Carbon border measures

Sandra Parthie, Head of Brussels Office at IW Köln, Institut der deutschen Wirtschaft

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There seems to be renewed political appetite for a carbon border tax, judging from the political guidelines by EU Commission president-elect Ursula von der Leyen. The idea is certainly not a new one and it did some rounds already under various names – as a tax, an adjustment, a fee or some generic measure. But so far, it remained elusive. While the concept has its merits, the details, as well as the question of implementation, are hard to work out and solve. But the political momentum has certainly increased and might eventually help to propel this instrument forward as a crucial one in the fight against climate change.

The general idea is to levy a fee or higher tariffs on the carbon content of materials and goods imported into the EU from countries that do not meet the EU’s environmental standards. Thereby, the Commission hopes to achieve its new goal of reducing net greenhouse gas emissions to zero by 2050, to eliminate carbon leakage and to protect domestic businesses from lower-cost and less-climate friendly, competitors abroad.

All are very commendable, and in the face of climate change, very essential goals, to which it is hard to disagree. How to get there, and in particular whether the proposed carbon border tax is the best instrument to achieve it, however, is rather controversial. As a tax, it will face the issue of unanimity among the EU member states, which is notoriously hard to achieve.

Thus, it might be off to an easier start if the measure takes the form of a tariff. Given the EU economic heft, using trade policy tools for its climate targets is not such a bad idea. It hinges of course on the WTO compatibility. The WTO’s “National Treatment Principle” prohibits, in short, the discrimination of imports over domestic products. But as always, there are exceptions to the rules. They could apply if the carbon border measure is introduced on the grounds of environmental protection and is equivalent to measures imposed on domestic products. So, the EU would need to demonstrate that the carbon border measure is in line with its domestic climate protection measures, e.g. the ETS and effort-sharing requirements. It has done something similar already with regard to biofuels (incl. those made from palm oil) by setting sustainability criteria for fuels made inside the EU and imported by it.

But there are some aspects to keep in mind when going down the tariff route: First, any carbon border measure is – no matter its name or shape – at the end of the day a protectionist measure. Given the current state of international trade affairs, adding European carbon border measures to the mix carries the political risk of impacting it negatively. An intuitive response to this might be that a reduction in global trade would rather be a good thing for climate protection efforts. But be aware – research shows that depending on the production conditions it might be less Co2 intensive to trade a certain good as opposed to producing it in an energy-intensive way locally, as is e.g. the case for greenhouse-grown tomatoes in the UK versus sourcing and transporting the fresh vegetable from Spain.

The technical-sounding question of how to count or account for the carbon content of a product is therefore very crucial and might yield some counter-intuitive results. While it is easier to do the accounting for some products, e.g. biofuel or steel, it becomes hugely complicated for chemical products, especially when including the value chain. There, one needs to look into production factors such as whether renewable energy is used, whether the production process is energy-efficient, etc..

A feasible solution would therefore be indeed making use of international trade agreements and include requirements for low-carbon standards of traded products. But given the difficulty in correctly accounting for Co₂ a potential carbon border fee should only be applied to selected sectors, at least at first.