Will a carbon border tax (CBAM) be a recipe for problems in climate policy?

The European Union is relentless in its efforts to reduce greenhouse gas emissions. So far, however, the EU’s ambitious and long-standing efforts have been undermined by the growing risk of carbon leakage, and have not found a following among countries and regions outside the Union. The solution to these problems is supposed to be the Carbon Border Adjustment Mechanism (CBAM) being introduced in the EU. Does the new mechanism have a chance to cope with these challenges?

What does the new CBAM mechanism address?

Recall that CBAM applies to the import of certain greenhouse gas-intensive goods into the EU customs territory. In practice, it introduces a levy on emissions, and is therefore a form of carbon border tax (resembling an environmentally dictated duty in many respects). During the period of full operation of the mechanism, importers will incur a financial cost due to the need to purchase special units (CBAM certificates) to account for emissions – similar to what is done for activities within the EU that are covered by the greenhouse gas emissions trading scheme (the so-called EU ETS – it applies to the EU’s high-carbon industrial and energy sectors).

The price of certificates will correspond to the price of emission allowances at EU ETS auctions. The size of the settlement will be based on the amount of greenhouse gas emissions generated in the production of the goods (so-called “embedded emissions”), but deductions will be possible for the emission fee that has already been paid in the country of origin of the goods. The transition phase of the mechanism has now begun (it will last until the end of 2025), limited to reporting obligations. The need for financial settlement will be introduced gradually (the first settlement will be in 2027 for 2026). The mechanism now covers commodities from the cement, fertilizer, iron and steel, aluminum, and hydrogen and electricity sectors. In the future, CBAM is to be expanded to match the scope of production covered by the EU ETS.

Carbon border tax – objectives and benefits

CBAM is expected to pursue several goals. Some of this has an environmental dimension, but the anticipated economic impact is also not insignificant. The carbon border tax is intended to prevent carbon leakage outside the EU (i.e., shifting production to countries with less restrictive climate policies or replacing EU production with imports). The EU is increasing its climate ambitions, so the growing risk of runaway emissions could undermine the effectiveness of EU emissions reduction policies. Since production outside the EU tends to be more carbon-intensive due to lower environmental standards, remaining in production in the EU should result in a global reduction in emissions. In parallel with the introduction of the CBAM mechanism, the free allocation of allowances in the EU ETS is to be phased out. Accompanying this increased price pressure on industrial sectors is expected to accelerate the pace of emission reductions in the EU ETS itself.

But the impact of the carbon border tax is supposed to go even further – it is supposed to create incentives for non-EU countries and businesses operating there to reduce emissions. An economic incentive is expected to act on third-country entrepreneurs: lower carbon intensity in the production of imported goods will result in a lower border tax burden and therefore improve the price competitiveness of goods sold in the EU. In turn, the CBAM’s ability to take into account the emission fee paid in the country of production of the good should encourage non-EU countries to introduce such policies at home. A less emphasized but also important goal of the carbon border tax is to improve the competitiveness of EU producers. They are saddled with the cost of clearing EU ETS allowances, which are rising significantly and are projected to get higher in the coming years.

Currently it is approx. 80 euros per t of_CO2, but various think tanks, including the Center for Energy and Climate Analysis (CAKE), which operates within the KOBiZE, estimate that in 2030. can reach approx. 150-180 euros per t of_CO2. These costs are borne by EU manufacturers, while they are significantly lower or even zero for non-EU producers. CBAM is supposed to offset this burden (but only for imports into the EU customs territory), as it ensures that the cost equal to the price of allowances in the EU ETS will be related to the emissions generated in the production of imported goods.

CBAM controversies and challenges

CBAM will affect international trade and is likely to cause some countries’ revenue from exporting goods to the EU to decline. As a result, the Union’s actions are accompanied by external criticism, and questions are raised about the mechanism’s compliance with World Trade Organization law. Such objections have been raised, among others. By the BRICS countries – Brazil, Russia, India, China and South Africa. International resistance may cause difficulties in introducing the mechanism. The EU, on the other hand, declares that CBAM has been structured to be WTO-compliant.

The challenge may be the verification of the reported emissions data itself. Under CBAM, the reporting obligation lies with the importer, but he must obtain information from the manufacturer of the goods (this is based on the production process used at the specific facility producing the goods), which operates in a third country. It may be doubted whether misrepresentation will occur in practice, especially in cases where a single manufacturer has several installations with different emission levels, or in countries where the government retains a high degree of control over companies (e.g., China).

At the same time, the CBAM mechanism itself has several limitations that may reduce its effectiveness in achieving its goals. First, it applies only to the import of goods into the EU customs territory. Meanwhile, some commentators and associations of EU producers have vociferously stressed the need for solutions to offset the costs arising from the EU ETS when exporting EU goods, to ensure that EU goods can more easily compete in non-EU markets. The European Commission itself, in its impact assessment, predicted a loss of 6.8 percent. export markets to foreign companies. Despite this, such solutions were not included in the adopted law. Critics point out that the withdrawal of free allocation in the EU ETS, combined with the current design of CBAM, will further increase production costs in the EU and will not prevent carbon leakage.

Second, by preventing carbon leakage for covered goods, CBAM may indirectly exacerbate the risk of carbon leakage in the sectors that use these goods (downstream products). An example is the automotive sector, where CBAM-covered steel is essential. EU producers have so far been able to import it with steel from outside the EU, unencumbered by an emissions fee. After the introduction of CBAM, they will always bear the cost of emission fees (with steel produced in the EU – resulting from the EU ETS, and with imported steel – from CBAM).

In contrast, non-EU automotive manufacturers will be able to purchase steel unencumbered by such a cost. This deterioration in the competitive position of downstream EU manufacturers, combined with other events such as subsidies and tax preferences introduced by the U.S., for example, could cause production to shift outside the EU (and thus increase carbon leakage) in these sectors, as well as worsen the situation of European industry rather than improve it. However, carbon leakage will not occur if non-EU countries introduce an emission fee on indigenous production of an amount equivalent to that in the EU.

What might the future bring?

Despite the above doubts and drawbacks, a number of studies, including one completed by CAKE, support the claim that CBAM has a beneficial effect on reducing greenhouse gas emissions. CAKE’s analysis shows that the implementation of the border tax will help reduce global emissions. In addition, it could have a positive economic impact, strengthening the competitive position of sectors that are most burdened by emissions settlements in the EU ETS. At the same time, CBAM will result in increased trade among EU countries and increased production for internal markets, while reducing imports from regions outside the EU. The latter circumstance will have the effect of strengthening the resilience of the Union’s economy to the effects of global crises, which is important, for example, in the context of the disruption of supply chains to EU countries observed during the crisis caused by the COVID-19 pandemic or sanctions against Russia.

However, CBAM is likely to have another effect, less tangible, but who knows if not more significant. He is trying to put into practice the idea of “carbon clubs” (carbon clubs), which among others. is promoted by Nobel laureate William Nordhaus. Their goal is to prevent some countries from benefiting from the actions and efforts of others, without their own contribution to climate protection.

CBAM provides a kind of extension outside the EU of the operation of the “price signal” from the EU ETS. If third countries, following the example of the EU, were to introduce analogous systems based on a price for emissions (taxes, ETS), CBAM as such would lose relevance and would only serve as a bridge to establish new levels of international cooperation to agree on coherent and effective global climate policy actions to ensure the stability of the world economy.

Authored by Anna Sosnowska – National Center for Balancing and Managing Emissions (KOBiZE) at the Institute of Environmental Protection-State Research Institute (IOŚ-PIB).

Robert Jeszke – Center for Climate and Energy Analysis (CAKE) at the National Center for Balancing and Managing Emissions (KOBiZE) at the Institute of Environmental Protection-State Research Institute (IOŚ-PIB).