III obligations, states that
“internal taxes and other internal charges and laws, regulations and requirements affecting the
internal sale, offering for sale, purchase, transportation, distribution or use of products ... should
not be applied to imported or domestic products so as to afford protection to domestic
production.”
Article III:2, which addresses taxes on products (e.g. excise and sales taxes, also referred to as
“indirect taxes”) states that the products of a WTO Member imported into the territory of another
WTO Member “shall not be subject, directly or indirectly to internal taxes or other internal
charges of any kind in excess of those applied, directly or indirectly, to like domestic products.”
To determine whether the tax on an import exceeds the tax on the like domestic product, a strict
test is applied, under which “even the smallest amount of ‘excess’ is too much”; neither a “trade
effects” test nor a de minimis standard qualifies the prohibition.138 Further, Article III:2 requires
that actual, rather than nominal, tax burdens be compared. An identical tax rate can be found in
some cases to result in a heavier tax burden on an import because of the method of taxation, and
thus a WTO review would likely take into account not only the tax rate but also “the taxation
methods (e.g., different kinds of internal taxes, direct taxation of the finished products, or indirect
taxation by taxing the raw materials used in the product during the various stages of its
production) and of the rules for tax collection (e.g., the basis of assessment).”139 In general,
panels have viewed the policy purpose behind a tax as irrelevant so long as the Member imposing
the tax does not violate the GATT or other WTO obligations.140
Article III:4 of the GATT 1994, requiring national treatment in internal regulation, states that
products of any WTO Member imported into the territory of any other Member “shall be
accorded treatment no less favourable than that accorded to like products of national origin in
respect of all laws, regulations and requirements affecting their internal sale, offering for sale,
purchase, transportation, distribution or use.”
In determining whether imported and domestic goods are “like” products for purposes of both
GATT Article III:2 and Article III:4, panels have ordinarily used four criteria: (1) the properties,

138 Appellate Body Report, Japan—Taxes on Alcoholic Beverages, at 23, WT/DS8/AB/R, WTDS10/AB/R,
WT/DS11/AB/R (October 4, 1996) (hereinafter, Japan Beverages AB Report).
139 Panel Report, Argentina— Measures Affecting the Export of Bovine Hides and the Import of Finished Leather, para.
11.182, WT/DS155/R (December 19, 2000).
140 See, for example, Panel Report, United States—Taxes on Petroleum and Certain Imported Substances, L/6175 (June
17, 1987), GATT, B.I.S.D. (34th Supp.) at 136 (1988); Japan Beverages AB Report, supra note 138, at 16.
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nature, and quality of the products; (2) end-uses; (3) consumers’ tastes and habits; and (4) tariff
classification.141 To date, GATT/WTO case law has not permitted Members, under GATT Article
III, to distinguish between products that would otherwise be considered “like” on the basis of a
processing and production method (PPM) that does not relate to a product characteristic. Thus,
applying such a distinction in a regulatory scheme and subjecting products to different
requirements based on this distinction may provide a basis for finding that an imported good is
treated less favorably than the like domestic item or that any resulting import prohibition
constitutes a quantitative restriction prohibited under Article XI, below.142
Article XI:1 of the GATT generally prohibits quantitative restrictions on imports and exports,
providing that “[no] prohibitions or restrictions other than duties, taxes or other charges, whether
made effective through quotas, import or export licenses or other measures, shall be instituted or
maintained by any contracting party [i.e. WTO Member] on the importation of any product of the
territory of any other contracting party or on the exportation or sale for export of any product
destined for the territory of another contracting party.” Deviations from this rule are allowed only
in certain well-defined circumstances, generally unrelated to climate change issues. A quantitative
restriction may be distinguished from an internal regulation enforced at the border by examining
whether the measure affects the opportunity for importation or entering the market, in which case
Article XI would apply, or whether it affects competitive opportunities in the domestic market, in
which case Article III would govern.143
Article XX, containing the GATT general exceptions and operating as a defense in GATT
disputes, allows a WTO Member to justify, on a variety of public policy grounds, a measure that
has been found to violate a GATT obligation. Conditioning market access on compliance with a
policy unilaterally prescribed by a WTO Member, while potentially irksome to trading partners,
has been viewed by the WTO Appellate Body as a common feature of measures falling within the
scope of Article XX exceptions, and thus such a policy may be pursued under the GATT
providing implementing measures satisfy Article XX requirements.144
Of relevance in the climate change context are Article XX(b), covering measures “necessary to
protect human, animal or plant life or health” and Article XX(g), covering measures “relating to
the conservation of exhaustible natural resources if such measures are made effective in
conjunction with restrictions on domestic production or consumption.” Any law or regulation that
is provisionally justified under Article XX(b) or Article XX(g) must also comply with the proviso

141 Appellate Body Report, European Communities—Measures Affecting Asbestos and Asbestos-Containing Products,
para. 101 WT/DS135/AB/R (March 12, 2001) (hereinafter, EC Asbestos AB Report). “Like product” determinations
under Article III are made on a case-by-case basis under a significant body of GATT/WTO jurisprudence. See,
generally, id. at paras. 87-103 and WTO ANALYTICAL INDEX, supra note 130, at 145-48, 163-67.
142 See Panel Report, United States—Import Prohibition of Certain Shrimp and Shrimp Products, paras. 7.11-7.17,
WT/DS58/R (May 15, 1998). Although there is language in WTO decisions indicating that less favorable treatment of a
like imported product may be permitted if it can be explained by factors unrelated to foreign origin (e.g., Appellate
Body Report, Dominican Republic—Measures Affecting the Importation and Internal Sale of Cigarettes, para. 96,
WT/DS302/AB/R (April 25, 2005)), there has not yet been a WTO case in which a panel or the Appellate Body has
ratified less favorable treatment of an imported good under GATT Article III based on the fact that it was produced by
means of a particular non-product-related processing or production method (PPM).
143 Panel Report, India—Measures Affecting the Automotive Sector, para. 7.224, WT/DS146/R, WT/DS175/R
(December 21, 2001).
144 Appellate Body Report, United States—Import Prohibition of Certain Shrimp and Shrimp Products; Recourse to
Article 21.5 of the DSU by Malaysia, paras.136-38,WT/DS58/AB/RW (October 22, 2001) (hereinafter, U.S. Shrimp
(Article 21.5) AB Report).
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to Article XX, which requires that the measure not be applied “in a manner which would
constitute a means of arbitrary or unjustifiable discrimination between countries where the same
conditions prevail, or a disguised restriction on international trade.”
Border IRA Requirements under the GATT 1994
As explained earlier in this report, the manufacture of certain products results in direct carbon
emissions. Production of these and other products may also result in what are deemed to be
indirect carbon emissions due to the high amount of energy (generally electrical energy) needed
for their production and the heavy use of carbon-based fuels to provide such energy. Thus, a focus
of concern in a domestic GHG-reduction program is its implications for goods that are carbon-
intensive, energy-intensive, or both.
Where emission caps are placed on energy producers and on manufacturers of carbon-intensive
products, the cost of the caps for these producers and manufacturers, as well as for manufacturers
that are heavy users of carbon-intensive energy, may adversely affect the competitiveness of these
manufacturers’ products vis à vis the same or similar products produced in countries without
carbon controls. Depending on the situation of the firm and the products produced, the loss of
competitiveness may occur on the import side, the export side, or both. A significant and
irremediable loss of competitiveness may cause such firms to move their production to countries
without GHG-reduction controls, potentially resulting in increased GHG emissions in these
countries, or “carbon leakage.” Increased emissions may also result from increased production by
existing foreign facilities whose presumably more price-competitive goods would be in greater
demand worldwide. In such case, a loss of competitiveness, an economic concern, would be the
reason for an adverse environmental effect. A border IRA requirement that takes into account the
level of greenhouse gases emitted in the production of the imported product in light of domestic
regulatory requirements may seek to “level the playing field” for a particular product or sector
and so prevent the carbon leakage that may negate the beneficial environmental outcome of the
domestic GHG-reduction program.145
Requirements of H.R. 2454 and GATT Articles
A border requirement of this type proposed under H.R. 2454—that is, requirement that an
importer of a product from a country that has not taken sufficient action to reduce GHG
emissions, as judged by the importing country—potentially implicates the GATT articles
described above, namely, Article I, requiring most-favored-nation treatment; Article II,
prohibiting added duties and other fees and charges on goods subject to negotiated tariff rates;
Article III, requiring national treatment of imported products; and Article XI, prohibiting
quantitative restrictions on imports.
Since an importer of a foreign-produced item would incur a cost in amassing the IRAs that would
be needed for importation under H.R. 2454, the fees and charges paid by the importer may be
found to constitute a “charge of any kind imposed on or in connection with the importation” of a
item subject to tariff rates bound under GATT Article II and, as such, be prohibited under Article
II:1(b). Because the vast majority of products in the U.S. GATT Schedule are subject to bound

145 For further discussion, see CRS Report R40100, “Carbon Leakage” and Trade: Issues and Approaches, by Larry
Parker and John Blodgett.
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tariff rates, the requirements of Article II would apply broadly to products imported into this
country. In one instance, a GATT panel found that the interest charges and other costs connected
with the posting of security to guarantee that imports of a particular item would be made at a
minimum price were “‘other duties or charges of any kind imposed on or in connection with the
importation’ in excess of the bound rate within the meaning of Article II:1(b),” and thus
inconsistent with this obligation.146 More recently, a WTO panel, citing this GATT case, found
that the interest charges, costs, and fees incurred by importers in connection with posting an
additional customs bond required by the United States were import charges prohibited by the
above-quoted Article II:1(b) language.147 The United States did not appeal this finding.148 As in
these cases, the importer subject to the IRA requirements would incur the cost of obtaining the
allowances to satisfy a requirement associated with an importation rather than pay a specified fee
imposed directly on the carbon-intensive or energy-intensive product. Since Article II:1(b) speaks
broadly of “duties or charges of any kind,” the expenditure of funds to obtain the required
allowances may well result in the type of charge that falls within the scope of the Article II:1(b)
obligation.
If the importer’s failure to comply with such requirements serves to prohibit a product from being
imported into the United States, this aspect of the IRA program may also be viewed as
inconsistent with the general prohibition on quantitative restrictions in GATT Article XI:1.
Further, to the extent that a fee or charge would not apply to goods originating in a country with a
GHG-reduction program or in a country exempted for other reasons (e.g. de minimis emissions),
there may arguably exist discriminatory treatment of like products from non-exempted countries
for purposes of the most-favored-nation obligation of GATT Article I.
Alternatively, the United States may be able to avoid the Article XI prohibition on quantitative
restrictions if the IRA requirement on imports could be shown to be part of an internal regulatory
regime governing the “internal sale, offering for sale, purchase, transportation, distribution, or
use” of carbon-intensive and energy-intensive products for purpose of GATT Article III:4. If so,
the United States may be able to prohibit imports that do not meet U.S. regulatory requirements
from entering the United States without violating Article XI. It appears difficult, however, to fit a
border program such as provided for in H.R. 2454 within the parameters of this GATT article.
Generally speaking, the regulation of products based on their carbon emissions raises issues as to
whether otherwise like items (e.g, a particular type of steel product) may be distinguished on this
basis under current WTO law. If steel products are found to be like products based on the criteria
ordinarily used by panels (i.e., product characteristics, end uses, consumer preference, and tariff
classification), distinguishing them based on a substance emitted in their production may thus be

146 Report of the Panel, European Community Programme of Minimum Import Prices, Licenses and Surety Deposits for
Certain Processed Fruits and Vegetables, para. 4.15, L/4687 (adopted October 18, 1978), at http://www.wto.org/
gatt_docs/English/SULPDF/90950205.pdf. For the Article II:2(a) exception for internal taxes to apply, it would have to
be shown that the import surcharge were “equivalent” to an Article III:2 internal tax applied “in respect of the like
domestic product or in respect of a product from which the imported product has been produced in whole or in part.”
147 Panel Report, United States—Import Measures on Certain Products from the European Communities, paras. 6.62-
6.67, WT/DS165/R (July 17, 2000).
148 Appellate Body Report, United States—Import Measures on Certain Products from the European Communities,
para. 100, WT/DS165/AB/R (July 17, 2000). The Appellate Body stated, however, that it agreed with the apparent U.S.
concession during oral argument that, in light of the panel finding on charges and costs, the increased bonding
requirements themselves were inconsistent with this portion of Article II:1(b). Id. If challenged, the IRA requirements,
aside from the fees paid by individual importers, may similarly be found to be inconsistent with the cited obligation.
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a problematic basis for differing regulatory requirements, and thus a case for less favorable
treatment of the like imported good could be made. More fundamentally, however, because H.R.
2454 would place its relevant domestic requirement (i.e., emission caps, on producers and not on
the sale, purchase, or use of domestically produced carbon-intensive and energy-intensive goods),
the bill would not appear to create the sort of domestic regulatory regime affecting domestic and
imported products that is essentially contemplated under Article III. Thus, even though the
production of domestic carbon-intensive and energy-intensive products may be economically
affected by the requirements placed on domestic producers, the sale, purchase, or use of these
goods would not be subject to regulatory requirements. The absence of a counterpart internal
regulatory program applicable to goods produced in the United States would thus render the
import prohibitions under the IRA program liable to the Article XI claims discussed above.
Justification of H.R. 2454 IRA Program under Article XX General Exceptions
As noted above, if a trade-related GHG reduction measure is challenged in a WTO dispute
settlement proceeding and found to violate a GATT obligation, the defending Member may seek
to justify it under a GATT general exception, the most likely candidates in the climate change
context being Articles XX(b), covering measures “necessary to protect human, animal, or plant
life or health” and Article XX(g), covering measures “relating to the conservation of exhaustible
natural resources if such measures are made effective in conjunction with restrictions on domestic
production or consumption.”149 A measure falling within the scope of an exception is also subject
to the overall Article XX proviso or “chapeau” requiring that any such measure not be “applied in
a manner which would constitute a means of arbitrary or unjustifiable discrimination between
countries where the same conditions prevail or a disguised restriction on international trade.”
Finding that a measure is justified under an exception involves a complex analysis of the alleged
policy goal, the relationship of the measure to the goal, and details of the measure’s
implementation in light of the discriminatory and protectionist application to be avoided under
the proviso. If challenged, it would not be the GATT-inconsistency that would need to fall within
the scope of the exception, but rather the border measure program as a whole.150 Because Article
XX(b) requires a showing that a challenged measure is “necessary” to achieve the aim of health
protection, whereas Article XX(g) requires only that a relationship be shown between the
challenged measure and the stated conservation goal, it would generally be more difficult for a
measure to qualify under the former than under the latter. In either case, however, since
maintaining domestic competitiveness per se is not a policy goal protected by Article XX, the
extent to which the IRA requirements of H.R. 2454 address articulated goals of protecting health
or conserving natural resources would be critical in determining whether the program falls within
the scope of the relevant exception.
Article XX(b)
Successful invocation of Article XX(b) first requires a showing that the policy objective of the
challenged measure is to protect human, animal, or plant life or health, and that the measure is
necessary to achieve this end. As noted below, the WTO Appellate Body has implied that health

149 In addition, some GATT-inconsistent measures may qualify for the more generic Article XX(d) exception for
“measures necessary to secure compliance with laws or regulations which are not inconsistent with” the GATT.
150 See Appellate Body Report, United States—Standards for Reformulated and Conventional Gasoline, at 16,
WT/DS2/AB/R (April 29, 1996) (hereinafter, U.S. Gasoline AB Report).
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protection may be a goal of a domestic climate change program. At the same time, since the
purported health protection would be achieved through the prevention of carbon leakage that is
manifested as increased carbon emissions in foreign countries, and because Article XX(b) does
not expressly state whether the objects of protection need to be located in the territory of the
Member imposing the restriction, a jurisdictional issue may arise in a climate change case,
requiring a panel to clarify Article XX(b)’s territorial reach and how it may be satisfied. The
global impact of the climate change problem may be sufficient, however, to find any local nexus
that may be needed.151
To find necessity, the Appellate Body has articulated a test that includes weighing and balancing
of “the relevant factors” with an examination of less trade-restrictive alternatives. Under this
process, the panel (1) considers “the importance of the interests or values at stake, the extent of
the contribution to the achievement to the measure’s objective, and its trade restrictiveness,” and
(2) if the panel preliminarily finds necessity, “confirms” this conclusion “by comparing the
measure with possible alternatives that may be less trade restrictive while providing an equivalent
contribution to the achievement of the objective.” 152 The comparison “should be carried out in
the light of the importance of the interests or values at stake.”153
The WTO Appellate Body has stated that the more vital or important the value being pursued, the
easier it would be to find that the chosen measure is necessary to achieve the chosen level of
health protection.154 The measure does not need to be shown to be indispensable, but, under
recent WTO jurisprudence, it must be “apt to produce a material contribution to the achievement
of its objective”; in other words, a measure providing a “marginal or insignificant” contribution
would not be considered necessary to achieve the stated goal.155 Immediate impact of the measure
need not be shown, the WTO Appellate Body having recognized that solving complex
environmental problems may require a range of interacting measures and that “the results from
certain actions—for instance, measures adopted in order to attenuate global warming and climate
change …—can only be evaluated with the benefit of time.”156 A higher level of contribution to
achieving the stated goal may be needed where the measure is particularly restrictive, as is the

151 In European Communities—Tariff Preferences for Developing Countries, the European Communities (EC) argued
that special tariff preferences for countries combating drug production and trafficking could be justified under Article
XX(b) on the ground that they were necessary to protect human life and health in the EC by supporting measures in
drug-producing and trafficking countries that would reduce the supply of drugs into the EC. The panel was willing to
examine whether EC health protection was a policy objective under the program , but was unable to find official
evidence of this objective. Panel Report, European Communities—Tariff Preferences for Developing Countries, paras.
7.180-7.183 7.201, WT/DS246/R (December 1, 2003). In United States—Import Prohibition of Certain Shrimp and
Shrimp Products (U.S .Shrimp), the Appellate Body specifically did not address whether there is an implied
jurisdictional limitation in Article XX(g), but did find that, because the sea turtles which the challenged statute sought
to protect were known to occur in waters under U.S. jurisdiction, there was a “sufficient nexus” between the
endangered marine species at issue and the United States for purposes of the exception. Appellate Body Report, United
States—Import Prohibition of Certain Shrimp and Shrimp Products, para. 133 (hereinafter, U.S. Shrimp AB Report).
152 Appellate Body Report, Brazil—Measures Affecting Imports of Retreaded Tyres, para. 178 (December 3, 2007)
(hereinafter, Brazil Tyres AB Report).
153 Id.
154 Appellate Body Report, Korea—Measures Affecting Imports of Fresh, Chilled and Frozen Beef, para. 162.
WT/DS161/AB/R, WT/DS169/R (December 11, 2000); see also EC Asbestos AB Report, supra note 141, at para. 172.
155 Brazil Tyres AB Report, supra note 152, paras. 150-151.
156 Id. para. 151. The level of contribution of a measure can be demonstrated, for example, by evidence or data relating
to the past or present or “quantitative projections in the future, or qualitative reasoning based on a set of hypotheses that
are tested and supported by sufficient evidence.” Id. See also U.S.-Gasoline AB Report, supra note 151, at 21.
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case with an import ban.157 It would be up to the complaining Member in a dispute to identify
possible alternative measures; if it does so, the defending Member would be able to rebut such
suggestions on the grounds that the alternative inadequately contributes to the goal or is not
reasonably available for this purpose.
Article XX(g)
For Article XX(g) to apply to a GATT-inconsistent climate change measure, the WTO Member
would need to show (1) that conservation of an exhaustible natural resource is at issue; (2) that
the measure relates to conservation of this resource; and (3) that the measure is made effective in
conjunction with restrictions on domestic consumption or production. In United States–Import
Prohibition of Certain Shrimp and Shrimp Products (U.S. Shrimp), the WTO Appellate Body
took a broad view of exhaustibility in light of evolving multilateral agreement and action in the
conservation area since the adoption of the GATT in 1947 and found that the Article XX(g)
applies not only to exhaustible mineral or other non-living natural resources, but also to all
exhaustible resources, whether living or non-living.158 Since the renewability of a resource would
not preclude it from falling within the scope of the exception, 159 the exhaustible resource at issue
in the climate change context might be the atmosphere at a suitable temperature or a species
adversely affected by rising global temperatures. As with Article XX(b), however, the
jurisdictional reach of the provision may need to be addressed, with similar considerations
coming into play.160
For a measure to “relate to” the conservation of exhaustible natural resources, it must be
“primarily aimed at” this goal.161 As articulated in U.S. Shrimp, this test requires a “substantial
relationship” between “the general structure and the design of the measure … and the policy goal
it purports to serve,” a situation also characterized as “a close and genuine relationship of ends
and means.”162 The relationship of a climate change measure to the claimed conservation goal is
key, thus requiring a focus on how the measure would prevent carbon leakage and therefore
conserve the earlier-identified natural resources. Evolving studies on the prevention of leakage
may, however, present problems in this regard. Even though the WTO Appellate Body has
indicated that the immediate effect of a GATT-inconsistent climate change measure may not need
to be established in order to successfully invoke a GATT exception, the existence of credible
studies questioning whether leakage would be prevented by such measures may increase the
difficulty of showing that the program is primarily aimed at preserving the natural resource or
resources shown to be at risk.
To show that the measure is made effective in conjunction with restrictions on domestic
consumption or production, a panel would examine whether the restriction on the imported
product is imposed with respect to the same domestic items and whether the restriction, while not

157 Brazil Tyres AB Report, supra note 152, para. 210.
158 U.S. Shrimp AB Report, supra note 151, paras. 127-131.
159 Id. at para. 128. See also Panel Report, United States—Standards for Reformulated and Conventional Gasoline,
para. 6.37 WT/DS2.R (January 29, 1996) (a policy to reduce the depletion of clean air found to be a policy to conserve
a natural resource for purposes of Article XX(g)).
160 See supra note 151 and accompanying text.
161 E.g., U.S. Gasoline AB Report, supra note 150, at 21.
162 U.S. Shrimp AB Report, supra note 151, paras. 136-37.
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needing to provide true equality of treatment between the two,163 is “even-handed” in its approach
to imports vis à vis the restriction placed on domestic goods.164 The existence of “even-
handedness” may become an issue to the extent that H.R. 2454 permits border measures to apply
to “manufactured items for consumption” or the imported counterparts of items produced by
industrial sectors that did not initially qualify for the receipt of emission allowances under the
statute.
Article XX “chapeau”
The Article XX “chapeau,” which is aimed at preventing abuse of the Article XX exceptions,
focuses on how the GATT-inconsistent measure is applied. In the view of the WTO Appellate
Body, interpreting and applying the proviso is a “delicate” task of finding “a line of equilibrium”
between the right of a Member to invoke an Article XX exception and the rights of other
Members under GATT substantive obligations; the line moves “as the kind and the shape of the
measures at stake vary and as the facts making up specific cases differ.”165 In a 2007 case,
Brazil—Measures Affecting Imports of Retreaded Tyres (Brazil Tyres), the WTO Appellate Body
examined earlier cases in which it has applied the proviso and determined that the common mode
of analysis in cases involving arbitrary or unjustifiable discrimination involved a determination as
to whether the discrimination “had a legitimate cause or rationale in light of the objectives listed
in the paragraphs of Article XX.”166 The second element of the proviso has been the subject of
less jurisprudence, but it appears to be agreed upon that the prohibition on creating a “disguised
trade restriction” is aimed at avoiding a protectionist effect.
Unjustifiable discrimination was found to arise in two aspects of the U.S. pollution reduction
program at issue in United States—Standards for Reformulated and Conventional Gasoline (U.S.
Gasoline), a case challenging the application of a statutory baseline to foreign refiners in
assessing whether imported gasoline met Clean Air Act standards, while more favorable
individual baselines were applied to their U.S. counterparts. First, the United States had failed to
engage affected exporting countries in exploring cooperative arrangements to mitigate
administrative difficulties that the United States claimed would exist in acquiring foreign data for
verification and assessment purposes if individual foreign baselines were used.167 Second, the
United States had taken into account burdensome costs that would be placed on domestic
refineries if they too were subject to the statutory baseline, but had not considered costs that
would be incurred by foreign firms under the program.168
In U.S. Shrimp, the Appellate Body found unjustifiable discrimination in the “intended and actual
coercive effect” on foreign government policy decisions of the U.S. program prohibiting the
importation of shrimp from countries not certified by the United States as maintaining a

163 U.S. Gasoline AB Report, supra note 150, at 21.
164 U.S. Shrimp AB Report, supra note 151, paras. 143-144.
165 Id. paras. 158-59. In considering the U.S. restriction on shrimp caught with methods harmful to sea turtles, the
Appellate Body stated that its analysis of the proviso would be colored by the preambular language to the WTO
Agreement, which conditioned the trade objectives originally set out in the GATT with the following statement: “…
while allowing for the optimal use of the world’s resources in accordance with the objective of sustainable
development, seeking both to protect and preserve the environment and to enhance the means for doing so in a manner
consistent with their respective needs and concerns at different levels of economic development.”
166 Brazil Tyres AB Report, supra note 152, para. 225.
167 U.S. Gasoline AB Report, supra note 150, at 26-28.
168 Id. at 28.
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regulatory program and an incidental taking rate of sea turtles comparable to that of the United
States or having a fishing environment that did not pose a threat to sea turtles.169 According to the
Appellate Body, the United States had implemented the statute to require that exporting countries
adopt a regulatory program with policies and enforcement practices that were “not merely
comparable, but rather essentially the same,” as the program applied to U.S. shrimp trawlers, and
in some cases, to prohibit the importation of shrimp caught with methods identical to those
employed in the United States because the shrimp were harvested in waters of countries not
certified by the United States as using acceptable techniques.170 The Appellate Body stated that
discrimination results “not only when countries are differently treated, but also when the
application of the measure at issue does not allow for any inquiry into the appropriateness of the
regulatory program for the conditions prevailing in those exporting countries.”171
As in U.S. Gasoline, the Appellate Body in U.S. Shrimp also found unjustifiable discrimination in
the failure of the United States to engage affected WTO Members diplomatically—here, “serious
across-the-board negotiations with the objective of concluding bilateral or multilateral agreements
for the protection and conservation of sea turtles”—before enforcing the import prohibition on
shrimp against these countries.172 Actual conclusion of an international agreement is not required,
however, so long as “serious, good faith efforts” are made to negotiate an accord.173
The Appellate Body has also indicated that it will look at the length of the phase-in period for
foreign compliance with a regulatory program, both as to compliance burdens resulting from a
relatively short period and any differences in treatment between affected countries.174
Arbitrary discrimination may likewise result from placing a “single, rigid, unbending
requirement” on foreign countries under a regulatory program, as well as from not according
agency officials sufficient flexibility in making determinations under it.175 The Appellate Body
looked for flexibility in implementation, stating that where market access is conditioned on an
exporting Member adopting a regulatory program that is “comparable in effectiveness” to that of
the importing Member, the exporting Member will have “sufficient latitude … with respect to the
programme it may adopt to achieve the level of effectiveness required” and may thus adopt a
program that is “suitable to the specific condition prevailing in its territory.”176
Avoiding arbitrary discrimination has also been found to implicate due process concerns, and
thus, where a statute requires that exporting countries fulfill certain conditions before their
exports are permitted entry into the United States, the accompanying regulatory process should be
“transparent” and “predictable ” and should not be ex parte, that is, conducted only with input
from the importing Member’s agencies and officials.177 Instead, the importing Member should
give affected exporting countries an opportunity to explain their situation to agency decision-

169 U.S. Shrimp AB Report, supra note 151, para. 161.
170 Id. (emphasis in original).
171 Id. para. 165.
172 Id. paras 166-172.
173 U.S. Shrimp (Article 21.5) AB Report, supra note 144, para. 134.
174 U.S. Shrimp AB Report, supra note 151, paras 173-174.
175 Id. para. 177.
176 Id. para. 144.
177 Id. para. 180.
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makers, and provide them with a reasoned explanation for denial of requests and petitions, as well
as procedures for review of any such denials.178
Determining whether a disguised restriction on international trade exists involves focusing not on
the restriction per se, but rather on what it may mask. Since this portion of the Article XX proviso
is also aimed at avoiding abuse and illegitimate use of the Article XX exceptions, the Appellate
Body has found that a restriction that formally meets the requirements of an exception “will
constitute an abuse if such compliance is in fact only a disguise to conceal the pursuit of trade-
restrictive objectives.”179 Because the aim of a measure “may not be easily ascertained …the
protective application of a measure can most often be discerned from its design, architecture, and
revealing structure.”180 While the Appellate Body has indicated that the same considerations that
are used to determine if discrimination exists may be used to find a disguised trade restriction,181
a subsequent WTO panel chose not to examine whether discrimination existed for this portion of
the proviso where discrimination had not already been found. Instead, it focused on possible
protectionist objectives of the measure and the extent to which it had benefited a domestic
industry to the detriment of foreign producers.182
Given these cases, were the IRA program found to violate U.S. GATT obligations but the
program was found to fall within the scope of a GATT general exception, the United States would
seemingly need to address issues such as the following to show that the program was applied
consistently with the Article XX proviso: (1) engagement of trading partners for the purpose of
negotiating a bilateral or multilateral solution both to the GHG-reduction goal and addressing the
use of border measures to remedy the competitiveness concerns that lead to leakage and
administrative problems that may arise in implementing the border measure program, particularly
in regard to the use of foreign data; (2) use of a flexible regulatory standard under which the
Member permits comparability in the effectiveness of foreign programs in achieving the
importing Member’s policy goal; (3) creation of a regulatory process that gives exporting
Members a meaningful opportunity to be heard and to resolve problems and deficiencies in
seeking and obtaining access to the importing Member’s market; (4) providing an adequate
phase-in period before import requirements enter into effect; and (5) permitting the importation of
goods that in fact comply with the requirements of the regulatory program, thus avoiding overly
broad regulatory categories that may result in penalizing such compliance.
As discussed earlier, the negotiating objectives under Part IV, Subpart 2 include seeking both
multilateral GHG-reduction commitments and provisions permitting parties to remedy
competitive imbalances that lead to leakage. Additionally, however, seeking data cooperation
agreements may also be important in that the regulatory program may rely heavily on foreign
emissions and production statistics. The avoidance of arbitrary or unjustifiable discrimination
may depend on the quality of such data where they are used to assess emissions-reduction activity
in order to determine whether and to what extent border adjustment apply, as well as to
distinguish between countries “where the same conditions prevail.” Arguably, even though
modeling may potentially be used under the legislation to produce otherwise unobtainable hard

178 Id. paras 178-83.
179 Panel Report, European Communities—Measures Affecting Asbestos and Asbestos-Containing Products, para.
8.236, WT/DS135/R (September 18, 2000) (hereinafter, EC Asbestos Panel Report).
180 Id.
181 U.S. Gasoline AB Report, supra note 150, at 25.
182 EC Asbestos Panel Report, supra note 179, paras. 8.237-8.239.
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data, a general lack of usable emissions data may raise questions as to whether the border
requirement may be applied in a nondiscriminatory fashion in all cases for purposes of Article
XX.
Further, even assuming that reliable foreign data existed, problems may nevertheless arise in
obtaining it. In the absence of a WTO agreement, such as the WTO Antidumping Agreement and
the Agreement on Subsidies and Countervailing Measures (under which WTO Members have
agreed that they or their exporters will provide information to authorities of the importing
Member for investigatory or regulatory purposes), exporting countries and their firms may be
reluctant to provide emissions or production data to EPA for purposes of making comparability or
other determinations under the IRA program. Unlike the situation in U.S. Gasoline, where the
quality of the imported gasoline directly affected the quality of the atmosphere within the United
States, the carbon-intensive and energy-intensive goods that would be subject to IRA
requirements would not themselves be environmentally harmful within U.S. territory. In such
case, foreign entities may arguably feel less compelled to produce data than they would in a
situation where their products clearly contributed to a problem within the sovereign jurisdiction
of the United States.
The issue of penalizing compliant imports may arise where the importing country measures the
comparability of a foreign program by determining an average national emissions rate, bases the
required amount of border emission credits for an imported product on this average, and subjects
all such goods originating in the country to the same requirement, regardless of actual GHG gases
emitted in their production. Other issues are likely to arise where import requirements are based
on GHG emissions, for example, accurately determining the level of emissions attributable to
production of goods occurring in multiple countries under a variety of production processes. In
addition, the extent to which a border program covers imported goods that are downstream from
the type of products that are produced by domestically capped manufacturers or by initially
eligible industrial sectors could be a factor in examining whether the program is applied in a
manner that constitutes a disguised restriction on international trade.
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Appendix. EC Draft List of Eligible Industries



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Source: European Commission, Draft Commission Decision of determining, pursuant to Directive 2003/87/EC of the
European Parliament and of the Council, a list of sectors and subsectors which are deemed to be exposed to a significant
risk of carbon leakage (Brussels: 2009).




Author Contact Information

Larry Parker
Jeanne J. Grimmett
Specialist in Energy and Environmental Policy
Legislative Attorney
lparker@crs.loc.gov, 7-7238
jgrimmett@crs.loc.gov, 7-5046




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