Jul 09, 2021 Trade

The charm of setting carbon prices at the border

Trying to reduce CO2 emissions by itself might prove difficult for the EU, not least as it could undermine its competitiveness. A carbon border tax could help.

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On July 14, 2021, the European Commission will publish the "Fit for 55" package of legislative proposals to help reduce emissions 55% below 1990 levels by 2030.[1] Seeking to accomplish this requires herculean efforts across many industries and has the potential to put European companies at risk from losing competitiveness to companies from countries that are less ambitious. One favorite "climate-tool" from the EU is to tax CO2 emissions. Thus, an obvious way to solve the competitiveness problem is by introducing a carbon border tax.[2] Such a tax will be proposed by the EU for certain industries and would require steel, iron, cement, fertilizer, aluminum and electricity importers to buy carbon allowances from 2023.

One favorite "climate-tool" from the EU is to tax CO2 emissions.

As our Chart of the Week shows, it makes a substantial difference for some countries whether you look at how much CO2 they produce and how much CO2 they consume. Or in other words: how much CO2 emissions they export and import. The chart shows that the United States, being a service-oriented country, must import many of the goods it consumes, and as such it is importing significantly more CO2 than it exports. The same, albeit to a smaller degree, is true for Europe and Japan. On the other side of the equation is China and Russia, exporting goods and natural resources respectively. Applying a consumption-based approach would cause developed countries' emissions to be 13% higher.[3]

Burdening domestic companies with a CO2 tax while leaving imports untouched would inevitably lead to so-called carbon leakage. That means encouraging energy intensive companies to shift production to countries with less stringent carbon policies, which would undermine any efforts to reduce carbon emissions on a global basis.

That is why we believe taking a holistic approach when it comes to CO2 is so important. A carbon border tax would both help to create a level playing field for companies as well as encourage consumers to opt for less CO2 intensive products. It might also reduce the volume of goods that are only shipped around the world as a result of exploiting different environmental standards. But as well-intended as such a tax might be, it will create winners and losers. Hints on countries' views can be seen in the chart's estimates of emissions embodied in trade. U.S. special climate envoy John Kerry urged delay in introducing a carbon border tax as the idea should be a "last resort" due to its "serious implications for economies, relationships and trade".[4] An Asian survey concluded that the proposal is protectionist.[5]

So, a carbon border tax is set to face opposition and its implementation is likely to be complex. It will cause some disruption in established global production chains and trade. Then again, who said that fighting climate change would be an easy task? At least more people have begun to recognize by now that it is worth the effort. 

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