Global Market Carbon Taxes: Are There Any Changes?

After a long and unpredictable legislative journey, negotiations have reached the final stage for the first global carbon border adjustment mechanism (CBAM) by the European Union. Some members of the United States Congress seem to be paying attention.

The European Parliament disapproved a proposal for reforming the EU’s Emissions Trading System. This sets the EU’s internal carbon price. It also delayed a vote on the complementing CBAM to stop carbon leakage. However, both the and parts of the larger climate package had passed with large majority.

Given the Council of the EU tariff. While the general approach of the Council did not include a decision on the rebates in its proposal, the Parliament’s version includes export rebates for those sectors that are dependent on exports.

The Commission will assess the compatibility of rebates with World Trade Organization (WTO) rules. This is crucial for EU-US relations as if either the WTO (or the U.S.) consider CBAM a protectionist measure, it may cause the U.S. tariffs on EU goods.

Second, the Parliament’s version expands CBAM’s coverage vis-a-vis that of the Commission’s proposal. It also includes a timeline for adding other sectors in future. The expanded scope of the CBAM could have significant consequences for producers in third countries without a carbon-tax. This includes producers from the United States who export to the EU.

The Commission also stated that producers who pay a carbon fee in their home country equivalent to EU standards will be exempted from the CBAM tax. The EU has not yet established a procedure for determining whether another country’s carbon taxing system is equivalent to the EU. Even if the U.S. implemented a carbon tax it is not clear if the EU would accept it as equivalent and remove CBAM from U.S. imports.

The EU may have achieved another important goal, though it is still negotiating its own law to stop carbon leakage. CBAM was the Council’s approach. It emphasized “encouraging partners countries to establish carbon pricing strategies to fight climate change.” This means that by simply proposing CBAM as an import price, the EU attempted to force the U.S. to join the climate negotiating table. The approach appears to be working.

U.S. U.S. Whitehouse’s bill, unlike many other proposals, would be a partial border adjustment and not just a border tarif. This distinction is important. Although it’s a significant improvement to include a partial frontier adjustment, there are still many shortcomings.

Two variables generally determine the carbon tax basis. The first determines how imports and exporteds are taxed. The second determines what percentage of domestic carbon emissions are taxed.

One can easily imagine a carbon tax based on domestic production’s carbon output. It seems easy. This would lead to a tax bias against domestic manufacturing. Domestically produced goods would be subject to taxes while imports would not.

This policy design could lead to carbon loss. As illustrated in Table 1, companies that are subject to regulations or taxes to reduce carbon emissions may move their operations offshore. They will not be subjected to the same policies and thus, they won’t be able to reduce (or possibly increase) carbon emissions. For example, the current EU policy under ETS is susceptible to leakage.