International Trade

The EU may tax imports for a good cause

June, 2021

By: Stefano Riela

board member of New Zealand Europe Business Council

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Since 2005 the EU has adopted an Emission Trading System (ETS). It is a ‘cap and trade’ system whereby European firms purchase greenhouse gases (GHG) emission allowances below a maximum ceiling that decreases over time. Allowances can be bought and sold between firms and the cap guarantees their value. With this system, firms internalise the cost of emissions and are pushed to more efficiency and less polluting production.

Currently, the ETS covers only a few sectors – electricity generation, energy-intensive industries such as refineries, aluminium and steel mills – and about 40 per cent of GHG emissions in the European Economic Area (EEA): the EU States, plus Iceland, Liechtenstein and Norway. The effectiveness of this system is demonstrated by the fact that the approximately 15,000 plants involved in the ETS have reduced emissions by about 35 per cent since it came into force. At the same time, the sale of allowances brought over 57 billion euros into the coffers of EU countries, resources invested mainly in the energy sector and in policies to fight climate change.

Though other countries ‘price’ carbon (New Zealand maintains one of the most ambitious mechanism), the EU is a net carbon importer: the carbon content of exported goods is lower than that of imported goods. And if other countries have fewer restrictions on emissions, the purchase of ETS allowances is an additional burden on European firms squeezing their international competitiveness.

To remain in the market and to avoid a doomed destiny, European firms may shift their operations where legislation is less strict. The act of replacing internal production and emissions with foreign ones goes under the name of ‘carbon leakage’. This negatively affects the European economy and employment in favour of other countries, but it is not a zero-sum game as it may sound. Foreign productions will be more polluting due to less stringent constraints on top of the additional emissions related to transport (more exports from non-EU countries to the EU).

To prevent carbon leakage, European firms most exposed to international competition have benefited from free ETS allowances. However, this exception, in addition to creating intra-EU asymmetries, is not consistent with the now more significant commitment to reduce emissions. For this reason, the EU intends to make the ETS fully work with auctioned allowances. Moreover, on 21 April, the EU committed to more ambitious GHG emissions targets: a reduction of at least 55% by 2030 compared to the levels of the 1990. Consistently, the EU intends to expand the ETS to other sectors such as buildings and transport (flights within the EEA are already part of the ETS).

The market has already reacted to those proposals and ETS allowances have reached record values. Nowadays, the reference price exceeded 50 euros per tonne of CO2 equivalent; more than double the price in the same period in 2020 and 2019 (see figure below).

Source: Ember

A new EU tax on polluting imports?

To close the competitive gap to the detriment of European industry, the EU is considering introducing a carbon border adjustment mechanism (CBAM). Non-EU imports produced with a price for GHG emissions lower than the European one based on the ETS will have to pay the differential. It is therefore about restoring fair competition between European productions burdened by the ETS and imports – a level playing field to avoid an arbitrage that is harmful to the European economy and to the fight against climate change.

The Commission will unveil the details of the CBAM in a few weeks’ time (a leaked version has been published by Euractiv) with the paradoxically hope to wipe it out as soon as possible. If the CBAM is not effective, that means that all countries have adopted legislation on GHG at least equivalent to that of the EU.

It will take months for the Commission’s proposal to become legislation (it needs the approval of the European Parliament and the Council of the EU), but in the meantime it will be excellent food for thought for the United Nations Conference on Climate Change (COP26) to be held in Glasgow from 1 to 12 November 2021.

Stefano Riela, board member of New Zealand Europe Business Council

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