How do governments impose a higher price on carbon without pushing industry abroad?

Cabinet mandate letters propose ‘carbon border adjustment measures’ as a possible solution

carbon border tax

With Canada’s carbon price set to climb dramatically in the coming years, it’s essential that governments find ways to protect the competitiveness of the country’s industrial sector and prevent a shift in production to countries with weaker climate measures.

Political leaders in the European Union, the United States and Canada are increasingly exploring how they might implement carbon border adjustment measures (CBAMs), also known as carbon border taxes, to allow greater ambition on emission reduction without undermining their economies. Imposing higher carbon costs on industry can result in lower emissions in the home jurisdiction but higher ones elsewhere, resulting in no benefit for the climate. Governments in Canada and Europe currently levy carbon taxes on a small portion of production to avoid that leakage scenario. Border measures would allow them to impose steeper carbon costs while protecting their industry.

In Canada, Prime Minister Justin Trudeau has given his cabinet ministers the task of figuring out how to stop what’s known as carbon leakage, when carbon-emitting industries move abroad to avoid paying penalties. The Liberal government has committed  to raise Canada’s federal backstop carbon price from $50 a tonne in 2022 to $170 by 2030, and that includes the output-based pricing system that applies to large industrial emitters. Provinces that have adopted their own pricing systems to avoid the federal one will be expected to match Ottawa’s price increase.

Canada would be well-served to find co-operative approaches in implementing any border measures, researchers from the Canadian Institute for Climate Choices (CICC) told a webinar on December 15, previewing a report on CBAM co-operation to be released in the coming weeks. That effort is enormously complex, as different jurisdictions – even within Canada – have varying approaches to carbon pricing that make it difficult to make comparisons, the report concluded. At the same time, governments will have to avoid the temptation to wield CBAMs as unfair trade measures that use the climate battle as a pretext for outright protectionism. 

“Coordinating best practices [on CBAMs] can smooth the protectionist waters,” CICC economist Dave Sawyer said. Through a co-operative approach, governments can maintain competitiveness by ensuring equivalent climate costs while motivating other countries to increase their ambition. 

Former environment minister Catherine McKenna said the trade issues around climate transition are challenging but must be addressed. “It matters because competitiveness matters,” she told the webinar. “It matters because we want to tackle climate change, but we also want to have industries in Canada and we want to have good jobs in Canada.”

The Liberal government is currently developing its approach to carbon border adjustments. In his mandate letter to Finance Minister Chrystia Freeland that was released December 16, Trudeau tasked the minister with working with provinces as well as key trading partners like the United States and the EU on CBAMs.

Trudeau’s instructions to his ministers signalled an unprecedented government-wide effort to combat climate change. Freeland is charged with a host of policies to ensure that financial markets and pension funds put climate change risks and opportunities front and centre in their decision-making. Environment Minister Steven Guilbeault and Natural Resources Minister Jonathan Wilkinson have lengthy to-do lists, grounded in the Liberal commitment to reduce emissions by at least 40% by 2030 from 2005 levels and achieve net-zero by 2050. Their remit includes setting greenhouse-gas-reduction targets for the oil and gas sector and putting the country on track for a fossil-free power grid by 2035. Guilbeault is also tasked with producing the country’s first strategy on climate adaptation by the end of 2022.

Coordinating best practices [on CBAMs] can smooth the protectionist waters.

– Dave Sawyer, economist, Canadian Institute for Climate Choices

Every minister in an economic portfolio had climate-related priorities. Infrastructure Minister Dominic LeBlanc is to oversee an effort to establish a “buy clean” strategy that would support the use of made-in-Canada, low-carbon products in Canadian infrastructure projects. Innovation, Science and Economic Development Minister François-Philippe Champagne is tasked with promoting the country’s cleantech sector and the electric vehicle supply chain, including establishing new rules around foreign investment in the critical mineral sector. 

Freeland’s mandate on CBAM suggests the federal government will apply a carbon tariff on imports from countries “that are not doing their part to reduce carbon pollution and fight climate change.” The measures would apply specifically to carbon-intensive goods such as steel, cement and aluminum, the letter said.

The tricky business of determining which countries are “doing their part” in cutting emissions will be fraught with tensions and international rivalries, particularly given the long-standing principle at the United Nations that developed, emerging and least-developed countries have differing responsibilities for climate action.

EU championing carbon border measures 

The EU is leading the charge on CBAMs as it drives greater climate ambition and a rising carbon price. New German Chancellor Olaf Scholz is a champion of carbon border measures and pledges to help push such measures through the European Parliament.

The Canadian government has begun to assess the impact that the adoption of carbon border measures would have on exports to the EU, said Marie-France Paquet, chief economist at Global Affairs Canada. If the Europeans acted alone, it would result in tariffs on Canadian exports averaging 0.54% – higher than the average levies for the U.S., Australia or Japan, Paquet told the webinar. In a joint approach, that average tariff would drop to 0.15%, and Canadian exports to Europe would increase, she said.

Germany is taking over the presidency of the G7 in January, and Scholz is expected to push members to work together on carbon border measures, Ambassador Sabine Sparwasser told the webinar.

Germany and the EU have set out to rapidly transform their economies from a reliance on fossil fuels to clean energy, the ambassador said. “With this agenda, we do need to look at good ways of keeping our economies competitive and at good joint ways of avoiding carbon leakage within the EU and with very like-minded partners.”

Cooperation with the United States – which is by far Canada’s leading trading partner – would be tougher because it has no national carbon price and instead relies on a raft of state and federal regulations, pricing systems and subsidies. At the same time, Canada’s own climate strategy goes well beyond pricing to include a host of regulations, such as the Clean Fuel Standard.

The U.S. and EU announced at November’s UN climate summit in Glasgow, COP26, that they intended to negotiate a CBAM for trade in aluminum and steel.

It is impossible to overestimate the enormity of the challenge, even in reaching agreement with the EU, Sawyer said. Governments will have to ensure consistency regarding how carbon intensity in industry is measured and in assessing what climate-related costs are imposed by governments. 

It matters because competitiveness matters.

-Catherine McKenna, former minister of environment and climate change

The Canadian system alone is a patchwork of federal and provincial policies, noted Ken Boessenkool, a former Conservative Party strategist and a lecturer at the Max Bell School of Public Policy at McGill University.

“Each province has addressed the competitiveness issue in a different way,” Boessenkool said. “That will be a challenge when you want to put on top of it a single carbon border adjustment.”

Under the output-based pricing system adopted by Ottawa and provinces like Ontario and Alberta, industry pays the carbon levy on a small percentage of emissions. The approach avoids adding undue costs to industry while encouraging the companies to cut their emissions. But each province has its own procedures to determine what output will be taxed. Under a cap-and-trade approach used by Quebec and Nova Scotia, companies get free allowances up to a cap, again effectively paying only a small percentage of their output.

The EU has an emissions trading system, and the goal is to drive down the amount of free allowances provided in order to reduce emissions by 55% by 2030 and to zero by 2050, said Susanne Droege, a researcher at the German Institute for International and Security Affairs. 

To protect its industry from resulting climate costs, the EU has introduced legislation with carbon border measures to be phased in over 12 years. It would cover steel, aluminum, cement, fertilizers and electricity from non-EU countries.

The legislation was drafted with an inward focus on European industry, and “there was not much dealing with the international ramifications,” Droege said. But trading partners – from Ukraine and Russia to the U.S. and China – are now engaging in the debate.

Leading politicians in Europe, including Germany’s Chancellor Scholz, have acknowledged the EU will not be able to go it alone in establishing a workable carbon border regime and will need partners. Scholz is looking to establish “climate clubs” – countries with high mitigation ambitions – to work together on trade issues. It’s a club from which Canada cannot afford to be excluded.

With the support of the Embassy of the Federal Republic of Germany in Canada.

Latest from Climate Crisis

current issue