If you ask the average person what springs to mind when they think of green policy, they’ll likely mention electric vehicles, wind turbines or heat pumps. All spot on. But the Government has just made a huge step forward towards Net Zero – and it barely seems to have registered. Welcome to the world of CBAM.
A Carbon Border Adjustment Mechanism (or more simply Carbon Border Tax) does what it says on the tin – applies a tax to goods imported into this country based on their Greenhouse Gas (GHG) emissions. Its vital importance lies in its role as a counterpoint to our Emissions Trading Scheme (ETS), now hived off from the EU version post-Brexit.
As a reminder, the ETS puts into practice that lofty ideal of carbon pricing – in economist-speak, ‘internalising the externality’ of GHG emissions. Thus the scheme puts a price per tonne of carbon that companies in relevant sectors have to pay, based on how much they emit. The price is set by the market where allowances to emit GHGs are traded, while the total cap on emissions allowances decreases every year (the so-called ‘cap and trade’ model). In this way we provide a strong price signal for decarbonisation, but leave decisions on when and how to do it up to business themselves, meaning we get the most cost-effective emissions reductions. Indeed carbon pricing is one of the most free-market ways to achieve Net Zero (so long as it’s revenue neutral), and the Centre for Policy Studies has long argued in favour of it.
The potentially fatal flaw in the ETS, though, is that it applies only to domestic businesses. So, say, a UK steel producer who is either dutifully paying their (ever-increasing) ETS bill, or investing the money to decarbonise their business, faces a huge risk of being undercut by overseas producers who are not subject to such a trading system or carbon tax. Left unchecked, this could lead to plant closures and the further hollowing out of the UK’s industrial base, leaving behind devastated communities. Worse, all this pain would be for no environmental gain – all we’ll have done is ‘offshore’ these emissions rather than eliminate them – an issue known as ‘carbon leakage’. While the current policy of giving out a certain number of ETS allowances for free mitigates this to some extent, this can only go so far. And while the current extent of such leakage varies by industry (and is contentious), the risks will continue to grow as carbon prices increase over time.
So, after much foot-dragging, the government announced just before Christmas that we will introduce a carbon border tax by 2027. Put simply, foreign goods sold into the UK market will attract the equivalent carbon cost as if they were produced here. Domestic producers will no longer be put at a disadvantage, while foreign ones will have to decarbonise themselves (or pay up) should they wish to export to us. Indeed a CBAM is one of the most effective tools we have to encourage other nations to reduce emissions – unlike the texts agreed at COP, there’s no wriggling out of this.
Rather shamefully, the EU is ahead of us in this area (their CBAM will come into force in 2026) – and indeed witness the Chinese and Indian governments racing to decarbonise their affected industries as a result. It’s important to point out that this isn’t green protectionism (as much as some in the developing world will suspect it is) – we’re not favouring our domestic industries in any way, simply making sure that foreign ones compete on a level playing field if they wish to export to us. It’s undoubtedly the case that CBAM increases the regulatory burden on importers (though this should be minimised as far as possible), but it’s a necessary evil if we’re serious about decarbonising while remaining competitive.
But as ever with such schemes, the devil is in the detail. For starters, to be as effective as possible our CBAM should be introduced at the same time as the EU’s in 2026, not a year later. Moreover you’d think the CBAM would apply to all sectors covered by the ETS – but you’d be wrong. Instead only a golden few have been selected; aluminium yes, refined products no. Given the novel nature of this policy and the complexity of industry supply chains one can understand the Government’s desire to start small and learn as the scheme expands. And to be fair we did use our Brexit freedoms to deviate from the sectors the EU chose (so ceramics and glass are included in ours but not initially in theirs). But leaving it up to Whitehall to opaquely decide which sectors are most at risk from carbon leakage (and thus deserving of CBAM protection first) is a recipe for bad outcomes – and furious lobbying, of course.
Moreover the Government announcement seemed designed more to generate good headlines than to give certainty to business – many of the crucial details have been punted to yet another consultation due to happen at some point this year. How much of the supply chain for each industry will be in scope, and what will the approach be for finished products? Supply chains can be notoriously long and complex – if CBAM doesn’t extend up and down the chain appropriately, the risk of leakage will remain. Ditto if foreign producers respond via so-called ‘resource shuffling’ – selectively exporting lower-carbon products to the UK (and EU), without actually changing their production methods.
What will the phase-in look like, and will more industries be added further down the line? How will all that money newly flowing to the Treasury’s coffers be used? Ideally it should be recycled back to the taxpayer in order to minimise the burden on consumers. Many of these trade-offs have been left for whatever Government emerges after the election to decide.
But while there’s important work to do before this policy is as watertight as it needs to be, we shouldn’t lose sight of the fact that this is an important milestone for the UK. CBAM is a mouthful and may sound hopelessly complex. But if we’re serious about hitting Net Zero while maintaining this country’s economic competitiveness, implementing an effective carbon border tax is one of the most important levers we can pull.
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