Realising the benefit of a global carbon tariff

Author: Vinod Thomas, AIM

Taxing the carbon content of imports, if done right, can contribute to cutting global emissions and slowing climate change. The European Union has made the first such proposal, and its potential for good or for harm can be seen in relation to how it might work in Asia — the bloc’s major trading partner and a region with very high stakes on global warming.

The proposal will enhance the wellbeing of people and the health of the planet if its implementation contributes to lowering the high carbon intensity of international trade in Asia. But it will turn into an economically costly project if it degenerates into a protectionist trade war between regions.

The starting point for worrying about international trade in the context of climate change is that calculations of country responsibility for global emissions usually leave out the roughly one-fifth of effluents that are embedded in traded goods. Accounting for these would be timely as the divergence between consumption and production-based emissions has been rising. Instead of a 3 per cent increase in production-based emissions since 1990, the United States now shows a 14 per cent rise of consumption-based emissions.

Beyond the global case for addressing the carbon content of trade, the European Union has special concern. As the region has adopted carbon pricing through a domestic emissions trading scheme, there needs to be a cost adjustment at the border that ensures a level playing field for imports and domestic production in the same categories. ‘Carbon leakage’ is said to take place when pollution control in the European Union leads its producers to relocate to Asia where the environmental standards are looser.

To protect the competitiveness of domestic industries, industrial installations with lower allowable emissions and a risk of carbon leakage would receive free allowances — which should not be necessary after the border taxes are in effect.

The European Union’s proposed ‘carbon border adjustment mechanism’ would place a tariff on highly carbon-intensive imports, a plan that has resonated among Democrats in the US Congress. The import tax would reflect pollution control costs of the European Union’s emissions trading system. Cement, iron, steel, aluminium, fertiliser and electricity would be among the most affected items, all of which are important to Asian regional trade.

For example, China, South Korea, the United States and Germany account for more than one quarter of global imports of iron and steel. Turkey, Russia and South Korea are the top exporters of iron and steel to the European Union. Australia exports AU$20 billion (US$14.6 billion) in goods to the European Union, including gold and coal, but may not be in the top 10 affected countries.

The EU proposal is for a differential approach on imported goods based on whether there is a carbon price in the exporting country. This differentiation might be acceptable vis-a-vis the World Trade Organization’s most-favoured-nation rule on environmental-protection grounds. According to the EU proposal, if exporters have paid a carbon price in their countries, they would be eligible for an equivalent credit to offset the import tax. But this is currently not an argument Australian companies can make, as the country’s carbon pricing scheme of 2014 has been removed and no equivalent alternative is in place.

Asia has arguably the largest blend of high, middle and low-income economies among the world’s regions. Differences in income levels make a case for an allowance for the low-income nations either in terms of the carbon tariff rate or the time frame for its adoption. Low-income countries have also made a consistent case for financial support for their energy transition from high-income countries.

Juxtaposed with the case for border taxes on carbon are the risks. Most importantly, the EU tariff should not be highjacked for domestic protection of industry, nor should this policy move turn into a trade war without achieving significant cuts in carbon emissions — its primary rationale.

The tariff should also not be used as a blunt instrument hitting imports from a country but rather designed to target carbon emissions of imports, motivating the exporter to switch to less-polluting ways. The desired environmental outcome calls for a shift to low-polluting fuels rather than export diversion to others, sidestepping pollution abatement.

A desirable scenario would be that Asia, together with other emitting regions, cuts carbon emissions sufficiently for the…

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