EU’s carbon border tax – Explained, pointwise

Introduction

In March 2021, the EU Parliament had adopted a resolution to implement a ‘Carbon Border Adjusted Mechanism’ (CBAM), pertaining to which proposed that goods entering the EU would be taxed at the borders. The E.U. proposal still needs to be negotiated among the 27 member countries and the European Parliament before becoming law.

If the E.U. tax is well-received, it could set the standard for similar border adjustments. If not, it could inflame global tensions over international commerce.

About EU’s carbon border tax

• Under the new scheme, European Union (EU) from 2026 onwards shall impose a border taxes on imports of carbon-intensive goods such as steel, aluminum, cement, fertilizers and electricity via carbon border adjustment mechanism (CBAM).
• The aim is to help slash the EU’s overall greenhouse gas emissions 55% below 1990 levels by 2030.
• The tax plan, yet to be legally formalized, will come into force from 2026.

Rationale behind the tax

• To ‘incentivize’ greener manufacturing around the world and to protect European industries from outside competitors who can manufacture products at a lower cost as they are not charged for their carbon emission during the manufacturing processes. So, the carbon border tax is an indirect attempt to force emerging economies, including India, to adopt cleaner (non-fossil fuel-based) practices to manufacture goods.
• Preventing carbon leakage: The 27 EU member states have much stricter laws to control GHG emissions. It has an ‘Emissions Trading System‘ that limits how much GHG individual industrial units can emit; those that fail to cap their emissions can buy ‘allowances’ from those who have made deeper cuts. This makes operating within the EU expensive for certain businesses, which, the EU authorities fear, might prefer to relocate to countries that have more relaxed or no emission limits. This is known as ‘carbon leakage’ and it increases the total emissions in the world.

How the carbon border tax will work?

Right now, under the Emission Trading System, large polluters must procure permits for every ton of carbon dioxide they emit. The number of permits changes over time, driving up the price. Currently, the price of those permits is nearly $60 per ton, giving European companies a financial incentive to cut emissions.

• The E.U. is now proposing to tighten that cap further, while phasing out the number of free allowances it has long given to industries exposed to trade competition, like steel.
• Companies abroad that want to sell cement, iron, steel, aluminum, fertilizer or electricity to the E.U. would also be required to pay that price for each ton of carbon dioxide they emit in making their products. The idea is to level the carbon playing field.
• The border tax would not take effect until 2026.

Countries that might be impacted

The countries that would potentially be most affected include Russia, Turkey, China, Britain, and Ukraine, which collectively export large amounts of fertilizer, iron, steel, and aluminum to the European Union. The United States sells significantly less steel and aluminum to Europe, but could also see an impact.

Why is India opposing it?

As per data from the commerce ministry, India’s third-largest trading partner, the EU accounts for 11.1% of India’s total global trade.

• Impact on exports: With 14% of India’s exports going to EU countries, the CBAM could put Indian exporters in a spot. Almost 25% of the EU’s iron and steel imports currently come from countries that will take a CBAM hit, a figure that could drop should EU demand shift in favour of suppliers within the bloc, in turn hampering trade ties with India. Exports of iron and steel and aluminium products from India to the EU were around $4 billion and $500 million, respectively, in 2020-21.
• The additional cost of CBAM certificates for goods imported by the EU may distort prices of the goods in downstream industries, affecting the competitiveness of sectors like automobiles, electrical goods, machinery and equipment.
• Challenges for companies with large GHG footprint: The tax would create serious near-term challenges for companies with a large greenhouse gas footprint–and a new source of disruption to a global trading system already impacted by tariff wars, renegotiated treaties, and rising protectionism.
  • A levy of $30 per metric ton of CO₂ emissions could reduce the profit for foreign producers by about 20% if the price for crude oil remained at $30-40 per barrel.

Issues/concerns/challenges

• Fundamental change in how companies all over the world manufacture products can’t be forced by tariffs.
• Protectionist measure: The carbon tax may end up being protectionist, and will hit emerging economies like India hard.
• Retaliatory tariffs: Countries such as the United States, China and Russia have all objected to the border carbon tax, raising the prospect of retaliatory tariffs and trade wars.
• Bypassing CBDR principle: The EU is essentially bypassing the principle of ‘Common But Differentiated Responsibilities’ and Respective capabilities (CBDR – RC) that should guide international climate action.
• A carbon border tax will be hugely disruptive for global trade, already suffering due to Covid and rising protectionist practices.
• Challenges in emission assessment: It is currently unclear how the EU would assess emissions of an imported product. Would it be from the entire value chain, upstream and downstream?. There are many small businesses that will face difficulty in quantifying their emissions and additional costs will be passed on to the consumers, eventually.
• Challenges at WTO: Countries may also try to challenge to the border adjustment at the World Trade Organization, although European officials say they are working to ensure the rules will withstand to legal objections.

Suggestions/Measures

• Need to be complemented with newer tech and finance: A mechanism to charge imported goods at borders may spur the adoption of cleaner technologies. But if it happens without adequate assistance for newer technologies and finance, it would amount to levying taxes on developing countries.
• Fixed duty or tax on imports: To counter problems faced in emission assessment, a fixed duty or tax on imports can be imposed. The design of such a levy also matters. If it discourages sectors and industries that are already adopting cleaner technologies and becomes another procedural and compliance hassle, it could prove counterproductive.

India

• The, higher input-cost pressure may tempt downstream sectors to relocate outside the European Union. This would create magnificent opportunities for India’s growth-seeking industrial sector, backed by policy support for a business environment that lets industries flourish.
• The carbon-emission intensity of Indian steel plants is currently in the range of 2.3-2.8 tonnes for every tonne of crude steel produced, higher than the world average of just 1.8 tonnes (as per the World Steel Organization). Although about half of India’s iron and steel production is done via electric method, which emits less carbon than the traditional oxygen furnace, emissions embedded in the use of coal for energy is still a concern. A more fail-safe approach for the world’s second-largest steel producing nation would be to become carbon competitive in the medium to long run, by moving aggressively towards sustainable production. A trade deal with the EU that takes into consideration the principle of “common but differentiated responsibilities” under the Paris pact may open some space for a combined but fair contribution to the cause of carbon reduction. A trade deal is imminent and will buy time for India to bring down emissions to desired levels.

Conclusion

Rich countries of the global north bear historical responsibility for greenhouse gas emissions but a report by Oxfam says that rich nations have only mobilized $22.5 billion of the targeted $100 billion for climate funding. Hence, instead of imposing a carbon border tax, richer countries should fulfill their promises of technological and financial assistance to enable developing countries to make the transition to low-carbon pathways for growth.

Source: TOI, Economic Times, Business Standard