Carbon border adjustment – what approach should the UK take? (Report on CIOT/IFS debate)

* You can watch the debate in full here *

The UK government is currently exploring options to address the issue of carbon leakage. Among the potential solutions being considered is the implementation of a CBAM. This would involve imposing a tax on imports based on the amount of carbon they embody, accounting for any untaxed carbon content.

Chaired by IFS Deputy Director and Head of Tax, Helen Miller, the participants in the discussion were:

• Michael Keen, Ushioda Fellow at Tokyo College, University of Tokyo and an International Research Fellow at the Institute For Fiscal Studies
• Alice Pirlot, Assistant Professor, International Law, Faculty Associate, Centre for Finance and Development, Geneva Graduate Institute 
• Jennifer Rowland, Deputy Director for Energy and Transport Tax, HM Treasury
• Richard Woolley, Head of Energy and Climate Change, Chemical Industries Association

The event began with Susan Ball, President of CIOT, welcoming the online audience, followed by Helen Miller introducing the panel.

Jennifer Rowland, the first speaker, highlighted the significance of carbon leakage in addressing global emissions. She noted that currently in the UK, the main policy for mitigating carbon leakage involves providing free allowances within emissions trading schemes. However, the government is also exploring other carbon leakage policies to address the issue.

Rowland explained that the government announced the publication of a consultation on carbon leakage on 30 March, which will remain open until 22 June. The consultation considers a range of options and poses questions regarding various policies, including mandatory product standards, which would involve setting a limit on the emissions embodied in certain products, voluntary measures such as labelling and a CBAM. If the government do introduce a CBAM they want to do so in the least burdensome, most effective way, finding the ‘sweet spot’ of simplicity and fairness. She emphasised that the government is eager to receive input from all stakeholders.

Michael Keen, the second speaker, said that the overarching goal with a CBAM is to make space for more aggressive domestic carbon pricing and to contribute to more efficient and effective global mitigation efforts. He identified three potential objectives: tackling leakage, maintaining competitiveness (by levelling the playing field) and encouraging other countries to adopt similar measures (providing leadership). The final one of these was, he thought, quite a weak argument. It depends on how much of your domestic carbon emissions is embodied in your exports. For major emitters such as China that is relatively low.

Keen said out that if every country used carbon pricing as their main instrument for mitigation but they all had different carbon prices than a CBAM would satisfy economists - that would be “a very nice and simple world”, he said. However, not all countries use carbon pricing as their main mitigation tool. He also posed the question of whether we should remitting taxes on exports. Moreover, reporting issues pose a challenge in implementing a CBAM – “if we get so good on reporting on carbon emissions … we could pretty much do a carbon tax like VAT”, Keen suggested.

Alice Pirlot, the third speaker, said that if a CBAM is only imposed on imports, there will still be a risk of carbon leakage to some extent. To avoid this it would be necessary to apply it to exports as well. Perlot said that from the administrative point of view, it would be more effective, but also more complex, if a CBAM were to apply not just to basic materials such as steel and aluminium but to manufactured products like cars too.  There is also the question whether the CBAM should be imposed on carbon intensive products from all countries or only on products made in countries that are deemed to be ‘non-cooperative’ – in which case the CBAM would become more like a tariff.

Pirlot said that CBAMs are controversial under international trade and international climate change law. It is difficult to predict whether a CBAM can be ‘justified’ on environmental grounds or if it discriminates against and between foreign products.  It would be difficult for a UK government to show that a carbon price being imposed on domestic producers through an emissions trading scheme is equivalent to a price being imposed on foreign producers via a CBAM.

Under international trade law you need to be non-discriminatory, treating imports the same as domestic production. Under the Paris agreement (climate change law) developed countries are supposed to take the lead and developing countries are permitted to do less. Moves towards a uniform carbon price such as through a CBAM conflict with this.

Ambitious carbon pricing policy must be complemented by stable, effective and predictable carbon leakage mitigation measures, said Richard Woolley, the fourth and final speaker. “A CBAM could be really helpful, but it must be well designed and the input from industry must be considered carefully.” Representing the Chemical Industries Association, Woolley mentioned that over 96 per cent of manufactured products used daily have chemical industry content, making it a significant contributor to the UK economy.

What are the key design features of a UK CBAM? It needs to align with the UK emissions trading scheme, Woolley said. A CBAM must provide support to prevent UK products being priced out of overseas markets. It must not encourage companies to switch to similar but equally polluting products outside the scope of a CBAM. He also raised the prospect of 'resource shuffling' – countries exporting to the UK redirecting their low carbon products to the UK and their high carbon products to markets which impose lower climate costs.

Woolley urged the government not to withdraw free allowances under the emissions trading scheme until the CBAM measure is proven to be effective, emphasising that continuity in carbon leakage mitigation policy is important. The EU scheme allows for the gradual phase out of free allowances over time. Implementing a UK CBAM that is significantly different from EU's could risk mutual non-recognition, he added.

The chair put a number of questions tabled by the audience to the panel, including:

How do we assess embedded carbon?

Jennifer Rowland said while that the government is still looking into this. She noted that the EU is looking at doing something on default values. Under this approach companies are given a choice – provide detail on emissions or take default values and apply those.

Michael Keen suggested that use of default values could be a good option. All kinds of tax matters involve an element of approximation, he observed. But Alice Pirlot was concerned that approximation might be problematic as a CBAM has obvious cross-border effects.

Addressing this question Richard Woolley made a plea to policymakers not to wait for evidence of carbon leakage before acting. It doesn't happen in a textbook way, he explained. Company A doesn’t close down its cleaner production facility in the UK and open a dirtier one somewhere else. It’s more likely company A will shut down the facility because it can’t compete with company B which is producing in a dirtier way but the companies may not be publishing detailed emissions data. There is evidence, he said, that the chemical industry in countries not imposing environmental costs is growing fast, whereas it is not growing in the UK. Investment leakage is a big part of the picture.

How do we avoid legal problems with a CBAM?

Pirlot said that policymakers should design a CBAM in the least discriminatory manner possible to prevent it from being perceived as a ‘protectionist measure’. She advised policymakers to engage with other countries before adopting CBAM measures and be very careful with the design features.

How closely is the UK looking at the EU CBAM?

Jennifer Rowland stated that the UK acknowledges the similarities between its own carbon pricing system and that of the EU. While the government will take into account what the EU is doing, they are also looking at other jurisdictions.

Keen said there was a case for close alignment across a variety of schemes between rich countries because we share a common ambition. Woolley said the Chemical Industries Association advocated for linking the UK and EU emissions trading schemes: “having the same carbon price as our competitors means that we are never at a disadvantage”.

What would you do?

Woolley said the government should go for a CBAM but engage with industry and listen to feedback. Keen agreed the government should go for it and do their best to keep the lawyers happy. Pirlot would reallocate the revenue from a CBAM to projects in developing countries. Rowland said the government would keep engaging and that conversations such as this were really helpful.

A video recording of the debate is available here