Mastering the New EU Carbon Tax
November 4th, 2021
15 min read
The arrival of the long-anticipated Carbon Border Adjustment Mechanism will undoubtedly have ramifications across nations and tilt the competitive balance between industries.
The European Union has recently announced a comprehensive plan to augment its climate change mitigation efforts. This plan includes the adoption of a Carbon Border Adjustment Mechanism (CBAM), more widely known as a carbon border tax. The measure itself has been discussed ad nauseam by experts and dreaded by governments who worry about the potential backlash that it may provoke.
Many countries already have carbon pricing policies embedded in their regulatory frameworks, usually in the form of taxes on emissions or "cap and trade" systems. The World Bank currently counts 64 initiatives of this kind that are present in 45 countries. However, the EU is now taking a step further by extending its carbon pricing scheme to new sectors and imposing a carbon tax on imported goods.
The proposed CBAM is intended to equalize carbon prices for domestic and foreign producers who operate in the world’s largest single market. The EU claims that this measure will help alleviate "carbon leakage" by leveling the playing field for EU and non-EU businesses. The tax would create an incentive for manufacturers around the world to slash their carbon footprints and an impetus for countries to adopt more ambitious climate policies.
The implementation process will have several stages that will transition rather expeditiously. Importers will start facing considerable administrative burdens as early as January 2023, and they will immediately be required to develop mechanisms to assess, verify, and report their emissions. However, the full financial effect of the tax will be felt in January 2026, at which point all producers will be required to purchase permits and pay the carbon costs of their products or materials.
The arrival of the long-anticipated Carbon Border Adjustment Mechanism will undoubtedly have ramifications across nations and tilt the competitive balance between industries. Under the new policy, a levy will be placed on each metric ton of CO2 that is brought into the EU. The tax liability for importers will depend on the carbon intensity of the product and the tax rate per metric ton. As such, the CBAM is expected to reduce the attractiveness of offshoring as an instrument for circumventing EU climate costs.
The European Union dominates trade relations with the Western Balkans. It is the closest trading partner of the region, accounting for 70% of all trade. As such, CBAM will soon become a major issue of competitiveness in the Western Balkans. The impact of the tax will naturally be felt more strongly in economies where emissions increased after the introduction f the EU’s domestic carbon pricing scheme, namely Serbia and BiH.
By implementing CBAM, the EU is sending a clear signal to its trading partners about the importance of green policies. The Western Balkans have a narrow window of time to prepare for the new tax and they engage constructively with EU decision-makers to help shape the future of climate policy.
Although the details of the proposal will be subject to negotiation with the European Parliament and the 27 member states in the upcoming months, there is already broad political consensus and clarity on the intent of the bloc. Indications suggest that, once the tax is in place, importers will be charged an estimated fee of €75 per metric ton of Co2 emissions.
The most significant initial impact will be on the cost of materials made by high-carbon inputs such as steel, cement, aluminum, chemicals, and electricity. This effect is projected to amplify in subsequent years as the tax rate increases and more products enter its scope.
CEOs must come to terms with the fact that the new CBAM will quickly alter competitive dynamics throughout industries and value chains, and seize the moment to increase market share, find new cost efficiencies, and boost valuations. Companies should be proactive in complying with the new regulations and thrive in the new environment.
There are different approaches to managing this regulatory shift and transforming it into a competitive advantage.
Companies that place themselves at the forefront of tackling carbon emissions will have an exceptional opportunity to develop a strategic advantage in trading with the EU and a head start on the global stage, as other nations adopt more extensive carbon-pricing mechanisms.