Navigating the carbon-tax era in trade

Source– The post is based on the article “Navigating the carbon-tax era in trade” published in Business standard on 5th July 2023.

Syllabus: GS3-Environment

Relevance: Climate change related policy

News- The process for the EU’s Border Carbon Adjustment Tax (Border-CAT) is set to start this year and will kick in from January 2026, initially covering steel, aluminum, cement, fertilizers, hydrogen, and electricity.

This tax could cause trade disruptions, as developed countries, accounting for 65% of global trade, may charge a carbon tax of 20-35% over import duties.

What are the impacts of the EU’s Border Carbon Adjustment Tax?

Firstly, World Trade Organization (WTO) commitments on tariffs will become meaningless for countries charging a carbon tax. Free trade agreements (FTAs) with developed countries, which are charging carbon tax, will become one-sided.

Secondly, the EU’s exports may become expensive. While China may become the lowest-cost supplier of clean energy-compliant products. It will do so through a combination of hydroelectric and green hydrogen-led production of steel, aluminium, cars, and other industrial products.

Thirdly, the world will be divided into countries charging carbon tax and the rest of the world (RoW).

Fourthly, it may reduce the EU’s exports to RoW markets, where cheaper products will be available from countries that do not charge a carbon tax.

Finally, the tax will not stop dirty imports; it will just tax them. So, the carbon tax will have an insignificant impact on the reduction of global emissions.

What should be the actions taken by Indian government and industry?

Set up a carbon trading mechanism and re-designate customs, excise duty, and cesses charged on petroleum, coal and other items as carbon tax. This will reduce the amount of tax to be paid to the EU.

The government must devise a WTO compatible carbon tax retaliation mechanism. It should sign new FTAs with developed countries after resolving the carbon tax issues.

The government may consider a new PLI for low carbon trial projects and must create a cadre of energy auditors to help firms with emissions data, ensuring their accreditation by the EU system.

Each firm must know its unit’s current state of baseline emissions and calculate the monetary impact associated with them.

They should set internal targets to decarbonize and evaluate the costs of adopting renewables.

Large firms may consider setting up two production lines — one for carbon tax markets, and the other for the RoW and develop strategies to enhance their competitiveness in the new trade regime.