Opinion in lead

Implications of the carbon border tax

In its fight against climate change, the European Union, in July 2021, decided to integrate its trade policy with climate policy by proposing the Carbon Border Adjustment Mechanism (CBAM). The proposal was in line with its goal to cut net greenhouse gas (GHG) emissions by at least 55 per cent by 2030 compared to 1990 and achieve carbon neutrality by 2050. To achieve this, the EU is updating and revising EU legislation and putting in place new initiatives with the aim of ensuring that EU policies are in line with the climate goals, calling it ‘Fit for 55’. The CBAM, which was agreed on by the EU Council and Parliament in December 2022, is one of the initiatives under its Fit for 55 programme.

The CBAM will enter into force in its transitional phase as of 1 October 2023 and is planned to be fully implemented by January 2026. The CBAM will initially apply to imports of certain goods whose production is carbon intensive and at the most significant risk of carbon leakage, such as cement, iron and steel, aluminum, fertilizers, electricity and hydrogen. According to the EU, this move is aimed at curbing what it has called ‘carbon leakage’, which occurs when companies based in the EU move carbon-intensive production abroad to countries where less stringent climate policies are in place than in the EU, or when the EU products get replaced by more carbon-intensive imports. By 2023, importers will be required to report emissions embedded in the goods they import and purchase carbon import permits for each metric ton of carbon dioxide (CO2) emissions produced by carbon-intensive products brought into the EU. Goods imported from countries that have domestic carbon-pricing regimes similar to the EU’s will be exempt from the levy, subject to an agreement between those countries and the EU.

According to a recent report, EU importers and non-EU producers will be required to pay an estimated EU€75 per metric ton of CO2 emissions. This could increase the cost of materials made by more carbon-intensive producers, such as China, Russia, and India, by 15 to 30 percent overnight. By 2030, the tax rate is projected to reach EU€100 per metric ton, and more products will likely fall within its scope at that point. This could affect the countries that manufacture the products in the list and have less stringent emission controls where a large number of European companies have outsourced their production. For example, China and India have territorial footprints larger than their consumption footprints since a large volume of their CO2 emission is from the manufacturing of goods for exports rather than for household consumption in their own countries.

Some nations including Canada have supported and shown their interest in the EU CBAM policy as Canada is also exploring its own version of Border Carbon Adjustments (BCA) as a part of Canada’s transition to a low-carbon economy. The United States has also stated its support for the CBAM, which would help the US align with the EU and quicken climate action. However, considering that the CBAM does not yet have a majority of support in Congress, US President Joe Biden has not made it a priority.

On the other hand, many developing countries, especially Brazil, South Africa, India and China (BASIC), have opposed the CBAM, calling it ‘discriminatory’ and against the principles of equity and ‘Common but Differentiated Responsibilities and Respective Capabilities’ (CBDR-RC). These principles acknowledge that richer countries have a responsibility of providing financial and technological assistance to developing and vulnerable countries to fight climate change. These countries argue that any measures to address climate change must be consistent with multilateral trade rules and must not impose arbitrary restrictions on international trade. There are also concerns about high substantial costs that non-EU partners are likely to face due to increased tariffs on CBAM goods imported into the EU. Countries such as Russia, China, and India export significant amounts of goods covered by the CBAM. They have also criticized the EU for adopting green protectionism disguised as climate action. They have also threatened to initiate a dispute against the EU’s move at the World Trade Organization (WTO) claiming that the CBAM breaches WTO rules. The CBAM proposal has also faced severe scrutiny from many EU partners, who are sceptical about its effectiveness in achieving its stated objectives, and concerned about its effect on the WTO, and its consistency with the Paris Agreement.

This proposal will have an adverse effect on the already fragile global trading system on the heels of the Covid-19 pandemic and the Russian invasion of Ukraine. There are also chances that different countries and economies may opt for different carbon tax mechanisms. There might not be uniformity in tariff calculations and valuation of the products between the countries of origin and destination.

Furthermore, CBAM could have severe implications for the least developed countries (LDCs), the majority of which rely on commodity exports. The carbon border tax requires producers to verify the GHG embedded in their products. This can impose a significant technical and administrative burden on the LDCs, which already have difficulty navigating the myriad non-tariff barriers in international trade. Some critics are calling this policy green protectionism that will unduly shield local industries in the EU from foreign competition. Rich economies have long exported their emissions to the least developed and developing countries while enjoying goods at cheaper rates and not doing much towards reducing their own domestic emissions. The CBAM does not comply with the Paris Agreement and there is no exception for the LDCs, as well as no provision for using revenue from the CBAM to support decarbonization in the LDCs. Currently, few African LDCs like Mozambique, Mauritania, Sierra Leone, and Senegal seem to be the most affected and exposed countries which would impact their GDP growth because of CBAM, however the impact of CBAM would have to be borne by other LDCs as well who are the least responsible for emitting carbon.

Although CBAM is an effort to encourage decarbonization and can bring about strict carbon regulations across the world, it also brings significant complexities. The foundations of the world trading system could be disturbed and this could also exacerbate global trade tensions. Many developing countries are already viewing this as non-compliant with the Paris Agreement and the Rio Declaration, which states that standards applicable to developed countries cannot be applied to developing countries and hence this contradicts the EU’s idea that there should be a single global standard for the environment. The CBAM also fails to answer key issues like how to fairly account for emissions related to the production of imported goods and how to duly consider the costs that companies already face in complying with climate regulations in exporting countries.

The proposed CBAM is a good initiative that can help boost climate change mitigation. However, there must be efforts to frame it in a way that will be applicable and acceptable to all the countries and to avoid a bipolar world of rich and green economies on the one side and poorer economies on the other. It should also take into account the differential responsibilities and respective capabilities of countries under the Paris Agreement to mitigate emissions.

Mr. Paudel is Programme Associate at SAWTEE. This article was published in Trade, Climate Change and Development Monitor, Volume 20, Issue 1, January 2023.