Making an EU Carbon Border Tax easier with a Carbon Club

My six tips for a European Carbon Border Tax.

The President of the new European Commission Ursula von der Leyen has asked Commissioner for Trade Phil Hogan to levy a CO2 tax on imports to the EU: “to contribute to the design and introduction of the Carbon Border Tax, working closely with the Commissioner for the Economy. … Fully compliant with WTO rules ”. This helps maintaining a level playing field while tightening the CO2 targets and to promote sustainable development with trade. Von der Leyen wants to have such a tax as part of the New Green Deal for Europe within 100 days. She wants to start with a few sectors, for example steel, aluminium and cement. Such a so-called trade barrier is, in principle, possible, given trade rules and the best chance is to make a tax with a larger group of countries – a Carbon Club – and connect the tax system closely to the ETS. This is because of the level of the levy and because of the possible link with ETS and CO2 market in other countries.

Serious option: carbon border tax

France has been advocating such a border levy for 10 years. France planned a CO2 tax itself, but has dropped it. And it was not needed for international competition. Hence, the European industry, which would be vulnerable to ‘carbon leakage’ if it had higher CO2 costs than the competition, gets about 85% of the emission allowances free of charge through a CO2 benchmarking system. Germany previously was opposed to a carbon tax to prevent a trade war with the U.S. But now that Trump has again announced to step out of the Paris Agreement and France in September convinced Germany to investigate an EU carbon border tax. This makes it a serious option.

Setting border tax adjustments not easy

The EU will be the first to impose trade barriers for climate policy and it is not simple. The WTO leaves room for carbon border tax adjustments, as it can be argued that parties to the Paris Accord, according to the World Bank and IMF, must in fact introduce an effective carbon pricing system in order to meet the CO2 obligations. The EU can point to Article XX of the General Agreement on Tariffs and Trade (GATT): a trade barrier, which is a border tax adjustment, is allowed if ‘necessary to protect human, animal or plant life or health’, or relation to the exhaustion of natural resources’. It should not result in arbitrary or unjustifiable discrimination between countries. This is also not the case, because if exporting countries demonstrate they lower CO2 emissions for production and companies have CO2 costs, they should not be subject to an import levy . For example, in the EU-Mercosur deal, using a carbon border tax can make a country like Brazil adhere to the Paris Agreement and reduce more carbon emissions due to deforestation; now the EU cannot enforce that. Trade partners can, of course, impose levies back. But in any case, climate investments in the EU can be secured.

Six principles for a carbon border tax with the ETS as basis for Carbon Border Tax

A carbon border tax would be easiest to set if the EU had a CO2 tax. But because taxation is member states’ sovereignty and there is already an ETS carbon pricing, the border tax must at least build on the ETS; for the level of the levy and to make use of a possible link with ETS and CO2 markets in other countries. In the preparation of a carbon border tax, in my opinion, the following 6 principles should also apply.

  1. No carbon border tax application for trading partners with its own ETS or CO2 tax, such as Canada, South Korea, New Zealand and Mexico. A list of these can simply be drawn up. The question then is what one does with imports from California, because that has a similar ETS system, which means for the producer CO2 costs. Such a list of countries is a good step for setting up a “Carbon Club“, a concept developed by Environmental Defense Fund. I am thinking of a ‘GATT’-like trade agreement, where products can be traded among themselves, without CO2 tax and in which countries. And in such a club, companies are allowed to use each other’s emission rights or credits to meet CO2 requirements. The club can then applya joint carbon border tax on imports from third countries. A carbon club of countries with carbon pricing systems is also good alternative if the Climate Summit in December in Madrid fails to reach common rules on international CO2 trading.
  2. Determining the basis of the levy is not yet easy. The EU must request a carbon label for each product (x grams of CO2 per washing machine). The question remains to what extent the LCA and indirect emissions should be taken into account, where the EU ETS itself does not. The tax can also be levied on the ‘avoidable’ emissions just like the upcoming Dutch tax designed for the industry, additional to ETS. That may be fair, but it does not yet provide a level playing field for the EU’s CO2 costs compared to the competition.
  3. Here, the question arises as to whether, when introducing a carbon border tax, the EU should stop allocating free allowances at all and go for 100 percent auction. In doing so, it is assumed that the border tax already guarantees level playing field. The European Commission will need to investigate how quickly the percentage of allowances to be auctioned can be increased for industry and whether costs can be passed through. The industry will applaud a carbon border tax but against 100% auction. Auction is also not necessary for achieving the CO2 targets, with a decreasing budget, but in the long term there will also be no room for a CO2 budget.
  4. For the level of the tax the best is to start low, say 5 euros per tonne to help acceptance and to star having at least a a price signal. A high levy of say 26 euros, like the current EU ETS price is of course more stimulating to reduce the CO2 emissions of the exporter. IF the EU will apply a 100% auction, than the border tax should be at least equal to the auction price.
  5. The revenues of the tax should be spent smart. Green political parties suggested that the European Commission should use the revenue to purchase EU allowances. This is not wise, as this leads to a higher CO2 price for the own industry than is necessary to achieve the CO2 target. And it frustrates the operation of the Market Stability Reserve, which could then bring extra permits to the market. The European Commission would like to use the revenues to compensate for loss after the Brexit, where the EU will miss U.K. ETS auction proceeds. I would rather like to divide the revenue destination as follows,
    1. partly to the companies that export goods, with higher CO2 costs than in the country of destination,
    2. partly to innovation funds
    3. partly to the country of importation.
  6. Countries exporting goods to the EU do not have to pay the carbon border tax if they surrender commensurate allowances or carbon credits in line with the carbon label. The EU can use these credits to help achieve sharper CO2 targets, as en the same CO2 reductions are achieved as if production had taken place in the EU. And the exporter then incurs comparable CO2 costs at the border.

In such a way, an EU carbon border tax, in relation to a carbon club of countries with effective carbon pricing, is more feasible to apply a carbon border tax in line with the the WTO. And it also promotes raising the EU’s climate ambitions, making carbon pricing more effective and increasing its international impact.

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