Trade Cases

Leibowitz: EU, US Need to Sort Out CBAM Issues

Written by Lewis Leibowitz

The United States and European Union are quarrelling about several trade issues. None is more far-reaching than the trade impact of measures to address climate change. 

IN PROGRESS... Leibowitz:

While some still doubt the need or ability of the world’s nations to tax or subsidize their way out of human-caused global warming, governments, at least in Europe and the United States have concluded that governments must do something. The US has started this process by subsidizing, as the “Inflation Reduction Act” creates electric vehicle (EV) and other subsidies through tax credits. But the “clean vehicles” must be assembled in North America, and critical materials, such as lithium-ion batteries, must be manufactured either in North America or a country with which the US has a free trade agreement (FTA). So far, at least, the US has not passed legislation imposing a tax on carbon emissions or an “emissions trading system” under which heavy carbon emitters must buy entitlements to pollute from companies that are relatively cleaner. Instead, the subsidies enacted will reward less carbon-intensive manufacturing methods (e.g., electric cars) rather than taxing carbon-intensive methods. 

In 2009, the EU created an emissions trading system (or ETS) for selected industries that emit lots of carbon: cement, iron and steel, aluminum, fertilizers, electricity and hydrogen. Until 2019, companies in these industries had to obtain the right to pollute, but didn’t have to pay for it. If the EU starts charging for ETS certificates, the community has identified a serious risk of “carbon leakage.” This means that goods imported from countries that have not put a “price” on carbon will have a built-in competitive advantage over European competitors. 

To compensate for that, the European take on “leveling the playing field,” the European Parliament recently adopted legislation to impose a tariff on imports of products that are manufactured outside the EU that do not build in a price for carbon emissions. That is the “carbon border adjustment mechanism,” or CBAM. 

The United States and the EU have been discussing joint action to address climate issues, especially in metals—steel and aluminum. Readers will recall that in late 2021 the US and EU agreed to eliminate Section 232 tariffs on EU steel and aluminum imports into the US. They also agreed to initiate discussion leading to an agreement on joint action to reduce steel and aluminum overcapacity in their markets. The deadline for an agreement is Oct. 1, 2023—failure to agree could lead to a resumption in US tariffs on steel and aluminum from Europe. Six months is not a long time from now. 

The CBAM legislation in Europe has attracted attention in the US. The CBAM will take effect this year, but only to require information. Import taxes will begin to phase in starting in 2026. But already, the US wants to get an exemption on CBAM.

As we’ve seen before, one of the basic principles of the world trading system is “non-discrimination.” That principle has been violated by numerous actions, by the United States, Europe and many other countries, either through tariffs or quotas, and retaliatory actions by affected countries. But the EU insists that its CBAM will not be discriminatory—any country that imposed a cost on carbon in manufacturing will see its CBAM taxes reduced or eliminated, and any country that does not impose a cost on carbon will not. At present, the EU is not conceding any special deal with the United States on CBAM.

If the two sides don’t make progress soon, there could be a new dust-up between the two largest economies on the planet. But for a couple of huge reasons, this is not to be desired. First, the US and EU share many common interests, including a desire to preserve the post-war world order against attacks from Russia and China. Solidarity on Ukraine and other issues in the face of these challenges should not be jeopardized by differences over carbon policy.

Second, kicking the can down the road on climate is not in the interest of the US or the EU, at least as they are currently governed. If climate change is an emergency, we need to deal with it as such and not persist in postponing action. So, extending the negotiations on steel and aluminum would not present a favorable appearance on the world stage.

So, how can we narrow these differences? The US is facing criticism from Europe for not expanding the EV tax credit to foreign (EU) assembled vehicles. The US could give on this, but more than an “essential minerals” FTA would probably require legislation. And that in turn would require that the administration actually negotiate with Republicans, who control the House, although narrowly. The US could also create some mechanism to put a price on carbon in manufacturing, but the same legislative problems persist on that.

The EU could alter its ETS to provide credits for US steel and aluminum producers. That would require changing the ETS and/or the CBAM provisions on which the ink is barely dry. 

It’s a lot to do in the next five months. There could be a last-minute deal. But if there isn’t, the fur could fly. 

Lewis Leibowitz 

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Lewis Leibowitz, SMU Contributor

Lewis Leibowitz

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