Europe, a Carbon Tax, and Climate Change

This is the 2nd and final part on Europe’s new climate proposals introduced last week. You can read the 1st part – Europe, Carbon Markets, and Climate Change, here

What do you do when you face an existential threat that causes catastrophic weather events almost whimsically, but you have been perpetuating the underlying causes for a little under a couple of hundred years? You have two choices –

a/ Discount history, and take all necessary steps considering the scale and imminence of the threat, that will infringe those that aren’t as culpable as you, or

b/ Account for history, say mea culpa, and do what you must and help lead a global response on the threat without infringing the not-as-culpable

The subject of a carbon border tax, officially called the Carbon Border Adjustment Mechanism (CBAM) under the proposed EU regulations to fight climate change, falls squarely under option A. That is because, option B means you are spending resources fixing past misdeeds that come at the cost of current and future growth.

Here is an excerpt that tells us what a carbon border tax actually does –

When companies in the European Union make products, many of them are required to purchase permits for the climate-warming carbon emissions that are produced in the process.


Carbon leakage happens when goods that would normally be purchased locally are instead imported from companies elsewhere that don’t face the same regulations. It also occurs when local companies move their production to another location to avoid having to cut their emissions.


The result is emissions that continue unabated, and those emissions affect the entire planet.

A carbon border tax is intended to prevent this leakage by imposing the same cost on imports that don’t face carbon taxes at home.

The EU wants a carbon border tax on imports – but would it do the job officials expect? The Conversation

The carbon tax applies to companies outside the EU that want to sell cement, iron, steel, fertiliser, aluminium, and electricity into the bloc. They will be expected to pay proportional price of emissions in the EU carbon markets for the volume sold.

Whether or not the EU has locus standi to tax other countries for lax to no emission controls in manufacturing is as much a moral question, as it is a question of who bears responsibility for the current climate crisis. As with everything about morality, you cannot make a choice that somebody else would not find amoral.

This post is not a polemic against the European Union’s efforts to fight climate change or a moral lecture on what the best course of action is. If you have read my previous post, you’d know I am an admirer of their endeavour.

I personally think that the proposed carbon tax does not rank well on any scale of pragmatism and will dent what are already slender hopes of a coordinated, cooperative global response to tackle climate change.

Before I explain why it does more harm than good, here are my (unbiased) caveats that explain why it is understandable that the EU went ahead with this

— The proposal is a blueprint and is due to take effect in 2026 with a gradual phase-in. This phase-in is to give countries with high-emissions manufacturing to adjust to the new regulations and allow the EU to whet their appetite for the proposed taxation regime

— This move could potentially spur such countries to price carbon domestically. If that was to happen at-scale, companies paying for emissions in non-EU markets could pay the taxation difference, as per the provisions

— There are not a lot of medium to large export economies without climate regulations, but there are aplenty without robust enforcement

— A carbon tax has been debated for some time now and if anybody had the wherewithal to try it, it could have only been the EU – because the bloc insulates individual countries from a competitive disadvantage when it comes to taxing essential industrial imports

— Europe’s Emission Trading System established in 2005 put its manufacturing competitiveness at risk by making firms buy emission permits and that increased costs. This was offset through subsidies and free allowances, and this could not have continued indefinitely

With this out of the way, here are two explanations for why it has the potential to stifle progress on a global response to the climate crisis.

It only addresses the economics of carbon emissions and bears close resemblance to an ostrich effect when it comes to the politics of it

Firstly, the EU shouldn’t call what is essentially a tax, as an adjustment. It is like calling traditional car models as ‘movement-oriented combustion engines.’ Secondly and more importantly, this move will very likely shift the narrative from climate action, resulting in trade tensions, reciprocated through prohibitive, counter-tariff setting. Top exporters in the sectors where the carbon tax is applicable, such as United States, Russia, and China, have all expressed their objection to varying degrees.

While the provisions currently allow for bilateral negotiations with individual countries, especially the ones proactively adopting strong climate policies, it is not in good faith with countries dealing with other equally pressing developmental priorities. Pandemic response, universal vaccination coverage, increasing unemployment, widening inequality, and stimulating local economies, all point towards higher resistance to what could be perceived as external pressure. It is likely to create friction and further drive a wedge in a world where domestic politics are increasingly taking nationalist undertones.

It will have unintended consequences and has significant opportunity costs if we persist with a problematic policy when more is required

I will admit that a carbon tax has not been tried before (except in the state of California and with dubious results while we are at that), and it might be remiss to claim something would not work without evidence. But there is a rich history of policymaking and enough precedents where poor policy design has resulted in skirting or circumvention.

~80% of the proceeds from the existing EU Emissions Trading System has been directed towards renewable energy, energy efficiency, and sustainable transportation projects, but financing first-order initiatives is convenient when there are funds available. Carbon offset programs are a classic example of what happens when you prioritise compliance, resulting in disinterested action when it should be deliberate.

More importantly, the companies within the sectors identified have varied wherewithal to invest in developing low-carbon or no-carbon manufacturing processes. This would be moot should technologies be commercially viable and are easily accessible, but we are some years from that.

Resource shuffling” is a very real possibility, where foreign companies send their cleanest exports to the EU, resulting in a reallocation instead of an overall reduction in emissions.

The biggest externality is what it will do to manufacturing ecosystems. Imagine this – steel imports from countries with lax to no enforcement of emissions control are taxed when they sell to Europe. At the same time, EU steel manufacturers are paying for their emissions locally and it is built into the product’s costs making it uncompetitive in non-EU markets. If we follow this scenario to its end, it will most likely result in EU-manufactured steel for the EU markets (*cough* protectionism *cough*), while the rest of the world continues to operate in a business-as-usual scenario. That helps no one. This is under a rather reasonable assumption that countries do not step up their efforts to set up national carbon markets and price domestic emissions.

I do not know how Europe’s new policies will play out or whether there are better ways to go about it, but I will repeat what I said in one of my earlier posts –

What is encouraging and frustrating about a low-carbon future in this world is that it is down to the seriousness of a few nations to follow through on their commitments.

I sincerely hope the EU pulls off a diplomatic masterpiece in pushing forward with its carbon tax, spurring US and China into following them with coherent and consistent policies, and constructively engaging with developing countries with looser environmental standards (read: India) in supporting their transition to a low-carbon future.

All eyes will be on Glasgow when it hosts the next set of the UN climate talks (COP 26) in November this year.

The next few months are critical to set a conducive tone for constructive dialogue and align on clear goals that must include a version of the following –

1/ In countries with high emissions and advanced reduction strategies, push for increasing the price of carbon

2/ In countries with high to moderate emissions and limited to no reduction strategies, incentivise and support setting up of provincial or regional carbon markets to discover the price of carbon locally

3/ Push developed countries to renew their vows of supporting poorer economies with limited carbon footprint, to adapt to and the mitigate the effects of adverse climate events

I am finishing off with a quote from our dear Mr. Timmermans, like I did in the first part of this two-part series –

The onus is on the Commission to prove that this leads to solidarity and to fairness in this transition.


If we can prove that, I think the resistance will be less. If we fail to prove that, I think the resistance will be massive.

Europe Unveils Plan to Shift From Fossil Fuels, Setting Up Potential Trade Spats, The New York Times

Touché again, Mr. Timmermans.

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