Recently, the European Union unveiled its new plans for how it is going to reach its goal of reducing the continent's emissions by 55% by 2060. Among a host of new policies that make up this new sustainability pledge is the introduction of a carbon border tax, which entails taxing any imported goods that do not meet the EU’s sustainability requirements. Generally, economists view tariffs on imported goods as inimical and tend to shy away from most protectionist policies. So why has this border tax been well received, and what does it mean for the future of climate change?
This new tax has a twofold function. Firstly, it is a preventative measure against the loophole in domestic carbon tax called ‘carbon leakage’. If a company that is based in the EU, say France for example, wanted to avoid the EU’s domestic carbon tax, all they had to do was produce their goods in a nearby country outside the EU and then imported it back into France with no tax. This carbon tariff prevents that almost perfectly and should work nicely. The second function is more diplomatic. It is meant to serve as an incentive to other nations that trade with the EU to start enacting their own climate change policy – you do not pay the tariff if you have paid some form of carbon penalty at home. This second function has some interesting implications and is worth investigating.
At this point, if you know your basic economics, you’d be thinking to yourself, “Hey, if the EU enacts this tariff, won’t it just make all goods in the EU more expensive, making their citizens worse off?”, and you’d be correct for making that assumption. This tariff is a trade-off and a gamble. It’s a trade-off, as the EU is making the logical assumption that the cost of climate change is worse for its citizens than the cost of an extra tariff. It’s a gamble because the tariff only becomes cheaper if other nations begin to enact more climate change policies similar to theirs. Many people have talked about this aim and have started encouraging other nations to adopt a similar tax. So this brings us to our main question: how many countries would have to put in place carbon border taxes so that it becomes cheaper to have them than to not have them? When do carbon border taxes become economically efficient?
This question is based on the logic of tariff tipping points and basic trade economics. It follows that tariffs are economically harmful to the nation when no one else has them in place but they become economically beneficial, or at least neutral, when everyone else also implements them. To explain this logic let’s use a scenario. Say for example South Africa put a carbon border tax in place while no one else had them. All carbon-heavy goods being imported would suddenly become much more expensive for us due to the tax, dampening demand in South Africa and making the tariff economically harmful. However, if you take the opposite end of the scale, where every other nation has this tariff but South Africa did not, our imports would not be affected, but all South African exporting companies would be paying higher taxes, creating lower profits. Then, domestic goods in the importing nations become relatively cheaper, meaning South African goods would not be bought. So carbon-intensive South African exports would decrease. For South Africa to recoup this loss (using the common GDP function), it could increases taxes by a proportionate amount, in the form of a carbon border tax, to cancel the losses from exports and raise government revenue. The tax would decrease imports the same amount exports decrease, nullifying the effect from exports. Therefore, when every other nation has a carbon border tax, it becomes economically beneficial to enact one yourself. If you zoned out for that entire paragraph, no worries, it is just the conclusion that is important: carbon border tariffs become better to have when more countries implement them. Once this is established, you begin to wonder: how many nations does it take before this tipping point from economically harmful to beneficial occurs?
Obviously, the answer to this question will differ for each nation, as they all have different trading partners that would affect their policy and all vary in the extent of their reliance on carbon-intensive exports. For simplicity sake then, it is useful to consider this question from a global perspective. I will make the assumption here that a country’s exports and imports come from the same nations and that the number of goods flowing both ways is similar. It is an illogical assumption but it makes this question easier to analyse.
So with this logic in place, it makes sense that this tipping point occurs at the 50% point. At the 30% mark, when 30% of your trading partners also have this policy, then 30% of your exports will go down. Say you enact border tax at this point to stop the losses on your exports. Then, you no longer lose that 30% in exports, but the other 70% of your trading partners do not have this policy, and so 70% of your imports become negatively affected. So having a carbon border tax when only 30% of your trade partners do has a net 40% loss (30%-70%). When 60% of your partners have the policy, however, it is a different story. 60% of your exports are worsened if you do not have the policy, but only 40% of your imports are affected if you do have it, making for a net 20% gain (60%-40%). Therefore, it becomes clear that the 50% point is the tariff tipping point.
What does this conclusion mean for us? Firstly, it shows the incredible power of collective action and what we can achieve if we work together, especially in combatting climate change. Secondly, it shows the responsibility that countries like America, China and the EU bear. These three alone make up a significant chunk of world trade, far beyond the rest, and together can get us close to the 50% tipping point. South Africa cannot be the only one to enact a carbon border tax, as it will not be beneficial economically and will not incentivise anyone to do the same. The EU is a different story. They have considerable trade power and by enacting this policy they are sending a strong signal that they believe the world will eventually reach that tipping point. I’m excited that a world power is finally taking responsibility and paving the way on climate change policy. It is only once this tipping point is reached that companies that exploit the planet for money will have nowhere to hide and will be forced to face their actions, and, hopefully, change them for the better. Or it is possible that when the 50% point is reached, and enough countries have adopted a domestic carbon tax, there will be no need for a carbon border tax at all, and we will all be better off.
If you’re interested
William Nordhaus proposed a similar theory for climate change policy based around ‘climate clubs’ that ultimately reduce the cost of climate policy and prevent free-riding
Bibliography
https://www.statista.com/statistics/268184/leading-import-countries-worldwide/
https://view.e.economist.com/?qs=91cf7f9453852ab720cab4f4d5ebb95b7af7ab19a74056905a38b93016a4ded03e314629b80a9780259ef8c00ec06f27178ea99dee84c6a405250eea216d015ff0f801b0c34e4858ef761bbd8735a2f7
https://www.nytimes.com/2021/07/14/climate/carbon-border-tax.html