Taxing times as EU mulls best way to price carbon at the border

Steel is among the imports that are candidates for carbon border adjustment treatment. [Photo: Shutterstock]

This article is part of our special report The EU’s carbon border adjustment mechanism.

EU climate officials are currently mulling how to deploy a so-called carbon border adjustment mechanism (CBAM) on imported goods, as part of the bloc’s flagship Green Deal initiative, and it is proving to be a complex exercise.

The idea of slapping tariffs on imports that do not meet certain sustainability criteria has been around for a long time but it is only under Ursula von der Leyen’s leadership that the European Commission has turned it into a political commitment.

As part of her executive’s flagship policy, the European Green Deal, the design of a carbon border tax – referred to as an ‘adjustment mechanism’ to cast off the negative connotations associated with taxation – was made a priority.

Work is still ongoing behind the scenes to draft the CBAM, as the instrument has to be compliant with World Trade Organisation (WTO) rules, to prevent trade disputes, but also effective enough to promote the EU’s green principles, both externally and internally.

A public consultation on what the policy should look like and what imports it should target closed at the end of October and the Commission still plans to publish its proposal in the second quarter of 2021.

Which sectors will be covered by the policy are still unclear, although the Commission’s director of trade defence, Leopoldo Rubinacci, did admit at a EURACTIV event earlier this week that the steel and cement industries are at the forefront because they are most exposed to so-called carbon leakage.

“Risk of carbon leakage means either that production is transferred from the EU to other countries with lower ambition for emission reduction, or that EU products are replaced by more carbon-intensive imports,” the Commission said in its public consultation.

A Carbon Border Adjustment Mechanism (CBAM) would ensure that the price of imports “reflects more accurately their carbon content,” the Commission added.

Crucially, the level of the tax would fluctuate according to the price of CO2 allowances on the emissions trading scheme, the EU’s carbon market. EU sources say this is essential to ensure the tax is compatible with WTO rules as foreign exporters would be placed on an equal footing with European industries.

But the fundamental logic behind the EU executive’s border tax efforts – that third-party countries and regions might not mirror the bloc’s focus on sustainability without an extra push – is almost constantly changing.

Over the course of the last two months, China, Japan and South Korea have all made emissions-busting pledges of varying magnitudes, while Joe Biden’s victory in the US presidential race will almost certainly shift Washington’s climate policy.

That prompted the Commission’s climate tsar, Frans Timmermans, to claim this week that “the level of the carbon border adjustment mechanism and the intensity of its use will depend on our international partners”.

“If they do the same thing as we are doing, if they want to show the same ambition and go in the same direction, the need for it will be less,” he told participants at the annual European Business Summit.

Mauro Petriccione, the head of the Commission’s climate directorate, told the same summit that a “climate-neutrality club” is now forming, citing China, Japan and a likely pending announcement by Canada as positive steps in that direction.

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Talk is cheap

Climate pledges only go so far though. China’s has already been criticised for not including non-CO2 emissions, while there are doubts about how much US President-elect Biden can achieve early in his presidency, given opposition in the Senate.

A lot of global emissions are still on the table too: Russia, India, Brazil and Australia have shown little appetite so far to beef up their commitments, increasing the likelihood of the EU deploying the border tax once the finer details have been worked out.

Securing WTO-approval will be challenging but according to Simone Tagliapietra, an energy expert at the Breugel think tank, support closer to home will be easier to muster, given climate policy’s close links with the job market.

“It is likely to get support across the EU, as European leaders seek to protect companies and jobs from the risks of carbon leakage,” he told EURACTIV, adding that the CBAM also provides the EU with a vehicle in which to export the Green Deal’s principles.

Russia has already cried foul at the EU’s intention to deploy a border tax, warning that it will not be compliant with WTO criteria. Tagliapietra suggested that Brussels “should try to be as multilateral as possible to prevent trade disputes and claims of climate protectionism”.

“A sensible way to go would be to team-up with the US and jointly introduce CBAM in certain sectors. This process should be open to other countries as well, and fully transparent. This is the way to avoid climate policy-induced trade wars,” he added.

The Commission has already attempted to try and get out in front of any potential areas of dispute, announcing in September that any industries included in the border tax would lose access to free pollution permits under the EU’s carbon market.

Moscow cries foul over EU’s planned carbon border tax

Russia’s economic development minister warned last week that the EU’s plans to deploy a carbon tax at the bloc’s borders will not be in line with World Trade Organisation (WTO) rules, just as Brussels doubled down on the idea of green tariffs.

Making the mechanism

A study by the University of Cambridge’s Energy Policy Research Group recently looked into how the mechanism can be designed to reflect more accurately how many emissions companies are actually producing.

In one scenario, the Commission could decide to slap tariffs on a certain product from a certain country and just assume the carbon-intensity value of those imports. The study authors insist that methodology “runs counter to the economic logic of carbon pricing”.

Michael Mehling, one of the authors, told EURACTIV that the CBAM should not be a one-size-fits-all option and should offer flexibility to companies, which should in turn build support for the policy.

“There is also a chance that, by working transparently with other countries to agree on the process and applicable rules, the EU could actively help foster some degree of cooperation and mutual trust,” he added, suggesting that the bloc’s monitoring, reporting and verification (MRV) rules are the right candidate for that framework.

However, asked why the Commission would favour default assumed values over case-by-case assessments, Mehling said that avoiding the tailored approach would likely increase CBAM revenues and ratchet up the domestic effect on EU businesses.

“Compared to just using uniform reference values, moreover, it does add an additional layer of administrative complexity to process the MRV reports from foreign producers, which the Commission may be especially reluctant to face especially at the outset,” he added.

There are several other issues that need to be addressed. If companies are given the chance to declare their own carbon figures, Brussels will have to be wary of “resource shuffling”, where firms only export from their most efficient facilities.

Products manufactured in other less-green factories would then be sold on domestic markets, leading to no net decrease in climate impact.

Paying the bills

The EU executive calculates that the CBAM could bring in between €5-14 billion in annual revenues, depending on its scope and intensity. What should be done with those revenues is likely to be a topic of great debate.

As part of its proposal for a coronavirus recovery fund earlier this year, the Commission said that CBAM revenues could be used to pay off part the €750 billion in funds that the institution is going to borrow on the capital markets in the coming months.

However, the European Council stopped short of giving its approval to that aspect of the repayment plan and the Commission has been urged by other stakeholders not to use the funds for anything other than decarbonisation schemes.

“Emissions Trading Scheme revenues are best placed to become an important source of own-revenues for the EU. CBAM revenues are intended to limit international competitive distortions rather than to generate revenue,” Breugel’s Simone Tagliapietra explained.

Ensuring that border tax funds are not seen as a cash grab by third-party countries feeds back into the EU’s climate diplomacy efforts and Brussels will be keen to dispel any notion that the CBAM is only about paying off its debts.

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[Edited by Frédéric Simon]

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