EU’s Carbon Border Tax: Making emissions more expensive

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  Quantumrun Foresight
• September 29, 2023

Insight summary

The European Union's Carbon Border Adjustment Mechanism (CBAM) aims to equalize carbon pricing between domestic and imported goods and prevent industries from relocating to countries with lax environmental rules. Scheduled for full implementation in January 2026, the tax will initially cover sectors like iron, steel, cement, and electricity generation. Non-EU producers will face increased costs, impacting countries like China, Russia, and India. While the tax aims to spur global emissions reductions, it raises concerns for developing economies, which could find the costs burdensome. The policy is expected to particularly affect supply chain sectors and could lead to higher consumer prices for goods made with materials like steel and cement.

EU’s Carbon Border Tax context

The carbon tax, formally known as the Carbon Border Adjustment Mechanism (CBAM), will equalize the price of carbon between domestic and imported goods to ensure that EU climate goals are not jeopardized due to industrial relocation to countries with lax policies. The tax will also aim to encourage industries outside the EU and international partners to take steps in the same direction. CBAM is an important piece of legislation that will significantly impact the trading markets within the EU and outside. The CBAM mechanism will work as follows: EU importers will purchase carbon permits corresponding to the carbon price that would have been paid had the goods been produced under the EU's carbon pricing rules. This system complies with World Trade Organization (WTO) rules and other international obligations of the EU.

The tax was created to provide legal certainty and stability to businesses and other nations by gradually phasing in over several years. The program will initially cover iron and steel, cement, fertilizer, aluminum, and electricity generation. If a non-EU producer can show that they have already paid for the carbon used in the production of the imported good, then the corresponding cost can be fully deducted from the EU importer. The CBAM will also encourage non-EU producers to improve their production processes. 

Disruptive impact

The tax is scheduled to be fully implemented in January 2026. EU importers and non-EU producers of the affected materials will have to pay about USD $78 per metric ton of carbon emissions. This will immediately inflate the cost of materials produced by carbon-intensive manufacturers, such as China, Russia, and India, by 15 to 30 percent. And the impact will grow over time: the tax rate is expected to hit nearly USD $105 per metric ton by 2030, and more products will likely be included at that point. As a result, businesses need to measure their emissions and carbon tax exposure across their supply chains and product lines. They also need to develop a plan for responding to climate change. In addition, companies need to talk with EU decision-makers about the future of climate policy.

However, some economists are concerned that this would be too costly for developing nations. With weak institutional foundations, giving additional cash transfers and nothing else is unlikely to result in economic or environmental benefits. Aligning trade, climate, and domestic policies are the answer. This can be done in three ways: first, make the carbon tax “protection-neutral” for emerging economies. Other taxes can be reduced (tariff or non-tariff), particularly for cleaner industries, goods, or businesses. Second, make renewable energy technology available for third-world countries. And finally, domestic policies should be aligned to CBAM so that everyone has a fighting chance to comply.

Wider implications of EU’s Carbon Border Tax

Possible implications of EU’s Carbon Border Tax may include: 

• Developing economies struggling to pay the carbon tax. This could lead to businesses pulling out of the Europe market.
• Reduced global emissions as more companies re-align their production processes to meet the carbon tax requirements.
• The EU implementing subsidies and other protective strategies to support developing economies to reach their targets, including sharing clean energy technologies.
• The supply chain sectors like automotive, construction, packaging, and appliance being the hardest-hit. These sectors will struggle to meet the additional administrative burden of calculating emissions within their products.
• Consumer products that use steel, aluminum, and cement will become more expensive and unattractive for end-users.

Questions to consider

• How else do you think the EU’s carbon tax will affect global industries?
• How can companies prepare for the full implementation of this tax?