The U.S. response to the EU CBAM: Past responses and future prospects
Ann-Evelyn Luyten is an EU policy expert at a U.S. company. Previously, she worked as an Economic Affairs Officer and Training Officer at the World Trade Organization.
In July 2021, the European Commission (Commission) released a legislative proposal for a Carbon Border Adjustment Mechanism (CBAM) as part of its Green Deal package. As its response to the EU CBAM proposal, the U.S. raised its concerns about the mechanism at the World Trade Organization (WTO). In this blog, I address the three different approaches that the U.S. could take in the near future: (i) continuing to question the CBAM’s WTO compatibility at the WTO itself; (ii) introducing its own carbon border tax; and/or (iii) participating in a “Carbon Club.” Lastly, I argue that it remains to be seen whether and how the U.S., the EU, and other economies will cooperate closely to address carbon emissions.
Introduction of a European Carbon Border Adjustment Mechanism
The CBAM is one of the proposed tools aimed at achieving the European Union (EU)’s climate targets, which includes reducing by 55% the bloc’s carbon emissions compared to 1990 levels by the end of this decade and becoming carbon-neutral by mid-century. Proposed by the European Commission, the CBAM is currently undergoing the EU’s legislative process, and it currently is unclear how much the final version will differ from the original proposal. The Commission has characterized the CBAM as a climate measure that contributes to preventing the risk of carbon leakage, which occurs when companies move production to other countries with laxer emission constraints, thus leading to a rise in carbon emissions. At the same time, the Commission emphasizes that the CBAM is compatible with WTO rules.
In essence, the CBAM is a measure that would be applied at the EU border on imports to adjust for any discrepancies in carbon pricing in the country where those goods originated, relative to the EU's own carbon pricing. Under the Commission’s proposal, importers must purchase CBAM certificates, which must be equal to the total embedded emissions of imported goods. Furthermore, the price of the CBAM certificates will be calculated based on the weekly average auction price of allowances under the EU’s Emissions Trading System (ETS).
Due to practical concerns, only five emission-intensive sectors are targeted in the current proposal, namely cement, iron and steel, aluminum, fertilizers, and electricity. The CBAM would enter into force from 2023 until 2025 in a transitional form, where EU importers would be required to report the embedded emissions in imported goods. From 2026, the CBAM would enter fully into force and importers would be obliged to purchase CBAM certificates.
The Commission’s CBAM proposal is under review by the European Parliament and the Council of the EU (consisting of EU member states). The EU institutions will present their positions, which are likely to bring changes to the final text of the CBAM proposal. In January 2022, Mohammed Chahim, who is leading the European Parliament’s work on the CBAM, proposed broadening the targeted sectors to include organic chemicals, hydrogen, and polymers and to shorten the transition period so that it concludes in 2024 (instead of 2025).
The U.S. response to the EU CBAM proposal
The U.S. response to the EU CBAM proposal until now has been friendly, but not enthusiastic. Even before the Commission formally announced the CBAM proposal, the U.S. already raised its concerns about the prospect of such a mechanism both at the WTO Market Access Committee and at the Committee on Trade and Environment in 2020. In particular, the U.S. (and several other WTO Members) stressed that any EU CBAM must be consistent with WTO rules and must not constitute disguised barriers to trade. For instance, if EU industries subject to the CBAM continue to benefit from free allowances under the EU ETS, while foreign producers have to purchase CBAM certificates, some WTO Members question whether this would mean treating EU producers more favorably than foreign producers and thus violate the WTO’s rules on national treatment.
At the same time, the U.S. appears to be less concerned about the implications of the CBAM for U.S. exports to the EU, at least for now. Current projections of the CBAM’s economic impact gives an indication why: Chad Bown, a senior fellow at the Peterson Institute for International Economics, estimates that the U.S. export value that would be affected by the EU CBAM would be worth around USD 1 billion. Given that the value of U.S. export of goods to the EU in 2019 was around USD 260 billion in 2019, the estimated U.S. export value to be affected by the CBAM appears to be relatively small.
However, the impact of the CBAM on U.S. exports to the EU could quickly become more significant if and when the EU expands the scope beyond the five targeted sectors. The expansion of the CBAM could take place in 2026 at the earliest, as under the current proposal the Commission will present a report to the European Parliament and the Council on the application of the CBAM, which will cover possible extension of targeted sectors. Furthermore, as explained above, the European Parliament is already considering whether to expand the CBAM to include organic chemicals, hydrogen, and polymers.
What could the U.S. do in the future?
As a first option, the U.S. could choose to take a negative position against the EU CBAM. In fact, the U.S. signalled that it could take this approach when it expressed its concerns on the CBAM at the WTO. Furthermore, after his visit to Brussels in March 2021 to coordinate on climate issues ahead of the United Nations Climate Conference in Glasgow (COP 26), John Kerry, the U.S. Climate Envoy stated that the EU should only consider introducing the CBAM as a “last resort”. Given these signals, the U.S. is likely to continue to use the WTO as a platform to question the CBAM’s compatibility with the organization’s rules.
At the same time, the U.S. is less likely to introduce its own carbon border mechanism in the near future. When Biden became President-elect, he pledged to introduce the U.S. version of a carbon border tax. However, no concrete details have emerged since his inauguration in January 2021. In addition, Kerry mentioned in an interview in July 2021 that an introduction of a U.S. CBAM might harm the ongoing multilateral efforts that the U.S. is engaged in to encourage other countries to strengthen their climate policies.
As a second option, in the long run, the U.S. may eventually introduce its own carbon border tax after all, despite its current reticence. In a recent interview in December 2021, Kerry stressed that President Biden had instructed officials to evaluate all the implications of the EU CBAM. As a result, the U.S. is exploring whether to put in place its own carbon border mechanism. Without providing more details, Kerry mentioned that it may be a tool that the U.S. could employ if other countries are not serious enough in reducing carbon emissions. This indicates that the U.S. may introduce its own carbon border mechanism as a last resort, though how this would work is unclear, given the lack of a carbon price for domestic products at the federal level. Carbon pricing has long had a fraught history in the U.S. Congress, with past efforts failing to bear fruit.
Moreover, in July 2021, Senator Chris Coons (Delaware) and Representative Scott Peters (California) from the Democratic Party introduced companion bills in the Senate Committee on Finance and the House of Representatives Committee on Ways and Means, respectively, that would impose a "border carbon adjustment" fee on imports of carbon-intensive goods into the U.S. Under the Democratic proposal, a tariff starting in 2024 would apply to roughly 12 percent of imports coming into the U.S. and would target petroleum, natural gas and coal, aluminum, steel, iron, and cement. While the proposal has not advanced out of committee in either chamber, this may change in the future, and in the meantime President Biden has continued to signal potential support for border carbon adjustment.
Another option for the U.S. is to participate in a “Carbon Club.” According to Nobel laureate William Nordhaus, a club of countries that implement a carbon pricing system should agree on an “international target carbon price.” While countries who are members of the carbon club will not face any tariffs, other countries who choose not to join the club would face unilateral tariffs applied to all their exports into the club. If, for example, the EU, the U.S. and China succeed in creating a carbon club together with other economies, it will open up a promising avenue for attaining higher climate ambition without fear of carbon leakage and create a strong incentive for other countries to join. However, there are no signs of concrete actions from these economies to create such a club, although China mentioned plans for closer cooperation with the U.S. on climate issues at COP 26. Furthermore, the U.S. is unlikely to take a lead in creating a carbon club or join such efforts.
Conclusion: The way forward
The U.S. and the EU can cooperate closely to address carbon leakage, as this will create a huge momentum in reducing carbon emissions in a meaningful manner. One of the forums for such cooperation could be the Trade and Environmental Sustainability Structured Discussions (TESSD) underway among a group of WTO Members. The TESSD, which was launched by 53 WTO Members, including the EU, in November 2020, was joined by the U.S. and China in November 2021. Thus, it could be a good forum where dedicated discussions on trade and climate can take place, and that group’s ministers confirmed their intention to do so in December.
The EU will become the first mover by introducing its CBAM in 2023. However, it remains to be seen if and when the U.S. and other countries will join the force. We are likely to see a patchwork of different carbon pricing systems in different jurisdictions before governments take serious steps to discuss and implement a global carbon pricing system. This patchwork will make it more difficult for companies to implement the carbon pricing system and effectively reduce carbon emissions.
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