Why the EU’s Carbon Border Tax will Fail to Stop Carbon Leakage

Guest essay by Eric Worrall

The EU is once again attempting to impose a carbon tax on all imports, to stop “carbon leakage”, the loss of manufacturing or other businesses relocating to lower cost countries. But a few simple economic calculations demonstrate why the EU’s plan will not stop the ongoing haemorrhage of business activity.

Carbon Border Adjustment Mechanism: Questions and Answers

Why is the Commission proposing a Carbon Border Adjustment Mechanism?

The EU is at the forefront of international efforts to fight climate change. The European Green Deal sets out a clear path towards realising the EU’s ambitious target of a 55% reduction in carbon emissions compared to 1990 levels by 2030, and to become a climate-neutral continent by 2050.

The July 2021 package in support of the EU’s climate targets is an integral part of our strategy to achieve this, and will further seal the EU’s reputation as a global climate leader. As part of these efforts, the Carbon Border Adjustment Mechanism (CBAM) is a climate measure that should prevent the risk of carbon leakage and support the EU’s increased ambition on climate mitigation, while ensuring WTO compatibility.

Climate change is a global problem that needs global solutions. As we raise our own climate ambition and less stringent environmental and climate policies prevail in non-EU countries, there is a strong risk of so-called ‘carbon leakage’ – i.e. companies based in the EU could move carbon-intensive production abroad to take advantage of lax standards, or EU products could be replaced by more carbon-intensive imports. Such carbon leakage can shift emissions outside of Europe and therefore seriously undermine EU and global climate efforts. The CBAM will equalise the price of carbon between domestic products and imports and ensure that the EU’s climate objectives are not undermined by production relocating to countries with less ambitious policies.

Read more: https://ec.europa.eu/commission/presscorner/detail/en/qanda_21_3661

Why does this tax put an EU producer at a disadvantage?

EU Border Tax – No Sale

Simple – selling to another EU entity is price competitive, so far, but selling outside the EU is impossibly expensive, because you are competing with other sellers who don’t pay EU carbon taxes. An exporter outside the EU has an advantage over a manufacturer inside the EU, even if they have to pay a carbon border adjustment.

What about if the EU tries to level the playing field for EU based exporters, and applies a tax credit to exports? This opens the door to massive global carbon carousel fraud.

EU Carbon Tax Carousel FraudEU Carbon Tax Carousel FraudEU Carbon Tax Carousel Fraud
EU Carbon Tax Carousel Fraud

Either the EU destroys their own exporters, in an attempt to protect their domestic industry, or they have a big firefight on their hands, trying to contain carbon carousel fraud, which will only get worse any time they try to ratchet up their carbon price.

What about the effect of carbon pricing on businesses inside the EU carbon tax zone?

Classic supply and demand graphClassic supply and demand graphClassic supply and demand graph
Classic supply and demand graph, showing the impact on quantity of a tax driven rise in price per unit. In this case quantity is assumed to be a proxy for economic activity.

Ever visited a shopping centre, and wondered why all the interesting shops are slowly replaced by clothes shops or other high turnover businesses? The reason is all those interesting shops are not profitable enough to pay the rent, and over time they are replaced by simpler, less interesting businesses – safe, boring, profitable, but still a contraction in the diversity of life choices available to consumers.

Pretty much the same thing would happen to domestic high carbon businesses afflicted by EU carbon pricing.

The EU at least in principle likely hopes that revenue from the carbon tax will drop to zero, as people discover low carbon or zero carbon alternatives to the high carbon goods they currently use such as alumina, or simply learn to live without.

But this is a huge gamble. The only reason for carbon leakage in the first place is because the carbon intensive goods targeted by the EU are difficult to replace with low carbon alternatives, and difficult to live without.

If a carbon intensive good is irreplaceable, continued dependency on that high carbon good will be an ongoing anchor dragging on the European economy.

Of course you could make an argument that the benefits the people of the EU receive from reduced CO2 emissions outweigh the costs, that one day our descendants will thank us for giving them the opportunity to experience cold weather. But this does not help consumers and businesses today.

In conclusion, the EU carbon border adjustment will do nothing to prevent carbon leakage. The EU does not control enough of the global economy to make it more than an inconvenience for multinationals. The only people the EU border carbon adjustment will hurt are people living in the EU, who will see their choices and opportunities contract.

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July 20, 2021 at 12:13PM

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