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Why the EU’s proposed carbon border levy is an important test for global action on climate change

In the more than two decades since the Kyoto Protocol was adopted, national policies on climate change have had dangerously and disappointingly little effect on global emissions.

Within the current economic system, perhaps the most ambitious attempt to reduce emissions has been the EU’s emissions trading system (or ETS). In operation since 2005, the ETS covers more than 11,000 heavy-energy-using power stations, factories and airlines, representing around 40% of the EU’s greenhouse gas emissions. The scheme operates via a cap-and-trade principle where an EU-wide cap on emissions means that firms must buy allowances, essentially paying for their polluting activities.

Yet although the ETS has had some success in reducing emissions, finance professor Panayiotis Andreou and I recently showed that the scheme is under-penalising those who pollute the most – primarily because the price of allowances has typically been too low.

The current price of an allowance to emit greenhouse gases is around €33 per tonne, a price already much higher than the average over the life of the ETS. However, to meet EU climate change targets, this price will need to be more like €40 by 2030 and close to €250 in 2050. Given the substantial costs this will impose on EU firms, either to pay for allowances or to invest in low carbon technologies, companies based outside the EU will have a hefty competitive advantage unless they face similar regulatory controls in their own countries.

This is why the European Commission, the EU’s executive branch, plans to present its carbon border levy in June 2021 as part of its Green Deal planning. Frans Timmermans, the first vice-president of the European Commission, recently stressed that:

It’s a matter of survival of our industry. So, if others will not move in the same direction, we will have to protect the European Union against distortion of competition and against the risk of carbon leakage.

Three workers loading large steel rods
The carbon border levy for steel could be around €57 per tonne. Mr. Amarin Jitnathum / shutterstock

Although its details are still undecided, the carbon border levy is expected to charge imports into the EU at an amount related to the emissions trading system price. As commission official Benjamin Angel notes, this could mean setting a carbon amount per product and multiplying it by the ETS price. For example, given production of each tonne of steel typically generates around 1.9 tonnes of CO₂ emissions, if we assume an ETS price of €30 then a firm would pay €57 extra to import it.

Having such a levy in place would send a strong signal to EU firms that potentially expensive investments in environmentally beneficial technologies would not result in undercutting, either by non-EU rivals that enjoy looser regulations, or by firms relocating to outside the EU – the so called “carbon leakage” that Frans Timmermans mentions.

Combining the EU ETS with a border levy is a sensible and workable strategy, providing a long-term context for firms that encourages the reduction of emissions by pricing in the pollution they produce. The benefits of a border levy may also spill over to outside the EU in at least one of two ways. First, and most obviously, non-EU firms that wish to export into Europe will be encouraged to reduce emissions to limit their charge. Secondly, other governments and regulatory authorities will be watching closely to see if the approach is workable and this could see the spread of cap-and-trade agreements more globally.

Of course, less optimistically, the levy could result in protectionist moves by other trading blocs and this leads to a wider question. The world faces a number of issues which can only be solved by international co-operation, including climate change and protection of biodiversity but also encompassing issues such as the taxation of global technology firms. Can we work together to answer global challenges, or will national agendas stop this happening? The success or otherwise of the EU’s carbon border levy will provide some answers.

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