EU plans world’s first carbon border tax despite trade dispute fears

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EU lawmakers have agreed to introduce the world’s first carbon border tax with the aim of raising environmental standards globally and protecting its domestic industry, despite concerns that the plans could breach WTO rules and spark trade disputes.

The deal, reached in the early hours of Tuesday morning after 10 hours of negotiations between European parliament members and EU country representatives, means importers will have to buy permits for their carbon emissions at the same price paid by domestic producers under its emissions trading system.

Mohammed Chahim, a socialist MEP who led the negotiations for the parliament, said the agreement — which is provisional until a final set of negotiations this weekend, after which it must be approved by EU ambassadors — was a “win-win situation”.

The carbon border adjustment mechanism (CBAM) would be “a crucial pillar of European climate policies,” he said. “It is one of the only mechanisms we have to incentivise our trading partners to decarbonise their manufacturing industry.”

Some issues remain outstanding and will be discussed at the weekend talks. They include export rebates, which industry has lobbied politicians to include in the final law, and the free greenhouse gas allowances currently received by some EU companies. Analysts say potential provisions on these would make CBAM vulnerable to challenge under World Trade Organization rules.

The CBAM is designed to protect against “carbon leakage” — the risk that EU industries could outsource manufacture of goods for the domestic market to regions with lower environmental standards.

“Such carbon leakage can shift emissions outside of Europe and therefore seriously undermine EU and global climate efforts,” the European Commission said when the measure was first proposed in July 2021. It added that several countries, including Canada and Japan, were planning similar initiatives.

Governments across the EU are increasingly worried about potential deindustrialisation in Europe as energy bills force companies to cut production.

The introduction of generous tax credits to support the development of green technologies in the US through its Inflation Reduction Act has exacerbated concerns.

Until at least 2030, the CBAM will apply to iron, steel, cement, aluminium, fertilisers, hydrogen and electricity generation, as well as some manufactured products such as screws and bolts. Cars could also be included following a trial period starting next October.

EU companies in those sectors currently receive a certain number of free greenhouse gas allowances under the EU’s emissions trading system and must then pay for permits to cover any additional greenhouse gases they emit. After October the free allowances will start to be phased out.

But analysts have warned that retaining free allowances alongside the carbon border tax during the phaseout could violate WTO rules.

“If domestic companies do not pay for their emissions there is no way to ask for [the] CBAM at the border,” said Geneviève Pons, managing director for Europe at Paris-based think-tank the Jacques Delors Institute.

Industry has pushed back against abolishing the free permits, arguing that they free up money to invest in clean technologies.

“European industry is facing multiple fundamental challenges on its decarbonisation pathway,” Markus Beyrer, director-general of BusinessEurope, the pan-EU lobby group, said. “The dramatically high energy prices, together with the gap in climate targets between the high ambition of the EU and those of other actors is undermining European industry’s competitiveness so drastically that deindustrialisation is happening as we speak.”

Businesses have also lobbied for export rebates. EU industry body Aegis, which represents 25 sectors, said: “A CBAM with no export solution will weaken the competitiveness of our industries and send the wrong signal to investors: Europe is closing the shop for the industries of the future.”

But Pascal Lamy, a former EU trade commissioner, warned that including rebates would also risk disputes being taken to the WTO, which prohibit aid to support exports. “We have serious doubt on any form of export rebate because that would be an export subsidy,” he said.

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