Carbon price with border adjustment could be key tool for climate goals

By Steve Valk

Heading into the COP26 climate conference in Glasgow, Scotland, the United Nations released a report with some disturbing news: current pledges from the nations of the world to reduce greenhouse gas emissions will result in an increase in global temperatures of 2.7 degrees Celsius by the end of the century. 

This far exceeds the 1.5 C threshold that scientists say we must not pass in order to avoid catastrophic consequences. In fact, global temperatures are now 1.2 C higher than pre-industrial levels, and the impact is already being felt. 

So, how do we close the gap between what nations have pledged to do about climate change and what more is needed? 

The answer may lie with a policy known as carbon border adjustment mechanisms (CBAMs). In order to protect manufacturers in their own countries and prevent “carbon leakage” to other nations, countries that have implemented a price on carbon assess a fee on carbon-intensive goods imported from countries that lack a carbon price, thereby leveling the playing field. The European Union, which currently has a carbon price of more than 50 euros, has announced plans to implement a CBAM. Great Britain and Canada are also expected to impose a border adjustment.

At a side event on carbon pricing at the COP26 climate conference in Glasgow, European Commission President Ursula von der Leyen said, “If you come with dirty products on our market, you have to pay a price as if you were in the Emissions Trading System of the European Union. But we prefer you keep the money in your economy by putting a price on carbon in your economy.”

Economic powerhouses like Europe, the UK and Canada do a substantial amount of trade with nearly every nation in the world. By implementing a CBAM, they can exert leverage on other nations to initiate or increase a price on carbon in their own countries. (Imagine if the U.S. joined this club!) After all, why would a country let their businesses put money into European coffers when they could fatten their own treasuries? The prospect of an EU CBAM already has Russia considering a carbon tax.

To dig a bit deeper into this topic, I talked to Shuting Pomerleau, a climate policy analyst at the Niskanen Center who specializes in carbon taxes. The following is an edited version of our conversation.

 

Steve: Russia recently announced it was considering a carbon tax in response to the EU carbon border adjustment mechanism. Can you envision other nations doing this? Which nations have a high volume of trade with Europe and might respond to Europe’s CBAM by implementing a carbon tax?

Shuting: I definitely think that other nations, if not right now, maybe in the near term or long term, will follow suit and similarly consider a carbon tax or other climate policies in response to the carbon border adjustment. Now what nations, I haven’t really looked at the trade data in detail, but China and India are probably on top of the list of high volume of trade with Europe in carbon-intensive goods. I think if a carbon border adjustment is designed well, it’s a really powerful and useful mechanism to incentivize foreign producers to decarbonize. 

Shuting: I think this is a topic that will definitely be mentioned during COP 26. Maybe countries would potentially voice their opposition to such a mechanism or their concerns, especially the developing countries.

Steve: Developing countries, historically, have not contributed to the accumulation of CO2 in the atmosphere that the developed countries have. Do you think these countries will be given a discount or a pass on carbon border adjustments? If so, what kind of leverage would there be for them to do better?

Shuting: I think the EU officials recognize the need to give differential treatment for developed and developing countries due to the reason that you just mentioned. Maybe exempting the least developed countries or giving them some kind of credit. From a policy design perspective, I’m not entirely sure how practical it would be. Such a design element may have unintended consequences. If you were to partially or fully exempt a certain number of countries from a border adjustment, there’s a huge risk for circumvention through trans-shipping. Other countries that are covered in the border adjustment would want to ship their goods through those exempted countries. I think we should apply the border adjustment equally on all trading partners, including developing countries, and then provide more assistance and funding for developing countries.

Steve: Despite the pushback from a number of countries, the EU appears to be standing firm on the imposition of a carbon border adjustment. Do you think the WTO will back the EU on this policy?

Shuting: I think that [the EU] recognizes the importance of making their policy as compliant to the WTO rules as possible. They are planning to put in place a reporting system by 2023. Not starting implementation, just collecting data. They won’t do anything to collect the import tax until 2026. I think they’re working closely with the WTO to make the provisions and implementation compliant. They want to make sure exporters selling to the EU don’t double pay. If they’ve already paid for a carbon price in their home country, then they will get that amount of deduction or credit, but only for an explicit price, not regulations, tax credits, subsidies or standards. But giving credits to trading partners might risk violating the WTO rules.

 

As this conversation makes clear, the U.S. would be smart to put our own carbon price and carbon border adjustment in place. CCL’s own research department recently explored how this move would boost sales and increase employment in relevant industries.

Read the full interview with Shuting about carbon border adjustment mechanisms here. 

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