Progressive protectionism: Should Britain impose a carbon border adjustment tax?

Pressure is growing for the UK government to impose taxes on high-carbon imports but would such levies be legitimate tools for meeting the global net zero emissions goal, or are they old-fashioned trade protectionism in disguise? Ben Chu investigates

‘There is no point in damaging the competitiveness of economies such as the UK while other countries maintain their competitive edge,’ argues the former trade secretary Liam Fox (Reuters)

The former international trade secretary, Liam Fox, has urged the UK government to implement a new carbon tax on imports.

Mr Fox was on the tariff-cutting, free-trading wing of the Brexit movement, rather than the wing which wanted more protection for UK firms and domestic production.

Yet on Thursday Mr Fox said new import taxes were, nevertheless, made necessary as a result of efforts by the UK government to decarbonise domestic UK industry.

“There is no point in damaging the competitiveness of economies such as the UK while other countries maintain their competitive edge at a cost to the global climate,” he argued in a speech to the Centre for Policy Studies think tank.

But is this right? Are so-called carbon border adjustment taxes legitimate or even useful tools to be wielded by nations as part of the quest for global net zero emissions? Or are they old-fashioned trade protectionism in disguise?

It’s worth, first of all, examining the nature of the costs imposed on domestic industry from decarbonisation regulation.

While the UK was in the EU, we were subject to the EU’s Emissions Trading System (ETS).

This system effectively charged firms, such as manufacturers and energy companies, for each tonne of carbon dioxide they were responsible for emitting as part of their production processes.

The goal is to create a financial incentive for firms to minimise their emissions, perhaps by switching to zero carbon energy sources.

Now Britain has left the EU, the UK government has launched a British replacement for the ETS, which is imposing an effective carbon price on UK industry of £50 per tonne of emissions.

On top of this there is a direct £18 per tonne of emissions levy on power generators (called Carbon Price Support), giving the UK the world’s highest industrial carbon price.

That reflects well on the seriousness of the government when it comes to achieving net zero domestically.

Yet it’s also true that the UK imports a considerable amount of goods and services from countries whose industries now have much lower domestic carbon costs.

The UK’s independent Climate Change Committee estimates that around 46 per cent of the UK’s “consumption emissions” are imported, meaning they occur in production processes overseas to deliver goods and services that meet UK final economic demand.

So, other things being equal, it’s true the competitiveness of UK industry will be eroded by the UK’s relatively higher carbon levies.

There’s also a danger that if higher-carbon imports grow as a result of this cost discrepancy any progress by the UK towards net zero emissions risks being exaggerated.

It’s arguable that this has already been happening. Official measures of UK carbon emissions have fallen by around 40 per cent since 1990, one of the best national performances in the world.

But if you add in the carbon embedded in goods and services consumed in the UK, the reduction in emissions has been much less impressive, falling by only around 20 per cent.

The case for a carbon tax at the border is not only that it would level the playing field for cleaner UK-based producers but that it would be a way for the UK, acting unilaterally, to incentivise other countries to take similar efforts to decarbonise their own industries.

If these countries wanted to retain access to the relatively large and profitable UK market on the current terms (without facing carbon border tariffs) they would have to impose an equivalent carbon tax.

Moving to carbon border taxes is not without risk.

The danger is that other countries might regard a UK carbon border adjustment tax not as an attempt to cut carbon emissions, but to protect local industry, and respond with retaliatory levies on British exports.

China, the world’s largest manufacturer, for one, has strongly indicated that it does not regard carbon border levies as legitimate under the rules of the global trading system.

There is a danger that such taxes could be open to challenges in the World Trade Organisation.

However, the global political tide does seem to be moving in this direction, as countries impose new costs on domestic producers and fears grow over national competitiveness.

The EU is in the process of drawing up its own plans for a carbon border tax. And the Biden administration in the US is doing the same.

As the trade researcher Sam Lowe noted in a recent report for the Zero Carbon Campaign, the advantage of multiple countries and trading blocs moving in this direction simultaneously is that it reduces the risk of legal challenges and bilateral disputes, and also establishes a new international norm of carbon pricing, and a global floor on carbon pricing. The levy would then, in practice, only apply to those nations that refused to make serious efforts to decarbonise their industrial sectors.

The United Nations climate change conference (COP26) in Glasgow in November would be a good opportunity for nations to co-ordinate on this front.

The imperative, as Sam Lowe points out, is that nations must use carbon border taxes solely – and transparently – for environmental purposes.

If it appears governments are deploying them not primarily to reduce emissions but in order to benefit favoured domestic companies, the risk is a further fragmentation of the global trading system, which would leave us all worse off.