The World’s First Carbon Border Tariff, Explained

(Bloomberg) -- The European Union’s Green Deal—a set of policies aimed at remaking the bloc’s economy to reach net-zero emissions by 2050—is arguably the most ambitious government plan ever put forward to tackle climate change. But being first comes at a cost.

At least initially, goods produced in the EU will be more expensive than those not subject to emissions-reducing regulations, making local businesses less competitive against their global rivals. To keep companies from fleeing the bloc, EU policymakers are devising a way to penalize imports of carbon-intensive goods. Few details have been released yet (though even those have generated plenty of Sturm und Drang), but in general, here’s how to understand the basic idea behind the plan:

1. It’s a thumb on the scale

When European Commission President Ursula von der Leyen first floated the idea in July 2019, she called it a carbon border tax. It’s evolved since then, earning a new name: carbon border adjustment mechanism, or CBAM. Whereas a tax could draw the ire of the World Trade Organization, which doesn’t like protectionism, a border adjustment mechanism may spare countries that already put a price on emissions. Currently only a fifth of global emissions are subject to carbon pricing, according to the World Bank.

2. It’s a mirror

The CBAM will most likely function like a mirror image of the EU Emissions Trading System, the world’s biggest carbon market. In such a “notional ETS,” importers of emissions-intensive goods pay a charge linked to what they would’ve had to pay if they’d been covered by Europe’s carbon-reduction laws in the first place. The price of emissions allowances in the cap-and-trade program is already surging in anticipation of stricter climate goals.

3. It’s a puzzle

Designing the CBAM in a way that would make it compatible with the WTO is difficult but doable, according to EU policymakers. Yet there are more challenges Europe needs to address to implement the mechanism, ranging from political issues to technical factors such as how to determine the amount of carbon embedded in a product and how to credit countries outside the bloc. The commission plans to unveil draft regulations in June, but the scheme will have to be approved by the European Parliament and by member states to become law. That process involves negotiations that can take as long as two years, meaning the CBAM realistically won’t take effect until 2023.

4. It’s a cake

The commission has repeatedly stressed that the introduction of the CBAM will mean an end to—or at least a phasing-out of—the free carbon allowances currently given to businesses seen as most likely to leave the EU; keeping those allowances would make the CBAM incompatible with WTO rules. Industry wants to have its cake and eat it too, saying the free allocation of permits has to continue. This issue is set to be one of the biggest sticking points in negotiations about the final shape of the instrument.

5. It’s a piece of thread

Europe’s plans are already causing diplomatic unease in countries from Ukraine to China to India. The planned levy will be proposed just five months before a crucial climate summit, where coalition-building will be key to ensuring major emitters step up their efforts to reduce emissions. Threading that needle will be tricky, but possible, at least in theory.

6. It’s a lightning rod

Money from the border adjustment is a potential new source of EU budget revenue—from €5 billion ($6 billion) to €14 billion per year, the commission estimates. The decision on what happens to that revenue is what will draw the most opposition, warn Jos Delbeke and Peter Vis, former senior commission officials. A decade ago they saw the backlash when the EU tried to include international flights in the carbon market, a move partly seen as a tool to tap new sources of cash. “Any revenues should rather be channelled towards developing countries for climate purposes, or towards helping global industry decarbonise,” they wrote in a policy brief in December for the European University Institute.

7. It’s an opening gambit

The scope of the measure at the outset will be limited to a few sectors, with power, cement, steel, aluminum, and fertilizers the likeliest candidates. Europe imports electricity from Russia, Ukraine, and the Western Balkans. The biggest sources of cement imports are Belarus, Colombia, Turkey, and Ukraine, while steel is brought in mainly from China, Russia, Turkey, the U.K., and Ukraine. The border adjustment mechanism will be designed to enable a gradual extension into other industries over the coming years.

8. It’s a carrot and stick

The EU wants to provide a level playing field for its businesses and encourage more climate action from countries outside the bloc. But if other nations step up, or if the proposal escalates trade tensions, the CBAM may wind up being a tool the EU wields rather than something that’s applied across the board. “If the debate leads to a more ambitious implementation of climate policies globally, the best CBAM may well be the one that is never used,” Delbeke and Vis wrote.

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