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The EU’s plan to carbon tax the world

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In December 2019, the European Commission presented the Green Deal, a set of policy initiatives to make Europe climate neutral by 2050. The EU Green Deal included the possibility of having a “carbon border adjustment mechanism” (CBAM) for selected sectors.

The US commerce secretary warned last month at the World Economic Forum in Davos that the US would “react” to the EU’s plans for a carbon tax and accused the measure of protectionism.

Setting CBAs is a thought-provoking topic. While some experts regard CBA tariffs as protectionism, others believe it is a fair measure to preserve competitiveness under a climate crisis.

Let give you some background about the EU’s plan to carbon tax the world.

EU Emissions Trading System (EU ETS)

The European Union Emissions Trading System is a vital element of the European Union’s policy to tackle climate change. The ETS was launched in 2005 and is the largest international system for trading greenhouse gas emission allowances covering over three-quarters of the allowances sold on the global carbon market.

It taxes fossil fuel emissions under a cap and trade principle from around 11,000 power plants, energy-intensive industries, and airlines covering around 50% of total EU GHG emissions. The cap-and-trade system – limits the maximum greenhouse gas emissions and allows low emission industries to sell their extra allowances to larger emitters ensuring that aggregated emissions reductions occur.

Budget collected through the EU ETS scheme will contribute to financing the $1 trillion the European Green Deal Investment Plan to support sustainable investments over the next decade.

EU ETS contribution to European Green Deal Investment Plan

The Carbon Leakage

The EU ETS tax has a direct consequence; it increases the costs of producing energy and manufacturing goods in the EU. The current price is around 27 Euro per CO2 tonne emitted, and it has snowballed rapidly from 5 Euro per tonne since 2014. Moreover, the overall number of emission allowances will decrease at an annual rate of 2.2% from 2021 onwards, compared to 1.74% in the period 2013-2020, reinforcing further this trend. To avoid price variability may require setting a price collar system (carbon floor and ceiling price), as implemented in many other schemes worldwide, to guarantee the predictability and ETS system viability.

EU ETS increasing carbon prices, make EU carbon-intensive industry, such as cement or iron will need to adapt to higher operating costs losing competitiveness and making cheaper to import these goods from zero or low-carbon tax countries.

This effect is called ‘carbon leakage‘ as the products can be produced elsewhere and imported, with no net reduction in carbon emissions.

Not only carbon leakage is present in goods, but also in energy markets. EU countries import ‘tax-free electricity’ from Turkey, Ukraine, Morocco and the Western Balkans, generated in a higher proportion from coal. These carbon leakages also incentivize further use of coal in neighbouring countries. (read this report from sandbag.org)

The Carbon Border Adjustment Mechanism

To avoid this carbon leakage, the EU ETS is considering applying a carbon border adjustment mechanism (CBAM) tariff on imports from countries with no or low carbon taxes. Besides, the EU would use a tax-break or a subsidy to products exported to countries where there are no carbon taxes,

The aim of the EU setting the CBAM is to level the playing field and incentivize other countries to apply similar mechanisms to reduce their emissions. The EU Commission president, Ursula von der Leyenvon der Leyen, applauded California for its emission trading system and to China for its first moves towards a CO2 pricing system during the last World Economic Forum meeting in Davos. She also mentioned that “…if this [carbon tax] turns into a global trend, we will have a global level playing field – where no carbon border tax will be necessary.”

“If this [carbon tax] turns into a global trend, we will have a global level playing field – where no carbon border tax will be necessary.”

Ursula von der Leyenvon der Leyen, The EU Commission president,

Carbon Border Adjustment Mechanism barriers

There are three main challenges in implementing this mechanism.

  • First, no country has ever implemented a CBAM so far, so there is no experience on what could be the outcome.
  • Second, the CBAM increases the price of imported goods, so it could generate tensions inside the EU and with countries exporting to the EU. Moreover, it needs to be designed in a way that it complies with the World Trade Organization (WTO) rules to avoid reactions from exporter countries to EU such as China, Russia, India or the US.
  • Third, is how the carbon content of imports would be calculated. The EU would require deep economic analysis to determine the equivalence of the carbon costs between the goods produced in the EU and abroad in different industries. This study, would need a carbon emissions disclosure program for the EU and importing countries and a complicated regulation system. All details will be explained in a paper to be published between 2020 and 2021.

Summary

  • The EU green deal aims at making the EU region carbon neutral by 2050.
  • As part of the plan, the EU will establish a carbon border adjustment mechanism to avoid carbon leakages.
  • The implementation of CABM faces some challenges such as no previous experience, the potential reaction of exporter countries to the EU and the carbon tariff calculation complexity.
  • The following months will be critical to see whether the EU is successful in setting the CBAM and how effective it is in accelerating the carbon emissions reduction and thus combat climate change.

Let me know your thoughts about EU’s plan to carbon tax the world and if you like the topic share this article.

Thank you

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