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October 7, 2024
“Climate change is a global crisis, and to tackle it, emissions have to go down all across the world, not just move from one place to the next.” These were the remarks of European Commissioner for Climate Action Wopke Hoekstra, describing the need for the European Union’s (EU’s) recently-enacted Carbon Border Adjustment Mechanism (CBAM). CBAM is a regulation that aims to limit “carbon leakage” by placing a fee on carbon-intensive products imported from non-EU nations.
Carbon leakage occurs when companies migrate their manufacturing operations—and the emissions associated with them—to another country to skirt carbon emissions regulations. The CBAM transitional phase began in October 2023 and will run through 2025, marking a new step for global carbon policy.
The EU CBAM emerged from the European Green Deal, a policy roadmap introduced by the European Council in 2019 to help Europe become “the world's first climate neutral continent by 2050.” After the release of the Green Deal, the EU followed up with Fit for 55, a set of policy proposals aiming to reduce EU emissions by 55% by 2030. This policy package incorporated CBAM to ensure that regulations on EU industry are not negated by overseas migration of production.
Under CBAM, companies are responsible for the embedded cost of carbon in their products. This cost accounts for all emissions, direct and indirect, from the natural resource extraction, processing, manufacturing, and transportation associated with the product. The tariff currently applies to imports from the aluminum, cement, iron, steel, fertilizer, electricity, and hydrogen sectors—some of the world’s most carbon-intensive industries—but the scope of industries under its jurisdiction will likely expand by 2030.
CBAM serves as more of a stick than a carrot, despite the EU’s attempts to market it otherwise. It imposes an economic cost on imported goods with high greenhouse gas (GHG) emissions, as well as penalties for importers who fail to report emissions or lie about their impact. In this way, CBAM functions as an import tariff that encourages production and trade within the EU, with the benefits of a carbon tax that can help limit carbon emissions.
A fair price on carbon is established through a certification system in which companies must purchase a certificate and then surrender it to cover their emissions. The price of the certificate is determined by the EU Emissions Trading System (ETS), which puts a market price on carbon following the “polluter pays” principle. The weekly average auction price of EU ETS allowances determines the exact amount the carbon-intensive industry must pay via certificates. As the price is based on supply and demand, the amount is ever-fluctuating.
CBAM mandates a high level of transparency from international companies outside the European Union and European Union Free Trade Association importing products into the EU, which gives these companies a substantial workload. They first must seek authorization under CBAM to continue importing, and then collect data to report their total embedded emissions (also known as upstream emissions). Such assessments will require greater communication and transparency between importers and their suppliers. CBAM reporting is more specific than the reporting required by most other company standards, soliciting information on product-level emissions (the carbon footprint of one product, as opposed to the footprint of one facility) within a specific EU-built framework.
Implementing a carbon tariff on such a wide scale is no swift task. The idea for an EU CBAM was first introduced to the European Council in 2019, but reporting requirements for companies only began in 2023, and actual payments will not be fully in effect until 2026 (the “definitive regime”). The EU CBAM is still in its trial period, and the first quarterly report was due for EU importers on January 31, 2024. The first attempt at collecting reports indicated some hurdles in implementing the program. Technical glitches and confusion about the system led to fewer GHG emission reports from importers than expected, with many unaware of the new obligation or how to report their product emissions. Though described by EU officials as a “learning period,” the success (or failure) of the trial phase can provide a glimpse into the regulation’s future.
Experts say the EU CBAM will have a minimal effect on U.S. industry—“only a sliver” of U.S. exports fall within its jurisdiction. And within those industries covered by CBAM, U.S. products are far less carbon-intensive than those of many other countries. This could give American industry a competitive advantage in exporting to the EU. However, the EU CBAM will still require more substantial emissions reporting—an unwelcome change for some.
Discussion of CBAM in the United States extends beyond the context of the EU’s regulations. In recent years, policymakers have discussed the possibility of a U.S. carbon border adjustment mechanism to target American companies engaging in offshoring carbon emissions. Such regulations could boost domestic production and build sustainable industry practices.
The idea of a U.S. carbon border fee or charge has been gaining traction in Congress, on both sides of the aisle. Sen. Sheldon Whitehouse’s (D-R.I.) and Rep. Suzan K. DelBene’s (D-Wash.) Clean Competition Act (H.R.6622/S.3422), introduced in 2023, would create a carbon border adjustment for the United States, and it is one of multiple such proposals in recent years. The Clean Competition Act would tax both imported and domestic products with emissions above a set limit for each industry. A proposal from Sens. Bill Cassidy (R-La.) and Lindsay Graham (R-S.C.), the Foreign Pollution Fee Act (S.3198), imposes a fee only on imported goods, placing more emphasis on preventing global supply chain dominance by China and Russia.
Beyond CBAM-specific propositions, other recent legislative and regulatory actions have reflected greater American interest in understanding and managing carbon-intensive imports. The PROVE IT Act (S.1863/H.R.7198), introduced by Sens. Chris Coons (D-Del.) and Kevin Cramer (R-N.D.), and Reps. John Curtis (R-Utah) and Scott Peters (D-Calif.) passed out of the Senate Environment and Public Works Committee with bipartisan support in January 2024 and was introduced in the House in July. This bill would direct the Department of Energy to study the carbon intensity of various industrial products produced in the United States and abroad. Additionally, in April 2024, the Biden-Harris Administration announced a White House Climate and Trade Task Force, which is now working to produce data and policies to address carbon leakage and other carbon loopholes within global trade.
These ideas for climate-focused trade policy have the potential to satisfy Democratic and Republican interests alike. CBAM, while cutting down on carbon leakage, also encourages “Made in America” initiatives within both the private and public sectors, increasing demand for sustainably-made domestic products rather than outsourced goods. This can also decrease U.S. reliance on China, a priority of both the Trump-Pence and Biden-Harris administrations.
Efforts already underway in the United States signal a warming—at the state level, at least—to CBAM-like initiatives. California’s Cap-and-Trade Program and New England’s Regional Greenhouse Gas Initiative exemplify two successful state-led programs that use market mechanisms to decrease emissions. Together, these programs, alongside the EU CBAM, offer a blueprint for potential future plans at the federal level.
Imposing a tariff is a unilateral approach to reducing emissions, and leaders of many nations and trading partners of the EU are wary of being unfairly impacted.
Countries such as Russia, China, and India have argued against the legality of CBAM under World Trade Organization (WTO) rules, calling the program out as trade protectionism—the intentional restriction of international trade competition to boost or protect domestic industry. The WTO, the governing body of global trade, works against protectionism, and has instilled principles to ensure all trading partners are treated equally within the free market. In September 2021, the WTO Deputy Director-General Jean-Marie Paugam justified CBAM’s legality, explaining that “it should be clear that nothing in the WTO rules prevents the adoption of such a mechanism by a Member if it does not constitute unjustifiable discrimination or disguised protection.”
CBAM is one way for the EU to meet goals established under the Paris Agreement, an international treaty on climate change that was adopted at the twenty-first Conference of the Parties (COP21) in 2015. However, a key element of the Paris Agreement is “common but differentiated responsibilities,” which exists largely to protect developing countries from being overburdened with climate responsibility disproportionate to their economic abilities, or culpability for climate change. Certain research points to CBAM’s uneven distribution of economic risk across the globe, particularly in the Global South, where existing economic vulnerabilities and reliance on fossil fuels means CBAM will cause greater financial pressure than in other parts of the world.
Proposed solutions include incorporating countries’ vulnerability into carbon cost calculations, investing CBAM revenue into the Loss and Damage Fund (a Paris Agreement mechanism that provides financial support to climate-vulnerable countries), and establishing training programs to assist industries with managing emissions reduction. Incorporating the Paris Agreement policy of differentiation into CBAM could be a key step for compliance with new trade regulations, as well as for promoting climate justice between nations.
In the United States, bills such as the Clean Competition Act (H.R.6622/S.3422) and the 117th Congress’s FAIR Transition and Competition Act (H.R.4534/S.2378) have included plans to use the fees collected from a U.S. CBAM to fund both domestic decarbonization efforts and developing nations’ decarbonization and climate change adaptation efforts. The FAIR Act even stipulates that least developed countries would not be subject to an import fee. With CBAM regulations designed to disincentivize nations from supplying carbon-intensive goods, careful policymaking can limit unjust disparities between developed and less-developed nations.
There are even paths to increase climate-specific development aid and institutional capacity with CBAM funding. The upcoming COP29 in Azerbaijan aims to “enhance ambition and enable action,” particularly with regard to supporting developing nations and coalescing around global financial action. CBAM may prove incredibly relevant to these discussions, particularly given the EU’s rollout since COP28 in Dubai.
CBAM is a long-term solution to a long-term problem. The ideal solution for the WTO and other international organizations would be a global agreement on carbon pricing, rather than action by individual parties. However, in a context where true international compromise may still be out of reach, efforts such as the EU’s CBAM—and a potential American CBAM—are essential steps towards creating a sustainable and just economy.
Author: Gillian Murphy
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