Are carbon border taxes just more hot air?
Jean-Marc Daniel and Anna Souakri of ESCP Business School cast an eye over the European Commission’s carbon tax proposal, and underline its many shortcomings
In 2021, after rejecting the first draft and following a period of intensive lobbying by the businesses directly affected by the reform, the European Parliament finally approved the Commission’s proposal for a Carbon Border Adjustment Mechanism. The CBAM is the cornerstone of the “Fit for 55” package which aims to put the EU at the forefront of international efforts to cut carbon emissions. Heralded by the French government as a “victory” paving the way for the EU to achieve “energy self-sufficiency”, the final text of the CBAM actually looks more like a failure when we consider its ambitious initial objectives.
The principle of imposing a surcharge on goods imported into Europe, calculating their equivalent carbon cost with reference to the current price per tonne of carbon under the European Union Emissions Trading Scheme (EU ETS, otherwise known as the carbon market, introduced in 2005) is a step in the right direction. Nonetheless, the conditions under which this measure is to be implemented will ensure that it is largely meaningless, due to the persistent uncertainty surrounding measurements, the numerous exemptions, and the plans for how the funds raised are to be used.
Reducing emissions
In concrete terms, and after a transitional phase from 2023 to 2025 involving voluntary declarations, companies importing goods into the EU will have to purchase certificates corresponding to the amount of emissions generated in the production of those goods, charged at the same price applied under the EU ETS. How will these emissions be calculated? Using data provided by the countries exporting the goods, or else the default values for the relevant industrial sector. It is, however, very difficult to measure CO2 emissions at their point of production.
Of course, we have no guarantee that exporters will be rigorous in their declarations; in fact, it is in their interests to underestimate their emissions in order to remain competitive. The European regulators tasked with verifying the reliability of these data will soon find that transparency is a distant dream.
A measure with limited impact
The task is rendered all the more difficult by the fact that there has been no harmonisation of the methods used to calculate CO2 emissions in different countries. In terms of non-financial reporting, the EU is currently finalising its first package of standards under the CSRD banner (Corporate Sustainability Reporting Directive), while the US and UK both have their own rules. Everybody is moving forward with their own methods and definitions of scope, and at time of writing, many countries are yet to introduce any genuinely binding regulations. The impact of the CBAM is thus attenuated by the lack of precision which besets the measurement of CO2 emissions, not to mention the combined effect of various extra-financial and diverging regulations.
Put simply, the US-fostered one (ISSB – developed by IFRS) and the SEC (Securities and Exchange Commission) consider only the financial impact of the ecosystem on companies, e.g simple materiality, and its indicators are broad and essentially on climate versus European standards (CSRD, developed by European Commission & its EFRAG expert group) have a double materiality approach that is the financial impact of the ecosystem on companies and conversely, the company’s impact on the ecosystem.
Moreover, the remit of the CBAM will only gradually be expanded. Many industries have wriggled out of it for now, and will be hoping for more prevarication in the future, with deadlines receding into the distance just as they have done for the end of free CO2 allowances (licenses to pollute), which are now delayed until 2032, unless some other exceptional circumstances come along to change the state of play. And it is all the more worrying that, commenting on the 27 October final agreement between the European Parliament, the European Commission and the European Council to ban sale of combustion engine vehicles by 2035, the European Commissioner for the Internal Market, Thierry Breton said that it is very likely to resort to the review clause in 2026 and to delay beyond 2035. Or the clause may be reconsidered because combustion-engine vehicles are a source of external competitiveness and jobs for Europe so that their production should be maintained. If such a downgrade on a similar regulation to the CBAM part of the Green Plan of the EU is so considered, the same could occur with the CBAM.
Dispelling the myth of the painless transition
Last but not least, the CBAM in its current form runs contrary to the very principle of a carbon tax in the Pigovian sense of the term. Following the English economist Arthur Cecil Pigou’s definition, a carbon tax would seek to eliminate a negative externality (in this case, CO2 emissions) by creating a market capable of sending a price signal, and by using the sums raised to fund measures aimed at combating the negative externality in question – in this case, green energies and research.
But in reality, the plan is to use the CBAM to pay down some of the debt incurred during the Covid pandemic, and also to boost the European Social Fund. Worse still, the recent policies that European countries have taken to alleviate the effect of inflation – mainly caused by the energy crisis resulting from the war in Ukraine – boil down to subsidising fossil energy consumption (e.g: gas price cap, rebate for fossil fuel, etc.). All this does is increasingly distort the price signal and perpetuate the consumption of non-sustainable energy, instead of bringing about real change towards sustainable energy consumption patterns. This creates a moral hazard which will be reinforced if the sums raised by the CBAM are used to maintain such policies. And weak signals indicate that it is very likely given the EU countries are in discussion for a fossil fuel energy price cap based on over-taxation of sustainable energy. This was announced by President of the European Commission Ursula von der Leyen on 7 September in the midst of a debate on the notion of a “super profits tax” in several European countries and a mechanism for this contribution at European level.
Ultimately, these limitations are indicative of a deeper problem: the refusal to acknowledge that the energy transition will come at a cost, and that we will all have to pay. As economist Christian Gollier has shown, the idea of a cost-free energy transition is pure fantasy.