Professor David Collins, City Law School

Last week Jeremy Hunt, the UK Chancellor, announced that the UK would pursue implementation of its own Carbon Border Adjustment Mechanism (CBAM). The EU adopted its own CBAM which is due to go into effect gradually over the next few years – it is currently in an information-gathering stage.

CBAMs are tariffs on imports to reflect the carbon-intensity of their production. Designed to level the playing field between goods which come from countries with strong climate regulations and those where regulations are weak, CBAM tariffs are popular among competing producers who resent the advantage enjoyed by producers who can lower their prices as a consequence of less environmentally-friendly production processes. On the other hand, since CBAM tariffs will raise the price of imports, consumers, including downstream businesses, will suffer.

Careful economic analysis is needed for such environmental levies on an industry-by-industry basis, if not a product-by-product one. Clearly the bureaucracy required for the assessment and collection of CBAM levies will be enormous, requiring a legion of civil servants poring over all kinds of data. While CBAM produce revenue in the form of tariffs on goods, ensuing higher prices will be born unevenly across the economy – an unwelcome development during a cost-of-living crisis in a country seeking to remain attractive to foreign investors. In the case of the UK’s proposed CBAM it is unclear what such economic analysis of the initiative would yield. It is also not clear whether the UK’s anticipated CBAM (or the EU’s for that matter) could violate international law, specifically how it fits into the rules of the World Trade Organization (WTO).

Carbon border adjustment levies are effectively taxes imposed on imports based on the type of production process (high carbon intensity). Since like the EU’s, the UK’s CBAM will be imposed on imported products and not domestic ones, it arguably violates GATT’s National Treatment obligation (Art III) which was designed to enable competitive conditions in the home market. Depending on the structure of the UK’s CBAM, it might also violate GATT’s Most Favoured Nation rule (Art I) if it is applied on goods from some countries and not others. A finding of discrimination would necessitate that the products in question are ‘like.’ The fact that products are made at different levels of carbon intensity is likely to be insufficient to preclude a finding of likeness based on existing jurisprudence regarding consumer taste and products’ end usage. A CBAM might also be viewed as a quantitative restriction on imports, violating Article XI and XIII of GATT.

GATT Art II:2 a) permits the imposition of ‘internal taxes’ (taxes on products rather than on income) as long as it is done consistently with regards to the like domestic product, i.e. does not breach National Treatment. But it is far from clear that the CBAM would be considered as an internal tax. It may be viewed as an internal regulatory charge on goods produced with high carbon emissions. Indeed, some hold that the EU’s CBAM probably would not qualify as a border tax adjustment under WTO law because it is part of the EU’s carbon emission trading scheme rather than a charge on goods. Whether the UK’s proposed CBAM would satisfy this definition remains to be seen.

In the event that the UK’s CBAM were viewed as GATT non-compliant, it might be justified via GATT’s general exceptions, designed to integrate non-trade policy concerns. GATT Article XX g) allows otherwise trade restrictive measures which relate to the conservation of natural resources, provided that they are applied in a manner which is not arbitrary or discriminatory. Article XX b) permits trade restrictions undertaken which are necessary for the protection of human, animal or plant life or health. Regulating imports on this basis is generally allowed under WTO law, seen for example in the famous US-Shrimp case regarding efforts to save sea turtles through restrictions on shrimp imports. There is a difficult test of ‘necessity’ which must be complied with here, though. Is the CBAM the least-trade restrictive way of controlling harmful carbon emissions? This is by far from evident.

CBAMs may also raise issues in relation to subsidization which could transgress WTO law. In other words, a border tax based on carbon emission in production may be justified on the basis that the failure to tax properly in the originating country amounts to a subsidy, granting that product the upper hand in markets where environmental regulations are more-strict. The CBAM would therefore effectively function as a countervailing (anti-subsidy) duty. But under the WTO’s Agreement on Subsidies and Countervailing Measures, finding subsidization is not easy because the relevant benefit (soft-touch environmental regulations) would need to be ‘specific’ – meaning applied to certain companies or groups of companies. While this might also be demonstrable, the application of countervailing duties requires a product-specific finding of injury to the domestic industry in the importing country, unless it could be proven that the benefit of the lower regulation was expressly tied to export, which would be difficult for the government to prove.

Just as there is an economic question to answer in relation to the use of CBAMs, there is also a legal one. As a country which purports to uphold its international legal commitments, the UK should first determine that any carbon border tariffs have a solid legal foundation (not to mention an environmental one, which is also debatable) before implementing them, particularly where they might lead to economic harms.