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Business split as EU ponders border carbon adjustments

This week saw major announcements from the European Union on its plans on climate and tax for the coming years. These announcements, combined with continued uncertainties about transatlantic trade relationships, the UK’s exit from the EU, and the fallout from the corona virus epidemic, contributed to a truly febrile atmosphere in the business community in a capital that was showered by even more rain than usual.

On Wednesday the Commission announced plans for a new EU climate law. It opened consultations with civil society on various options that it is exploring towards some form of carbon border measure. This would come on top of the many new policies that aim to make the continent carbon neutral within the next thirty years and are intended to rack up the price of carbon.

With the EU’s carbon cost structure increasing, border adjustment is meant to alleviate competitive pressures for businesses from imported products originating in countries with lower environmental standards.

Much ink has been expended on carbon border measures. But now that the EU has outlined three possible lines of action, and that it is exploring ways to keep any border measure World Trade Organization-compatible, discussions are becoming less academic and much more concrete.

The three options the EU executive put on the table this week are: “a carbon tax on selected products – both on imported and domestic products, a new carbon customs duty or tax on imports, or the extension of the EU Emissions Trading System to imports”.

Attendees and speakers stranded in Brussels after a hearing hosted by the international trade committee of the European Parliament on the carbon border measure was cancelled at the last minute due to corona virus related restrictions, were nonetheless able to meet at an event put together at short notice by the economics think tank Bruegel.

Economists on evidence of carbon leakage

The event showed that any border measure remains controversial among economists.

Georg Zachmann, Bruegel’s in-house energy economist is sceptical that any such measure is needed at all. In a paper released this week, Zachmann argues that there is little empirical evidence of companies relocating production to a jurisdiction that is laxer on carbon pricing. Instead, the EU should focus on promoting innovation and the emergence of technologies that allow for cheap clean energy production. “There are a variety of reasons why a company is sitting in one place. The price of carbon is only one of them,” said Zachmann.

Gabriel Felbermayr, who leads the Kiel Institute for the World Economy, does not share Zachmann’s assessment. To him, carbon costs are much higher than the nominal price in Euros provided by schemes such as the EU’s market-based Emissions Trading System. There are a host of regulations – for example tighter car emissions standards – that increase the price of production and can be indexed as a form of price on carbon.

When taking that kind of costs into account, Felbermayr argues, then the models he has run show that evidence of carbon leakage becomes more evident. What is more, the formal carbon price in the EU will increase.

There are also legal complexities.

To David Kleimann, a scholar at SAIS at Johns Hopkins University, WTO-compatibility fears may well be overblown.

A carbon measure is allowed under Article II of the GATT and under the standard general exceptions to the WTO’s non-discrimination rules spelt out in GATTs Article XX. These offer space for environmental protection as a justification for discriminatory import restrictions.

“The only thing that would be problematic is making this tax contingent on a policy rather than on the carbon footprint of a country,” said Kleimann. Basing for example a tax on whether the country of origin of a product is party to the 2015 Paris Agreement on climate change “is a line under Article XX that shouldn’t be crossed. But other than that, WTO compatibility doesn’t seem to be a massive problem”.

To Kleimann, the real challenge is within the EU. Any tax decision requires unanimity among member states – something that is hard to achieve. It would make the first EU option particularly difficult to pursue. That problem would be less salient, however, in the case of a customs duty, where decisions are made under qualified voting majority.

Business splits

Business is split on the issue of border carbon measures.

Taken in an abstract way, the reasoning of the European Commission and of proponents of a border measure is simple and seductive: given that we impose such high costs on ourselves, we need to ‘level the playing field’ and avoid being undercut by foreign competitors that don’t operate under the same CO2 price constraints.

In practice, only few sectors really support this view – the reality and complexity of supply chains and products making tracking carbon near impossible. Capital-intensive and energy-intensive sectors such as steel or cement however, love the idea of imposing costs on imports. One would expect the EU’s chemical sector to also support carbon adjustment measures – but conversations held by Borderlex with sector representatives this week reveal reception of the Commission’s ideas is lukewarm: much depends on the measure adopted. One representative of German chemicals producers indicated preference for ETS linkages across borders.

The Commission is planning to put an end to free allocation of carbon emission permits under its Emission Trading System. These permits were initially given away to alleviate costs for energy-intensive sectors.

Reinforcing the ETS is a priority for ACEA, the leading auto lobby in the EU. “All energy carriers should be part of a stronger EU Emissions Trading System (ETS) that applies a carbon price at a level that drives real change. Many of the vehicle efficiency  technologies that will be needed to reach the industry targets are equivalent to a carbon price of well above €250 per tonne CO2 (the current ETS price is around €25),” says ACEA in a recent position paper.

Felbermayr says that we should primarily tax consumption and the global carbon footprint of a product. However, in his view free permit allocation under the ETS should remain. Free allowances are already a de facto border adjustment measure that helps sectors such as steel cope with competitive pressure from outside.

“Give away those allowances for free” said Felbermayr. “That would free production and instead we tax the goods these industries produce, regardless of whether these goods originate in Europe or not.”

Eurofer, the EU’s main steel lobby group, says almost the same thing. In a recent position paper, Eurofer asks for continued free allowances complemented for taxes on specific steel products, in particular “coils, slabs, plates, bars, billets… [potentially] extended to input products.”

The European Cement Association said: “Energy-intensive industries such as cement already face a shortfall of allowances under the ETS rules, increasing the production cost and the risk of production being offshored… the EU should look at a design that  complements the existing carbon leakage measures, whilst being fair for third country importers and EU producers.”

Clearly, interests are wide apart. The Green Deal is about to trigger a European lobbying and power battle of epic proportions.

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