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

The European Union has a bold plan for reducing carbon emissions from its factories. It has what might be an even bolder one for preventing the rest of the world from wiping out those cuts and destroying 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 Carbon Border 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 benefit: the cash such a carbon charge could bring in to strapped EU coffers.

1. What’s the problem?

The 27-nation EU has reached a preliminary deal to deepen its 2030 greenhouse-gas reduction target to at least 55% from 1990 levels and runs the world’s biggest carbon market. It also aims to become climate-neutral by mid-century under an unprecedented strategy called the Green Deal. Measures to tighten its existing climate goals that are set to 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. The cost of pollution in Europe has doubled over the past two years to record levels, and now the EU is planning to introduce the world’s first carbon-related levy on imported steel, cement and aluminum from countries with lower environmental standards than its own. According to a draft regulation, the charge would be based on carbon costs that EU producers already face, and will also affect fertilizers and electricity.

2. Why is it proposing this now?

The bloc is tightening its environmental rules in all areas from transport to energy production and trade. The EU’s plan to reduce emissions by at least 55% by 2030 is more ambitious than its earlier target of 40% and initially provoked opposition by a group of eastern European countries led by coal-reliant Poland. The new import levy will be included in a package of measures that the Commission is due to propose on July 14 to enact the new goal. They will need support from national governments and the European Parliament.

3. What’s the aim?

The EU wants to protect its industry while prodding other regions to move ahead with similar climate action. With carbon prices surging above 50 euros ($60) per metric ton, energy-intensive companies such as steel producers have been calling for additional tools to protect industry from the threat of carbon leakage. Political support is also building, with EU leaders rallying behind the proposal.

4. How will it help the planet?

The levy charged at the border is meant to encourage EU trading partners to adopt comparable carbon-pricing systems and avoid such payments, a development that would accelerate emission cuts. Though no carbon border adjustment mechanism has ever been tried, it has been the subject of numerous legal and economic analyses: 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.

5. Isn’t this protectionist?

EU Economic Affairs Commissioner Paolo Gentiloni argues the bloc is not protecting its industries in any unfair way. On the contrary, it’s shielding its companies from facing unfair competition. To ensure the new levy is in line with World Trade Organization rules, the Commission wants the CBAM to be an alternative to existing carbon-leakage protection tools, which include free permits to pollute in the EU carbon market for some companies. Yet few details are known about when and how those free allowances will be phased out, and the steel industry has made clear that unless the carbon levy comes on top of existing tools, it won’t support the new mechanism.

6. How will it work?

Importers will have to buy electronic CBAM certificates at prices corresponding to those in the EU Emissions Trading System, the world’s biggest cap-and-trade program for greenhouse gases. The price of those certificates will be the average of closing prices of all government auctions of carbon permits during each calendar week, according to the draft. The Commission is considering using a simplified system starting in 2023 for up to three years before the mechanism fully comes into force in January 2026.

7. Is it open to legal challenges?

The EU’s plans to impose a carbon import levy are causing unease in countries from Ukraine to India, and legal challenges are likely. Europe has already learned a trade and climate lesson when it included flights to and from Europe in its carbon market last decade, putting a price on every ton of CO2 discharged by planes. Following an uproar and threats of retaliation from Brazil to the U.S., Russia and China, the EU backtracked, scaling down its program. If the carbon levy proposal escalates trade tensions and industry withdraws its support, it may never grow into a full-blown policy tool.

The Reference Shelf

  • Bloomberg News stories on the Green Deal and a draft carbon regulation.
  • A European University Institute policy brief on why the CBAM won’t be a quick fix.
  • An American Economic Review article by Nordhaus on “climate clubs” and import levies.

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