Carbon Border Taxes 101: What Are They & Why Do We Need Them

According to a recent study, our planet’s global temperature will eventually rise in excess of 2°C from the greenhouse gases that are released by companies and other services around the world. No surprises there. Many experts agree that the goals outlined in the Paris agreement, which hope to limit global temperature rise to well below 2°C, will not be achieved based on our current track of consumptions and emissions. This means severe consequences for all of humanity, unless governments are able to come together and start implementing strict measures like the introduction of carbon taxes and carbon border taxes that would redirect liability of the effects of climate change on the perpetrators themselves. 

Scientists warn us to brace ourselves for impending doom almost weekly, and we are already witnessing the disastrous effects of global warming from sea-level rise to mass displacement to drought and wildfires.

To negate these effects, several governments around the world are re-framing policies and proposing plans like the recent EU proposal of the carbon border tax. We’re diving deeper into what this means and the consequences for the climate if implemented.

What is a Carbon Tax?

Back in 1979, U.S. House of Representatives congressman John Anderson proposed a US$ 50-cent-per gallon energy conservation tax on motor vehicle fuels to lessen consumption and dependency on foreign oil. His proposal outlined utilizing the revenues from the tax to reduce payroll taxes by 50%, increase Social Security benefits and compensate those who were not on a payroll.

Anderson was lucid about the potential backlash, saying at the time: “I am under no illusions regarding the popularity of this tax. But higher gasoline taxes in this country are unavoidable. We have no choice. Either we tax ourselves by means of a gasoline tax, or OPEC will tax us in the form of higher and higher prices for crude oil.”

This was a time when the taxing of fuels wasn’t associated with the reduction of CO2 emissions.

In today’s time, the definition is quite different. When a company burns fossil fuels which include coal, oil, gasoline, and natural gas, they produce greenhouse gases and release carbon dioxide and methane into the earth’s atmosphere causing global warming that eventually leads to extreme weather changes.

Hence, to pay for the external costs they impose on society, the government imposes a fee on these companies, and those costs help those who are affected by the disastrous effects, such as homeowners, farmers, as well as the government.

To implement a carbon tax, the government must determine the external cost for each ton of greenhouse gas emission. The U.S. Interagency Working Group on Social Costs of Carbon developed an estimate: US$40 per metric ton. However, according to a New York Times analysis of a 2018 United Nations report, the price should be much higher if we want to keep temperatures from rising above 1.5 C by 2030.

What is a Carbon Border Tax?

A carbon border tax is a tax on carbon emissions attributed to imported goods that have not been carbon-taxed at the source.

In the European Union’s economic recovery plan, which focuses on climate action, sustainable investments, and a just transition fund, the EU has proposed a carbon border tax on all imports by 2023. This will include imports like steel or cement, and the amount of tax will depend on the carbon emissions associated with the production of these goods.

This means that EU importers of products with high carbon footprints would have to buy carbon allowances with the aim to counter ‘carbon leakage’ and hold EU industries responsible for its direct effects on climate change.

Carbon border tax goes one step further than a carbon tax as the former holds those nations accountable that are contributing heavily towards climate change and are not carrying out enough action to mitigate the same and makes imports pay the same carbon price as domestic products thus also pushing countries to frame stronger climate policies as those levying their own carbon price domestically would be exempt.

ETS or a cap-and-trade system is another way of capping emissions and is quite similar to a carbon tax as both help reduce carbon emissions by promoting the lowest-cost emissions reductions encouraging investors and governments to form policies around the same. ETS sets an emissions cap that declines over time and it could increase certainty that emissions will fall below the predetermined emissions.

However, there have been recurring problems with the design of ETS such as as weak emissions caps, rapid change in emissions allowance prices, and over liberal allocations of emissions allowances to regulated entities.

How can a Carbon Border Tax help?

This carbon border tax has two major benefits. Firstly, by increasing the cost of carbon-based fuels, companies are then motivated to switch to clean energy such as solar energy, wind energy, and hydro-powered sources. Secondly, the tax will also increase the price of gasoline and electricity, with consumers understanding the importance of clean energy and thereby being more willing to transition to energy-efficient sources, further reducing greenhouse gas emissions.

There is evidence to suggest that such a tax can also boost economic growth, for instance, Sweden’s carbon tax has reduced its emissions by 26% in the past 27 years, and during this period, the country’s economy grew by 78%.

Is this type of tax fair and helpful?

Since 2005, several companies are already paying for carbon emissions through the EU’s Emissions Trading System or the ETS.

If the carbon border tax is applied, it runs the risk of breaching the World Trade Organisation (WTO) rules, which stresses equal treatment of similar products and no discrimination between domestic and foreign producers. It would be easier to comply if the import levy was matched by a carbon tax on all goods, including those manufactured in the EU.

Under this option, the carbon leakage issue could be addressed too, as foreign producers would have to pay a higher levy if they pollute more than other producers.

However, this makes things tough for EU producers as their export prices will shoot up resulting in lesser demand for their products globally. Another argument is that by making fossil fuels more expensive, it imposes a harsher burden on those with low incomes. They will pay a higher percentage of their income for necessities like gasoline, electricity, and food as they can’t even afford to switch to electric vehicles.

China, for instance, is reluctant to accept the EU’s proposal, because it can discourage other countries’ will to tackle climate change. This could also indicate that China, the third-largest partner for EU exports of goods (9%) and the largest partner for EU imports of goods (19%) in 2019 could back out as EU’s trading partner, thus removing one of the world’s largest economies and contributors to global warming in the conversation around action for climate change.

Though it’s worth noting that the EU buys more good from China than the other way around, so China may not want to lose the region as a trading partner and may eventually comply with a border carbon tax.

Back in 2015, a study of carbon taxes in British Columbia found that the taxes reduced greenhouse gas emissions by 5–15% while having negligible overall economic effects and a 2020 study of carbon taxes and economic growth in wealthy democracies found that existing carbon taxes have not harmed or limited economic growth.

However, studies have also found that without the increase in social benefits and tax credits, a carbon tax would hit lower-income households harder than higher-income households.

For instance, Mexico had introduced a carbon tax in 2014 and as the tax rate is minute, it has negligible effects on households. Widening the tax rate could lead to welfare losses and a rise in poverty if there is an absence of social welfare programs.

In Ireland, higher-income households emit only 37% more carbon dioxide than the lower-income households, along with the former’s income eight times more than that of the latter. That would mean that a carbon tax of
€20/tCO2 (approx US$24) would cost the lower-income households less than €3/week (approx US$3.6) and the higher-income households more than €4/week (approx US$4.8) and hence here a carbon tax would be regressive.

Professor of climate policy at ETH Zurich, Anthony Patt discussed how a list of jurisdictions such as California, Germany, China, Morocco, Massachusetts, and the U.K., have low or no carbon taxes but rather have devised a plan that includes more direct incentives, regulations, and infrastructure to promote renewable energy sources with all these places making huge strides in the clean energy sector.

The Future Of Carbon Taxing

The World Bank reports that there are currently 40 countries and 20 municipalities use either carbon taxes or carbon emissions trading and together all this already accounts for a 13% reduction in annual global greenhouse gas emissions, as per figures shared in the report.

It appears that the best way forward would be to introduce a carbon tax gradually. A 1% per year guaranteed increase in gasoline taxes would probably allow consumers time to switch to cleaner energy sources, and some of the revenues collected could be redirected to lower-income families.

But it is still unclear how that how much of a dent these taxes end up making in CO2 emissions.

Another strong criticism of carbon taxes involves the wealth and development disparity amongst countries: Actively encouraging fossil-fuel development by chasing GDP growth in developing and low-income countries and then punishing them on the back end seems profoundly unjust, especially considering that developing nations and their economic and cultural systems have been responsible for shaping the developed world for centuries.

For instance, if the U.S. has to meet the UN’s temperature-rise targets, the country must reduce fossil-fuel-based energy demand by 85% and for that to happen, the prices of those sources need to increase by at least 44 times, a massive hike which will be difficult to sell to businesses and consumers alike. This underlines the role of governments when it comes to establishing the tax, but it’s also clear that we need to concurrently pursue other effective climate action alternatives.

For effective action on climate change, there must be climate-focused wealth transfers, for instance, the Green Climate Fund that has been established as part of the Paris negotiations, and planning and executing structural changes to economic and trade institutions.

Also, developed countries could extend access to low-interest financing, provide technology transfers, and improve bilateral trade thus building the global capacity for climate mitigation and adaptation in developing countries.

Lead image courtesy of Unsplash.