Dr Dominic Hogg                            CBM0022

Written Evidence Submitted by Dr Dominic Hogg, Equanimator Ltd

I am an environmental consultant with more than twenty five years’ experience in environmental policy matters both at my current company, and formerly with Eunomia Research & Consulting Ltd, a company which I founded in 2001.

I have a long-standing interest in border tax measures related to greenhouse gas emissions, as well as resource consumption and use. I am making this submission in a personal capacity

My key points are that:

 

  1. This submission seeks to address a number of the questions the Committee has indicated are of interest.
  2. The first question – regarding the risks associated with carbon leakage – is one which preoccupies many observers, and has been a key issue in the development of the EU-ETS, which the UK was involved in until it exited the EU. It remains – judging by the Consultation document drawn up by BEIS earlier this year[1] – a key preoccupation of those who are (understandably) keen to ensure that UK businesses are not placed at a disadvantage relative to industries located in other countries.
  3. All economic instruments with environmental objectives are, in my personal experience with a number of them, routinely challenged on grounds of their supposed impact on competitiveness. There are relatively few sectors in the UK economy which are both a) carbon intense, and b) vulnerable to competitive threats owing to as a result of their being involved in producing goods that are widely traded. Nonetheless, that does not mean that there are no threats of carbon leakage under the current approach. It is just that the current approach is not the right one. This is because the way in which the leakage problem is ‘solved’ – by exempting carbon-intense industries from the effects of the policies in place – is clearly not a solution (since it undermines the policies).
  4. Rather than spend time answering this question about risks of leakage, therefore, it makes more sense to focus on solutions where these exist. The potential for applying border tax adjustments / a carbon border adjustment mechanism is nothing new. For more than twenty years, US academics have been urging the EU to implement border tax measures in order to convey a suitable signal to the US that it should take the matter of climate change (and carbon pricing) seriously. It would have been wise, in my opinion, to deploy the threat of CBAM/BTA as part of a parallel track of negotiations in the context of the COP26 but it would seem that too few countries saw its potential to persuade various exporting nations to the table, and the UK – as evidenced by this inquiry – has been behind the curve on this issue.
  5. That the EU did not adopt this approach, but instead, instigated a bureaucratic process to identify ‘at risk’ sectors, and issued free allowances to installations within those sectors, has both undermined the EU’s ambition in respect of climate change, and postponed the grasping of the opportunity in respect of BTA/CBAM to allow ambition to be maintained whilst preventing the erosion of international competitiveness as a result of wide disparities in carbon pricing. A more recent parallel within the UK has been the decision to compensate businesses for costs associated with the carbon price support (CPS) mechanism.
  6. If the intention is only to avoid exposing sectors to the full effects of carbon pricing, then logic suggests that those carbon-intense sectors which are offered a significant proportion of their allowances for free, whilst avoiding risks of carbon leakage, will do so in the context of a continuing absence / limitation of incentive to invest in abatement of climate change emissions, thereby increasing the risks which are faced in respect of climate change. Indeed, if this strategy is maintained, then it is difficult to see how government can escape the need to offer various forms of financial support to the sectors exposed in order to cajole them to make the necessary transition to a lower carbon future. The BEIS consultation of earlier this year noted: [2]

In 2019, we provided around £442 million to support qualifying energy intensive industries, including reductions in the policy costs of the transition to renewable electricity and compensation to partly offset the indirect impacts on electricity prices from the European Union Emissions Trading System (EU ETS) and the Carbon Price Support (CPS).

  1. Whether there are risks of so-called carbon leakage or not, if there is a mechanism that allows for carbon prices to industry to be increased without eroding the competitiveness of domestic industries, then surely that allows us to set aside the issue of whether leakage is a genuine risk or a less serious issue for the UK. CBAM/BTA is / are that mechanism.
  2. Note that within BEIS’s consultation, it includes ‘lack of abatement opportunities’ as a causal factor underpinning leakage risk. BEIS’s own position, regarding the abatement costs to some of the sectors under the EU-ETS, appears to be that the abatement costs are relatively high. It follows, therefore, that unless the UK addresses the leakage issue head-on through CBAM / BTA, then the emissions from sectors protected from leakage through issuing free allowances / compensating for the costs of the CPS will not fall unless government effectively pays for the abatement to be undertaken by those industries. That is not a solution that could be regarded as efficient in any sense of the word. Moreover, it is likely to be costly to the public purse, not least relative to a counterfactual where a CBAM / BTA is in place alongside auctioning of a diminishing number of allowances / a carbon tax.
  3. As we, move forward, the apparent desire to avoid exposing UK industry to a higher carbon price has the potential to backfire. Where UK carbon-intense sectors trade heavily with the EU, for example, then implementation of a CBAM at the EU level would potentially have the following effects (where UK industry was not subject to similar measures):

A)    EU industry is incentivised to abate more quickly than UK industry;

B)    UK industry is subject to carbon border adjustment measures, reducing the competitiveness of a more carbon-intense UK industry relative to EU-industry;

C)    UK exports are rendered less competitive as a result;

D)    EU industry achieves some ‘re-shoring’ of manufacturing relative to its trading partners, albeit some loss in EU competitiveness may occur vis a vis other countries whose industry is not affected by carbon pricing.

  1. This can be generalised to other jurisdictions implementing a CBAM. We would expect that where jurisdictions apply CBAM unilaterally, then their domestic producers are likely to become more competitive relative to third countries within their own borders. The exception would be where third country producers dedicate low carbon production to export to the CBAM-implementing jurisdiction, or where other measures render the third country a low carbon producer.
  2. This gives rise to a broader perspective. Strategically, the UK may want to consider how effective a policy of issuing a significant proportion of allowances to many carbon-intense sectors will be in the longer term. Is it credible to imagine that industrial sectors will – globally - be shielded from the impacts of carbon pricing beyond the short-term? Indeed, what are the global implications, for climate change, of that being the case? A CBAM allows the UK to pursue a more forward-thinking carbon pricing policy that incentivises carbon abatement by carbon intense industry, whilst also ensuring that this decarbonisation proceeds in the context of equal treatment of overseas producers, ensuring the worst impacts on competitiveness are avoided.

What role could a carbon border adjustment mechanism (CBAM) play in addressing carbon leakage and meeting the UK’s environmental objectives?

  1. The CBAM has an essential role to play in addressing carbon leakage as long as the carbon prices which are paid in other countries are lower than those prevailing in the UK.
  2. It may also make sense to move the prime responsibility for carbon pricing away from BEIS, and a trading scheme, and towards HM Treasury, and a tax-based system. Indeed, given the key role of pricing, financing, and targeted support measures, it feels right to make HM Treasury the primary Department with responsibility for meeting successive carbon budgets, coordinating input from other Departments as relevant. The move to a low-carbon economy, and one which also addresses the critical state of the natural environment, and the quality of the air we breathe, will require the environmental agenda to take centre stage in planning our future economic wellbeing.
  3. Historically, those of us interested in shifting taxes progressively onto ‘environmental pollutants’ have found it difficult to engage finance ministries in the discussion. Tax, we are repeatedly told, ‘is a Treasury matter’. That being the case, then given the Treasury’s central role in setting tax policy, and making final decisions as to how tax revenue will be spent, its role has to be considered pivotal in achieving the desired outcomes. BEIS, on the other hand, is, it could be argued, conflicted in terms of its priorities.

Should the Government pursue a unilateral CBAM? If so, why and what form should this take? If not, are there alternative approaches to addressing carbon leakage which the Government should be considering?

  1. Yes and no.
  2. Notwithstanding that strong case for collective action, the whole point of CBAMs is that they facilitate unilateral action in the face of a world that is moving far too slowly to commit itself to act on the issue of climate change. Committing to target thirty years hence is one thing: ensuring the targets already set can be met is quite another. Nothing makes wider adoption of CBAMs more likely than countries beginning to implement them. Taking unilateral action will speed up this process.
  3. On the more collective approach, it remains to be seen whether we might come to regret the lack of a more tactical use of CBAMs in the existing COP26 negotiations.  It may have been helpful to assemble a coalition of those entertaining / willing to seriously entertain CBAMs / BTAs, and to have them thrash out, with the WTO, a set of features which would be deemed sufficient to ensure CBAMs would be able to face down legal challenges (at least in principle). Such an approach, if it were deployed as a parallel negotiation in the context of wider discussions around Nationally Determined Contributions, could have been used to apply additional leverage to those who might otherwise seek to avoid serious action longer to decarbonise their economies.

If the Government were to introduce a CBAM, which products or sectors should be included and why?

  1. In the short-term, it might be the case that the ETS sectors (and associated goods) are the ones of focus. These might not capture the full range of manufactured end products, however.
  2. In the medium to long term, recognising that the UK is a net importer of goods (and a net exporter of services), the objective should be to implement a global system for tracking embodied carbon (and energy) in products as they move through successive manufacturing stages. There is an opportunity for the UK to take a lead here in terms of the associated technologies required. Already, there are ‘more and less’ credible datasets in the life-cycle assessment world which could allow for default figures to be established. In future, it seems difficult to understand how a net zero world could avoid seeking exactly this type of information in the transition to decarbonising products as far as possible.

What risks would need to be managed when designing and implementing a CBAM?

What practical and administrative challenges might arise when designing and implementing a CBAM? How might these be addressed?

  1. A key risk would be to ensure that the measure is WTO compliant. In this respect, the principle of ‘non-discrimination’ (equal treatment of domestic and overseas producers) would apply. Writing in the US context, Hillman wrote:[3]

Each of these steps [i.e. applying taxes to imports and rebating any taxes that may have been paid on domestic products that are exported] is permitted under the WTO rules provided: 1) that the tax is designed to fall within the parameters of an “indirect” tax on products rather than a direct tax on the producers themselves; and 2) that any parallel taxes on imports or rebates on exports do not discriminate in favor of U.S. products. Policymakers have sufficient latitude within this framework to design and implement a carbon tax system that represents a good faith effort to reduce carbon emissions while encouraging all other countries to cut their emissions too, all while preserving the competitive position of U.S. companies. Policymakers can be bold. The WTO will recognize genuine climate change measures for what they are and is unlikely to find fault with such measures, provided they do not unfairly discriminate in favor of U.S. companies.

  1. Discussions in the past with WTO representatives also suggest this is likely to be the case (whatever the objections to the EU proposal that may have been raised by country representatives at the WTO). Indeed, it would be strange if it were otherwise since the corollary would be that if a country sought to introduce a carbon tax, and apply it to traded sectors, then however strong the environmental rationale (and it could scarcely be stronger), it could only do so by placing its domestic industry at a competitive disadvantage.
  2. It would be preferable, in my view, for the UK-ETS to be phased out and replaced with a tax-based system. One of the reasons for this is that the border adjustment mechanism would be more straightforward. It is not beyond the wit of man to establish a basis for setting a carbon border adjustment mechanism in the context of a trading scheme, but when the traded price of allowances is fluctuating, it might be considered that there is an additional layer of complexity. A fairly simple, though nonetheless risky, alternative might be to deploy a high carbon price floor under the UK-ETS which effectively sets the price level for carbon for use in the context of border adjustment.
  3. Other issues may be the need to avoid ‘double counting’ (and hence, the need to consider the effects of policies in the country from which imports originate). The EU CBAM proposal makes provision for this.
  4. A further issue is the setting of ‘default’ rates for imports of the covered sectors and products. This would require some rationale based on international benchmarking (and the EU has already undertaken some work in this regard). The principles underpinning this would need to respect the need for non-discrimination, so that if imported goods could be shown to be ‘less carbon intense’ than the default values used to set the implied ‘border adjustment / tax’, such a lower rate could be accepted on the presentation of suitable evidence.
  5. Finally, the potential to offer ‘refunds’ to industries who export goods from the UK having already paid their levies should be considered, as should measures to ensure there is no major associated cashflow issue associated with the mechanism.

What wider opportunities and benefits might arise from introducing a CBAM?

  1. There are a number of possible wider opportunities:

a)      in relation to the extending of the CBAM from ‘raw materials’ to consumer products, (see above) based on the embodied carbon content of products.

b)     In relation to extending the scope of CBAM’s to other pollutants, not least, other air pollutants (NOx, PM2.5, SOx, etc.). Here, there might be – from a purist perspective – greater complexity given the fact that ‘impacts’ are linked to the location where emissions occur. Notwithstanding this point, the relevant issue for the UK and other countries is that the absence of any taxes on stationary sources of air pollution is a major omission. Their absence may also distort decisions regarding carbon abatement. For example, fitting carbon capture utilisation and storage on a coal-fired power station might mitigate the carbon emissions but would leave the other air pollutants unabated. This is likely to lead to inefficient outcomes, and may lead to a failure to fully capture some of the co-benefits of addressing climate change

  1. As regards benefits, there may be – as long as other countries do not follow suit – an element of re-shoring of industry if UK industry is more competitive at a higher carbon price than overseas competitors.
  2. A key upside should be to stimulating the use of secondary raw materials relative to primary ones (partial internalising of the differential externalities between primary and secondary materials production), reducing the energy use in production. 
  3. Relative to the counterfactual (where industry continues to receive free allowances and beneficial treatment under the CPS), the pace at which the UK gains from the improvement in air quality associated with reduced air pollution from point sources will be accelerated (notwithstanding the potential for some less beneficial decisions where there is no tax on other air pollutants such as NOx, PM2.5, SOx, etc..

October 2021


[1] BEIS (2021) Energy Intensive Industries: Review of the schemes to compensate energy intensive industries for indirect emission costs in electricity prices, June 2021.

[2] BEIS (2021) Energy Intensive Industries: Review of the schemes to compensate energy intensive industries for indirect emission costs in electricity prices, June 2021.

[3] Jennifer Hillman (2013) Changing Climate For Carbon Taxes: Who’s Afraid of the WTO? Climate & Energy Paper Series 2013, The German Marshall Fund of the United States.