Here’s How the EU Could Tax Carbon Around the World

(Bloomberg) -- The European Union has a bold plan for sharply reducing carbon emissions from its factories. It has what might be an even bolder plan for preventing the rest of the world from wiping out those cuts, and killing lots of European jobs at the same time. The plan is for taxing some of the carbon produced by the European factories’ global competitors, through what’s known as a border carbon adjustment mechanism. Other countries might call it a tariff, and a potentially illegal one at that. For the EU, the mechanism could be a way to hit two birds with one stone: protecting its industry while prodding other regions to move ahead with similar climate action. But there’s another as well: the cash such a carbon charge could bring in to strapped EU coffers.

1. What’s the problem?

The 27-nation EU, which already has a binding target to cut greenhouse gases by at least 40% by 2030 from 1990 levels and runs the world’s biggest carbon market, wants to become climate-neutral by mid-century under an unprecedented strategy called the Green Deal. Measures to tighten its existing climate goals that will drive up the price of carbon emissions within the EU are a central pillar of that strategy. The problem is what’s called carbon leakage – production shifting to places with laxer climate policies to avoid those costs.

2. What would that do to EU manufacturers?

They point to what’s already happening, as the cost of emissions permits has risen five-fold in the EU over the last three years, even before passage of Green Deal legislation. This year, carbon prices are likely to set records, rising by about a third to 30 euros ($32.50), according to a Bloomberg News survey of nine traders and analysts. ArcelorMittal SA, the Luxembourg-based steelmaker, cited that spike as one of the reasons behind its decision to temporarily reduce its European output by 7%. Makers of other goods whose production involves high levels of greenhouse gas emissions are also raising concerns even though analysts, including Jahn Olsen at BNEF, say there’s little evidence of industry fleeing the bloc. To shield producers from carbon leakage, the EU already gives special treatment to companies deemed at risk, awarding them a bigger share of free emission permits than other businesses.

3. What would the carbon border adjustment mechanism do?

The EU wants to ensure that imported goods makers face the same costs of emissions as European companies. A carbon border tax would penalize dirty imports from countries that lag behind in fighting climate change. It would likely apply initially to steel, aluminum and cement and could also be applied to imports of electricity. The European Commission, the executive arm of the EU, is considering both a carbon tax and extending the system of CO2 permits that exists in Europe to cover imports. The EU’s Emissions Trading System is the world’s biggest carbon market, imposing pollution caps on around 12,000 installations owned by manufacturers and utilities that are tightening over time. No draft of a border adjustment mechanism law is expected until next year, and any proposal would have to overcome differences among national governments and the EU Parliament over whether and how to impose a carbon levy.

4. So there’s a political side to this?

Yes. Putting a carbon price on imports would help improve the competitiveness of European companies and send a message to voters that the EU is protecting its businesses on the unprecedented journey to climate neutrality. A growing number of member states is also supporting the idea for a more pragmatic and not necessarily green reason: It could be a tool to boost the EU one-trillion euro budget. With the U.K. leaving the bloc, the EU lost one of the biggest net contributors and policy makers are struggling to plug the Brexit-induced 10-billion-euro annual hole. A carbon levy could become a new own resource in the financial plan for 2021-2027 that EU heads of government are set to discuss at an emergency summit in Brussels on Feb. 20. On the other hand, setting up a system that doesn’t run afoul of World Trade Organization rules could mean ending the practice of handing free emission permits to some energy-intensive companies in the EU carbon market. Big energy users have already signaled that they would oppose any move to limit their free allowances.

5. What do Europe’s trading partners think?

The EU is well aware that it might be on thin ice, and that the plan risks opening a new source of international trade tensions just as U.S. President Donald Trump is threatening to hit European automotive goods to retaliate against EU support for Airbus SE. One of the first official reactions to the idea came from the Kremlin, where Russian President Vladimir Putin’s top adviser on climate warned big businesses that they need to start preparing for harsher EU rules on emissions or face difficulties selling their products into that market. U.S. Commerce Secretary Wilbur Ross has warned of possible retaliation.

6. What’s Europe’s response?

The EU may be betting that the sheer threat of a carbon tariff would be a strong enough policy weapon to mobilize a greater global response to climate change. Though no border carbon adjustment mechanism has ever been tried out in practice, it has been the subject of numerous legal and economic analyses: The Yale economist and Nobel prize winner William Nordhaus has argued that the formation of what he termed a Climate Club in which participating nations impose small trade penalties on others could lead to large, stable coalitions with steep carbon reductions. The idea also gives the European Union a tool for taking up leadership on an issue that Trump has backed away from. European Commission President Ursula von der Leyen has kept underlining the EU resolve ever since she floated the carbon tax idea in July. In Davos, she praised California for showing the way with its emissions trading system and commended China for taking first steps toward carbon pricing. “These may be only first steps towards a level playing field,” she said. “But if this turns into a global trend, we will have a global level playing field – where no carbon border tax will be necessary.”

The Reference Shelf

• A European Commission white paper on the EU’s Green Deal strategy.
• Four economists look at how a carbon border tax might work.
• An article by William Nordhaus on “climate clubs” and import levies.
• Bloomberg News articles on the Green Deal and a carbon border tax.

To contact the reporter on this story: Ewa Krukowska in Brussels at ekrukowska@bloomberg.net

To contact the editors responsible for this story: Reed Landberg at landberg@bloomberg.net, John O'Neil, Grant Clark

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