Border Adjustment Mechanism (CBAM): A Nonviable but Prospective Instrument of
In line with its commitment to
climate action under the Paris Agreement, the European Union (EU) aims to be
climate-neutral by 2050.2 Pledging to drastically
reduce Europes greenhouse gas emissions, the 2019-2024 European Commission
(EC) envisages a number of measures.3 One such decarbonisation measure has already jolted climate
and trade discussions around the globe: China, Russia and the United States
have made it known that they oppose it. The measure may appear to be a
market-access anti-dumping and anti-subsidy defence instrument in disguise.
The Carbon Border Adjustment
Mechanism (CBAM) is a measure tackling the carbon intensity of domestic and
imported products. Three ways of CBAM implementation are being discussed:
carbon tax on imports and domestic production, a customs duty on imports, and
the extension of the EU Emission Trading System (ETS).4 All of these forms would require the calculation of carbon
benchmarks for products covered by the measure. The purpose is multifold as well: a CBAM would preserve the integrity of
EU climate policy and industrial competitiveness;5 it would ensure that all emissions come with a cost,
regardless of their country of origin;6 and it would help avoid the risk of carbon leakage, i.e., the
loss of sales or entire industries to cheaply-priced, carbon-intense imports
As it brushes against the
non-discrimination and other rules of the World Trade Organisation
(WTO),7 CBAM represents no silver bullet. The intended 2021 publication of
a CBAM proposal will affect a delicate balancing act8 between EUs
commitment to becoming the worlds first climate-neutral continent,9 the
preservation of its competitiveness, and the rules-based international trading
system. Aligning trade policy with decarbonisation, a CBAM may cause more
problems than it attempts to solve. Nevertheless, even if the current version
of the EUs CBAM proposal may be neither technically viable nor WTO-compatible,
the EU should keep it on the agenda for increasing its leverage in debating
climate action internationally, while developing parallel mechanisms and
stronger clean-industry markets for a carbon-freer future.
With CBAM, the EU attempts to avoid
the risk of carbon leakage caused by the high cost of EUs emissions-cutting policies. Through
direct carbon leakage companies might reduce output as the foreign companies
output increases (i.e., operational leakage), and eventually relocate to other
regions in order to avoid the carbon tax (i.e., investment leakage).
Through indirect leakage, EU
climate policies would cause a lower fossil fuel consumption: the global fossil
fuel prices would fall to the benefit of foreign fossil-fuel consumption. Even
if there is little evidence of any carbon leakage to date,10 the risk will
increase as the EU tightens its emissions target for 2030 and free allowances
under the ETS continue to decline.11
Putatively, a CBAM might address such
risks. It would be designed to protect businesses from carbon dumping outside
the continent. According to President von der Leyen,
There is no point in only reducing greenhouse gas emissions at home, if we
increase the import of CO2 from abroad. For her, this climate issue is an
issue of fairness towards our businesses and our workers. We will protect them
from unfair competition.12 While such ecology-and-business protectionist
ideas are not new,13 they have intensified with the 2019 European Green
Deal package and have generated significant technical, political and legal
Technical challenges of a CBAM include the difficulty of assessing carbon content
of products as data may be hard to trace. Industries may refuse to disclose
information on their supply chain. Moreover, a significant portion of carbon
leakage cannot be addressed by a CBAM (at least in its carbon border tax form)
since the leakage is predominantly driven by the fossil fuels energy price
channel (cf. indirect leakage, above).14 Furthermore, relatively few
industries face the risk of potential carbon leakage: steel, mineral
products/cement and aluminium production. While any CBAM would thus need to be
sector-specific, an additional challenge arises. Other industries may be in a
general sense equally or even more polluting and detrimental to the planet in
terms of green-house emissions. The examples include the transportation sector,
the energy sector and others. Finally, depending on the type of leakage, many
factors can outweigh its effects: transportation, non-tariff costs, political
risk, exchange rate concern, product differentiation, as well as the quality of
capital, labour and energy available in an economy.15
Political challenges16 may first relate to the use of money. The current plan of
the EU 2021-2027 financial framework stipulates that revenues from a CBAM will
contribute to the own resources of the EU budget for redistribution to the
economy.17 Such a proposal is damaging in terms of legal compliance and
cooperation with foreign partners.18 Instead of adding to its budget, it
might be politically more prudent to send CBAM revenues to developing countries
affected by the measure. Moreover, the international community will very likely
oppose negative impacts for carbon-intensive export, the cost of compliance and
extraterritorial overreach. In 2012, the EU already tried to game carbon
pricing through air transport services for the full distance of flights
arriving from outside of Europe.19 The EU had not only to learn that
carbon emissions may be correlated with distance but also to bury the proposal
after Chinese threats to cancel Airbus orders.20 Finally, any EU
preferential treatment of clean domestic and foreign producers would affect
less developed countries, further disbalancing trade and climate negotiations.
At least under its carbon border form, CBAM would exacerbate pre-existing
income inequalities as richer countries would shift the burden of reducing
emissions to poorer countries.21 True, the EU could exclude from CBAM the
developing countries or countries with carbon-pricing mechanisms that the EU
agrees are compatible with its own.22 However, that would defy the purpose
of CBAM as its overall climate impact would decrease.23
Legal challenges are probably the most burdensome and difficult to overcome,
especially those concerning the CBAMs WTO compatibility. Questions that the EU
must address in this regard are those of national treatment and the
compatibility with Articles II and III of the General Agreement on Tariffs and
Trade (GATT). While Art. II.2 requires any border tax to be implemented on
like products to those taxed domestically,24 Art. III.2 does not allow
the border tax to exceed the domestic tax rate (cf. below). The challenge is
that the carbon emissions for like products can be drastically different.
Also, to be effective, benchmarks would have to be determined for a whole array
of products and variations of those products. In other words, determining
whether products are alike creates a trade-off between the implementation ease
and environmental effectiveness (e.g., is steel the same if produced by
pollution-varying methods such as a blast furnace vs. an electric
mill).25 Research suggests that the best option for WTO compatibility
would be a product-based tax that does not vary by reference to carbon
intensity of production but is set at a fixed rate for specified categories of
Multiple political and regulatory
manoeuvres would be necessary for a CBAM to pass at the international and WTO
levels. The EU industry cannot expect any protection in competing with higher
carbon prices since trade partners will be encouraged to retaliate legally.
That is, the EU competitiveness argument is not WTO compatible. Measures of
discrimination cannot stand.
Any CBAM that, for example,
incorporates export rebates could appear as a protectionist measure (cf. Art.
I, II, III of GATT). For WTO compliance, a CBAM must assure non-discrimination
between imported and domestic goods (Art III.2; cf. above).
Some suggest that solution on this front
might be the extension of the EU ETS since it would ensure that a CBAM applies
to like domestic products.27 That is, domestic producers and importers
would need to pay the same carbon price. Any rebates exceeding a firms actual
carbon costs could otherwise be viewed as illegal subsidies.28 Also,
importers would need to have the opportunity to demonstrate the specific carbon
content of their imports in order to avoid a discriminatory treatment in the
assessment process. While such a measure is burdensome and politically
sensitive, it has a higher likelihood to be WTO compatible if challenged.
However, EU tradeable permits markets seem to be crashing. So, how could one
imagine this rolling out on an international basis?
What is more, CBAM must abide by the
most-favoured nation clause (Art I.1). This is possible only if the method to
determine the carbon content is the same for all imports and if importers are
allowed to deduce the carbon price paid in their home country. That would make
the measure non-discriminatory, given that the same conditions do not prevail
in third countries. Yet, since the likeliness of products has yet to be defined
with regards to carbon intensity of products, products may or may not have to
be taxed equally, and a differentiation by the carbon content of a product
might breach international trade rules.29
Should none of the above tactics
work, the EU might have a final even if non-viable resort to the
environmental argument. According to Art. XX(g), exemptions can be applied for
tariffs that protect human, animal, or plant life or health or when they are
related to the conservation of exhaustible natural resources. Nevertheless,
this approach is politically delicate in addition to the difficulty of
providing clear carbon leakage evidence.30 Moreover, the design of the
tariff would need to be explicitly implemented for global environmental
purposes rather than to shield the EU from competition.31 Finally, linked
to economic status and sovereignty issues, countries like India have long
objected to the environmental argument on the multilateral stage. In short, if
the EU desires to keep advocating for free trade, its own CBAM should not be
perceived as a restriction in disguise. The challenge is that invoking the Art.
XX(g) item is easy, but clearing the Chapeau is not (i.e., the introductory
clause of Art. XX, emphasizing GATTs exceptions and the manner in which a
measure in question is applied).32 Since any effort would have to be
applied in a non-discriminatory way to clear the Chapeau, it would come down to
how one defines national treatment.
An Extension: Create New Markets Instead
How could the EU avoid obvious
pitfalls of the CBAM, avoid the risk of regulatory scrutiny,33 and
capitalize on legally compliant opportunities?34 The optimal solution can
only be a strategic one. The EU needs to acknowledge the concern of
international businesses and politics over any form of a carbon
tax.35 While the EU can and perhaps should push for legal and political
benefits of a CBAM, it should at the same time invest in the creation of
completely new markets for clean products.
Savvily pressuring the international community on climate action through
CBAM-like taxation threats, the EU could in a parallel action create its own
conditions for Europes most promising low-carbon sectors to grow.
Such support systems have worked in
the past for renewables (e.g., solar panels): as foreign competitors saw not
only a dramatic drop in costs but also that meeting higher targets is possible
and the technology available, they were more likely to sign the Paris
agreement. The EU and the planet for that matter would benefit from gaming
a CBAM as a deterrent (even if not implemented) while supporting clean
alternatives by relying on Europes capital, institutions, strong intellectual
property rights, a relatively innovative industry and, after all, free trade.
Morningstar, the founding chairman of the Atlantic Councils Global Energy Center, at a 2020 February event, reported by Times, in
How Europes Border Carbon Tax Plan Could Force the U.S. To Act on Climate
accessed Jan 31 2021.
2 Cf. 2050 long-term strategy, EC webpage, at: https://ec.europa.eu/clima/policies/strategies/2050_en,
accessed Jan 31 2021. Cf. also The 2020 Climate and Energy Package https://ec.europa.eu/clima/policies/strategies/2020_en,
accessed Jan 31 2021.
3 Out of 163 National Determined Contributions (NDCs) to the Paris
Accord, 90 include the use of market and trade mechanisms. Such instruments are
designed to reach the targets of the Paris Accord nationally, with subsidies
for green technologies and environmentally friendly companies and producers,
special taxes and the enforcement of strict environmental regulation. They also
aim to externalize environmental protection with the use of tariffs, market
access restrictions and clauses in Free Trade Agreements (FTAs). These measures
are likely to increase conflicts which will be tackled through the framework of
the WTO dispute settlement body. P. R. Guix (Jan 25
2021) Greening the World Trade Organization: five priorities for EU foreign
accessed Feb 1, 2021.
4 Cf. S. Rilling (Dec 15 2020) ICIS EU Carbon: Carbon Border Adjustment
Mechanism possible implementations and EUA market implications https://www.icis.com/explore/resources/news/2020/12/15/10585694/icis-eu-carbon-carbon-border-adjustment-mechanism-possible-implementations-and-eua-market-implications, accessed Jan 31 2021.
5 As shown by Tsafos, The most important
reason to impose a carbon border adjustment mechanism is to secure the buy-in
of local industry for deeper decarbonization policies. N. Tsafos
(Aug 7 2020) How Can Europe Get Carbon Border Adjustment Right? https://www.csis.org/analysis/how-can-europe-get-carbon-border-adjustment-rightt,
accessed Feb 6 2021.
6 Carbon Border Adjustment EUROFER contribution to the public
consultation (November 12 2020) https://www.eurofer.eu/publications/position-papers/carbon-border-adjustment-eurofer-contribution-to-the-public-consultation/,
accessed Feb 1, 2021.
7 Cf. K. Taylor, idem.
8 The climate neutrality objective needs to be achieved in a way
that preserves the EUs competitiveness, including by developing effective
measures to tackle carbon leakage in a WTO compatible way. In this context, the
European Council takes note of the Commissions intention to propose a carbon
border adjustment mechanism concerning carbon-intensive sectors. Facilities in
third countries need to adhere to the highest international environmental and
safety standards. From European Council Conclusions on Climate Change, Zagreb,
6 March 2020, Subject: Long-term low greenhouse gas emission development
strategy of the European Union and its Member States, https://unfccc.int/sites/default/files/resource/HR-03-06-2020%20EU%20Submission%20on%20Long%20term%20strategy.pdf,
accessed Feb 1, 2021.
9 Ursula von der Leyen (Sept 10 2019)
The von der Leyen Commission: for a Union that
strives for more https://ec.europa.eu/commission/presscorner/detail/en/IP_19_5542,
accessed Feb 1, 2021.
10 G. Zachmann and B. McWilliams (Mar
2020) A European carbon border tax: much pain, little gain Bruegel Policy
Contribution Issue n˚5, http://aei.pitt.edu/102592/1/PC-05-2020-050320v2.pdf,
acc. Jan 31 2021, p. 4.
11 K. Taylor, idem.
12 Davos 2020: Ursula von der Leyen
warns China to price carbon or face tax (Financial Times, Jan 22, 2020)
accessed Jan 31, 2021.
13 Consider the 2007 draft by the Commission, the 2009 French
non-paper or the 2016 French non-paper for cement. Cf. also C. Stam and L. R. Moscovenko (Sept 14 2020) EU carbon border tax: How a
French idea ended up in the limelight https://www.euractiv.com/section/energy/news/eu-carbon-border-tax-how-a-french-idea-ended-up-in-the-limelight/,
accessed Jan 31 2021 as well as EU leaders to consider carbon border tax
(June 30 2020) https://www.argusmedia.com/en/news/2118909-eu-leaders-to-consider-carbon-border-tax,
accessed Jan 31 2021.
14 Cf. G. Zachmann and B. McWilliams,
idem., p. 4.
15 Cf. G. Zachmann and B. McWilliams,
idem., p. 6.
16 Besides foreign political obstacles to CBAM, internal political
challenges play a role as well. If CBAM is implemented as a carbon tax, it
would require unanimity in the European Council in order to be adopted.
Likewise, if it is a custom duty, it would require unanimity. True, special
legislative procedures could be used to circumvent unanimity but that would
infringe on the democratic process. Only the third implementation option an
extension of the EU ETS to imports would require a lower threshold, a
qualified majority in the European Council. In this case, importers would have
to buy allowances to cover their emissions or pay a levy based on the market
price of allowances. The type of allowances accepted could be EUAs, a separate
pool of virtual allowances or allowances from other established markets with
clear emission caps. S. Rilling, idem.
17 Cf. G. Claeys, S. Tagliapietra
and Bruegel (Jul 23 2020) Is the EU Council agreement aligned with the Green
Deal ambitions?, https://www.bruegel.org/2020/07/is-the-eu-council-agreement-aligned-with-the-green-deal-ambitions/,
accessed Feb 6 2021, as well as Dr2 consultants (Aug 5 2020) Summer recess
whats next? https://dr2consultants.eu/tag/multiannual-financial-framework/,
accessed Feb 6 2021.
18 Cf. G. Zachmann and B. McWilliams,
idem., p. 11-12.
19 Cf. A. Sapir and G. Zachmann (Mar 15
2012) EU Carbon levy: try to avoid air turbulences Bruegel Blog.
20 Cf. B. Lewis (May 13 2013) Exclusive-Airbus to China: We
support you, please buy our jets Reuters.
21 Cf. Bohringer, C., J. Carbone and T.
Rutherford (2016) Embodied Carbon Tariffs The Scandinavian Journal of
Economics vol 120(1).
22 Cf. B. Aylor, M. Gilbert, N. Lang, M.
McAdoo, J. Öberg, C. Pieper, B. Sudmeijer
and N. Voigt (June 30 2020) How an EU Carbon Border Tax Could Jolt World
accessed Jan 31 2021.
23 Cf. G. Zachmann and B. McWilliams,
idem., p. 11.
24 Until now, the WTO has determined whether products are like
one another by examining their end use, consumer tastes and habits, and their
physical characteristics, along with whether they compete with each other. Cf.
Hillman J. (July 2013) Changing Climate for Carbon Taxes: Whos Afraid of the
WTO? Climate & Energy, Policy Paper Series, German Marshall Fund of the
25 Cf. Hillman, J. (2013), idem.
26 Trachtman, J. (2016) WTO Law Constraints
on Border Tax Adjustment and Tax Credit Mechanisms to Reduce the
Competitiveness Effects of Carbon Taxes Resources for the Future Discussion
27 Consider a hypothetical and heuristically useful example
provided by Zachmann and McWilliams, 2020 (cf.
above), p.9: Under the ETS, free emissions allowances are given to companies
based on how well they perform against product-related benchmarks, with only
the best 10 percent of performers receiving all allowances for free. Benchmarks
(for example, 1.62 tonnes of CO2 generated per tonne of ammonia produced) have
been determined for more than 50 products15. Using such a well-established
methodology, which has not so far been challenged at the World Trade
Organisation, could resolve some complicated technical questions at the
beginning. But over time the question will arise whether the benchmarks should
evolve in step with EU decarbonisation16 or if the benchmark should be kept at
its initial level.
28 Cf. S. Rilling, idem.
29 S. Rilling, idem.
30 Cf. S. Rilling, idem.
31 Hillman, J. (2013), idem.
32 See World Trade Organisation, WTO rules
and environmental policies: GATT exceptions https://www.wto.org/english/tratop_e/envir_e/envt_rules_exceptions_e.htm, accessed Feb 15 2021.
33 There is a tactical possibility of creating a wide
international alliance with other countries that might join an EU initiative to
introduce domestic climate policies, together with a jointly-designed CBAM that
might alleviate some of the concerns. But some countries, including the US and
China, might have structural reasons to dislike such an approach. In Böhringer et al, idem.
34 Cf. N. Tsafos, idem.
35 As a response, the ECs international policy need to
continuously reiterate its promises to use all positive avenues of our climate
diplomacy to avoid a situation where proactive measures would somehow come as a
surprise to our partners [and to make] sure that whatever is introduced will be
compatible with WTO rules. In K.