The quantity of global carbon emissions, already at an unsustainable level, are continuing to rise despite modest steps to increase renewable energy use and electrify transport. This quandary is because most countries are not moving fast enough to implement climate policies. The United States in particular has been retreating from its commitments to decarbonize, although some of the slack is being picked up by individual states like New York. The one semi-bright spot is the European Union’s Emission Trading System (EU ETS), which has seen the EU carbon price reach a record high due to carbon credit allowance tightening.

Against this backdrop, carbon tariffs are in the news again. Some advocates believe that taxing the carbon embodied in imports will be necessary to expand from national carbon prices to a global price on carbon. The theory behind carbon tariffs (also known as carbon border taxes or carbon border tax adjustments) has long been known. While some countries will implement carbon pricing mechanisms to influence shifts to low-carbon energy, others will not. This scenario generates carbon leakage: industries with high-carbon emissions will flee to countries without robust carbon pricing and carbon-abating regulations. Then, the carbon abating country will be motivated to import products from non-carbon abating countries. The inevitable result is no global reduction in carbon emissions despite reductions in the carbon abating country.

Linked to this conundrum, the European Union has elected Ursula Gertrud von der Leyen as its new European Commission President. Among other statements in her policy-rich campaign manifesto, Ms. Von der Leyen placed the climate crisis at the top of her agenda. She called for Europe to become the world’s first climate-neutral continent and said this about what will likely be necessary:

“To complement this work, and to ensure our companies can compete on a level playing field, I will introduce a Carbon Border Tax to avoid carbon leakage. This should be fully compliant with World Trade Organization rules. It will start with a number of selected sectors and be gradually extended.”

Some consider the EU ETS and carbon border taxes as choices that are binary or should receive different emphasis. The carbon pricing policy foundation documented in a vast literature, however, is that both are complimentary and cannot be separated. Accordingly, the EU would need to further strengthen its ETS (by reducing the amount of allowances further and expanding it to more industrial sectors) and introduce a carbon border tax. Based on the policy prescription, the EU cannot choose or emphasize one of these policy options over the other.

The road ahead for implementation of Ms. von der Leyen’s proposal is arduous and will face an array of powerful countervailing forces. The EU has backed down before on its climate crisis policies, most notably its EU Aviation Directive, which entailed a capitulation to foreign governments and the airline industry.

Let’s give credit where credit is due, however: Ms. Von der Leyen has made a bold and ambitious proposal.

The views expressed in this blog are those of the author and not of any institution he is or was affiliated with.


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