Mr Trump’s Reciprocal Tariffs and the Carbon Boarder Adjustment Mechanism (CBAM)

President Trump has said – among plenty of other things – that he intends to introduce reciprocal tariffs in April this year on at least some trading partners. This would mean the USA imposing tariffs on its imports from a country at the same rate as that country imposes tariffs and other barriers on its imports from the USA.  There are legion objections to this, including that it undermines the main principle of the World Trade Organization (WTO), non-discrimination between different sources of the same good, and that it is impossible to implement in any strict sense.

We are learning, however, that such objections are not determinative for Trump, and so it is worth thinking the policy through. One question we have been posed is ‘will the Carbon Border Adjustment Mechanism (CBAM) be included in reciprocal tariffs?’  The answer is ‘most likely, but it may not make much difference’, as we explain below. Both the EU and the UK plan CBAMs, the former slightly in advance of the latter, so the analysis applies to both.

The previous US Administration was highly sceptical of the CBAM, with then US Trade Representative Katherine Tai, refusing to rule out retaliatory tariffs and the Court of International Trade ruling that its predecessor, free allowances, were a countervailable subsidy. The EU and UK have done everything they can to make the CBAM WTO-consistent, and hence not warranting any retaliation, although, in truth, there is still room for doubt. Overall, therefore, we may reasonably assume that Donald (‘tariff is most beautiful word in the dictionary’) Trump, who is also a climate change sceptic, will react strongly.

Trump has already declared that Value Added Tax (VAT) is a trade barrier, which is completely wrong, along with non-tariff barriers, exchange rate distortions and various other unspecified polices, so it is wishful thinking to believe that CBAM would be excluded. The key question is whether the CBAM will tip the UK over from not facing reciprocal tariffs (yet) to facing them: this is clearly possible, but it seems more probable to us that it will not be the straw that breaks the camel’s back.

A CBAM could never be included within a strictly interpreted reciprocal tariff policy that matched tariffs line by line: this is because, uniquely, the CBAM’s charges will be related (a) to estimates of a consignment’s carbon- (strictly emissions-) intensity so that it will vary between firms and (b) to the prevailing price of emissions permits in the EU or UK, so that it will vary through time - weekly in the EU and quarterly in the UK. Moreover, applying reciprocal tariffs on all goods imports would imply US Customs operating from a list of over two million potentially different tariff rates (up to 13,000 tariff lines x around 220 countries) and having to determine the origin of every consignment.

So, practically, the only solution for the USA is to use a pretty crude – well, arbitrary - approximation of what partners charge on their imports from the USA. And, as Alan Beattie points out, nearly all of Trump’s calculations to date come out with the answer 25% independent of the various objectives of the tariffs (fentanyl, trade balance, migration, national security), the product (steel, aluminium, softwood lumber) and the partner (Mexico, Canada, Colombia, EU).

This is the reason that we say that, on current form, it barely seems to matter whether CBAM enters the picture or not. It is true that including the CBAM could affect the outcome if the policy were ever codified to reflect partners’ actual policies rather than Trump’s approach to making deals and operationalised in such a way that officials could broadly assess the tariff equivalent of EU or UK policy on US exports. But even then, the problems of quantifying it, alluded to above, and of defining a counter-factual would make its inclusion highly complex.

Could the EU and the UK avoid the CBAM giving rise to additional barriers in the USA? Again, on current showing, whether the EU or UK were subject to the reciprocal tariff policy and how high the penalty would be appears mainly to be a matter of political manoeuvring and personal dynamics with the Trump regime. While the EU is currently less popular in Washington than the UK, it does have more muscle for retaliation, so it is not clear that it is actually the more vulnerable.

Predicting US policy in Spring 2025 is a bit of a mug’s game, so our advice would certainly be not to worry about reactions to the CBAM until they become a lot clearer and rational.