On December 13, 2022, the European Union (EU) announced that it had finalized plans to institute the world’s first carbon border adjustment mechanism (CBAM). This announcement comes after years of debate in the EU member states on how to transition their carbon pricing system to a CBAM, which also led to a CBAM debate in the U.S. Congress.

Last session, members of Congress put forward several proposals to create a CBAM for the United States. Legislation ranged from a simple tariff on carbon-intensive products to establishing a carbon price and a CBAM. It is very likely that Europe’s new CBAM will reignite a debate over whether the United States should create its own CBAM.

As new legislation is developed and evaluated, it is essential that these proposals are compliant with the United States’ international trade commitments, namely rules under the World Trade Organization (WTO). The specifics of how or if a carbon price is set, how taxing carbon emissions is carried out, and how issues such as carbon leakage are addressed can run afoul of WTO commitments. If Congress fails to consider WTO commitments, the United States could be subject to retaliation from trading partners.

What Is a Carbon Border Adjustment Mechanism?

A key component of policymakers’ efforts to mitigate climate change has been centered on reducing carbon emissions. It is estimated that “one-fifth of the world’s carbon emissions come from the manufacturing and production sectors.” Policymakers ostensibly see cutting carbon emissions in manufacturing sectors as an essential aspect of their carbon emission reduction objective. The Biden Administration has a goal of “50-52 percent reduction from 2005 levels in economy-wide net greenhouse gas pollution in 2030” and the EU’s goal is to “reduce greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels.”

Increasingly, policymakers have sought to use trade policy to decrease carbon emissions, especially in developing countries with fewer environmental regulations than developed countries. A carbon border adjustment mechanism is one of the most prevalent examples of those efforts. A CBAM taxes carbon-intensive goods produced domestically or abroad based on an established carbon price, which is determined by the government. The border adjustment aspect of this is that the tax is based on domestic consumption of the carbon-intensive good, so products that are exported are given a rebate of the tax. A CBAM includes the rebate for exports to disincentivize moving carbon-intensive production overseas, known as carbon leakage.

Proponents of a CBAM claim that assigning a cost to carbon emissions would ensure that both domestically produced goods and imports are subject to that cost, and that this would prevent carbon leakage. The ultimate goal of a CBAM is to decrease carbon emissions by creating a cost to those emissions and hopefully incentivizing innovation to create cleaner ways to produce the goods. The U.S. Chamber of Commerce, a skeptic of a CBAM in the United States, contested these claims:

“[W]hile tariffs on steel, aluminum and other industrial imports may prevent leakage and protect U.S. industry from economic disadvantages, the competitiveness of many clean energy industries is dependent on affordable steel and aluminum and fabricated products…raising the costs of such goods could negatively impact deployment of clean energy technologies such as electric vehicles or renewables.”

The EU will implement the first CBAM in October 2023, when importers of iron and steel, aluminum, cement, fertilizer, electricity, and hydrogen will be required to report their carbon emissions to the EU. Starting in 2026, importers will need to purchase CBAM certificates, the price of which will be determined by the Emissions Trading System (ETS). The EU’s approach is not a traditional border adjustment, however, because it does not include rebates for exporters.

Congressional CBAM Proposals

During the 117th Congress, several pieces of legislation were introduced to use trade policy to impact carbon emissions. Some proposals sought to impose a tariff on carbon-intensive goods, while others would have set a carbon price and established a CBAM for the United States. The last Congress did not approve any legislation on this specific issue, but it is likely that some proposals will be reintroduced in the 118th Congress.

In July 2021, Senator Chris Coons (D-DE) introduced the Fair, Affordable, Innovative, and Resilient (FAIR) Transition and Competition Act. A companion bill was also introduced in the House of Representatives. The FAIR Transition and Competition Act would have instructed the Treasury Department to determine the “domestic environmental costs incurred” by domestic businesses producing a variety of products including aluminum, cement, iron, steel, oil, and natural gas, or the cost of the environmental regulatory burden in the United States. Treasury would have also been tasked with the “production greenhouse gas emissions” for the covered products and use the two numbers to calculate the border carbon adjustment fee for imports of that product.

The Clean Competition Act, introduced Senator Sheldon Whitehouse (D-NH) in June 2022, would have set a carbon tax of $55 per ton starting in 2024 on industries in the Environmental Protection Agency’s Greenhouse Gas Reporting Program. Covered companies would have to pay for their emissions that exceed their industry’s average. Most importers would pay the tax according to how their home country’s industry emissions compare to the domestic industry. Domestic companies covered by this law would receive a rebate for the carbon tax for exported products. Senator Whitehouse said his proposal would “give American companies a step up in the global marketplace while lowering carbon emissions at home and abroad and steering the planet toward climate safety.”

CBAM and WTO Compliance

The EU’s impending CBAM is likely to inspire similar legislation in Congress this session. When considering any new mechanism that would impact trade, it is essential that policymakers do not neglect the United States’ commitments under the WTO. International trade law and WTO experts such as Joel Trachtman of Tufts University and Jennifer Hillman of the Council on Foreign Relations have examined at length the areas where a CBAM might trigger a WTO violation, but the general conclusion is that CBAMs are uncharted territory.

The WTO agreements that a CBAM could violate are clearer, however. The WTO agreement most important for the structure of a tax on carbon-intensive products is the General Agreement on Tariffs and Trade (GATT), which details the core tenets of the WTO, such as the most-favored nation (MFN) and non-discrimination principles. Commitments under the Agreement on Subsidies and Countervailing Measures (SCM) are also important when it comes to making a measure border-adjusting by issuing rebates for exports. CBAMs have not been tested by a WTO dispute settlement panel, so it is difficult to know exactly how a panel would rule on questions under these agreements.

Uncertainty about the permissibility of CBAMs should give U.S. policymakers considering such a policy pause, because neglecting WTO rules could leave the United States open to retaliation by its trading partners. In recent years, U.S. trade policy and legislation, most recently with the Inflation Reduction Act (IRA), has disregarded WTO rules. The Biden Administration is currently engaged in yet another trade dispute with allies over its neglect of WTO rules in implementing the IRA. While debate among scholars remains, there do seem to be three principles to follow to have a “reduced risk of violating WTO law” when considering a CBAM: (1) the carbon tax must apply to domestic goods and imports; (2) imports from all WTO members must be treated the same; and (3) rebates for exports cannot exceed the carbon tax.

Application to Domestic Goods and Imports

There are several provisions in the GATT that matter for a CBAM – or indeed any kind of tax on carbon. Article II of the GATT states that imports from WTO members must be “exempt from ordinary customs duties” and “exempt from all other duties or charges of any kind imposed on or in connection with the importation” in excess of the MFN tariff rate. Article III of the GATT states that imports “shall not be subject, directly or indirectly, to internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to like domestic products.” In short, if a CBAM is applied as a condition of importation and causes the tariff rate to go above the MFN rate, it could violate Article II. If, however, the tax is applied after importation due to “an internal factor,” it must apply to imports and domestic goods equally, otherwise it could violate Article III.

In the case of the European Union’s CBAM, that its ETS and the carbon tariff are tied to the average ETS price could represent equal application of the measure on imports and domestic goods. The EU, however, offers free allowances to some of the covered products domestically, and while those will be phased out over time, their existence could potentially constitute a GATT violation.

Treat Imports from all Members the Same

Article I of the GATT details the parameters for most-favored nation treatment. At its core, this principle means that a WTO member must give the same “advantage, favor, privilege, or immunity” to all WTO members. In the context of a CBAM, an MFN principle violation could be triggered if the carbon tax set is contingent on the policies of other countries. Trachtman explains the example of steel in the context of a CBAM:

“[A]ll steel of a certain type would be treated as like products and required to be treated the same, regardless of its origin. If an import BTA were structured simply to apply to that type of steel, regardless of its origin, there would be no violation of Article I. If, on the other hand, steel from different origins were treated differently based on (i) the amount of carbon used in production or (ii) the carbon tax or carbon limit regime of its origin country, countries whose steel is treated worse might claim a violation of Article I MFN.”

The EU’s CBAM could run afoul of these commitments because it gives special treatment to countries that already have a carbon price. This is estimated to benefit South Korea and Singapore by allowing them to lessen their price when sending products to the EU. It is also likely that some countries, such as Switzerland, Norway, Iceland, and Liechtenstein, could be fully exempt from the CBAM because they all have an ETS that is tied to the EU’s.

Rebates Cannot Exceed the Carbon Tax

Export subsidies are generally prohibited under SCM because they create an unfair price advantage for exports by reducing costs for the domestic producer. Advocates of CBAMs claim that “without such an exemption, if few countries impose their own carbon taxes or carbon reduction schemes, then U.S. exporters would be at a competitive disadvantage.” This is the crux of the debate over carbon leakage, so proponents see rebates for exports as an essential component of a tax on carbon-intensive goods. Moreover, in order for such a tax to be truly considered a border adjustment, it must include a rebate. Under the SCM, any rebates for exports to compensate for carbon leakage cannot exceed the cost of the CBAM, otherwise the rebate could be considered an export subsidy.

An export rebate was not included in the European Union CBAM, though it was discussed as an alternative to the free allowances that are offered to some industries under the ETS. European businesses that currently receive free allowances asked the government to include an export rebate in the CBAM, but it was left out. According to the Peterson Institute for International Economics, “export rebates are a key point of friction between Parliament and the Commission, as they are not accepted by the Commission and were omitted from its proposal due to concerns about WTO compatibility.”

Conclusion

The EU’s new CBAM is likely to reignite debate in Congress over whether to create a similar mechanism in the United States. Europe’s CBAM could run afoul of WTO rules in several areas, which should give pause to U.S. policymakers. Compliance with WTO commitments should be a top priority when considering any new tariff or tax, Therefore, any proposal for a U.S. CBAM should be met with increased scrutiny, particularly considering that such measures are untested at the WTO.

Tori K. Smith is a Director of International Economic Policy at the American Action Forum.

To read the full article, please click here.

The post U.S. Carbon Border Adjustment Proposals and World Trade Organization Compliance appeared first on WITA.

The urgency of these measures has never been more clear. As a new report released by the U.N. last week demonstrates, governments’ existing plans to curb carbon emissions are insufficient to meet the Paris Climate Agreement’s goal of limiting the rise in global temperatures to 1.5 degrees C above pre-industrial levels by 2100. Instead, current climate mitigation measures put the world on track to cap global temperature rise at closer to 2.7 degrees by the end of the century—potentially enough to avoid the most calamitous effects of climate change but still well above the goals established by the Paris Agreement. These outcomes, though, are far from set in stone, and the U.N. concluded that countries can still limit warming by another half a degree, to 2.2. degrees C if they adopt and implement new net-zero emissions policies in the coming years.

The question then becomes this: What policy tools are available to the U.S. to incentivize other countries to move towards these net-zero outcomes?  There are a broad range of tools, but it is increasingly clear that trade policy and other border policies will play an outsized role. Trade policy can both incentivize good behavior and penalize bad behavior, in many cases leading to swifter outcomes than those achieved through purely voluntary commitments. In the climate context, we will see many ambitious commitments unveiled this week in Glasgow—but emissions know no borders, and until all countries are aligned on the urgency of the problem and have agreed to share the responsibility of reaching net-zero emissions, trade policy will likely remain a critical tool.

Using a system of carrots and sticks, the United States can leverage its climate leadership to develop an alliance of environmentally like-minded countries who enjoy preferential terms of trade and pursue deepened cooperation, including in how they work together to help developing countries meet their own climate commitments.  We have seen the first evidence of this approach just this week with the U.S. – EU announcement to negotiate a sectoral arrangement for steel and aluminum that will for the first time address carbon intensity as part of a trade initiative. And for those countries playing the short game, trade policy offers several templates to introduce carbon border adjustment mechanisms—or CBAMs—a class of trade measure designed to support climate mitigation policies by addressing carbon leakage (i.e. the migration of carbon-intensive production from areas with stricter emissions standards to those with weaker standards).

To CBAM or not to CBAM?

Although CBAMs are not on the formal agenda in Glasgow, several countries are considering implementing them, including the EU, Japan, and Canada. The idea of the U.S. implementing a CBAM has also been gaining traction among some trade experts and policymakers in Washington. The reason for CBAMs is clear: compliance with stricter emissions standards and deeper investments in environmental technologies leads to far more favorable environmental outcomes, but they come at a cost. A CBAM can help level the playing field so that producers in countries with a carbon advantage are not placed at a competitive disadvantage.  Yet a patchwork of uncoordinated CBAMs—including measures that are directed at like-minded allies—has the potential to be counterproductive by creating incentives for carbon arbitrage and reigniting a race to produce in the cheapest carbon markets. The United States has an opportunity to steer the global path forward on CBAMs, but it must do so both expeditiously and thoughtfully, taking into consideration the following critical questions for a U.S. CBAM framework.

1. How should the U.S. measure carbon content?

Before adopting a carbon border adjustment mechanism, regulators in the U.S. will have to decide how to measure the total carbon content of manufactured products. There are two major schools of thought when it comes to calculating carbon content: point-of-production analyses and life-cycle analyses. As the name suggests, point-of-production analyses account for the amount of carbon emissions produced at the site of production, including direct energy inputs. Life cycle analyses, by contrast, are additive and account for the total carbon footprint of a product across the entire value chain, including the emissions produced by the energy that was needed to produce and distribute the components and final goods in question.

Of course, a life-cycle analysis is more comprehensive than a point-of-production analysis, but there are still several question marks about how a life cycle analysis would work in practice. For instance, life cycle analysis methodologies vary greatly between and within international jurisdictions and can prejudice geographically equitable accounting of carbon output/savings. The starting point and scope of inputs included also vary by methodology, making an ‘apples-to-apples’ comparison of carbon output between countries impractical.

2. Which type of carbon emissions does the U.S. want to offset with a CBAM?

Carbon border mechanisms can address carbon leakage in one of two ways: either by applying a price or tax on either positive carbon output (i.e. the amount of carbon that that is “saved” through mitigation techniques and compliance compared to an unmitigated circumstance) or by applying a price to negative carbon output (i.e. the amount of carbon emitted in excess of what is mitigated).

These strategies, however, are not mutually exclusive, and the most equitable and comprehensive approaches use a combination of the two. An example of both positive and negative carbon adjustment would be a carbon price applied to the full unmitigated value of emissions in order to address domestic industry concerns about the imbalance between relative compliance costs or a combination of compliance costs adjustment (for negative values) and a carbon price/tax (for positive values).

3. How does the U.S. avoid facilitating adverse arbitrage between the cost-of-compliance and the price for carbon?

Complying with new or existing environmental regulations creates significant costs for manufacturers in highly-regulated markets like the U.S., placing those manufacturers at a competitive disadvantage relative to their competitors in less stringent regulatory environments. CBAMs may be designed to remedy this imbalance by pairing the cost-of-compliance (i.e. the price of complying with mitigation regulations) with the price of unmitigated carbon to create a more even playing field.

But regulators have to walk a careful tightrope in determining these costs. Pricing the cost-of-compliance provides the benefits of harvesting the U.S. carbon advantage, leveling the playing field to what U.S. firms already invest in environmental compliance. Moreover, setting a base price on the cost-of-compliance is both technically feasible and straightforward because values can be objectively determined from the capital and operational costs of relevant process technologies. However, if cost-of-compliance is imposed in conjunction with a price for carbon that is too low—and without appropriate regulatory guardrails—it could undermine regulatory effectiveness over time with pollutants other than greenhouse gas emissions and encourage off-shoring by incentivizing manufacturers to pay for the price of carbon rather than comply with regulation, resulting in adverse environmental/carbon arbitrage.

4. Which instrument(s) should the U.S. use to implement border adjustments?

In order to implement a border carbon adjustment, the U.S. can draw from a variety of new or existing border instruments, either independently or in conjunction—including a commoditized carbon price, tax/fee, specific tariff, a value-added tax (VAT), and import licensing fees, and/or various trade remedies like countervailing duties. Existing border instruments carry the benefit of administrability and efficiency, but market mechanisms have bold potential to accelerate decarbonization by creating secondary carbon markets and financial instruments that promote speedier and more efficient deployment of technologies for carbon elimination.

5. Product Coverage: upstream components and/or downstream components and products?

Taxing or pricing upstream commodities in isolation would likely have the unintended consequence of offshoring industries as manufacturing follows cheap inputs and operating costs to low-standard jurisdictions that face no border adjustment on downstream products. Full product value chains would need to be included in order to avoid carbon and/or environmental arbitrage.

6. How should a CBAM raise revenue: through the market or through fees/taxes?

The approach to raising revenue can make or break the effectiveness of carbon pricing and border adjustment mechanisms. Market-based approaches treat greenhouse gas units as a commodity unto themselves, allowing the market to set a “true” price for carbon mitigation. Under a market-based scheme, carbon credits become fungible assets that can be traded or hedged through financial instruments like options and futures with a market premium on pulling more carbon out of the air today than in the future.

Fees or taxes, by contrast, are collected by the government, which then redistributes those assets to correct for externalities (like higher energy prices or displaced workers) created by internalizing carbon costs in industry.

7. How would the U.S. use the revenue from a CBAM?

Revenue from taxes and fees can be either consumer- or industry-corrective and either balanced or unbalanced. Consumer-corrective options include direct subsidies to households to adjust for higher energy and fuel costs. An example of an unbalanced consumer-corrective mechanism would be a direct and equal payment to all households in all jurisdictions, where jurisdictions with higher energy transition costs receive a corrective payment while those in lower-cost areas—where the sun shines, the wind blows, and atoms react—receive a windfall. Alternatively, a balanced consumer-corrective approach would seek to level energy prices nationwide by providing payment credits to high transition-cost jurisdictions.

Industry-corrective approaches are similar but seek to adjust costs at the industry level before higher prices are passed onto the consumer. A balanced industry-corrective approach would include capital credits and subsidies to fund transition technologies and address legacy infrastructure overhang to keep the price of energy level across jurisdictions. An unbalanced industry-corrective approach would be an equalized feed-in tariff or subsidy for all utilities irrespective of local climatic conditions and the age and viability of existing energy infrastructure.

Revenue from a CBAM can also be used to provide “climate adjustment assistance” benefits to workers displaced by a shift to new energy sources, including retraining and extended health benefits.

An answer to the drawdown showdown?

Thinking expansively about the tools available to policymakers to incentivize a rapid and equitable drawdown will be essential to achieving the world’s economic and climate goals. Time is short and the stakes are high, but the practicability and potential of carbon pricing and border adjustments are promising and deserve the full attention of governments and stakeholders.

To read the full commentary by Silverado Policy Accelerator, please click here.

The post Tools of the Carbon Trade: Designing a Realistic Carbon Border Adjustment Mechanism appeared first on WITA.

The urgency of these measures has never been more clear. As a new report released by the U.N. last week demonstrates, governments’ existing plans to curb carbon emissions are insufficient to meet the Paris Climate Agreement’s goal of limiting the rise in global temperatures to 1.5 degrees C above pre-industrial levels by 2100. Instead, current climate mitigation measures put the world on track to cap global temperature rise at closer to 2.7 degrees by the end of the century—potentially enough to avoid the most calamitous effects of climate change but still well above the goals established by the Paris Agreement. These outcomes, though, are far from set in stone, and the U.N. concluded that countries can still limit warming by another half a degree, to 2.2. degrees C if they adopt and implement new net-zero emissions policies in the coming years.

The question then becomes this: What policy tools are available to the U.S. to incentivize other countries to move towards these net-zero outcomes?  There are a broad range of tools, but it is increasingly clear that trade policy and other border policies will play an outsized role. Trade policy can both incentivize good behavior and penalize bad behavior, in many cases leading to swifter outcomes than those achieved through purely voluntary commitments. In the climate context, we will see many ambitious commitments unveiled this week in Glasgow—but emissions know no borders, and until all countries are aligned on the urgency of the problem and have agreed to share the responsibility of reaching net-zero emissions, trade policy will likely remain a critical tool.

Using a system of carrots and sticks, the United States can leverage its climate leadership to develop an alliance of environmentally like-minded countries who enjoy preferential terms of trade and pursue deepened cooperation, including in how they work together to help developing countries meet their own climate commitments.  We have seen the first evidence of this approach just this week with the U.S. – EU announcement to negotiate a sectoral arrangement for steel and aluminum that will for the first time address carbon intensity as part of a trade initiative. And for those countries playing the short game, trade policy offers several templates to introduce carbon border adjustment mechanisms—or CBAMs—a class of trade measure designed to support climate mitigation policies by addressing carbon leakage (i.e. the migration of carbon-intensive production from areas with stricter emissions standards to those with weaker standards).

To CBAM or not to CBAM?

Although CBAMs are not on the formal agenda in Glasgow, several countries are considering implementing them, including the EU, Japan, and Canada. The idea of the U.S. implementing a CBAM has also been gaining traction among some trade experts and policymakers in Washington. The reason for CBAMs is clear: compliance with stricter emissions standards and deeper investments in environmental technologies leads to far more favorable environmental outcomes, but they come at a cost. A CBAM can help level the playing field so that producers in countries with a carbon advantage are not placed at a competitive disadvantage.  Yet a patchwork of uncoordinated CBAMs—including measures that are directed at like-minded allies—has the potential to be counterproductive by creating incentives for carbon arbitrage and reigniting a race to produce in the cheapest carbon markets. The United States has an opportunity to steer the global path forward on CBAMs, but it must do so both expeditiously and thoughtfully, taking into consideration the following critical questions for a U.S. CBAM framework.

1. How should the U.S. measure carbon content?

Before adopting a carbon border adjustment mechanism, regulators in the U.S. will have to decide how to measure the total carbon content of manufactured products. There are two major schools of thought when it comes to calculating carbon content: point-of-production analyses and life-cycle analyses. As the name suggests, point-of-production analyses account for the amount of carbon emissions produced at the site of production, including direct energy inputs. Life cycle analyses, by contrast, are additive and account for the total carbon footprint of a product across the entire value chain, including the emissions produced by the energy that was needed to produce and distribute the components and final goods in question.

Of course, a life-cycle analysis is more comprehensive than a point-of-production analysis, but there are still several question marks about how a life cycle analysis would work in practice. For instance, life cycle analysis methodologies vary greatly between and within international jurisdictions and can prejudice geographically equitable accounting of carbon output/savings. The starting point and scope of inputs included also vary by methodology, making an ‘apples-to-apples’ comparison of carbon output between countries impractical.

2. Which type of carbon emissions does the U.S. want to offset with a CBAM?

Carbon border mechanisms can address carbon leakage in one of two ways: either by applying a price or tax on either positive carbon output (i.e. the amount of carbon that that is “saved” through mitigation techniques and compliance compared to an unmitigated circumstance) or by applying a price to negative carbon output (i.e. the amount of carbon emitted in excess of what is mitigated).

These strategies, however, are not mutually exclusive, and the most equitable and comprehensive approaches use a combination of the two. An example of both positive and negative carbon adjustment would be a carbon price applied to the full unmitigated value of emissions in order to address domestic industry concerns about the imbalance between relative compliance costs or a combination of compliance costs adjustment (for negative values) and a carbon price/tax (for positive values).

3. How does the U.S. avoid facilitating adverse arbitrage between the cost-of-compliance and the price for carbon?

Complying with new or existing environmental regulations creates significant costs for manufacturers in highly-regulated markets like the U.S., placing those manufacturers at a competitive disadvantage relative to their competitors in less stringent regulatory environments. CBAMs may be designed to remedy this imbalance by pairing the cost-of-compliance (i.e. the price of complying with mitigation regulations) with the price of unmitigated carbon to create a more even playing field.

But regulators have to walk a careful tightrope in determining these costs. Pricing the cost-of-compliance provides the benefits of harvesting the U.S. carbon advantage, leveling the playing field to what U.S. firms already invest in environmental compliance. Moreover, setting a base price on the cost-of-compliance is both technically feasible and straightforward because values can be objectively determined from the capital and operational costs of relevant process technologies. However, if cost-of-compliance is imposed in conjunction with a price for carbon that is too low—and without appropriate regulatory guardrails—it could undermine regulatory effectiveness over time with pollutants other than greenhouse gas emissions and encourage off-shoring by incentivizing manufacturers to pay for the price of carbon rather than comply with regulation, resulting in adverse environmental/carbon arbitrage.

4. Which instrument(s) should the U.S. use to implement border adjustments?

In order to implement a border carbon adjustment, the U.S. can draw from a variety of new or existing border instruments, either independently or in conjunction—including a commoditized carbon price, tax/fee, specific tariff, a value-added tax (VAT), and import licensing fees, and/or various trade remedies like countervailing duties. Existing border instruments carry the benefit of administrability and efficiency, but market mechanisms have bold potential to accelerate decarbonization by creating secondary carbon markets and financial instruments that promote speedier and more efficient deployment of technologies for carbon elimination.

5. Product Coverage: upstream components and/or downstream components and products?

Taxing or pricing upstream commodities in isolation would likely have the unintended consequence of offshoring industries as manufacturing follows cheap inputs and operating costs to low-standard jurisdictions that face no border adjustment on downstream products. Full product value chains would need to be included in order to avoid carbon and/or environmental arbitrage.

6. How should a CBAM raise revenue: through the market or through fees/taxes?

The approach to raising revenue can make or break the effectiveness of carbon pricing and border adjustment mechanisms. Market-based approaches treat greenhouse gas units as a commodity unto themselves, allowing the market to set a “true” price for carbon mitigation. Under a market-based scheme, carbon credits become fungible assets that can be traded or hedged through financial instruments like options and futures with a market premium on pulling more carbon out of the air today than in the future.

Fees or taxes, by contrast, are collected by the government, which then redistributes those assets to correct for externalities (like higher energy prices or displaced workers) created by internalizing carbon costs in industry.

7. How would the U.S. use the revenue from a CBAM?

Revenue from taxes and fees can be either consumer- or industry-corrective and either balanced or unbalanced. Consumer-corrective options include direct subsidies to households to adjust for higher energy and fuel costs. An example of an unbalanced consumer-corrective mechanism would be a direct and equal payment to all households in all jurisdictions, where jurisdictions with higher energy transition costs receive a corrective payment while those in lower-cost areas—where the sun shines, the wind blows, and atoms react—receive a windfall. Alternatively, a balanced consumer-corrective approach would seek to level energy prices nationwide by providing payment credits to high transition-cost jurisdictions.

Industry-corrective approaches are similar but seek to adjust costs at the industry level before higher prices are passed onto the consumer. A balanced industry-corrective approach would include capital credits and subsidies to fund transition technologies and address legacy infrastructure overhang to keep the price of energy level across jurisdictions. An unbalanced industry-corrective approach would be an equalized feed-in tariff or subsidy for all utilities irrespective of local climatic conditions and the age and viability of existing energy infrastructure.

Revenue from a CBAM can also be used to provide “climate adjustment assistance” benefits to workers displaced by a shift to new energy sources, including retraining and extended health benefits.

An answer to the drawdown showdown?

Thinking expansively about the tools available to policymakers to incentivize a rapid and equitable drawdown will be essential to achieving the world’s economic and climate goals. Time is short and the stakes are high, but the practicability and potential of carbon pricing and border adjustments are promising and deserve the full attention of governments and stakeholders.

To read the full commentary from Silverado Policy Accelerator, please click here.

The post Tools of the Carbon Trade: Designing a Realistic Carbon Border Adjustment Mechanism appeared first on WITA.

The unprecedented policy support from EU institutions and member state governments throughout the pandemic has helped to cushion the worst impacts on employment and income. This, coupled with the rapid adaptation of firms and households to a ‘new normal,’ has helped to keep national economies afloat and societies running. Unemployment has remained in check and household incomes have been relatively stable thanks to a raft of firm support and social protection measures. Salary subsidies, generous leave allowances and debt holidays extended since early 2020 are just a few of the interventions that would, prior to the pandemic, have been unthinkable in the scale that we saw in 2020, blurring the lines between the public and private sectors.   

While the economic fallout could have been much worse absent the sizeable government support, it is also fair to say member states are not yet out of the woods. Despite government efforts, the threat of poverty is still very real for a segment of people living in the EU. Our recent report, entitled Inclusive Growth at a Crossroads​, found that a further three to five million people are ‘at risk of poverty’ in the EU27 countries today than before the crisis. Europe is in its steepest recession since World War II, with output across the EU shrinking by more than six percent in 2020.

Green shoots of recovery are beginning to emerge as governments reopen national economies. EU member states must now ensure careful and efficient implementation of economic recovery plans that support inclusion, protect the vulnerable and foster economic growth to bounce back.   

Beyond the far-reaching fiscal strategies, monetary policy programs have complemented efforts as central banks have worked to ensure favorable financing conditions and ample liquidity in the banking system. While this has kept debt servicing costs at bay, it has still come at a cost. Notably, debt-to-GDP increased by 13 percentage points on average in 2020 across the EU27 – a steeper increase than during the global financial crisis of 2008.

At the human level, the realities of the pandemic have been highly unequal, and in a way not seen in previous financial crises. Sectors of the economy that are typically less sensitive to business cycles – like entertainment, the arts and accommodation – were severely affected as social distancing limited human interaction. Meanwhile, sectors that are typically more procyclical, such as industry and construction, were less affected despite an economic contraction.

Within the EU27, there is evidence of rising inequality in multiple areas that will need to be proactively addressed by strengthening service delivery and tailored labor market programs to reduce potential scarring. For example, in the labor market, low-wage workers, the self-employed, young people, and those on non-standard contracts were more likely to experience lasting disruptions to their work. This threatens to echo through future generations as the disruptions to schooling could exacerbate existing inequalities by limiting opportunities and suppressing the incomes of tomorrow’s workforce. Parents in poorer households are more likely to report that their children have experienced difficulties with the transition to online schooling. Proactive support to children at risk of early dropout and those whose learning has been most compromised will be needed as the new school year sets in.

Since the turn of the year, the vaccination rollout in the EU27 countries has provided a cause for optimism and improving the prospects for recovery. Supportive monetary and sustainable fiscal policies will still be required to carefully balance the support targeted to those that need it most. The EU’s recovery plan is an opportunity, aimed at putting the member states on a more sustainable path. This would include repairing the damage from the COVID-19 crisis, while promoting and accelerating the green and digital transitions.

Countries are now at a crossroads as they deal with the aftermath of a difficult eighteen months. And while the pandemic challenge is not yet over, there are glimmers of hope that allow populations to look forward to gradual reopening with cautious optimism. As pressures related to the pandemic ease, countries have the opportunity to pivot towards more sustainable growth with a renewed focus on fostering resilience and cohesion.​

Gallina A. Vincelette is the World Bank’s Country Director for the European Union (EU), based in Brussels, Belgium. She is responsible for guiding the Bank’s operational and knowledge engagement with client countries and the EU institutions.

Reena Badiani-Magnusson is a Senior Economist at the World Bank. She has worked on social protection, human development and poverty issues over the past 9 years at the World Bank in several countries across Europe and Central Asia, East Asia and the Pacific and Africa. Reena holds a PhD from the Department of Economics at Yale University. She additionally holds a Masters in Environmental Economics from the MPSE in Toulouse University. 

To read the full commentary from World Bank Blogs, please click here. 

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This month, scientists renewed their calls for immediate and urgent climate action, citing the ongoing heat waves and historic floods as proof that European cities are ill equipped for the realities of global warming. The European Commission responded with its “Fit for 55” proposal, which will aim to address the root causes of warming and slash greenhouse gas emissions by 55 percent over the next decade, establishing Europe as the first net-zero bloc by 2050. If accomplished, these steps will be crucial in mitigating life-threatening climate change.

However, not everyone is happy with the news. Australia’s trade minister, Dan Tehan, condemned the EU climate measures—specifically the controversial Carbon Border Adjustment Mechanism (CBAM)—as protectionist policies which break WTO rules and hinder the global effort to combat climate change. Tehan said that the CBAM—which will tax imports based on their carbon footprint—is devised to fill Europe’s coffers rather than target carbon leakage.

And he’s not wrong. It’s easy to see how the CBAM and associated policies would unfairly manipulate the conditions of fair trade in the EU’s favor. The EU seems to have ignored how its policies would impact the developing world, which relies on trade to keep economies, industries and livelihoods afloat.

Of the world’s 25 richest countries, 15 are in Europe. This means the EU is well equipped to financially support policies which could bring real change on the international stage. However, time and time again the EU—blinded by its influential economic standing—misses the biggest thing, the one thing that is truly needed if we wish to combat climate change: inclusivity. Fighting climate change will require the foresight to introduce policies which include vulnerable economies.

Ultimately, every country on this planet must develop initiatives which address rising emissions. But not every country has the means at this time to do so. The EU’s Fit for 55 proposals would perpetuate these unequal playing fields and worsen existing economic and climate inequalities between countries.

The pandemic has already impacted global trade and posed economic challenges for developing countries. However, even before COVID-19, prominent economists claimed wealthy countries were trying to “kick away the ladder” from vulnerable countries attempting to join the economic elite.

For example, reports have already shown that since the EU banned palm oil as a biofuel in 2019, countries that produce palm oil have—in order to stay afloat—escalated trade with countries like China, which care less about sustainable production. The outcome of the EU’s ban? Not less palm oil, but more unrestricted and untraceable carbon emissions which impact the most vulnerable.

Ironically, the EU’s palm oil ban also ignored historic efforts on the part of palm oil-producing countries to address environmental concerns. For example, Malaysia’s national certification agency has successfully reduced deforestation by implementing a legally enforced scheme—called Malaysian Sustainable Palm Oil—which prohibits deforestation and encourages biodiversity.

It seems the EU remains dead set on ignoring these countries’ efforts and forcing them to trade with each other, and not with Europe. This will create economic and environmental “ghettos” wherein rich nations enjoy the advantages of unrestricted trade and healthy environments, and poorer countries lose their economic autonomy while navigating rising carbon emissions.

If the EU passes all of the Fit for 55 proposals, poorer nations would lose out on the chance to trade with the EU, meaning their chances at achieving carbon neutrality would diminish along with their economic stability.

By discounting developing countries, the EU clogs the global effort needed to avert dangerous warming, and entrenches systemic economic inequalities which must be addressed if we hope to solve the biggest calamity facing our generation.

What is desperately required are solutions which involve these countries in the decision-making process. We can’t pass policies which leave these nations stranded without a lifeline—it will only lead to more devastation.

EU leaders will have one more opportunity to solve these complex issues at the upcoming COP26 summit. Let’s hope they get it right.

Dr. Ibrahim Özdemir is a world-renowned ecologist and is a consultant to the United Nations Environment Programme. He teaches environmental ethics and philosophy at Üsküdar University, Istanbul, Turkey.

To read the full commentary from Newsweek, please click here.

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Labor unions and key industries on both sides of the Atlantic support such measures, as well as environmentalists who view BCAs as an enabling condition for meeting the global emissions reduction targets called for in the Paris Agreement. However, the EU and U.S. plans differ in ways that could complicate transatlantic cooperation, as well as muddle negotiations with China and large developing countries over the direction of climate and trade policy. This divergence could imperil the ability of both economies to achieve their common goals.

Divided, the EU and the U.S. lack the market power to persuade China and other emerging economies to reject carbon-intensive development pathways, including the expansion of coal-fired power generation. Individually, the EU and the U.S. account for 14 percent and 16 percent of worldwide imports, respectively. A harmonized transatlantic approach, however, would add up to at least a 30 percent global market share and would likely form the foundation of a broader carbon club of like-minded countries — a development that would create a de facto international carbon price.

Out of the two proposals, the U.S. plan, led by Sen. Chris Coons(D-Del.) and Rep. Scott Peters (D-Calif.), offers the most flexibility in transatlantic and broader international cooperation, including the possibility of a carbon club, because it is founded on climate policy ambition. Coons and Peters would have the U.S. waive the carbon fee on a country’s imports if that country did not impose a BCA on U.S. products and if the U.S. determined the foreign government enforced laws and regulations designed to limit or reduce GHG emissions that are at least as ambitious as the U.S.

The EU plan, on the other hand, has limited its ability to engage internationally: It would only grant a full waiver to countries with a carbon price that is linked to the EU’s Emissions Trading System, which would currently only benefit a small group of emitters like Norway and Switzerland. However, compared to the U.S. scheme, it is based on emissions performance, which would be more effective in reducing global emissions if adopted more broadly. Brussels would impose administrative costs on all foreign industry, outside of the EU’s limited exemption zone, and apply fees based on the carbon intensity of their products.

Both strategies have their advantages; there is a need for transatlantic dialogue and cooperation to develop a common position that takes the best from both proposals to achieve the global climate mitigation results desired. In this sense, there should be an alignment of interests between both economies, which are amongst the cleanest in the world in terms of manufacturing from a GHG life cycle perspective.

The U.S. needs to work with the EU to develop common approaches to carbon accounting. Imported fees on carbon pollution should be based on an objective formula that is independently verifiable as it relates to the carbon intensity of products. The U.S., for example, should not grant an exemption to China simply based on its promise to achieve net zero emissions by 2060 and adopt future regulations designed to achieve it.

On the other hand, the EU needs to embrace a more flexible view on how to exempt other nations, in the spirit of the U.S. proposal. Many countries are not in a position to adopt a price on carbon, because they are in different stages of GHG regulation. Instead of basing blanket exemptions on pricing carbon, the EU should credit decarbonization programs that are enforceable domestically, reportable and verifiable.

A transatlantic meeting of the minds is needed on how to merge climate and trade policy. Both sides of the Atlantic should work to leverage their combined market power, in coordination with other economies with similar climate mitigation goals, such as Canada, Japan and the Republic of Korea, to green global supply chains and encourage China to adopt policies that are consistent with the Paris Agreement. Moreover, forging a common path would help strengthen the security alliance between the U.S., the EU and their allies — a strategic objective that Washington and Brussels should both share and prioritize.

George David Banks is a fellow at the Bipartisan Policy Center. He was the former GOP chief strategist on the House Climate Committee and climate adviser to Presidents George W. Bush and Donald Trump.

Michael A. Mehling is the deputy director of the MIT Center for Energy and Environmental Policy Research and works on climate policy design and implementation on both sides of the Atlantic

To read the full commentary from The Hill, please click here.

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In the map, countries/jurisdictions with an ETS are shown in green, those with a carbon tax are shown in blue, and those with both an ETS and a carbon tax are shown in green/blue shading.

The European Union’s ETS, originally set up in 2005, operates in the 30 European Economic Area (EEA) countries – the 27 EU countries plus Iceland, Liechtenstein and Norway – some of which also apply national carbon taxes. According to the World Bank, the EU ETS currently covers 3.2% of global emissions.

So far, carbon pricing schemes only cover carbon emissions produced within the jurisdictions that operate these schemes. For instance, the EU ETS only applies to carbon emissions from production in the 30 EEA states, and Japan’s carbon tax only applies to carbon emissions from production in Japan.

The fact that carbon pricing schemes are implemented only in a limited number of countries, and with different levels of carbon prices between these countries, has long raised the fear of carbon leakage, namely the possible transfer of carbon-intensive activities away from countries with high carbon prices that would not only be detrimental to economic activity in these countries but could also increase global emissions. To avoid carbon leakage and level the playing field, it has long been argued that countries need to extend their carbon pricing schemes to emissions by producers located outside their borders but exported into the jurisdictions that operate such schemes. To this day, however, no national or supra-national jurisdiction has implemented a carbon border adjustment mechanism (CBAM), which would make up for the difference between its domestic carbon price and the carbon price in countries with a lower (or no) carbon price.

If adopted by the European Council and the European Parliament, the EU CBAM proposed last week by the European Commission would, therefore, be a first worldwide.

There are two main reasons why, prior to the proposed EU CBAM, no jurisdiction has introduced legislation to extend its domestic carbon pricing scheme to emissions produced outside its own territory.

First, the effective price of carbon emissions applied to tradeable products has so far been generally very low under most existing carbon pricing schemes. For instance, under the EU ETS, the effective carbon price paid by producers of manufactured products covered by the ETS (such as cement, chemicals or iron and steel) was essentially zero, since they received free allocations of emission permits. It was neither necessary nor possible, therefore, to impose a CBAM on similar products imported into the EU since, by definition, a CBAM is an adjustment meant to equalise the price of carbon between domestic products and imports.

The second reason is that a CBAM may not be compatible with the rules of the World Trade Organisation (WTO), and even if it is, it may not be politically acceptable to foreign trading partners, who could retaliate. This is what happened in 2012, when the EU decided to introduce a CBAM for the aviation sector, triggering a political backlash from powerful foreign countries (including Brazil, China, India, Japan, Korea, Mexico, Nigeria, Russia and the United States) that led to de facto withdrawal of the measure by the EU.

So how does the proposed EU CBAM score on these two issues and what are the chances that it will actually see the light of day?

The EU CBAM will only apply initially to a limited number of carbon-intensive products: cement, iron and steel, aluminium, fertilisers and electricity. For these products, free ETS allowances for EU producers will be reduced by 10% each year from 2025, resulting in their complete phase out by 2035, while the CBAM on imports will be gradually phased in at the same rhythm so it will only apply to the proportion of emissions that do not enjoy free allowances.

The CBAM will apply to imports at the price of carbon determined by the EU ETS system through auctions, which is expected to rise over time as free allowances, initially only in the five sectors listed above and later also in other import-competing sectors already subject to the EU ETS (including ceramics, glass, paper and other chemicals), are phased out. Given that the EU carbon price is currently already above €50 per tonne of CO2, it can probably be safely assumed that the effective price of carbon paid by EU producers in import-competing sectors subject to EU ETS will gradually rise to at least €50 by 2035, which is likely to generate carbon leakage in these countries and, therefore, justify the introduction of the CBAM.

Having established that the phase out of free ETS allowances will substantially increase the price of carbon faced by import-competing carbon-intensive producers in the EU, and therefore that the parallel phasing in of the CBAM is justified to avoid carbon leakage, we can now turn to the second issue and examine whether the proposed EU CBAM risks creating legal and political conflicts with third countries, and potential retaliatory measures.

Legal scholars agree that WTO rules in principle allow WTO members to adjust their ETS systems for imports as the EU CBAM proposes to do. Whether or not the EU CBAM complies with WTO rules is therefore down to its actual implementation and in particular whether it meets a double non-discrimination test: non-discrimination between domestic and foreign suppliers, and non-discrimination between foreign suppliers.

The EU CBAM purports to treat EU and foreign suppliers equally since they would both be paying the same price for their embedded carbon emissions for products sold in the EU – by purchasing ETS allowances for the former and CBAM certificates for the latter. Foreign suppliers would be entitled to claim a reduction against the CBAM for any carbon price paid in the country of production (which is not rebated or in other way compensated for upon export). Hence, suppliers from countries with carbon pricing schemes would be able to handle the CBAM administrative costs relatively painlessly. The situation would be different for suppliers from countries that implement carbon reduction policies through means other than carbon pricing. Whether this would be regarded by some of these countries as discrimination in terms of WTO law remains to be seen.

One accusation of discrimination that cannot be levelled against the Commission proposal is that it will exempt certain countries from the CBAM. Except for Iceland, Liechtenstein and Norway, which belong to the EU ETS, and Switzerland, which has an ETS linked to the EU ETS, the EU CBAM will apply to all countries. With respect to Switzerland, the explanatory memorandum accompanying the Commission CBAM proposal (pp 26-27) states that exemptions “could be granted to countries who have in place a carbon pricing system that imposes a carbon price at least equivalent to the price resulting from the EU ETS on products subject to the CBAM. In practice… such an approach may be considered for countries with an ETS linked to the EU ETS (e.g. Switzerland).” However, this statement raises a question about the meaning of ‘equivalence’ envisaged by the Commission. Switzerland’s carbon pricing scheme is equivalent to the EU’s scheme is two ways: like the EU, Switzerland has an ETS, and its ETS is linked to the EU ETS. Hence there is equivalence in systems and in carbon prices. But what about a country that also has an ETS, which is not linked to the EU ETS but nonetheless imposes a carbon price which is the same or even higher than the EU ETS, or another country that uses a carbon tax instead of an ETS, which also imposes a carbon price equal to or higher than the EU ETS?

The flipside of non-discrimination between third countries (with the exception of Iceland, Liechtenstein, Norway and Switzerland) is that developing, and even least-developed countries will be subject to the same EU CBAM as more advanced countries, despite the principle of common but differentiated responsibilities enshrined in the Paris Agreement. One way to reconcile the EU’s obligation under both the WTO and the Paris Agreement would be to seek a WTO waiver permitting the exemption of developing or least-developed from the EU CBAM, or similar CBAMs that may follow the EU CBAM.

Both sets of issues – potential discrimination between countries with and without carbon pricing schemes, and lack of differentiation in favour of lower-income countries – should be addressed at the multilateral level in the WTO, with the EU seeking to establish with other WTO members a memorandum of understanding on carbon border adjustment mechanisms that would define some basic principles. This would certainly help deflect not only potential legal challenges but also a political backlash against the EU CBAM.

The EU should be congratulated for having put forward a comprehensive response to tackling its own carbon emissions. It has done a service to the world by experimenting with policies that have not been tried elsewhere before, including a CBAM that complements its ETS. But the EU needs to collaborate with other jurisdictions to ensure its CBAM is embedded into a multilateral framework comprising both the Paris and WTO agreements, without which the pursuit of global carbon neutrality would ultimately be in vain.

André Sapir, a Belgian citizen, is Senior Fellow at Bruegel. He is also University Professor at the Université libre de Bruxelles (ULB) and Research Fellow of the London-based Centre for Economic Policy Research.

To read the full commentary from Bruegel, please click here. 

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