The US and EU are considering taxing imported carbon – a competitive incentive to increase climate efforts – as the cooperative approach of the Paris Agreement has become frayed.
Like all global policy issues, approaches to climate change are influenced by domestic politics, including its relative prioritization, and the nature of international relationships. While recognizing this, it is clear that environmental protection and climate change remain important global issues for maintaining common interest and addressing shared concerns.
Cooperation between countries, which has built up during the lifetime of the UNFCCC, is at the heart of international climate negotiations and is central to their effectiveness, especially as binding agreements are used less frequently. Almost all countries signed the Paris Agreement, far more than signed the Copenhagen Accord and Kyoto Protocol. The non-binding NDCs are the foundation of the Paris Agreement. They are submitted by governments and the UNFCCC secretariat assesses whether they are collectively ambitious enough to meet agreed global targets.
The cooperation-based foundations of the Paris Agreement have been under stress over the last few years due to the worsening relationships between China, the EU and the US. This, along with President Trump’s decision in 2017 to withdraw the US from the Paris Agreement, weakened the international climate action consensus.
In November 2017, the Trump administration began the withdrawal process, which came to its conclusion the day after the 2020 presidential election – a decision Biden reversed on his first day in office. In light of the views of the Trump administration, Ursula von der Leyen, while a candidate for European Commission president, stated the EU should ‘lead international negotiations to increase the level of ambition of other major emitters by 2021’. For his part, President Emmanuel Macron of France said that ‘cooperation between China and the European Union in this respect [the Paris Agreement] is decisive’.
In reaction to Trump declaring, in his first year in office, his intent to withdraw from the Paris Agreement, a Chinese Foreign Ministry spokesperson stated that China would continue to ‘step up concrete efforts to deal with climate change, and faithfully implement the Paris Agreement [and] stay committed to upholding and promoting the global governance on climate change and take an active part in the multilateral process on climate change’.
It is clear that China and the EU will continue to engage internationally on climate change issues whatever the political situation in the US.
As mentioned above, the European Parliament raised the EU’s NDC ambition in November 2020, increasing the European Commission’s proposed 2030 target of 55 per cent emissions reduction to 60 per cent, up from the current 40 per cent target. President Xi’s announcement of China’s 2060 carbon-neutrality target in September 2020 came one week after the European Commission announced its initial 55 per cent target. This sent a signal that China’s climate ambitions are at least as high as the EU’s.
A more competitive approach to climate geopolitics is emerging. It is clear that China and the EU will continue to engage internationally on climate change issues whatever the political situation in the US. What is more, to some degree, they see their role as more important when there is less engagement from the US.
However, as the international cooperative approach to climate action under the Paris Agreement has become frayed, the gap between countries’ decarbonization efforts has widened, leading some to consider mechanisms to ensure that their trade competitiveness is not undermined. For instance, while the EU has attempted to foster closer climate cooperation with China and to maintain the international climate consensus, it has also begun the process of implementing a more geopolitically competitive climate mitigation mechanism. The EU believes that the introduction of a carbon border adjustment mechanism (CBAM), in essence a carbon tax on imported goods, will not only protect EU businesses but also trigger decarbonization elsewhere. The carbon import tax applied to a given product can be thought of as reflecting the difference in embodied carbon between goods manufactured domestically to that being imported.
Energy-intensive industries have long argued that regulations and policies that increase the cost of emitting CO₂ put them at a disadvantage relative to their competitors that operate in jurisdictions where there is no equivalent price on carbon emissions. Climate-ambitious governments and campaigners are also concerned that, as decarbonization accelerates and become increasingly heterogeneous, carbon leakage will increase as production shifts to jurisdictions with weaker climate policies.
Taxing the embodied carbon of imported goods at the border is intended to serve multiple, equally important purposes: protecting domestic businesses that pay a greater penalty for their emissions, minimizing carbon leakage and the offshoring of emissions, and encouraging countries with weak climate policies to appropriately penalize emissions.
Taxing carbon at the border is also a significant shift towards a competitive geopolitical mechanism that attempts to stimulate climate action in trading partner countries. Successful implementation of carbon import taxes would result in the need for them waning over time – as decarbonization action equalizes across trading partners, the difference in embodied carbon between domestic and imported goods diminishes.
Taxing carbon at the border is also a significant shift towards a competitive geopolitical mechanism that attempts to stimulate climate action in trading partner countries.
Placing additional tariffs on goods will be politically and technically difficult. Any CBAM will need to comply with World Trade Organization (WTO) rules in order to avoid disputes and trade sanctions, yet also be effective in encouraging trading partners to implement carbon pricing or decarbonization policies. The balancing act regarding WTO rules is to ensure there is no infringement of the non-discrimination obligations of the General Agreement on Tariffs and Trade (GATT), specifically regarding Article III (national treatment) and Article I (most-favoured nation treatment). This means that domestic products are not given unfair preference over imports – for instance, by receiving free carbon allowances under the EU’s Emissions Trading System – and that all imports are taxed in a manner that does not give unfair advantage to one trading partner over another.
Aware of this difficult balancing act, the European Commission is proposing to test the CBAM on a sector-by-sector basis. It argues the measure would comply with WTO rules as, although these forbid discrimination between imports and domestic goods, the CBAM rules and associated domestic decarbonization policies can be designed to reduce infringement of GATT Articles I and III. In addition, an environmental-protection exemption argument is possible (but untested) under Article XX.
The difficulty that Article I can create in trade agreements pertaining to environmental protection and the potential for infringement of WTO rules proceedings is demonstrated in the stalled Environmental Goods Agreement negotiations. Forty-six WTO members (including China, the EU and the US) have been conducting negotiations since 2014 to eliminate tariffs on over 300 environmental products. However, the talks have not progressed since 2016, in part due to concerns that this open agreement could create ‘free-riding’ benefits for non-signatories on a most-favoured nation basis (Article I), something China is particularly concerned about. Indeed, the trade in low-carbon goods has a history of resulting in commercial disputes. Between 2007 and 2018, eight disputes were brought to the WTO regarding the trade in solar PV, of which four were initiated by China.
The potential for trade disputes under WTO rules due to the introduction of carbon border taxes can be seen by rough calculations of the carbon emissions embodied in international trade. A CBAM of €30 per tonne levied on all goods entering the EU would amount to €10 billion on imports from China, €3 billion on imports from the US, and €2 billion on imports from India. For all three countries, this would be equivalent to roughly doubling existing tariffs. This illustrates the stakes that could lead to trade disputes as well as the power of carbon border taxes to incentivize trading partners to decarbonize their exports.
In July 2020, the EU moved to the next stage of the introduction of a CBAM, with the launch of a consultation. This includes a review of the Energy Tax Directive (ETD). The EU’s language has changed from a ‘tax’ to a ‘mechanism’, which to some implies a more gradual implementation. The ETD review will look at minimum rates for fuels and at re-thinking tax exemptions to reduce the implicit subsidies of fossil fuels and certain economic sectors.
There is opposition to the CBAM inside and outside the EU. Heavy industry sectors, such as steel, are opposed to it as compliance under WTO rules will likely result in the revocation of mechanisms shielding them from the price of carbon (such as carbon credit allowances under the Emissions Trading System). The US has compared the CBAM to the imposition of a digital services tax by some EU countries, which led it to threaten tariffs on EU goods. In 2020, the then US secretary of commerce, Wilbur Ross, said that, ‘Depending on what form the carbon tax takes, we will react to it – but if it is in its essence protectionist, like the digital taxes, we will react’. However, the position of the US is likely to change with the new administration. The language of President Biden’s campaign platform was similar to the EU’s in this regard:
In late 2019, as it became clear that the European Commission was considering a carbon border tariff, China’s Environment Vice Minister Zhao Yingmin said, ‘We need to prevent unilateralism and protectionism from hurting global growth expectations and the will of countries to combat climate change together’.
A further deterioration of trust between countries in tackling climate change and a widening gap in decarbonization measures is likely to lead to greater political motivation to implement carbon border taxes, such as the EU’s proposed CBAM.
In many regards, a shift in stance towards more competitive climate diplomacy is perhaps a natural consequence of the trust-based NDC mechanism weakening. At the same time, it could be that the geopolitical threat of seriously considering such a competitive approach may swing countries around to re-engaging with the cooperative approach of NDCs. China’s 2060 announcement coming immediately on the heels of the EU declaring its increased ambition and CBAM consultation could be construed as such.