Abstract
In order to accelerate climate change mitigation and steer the global economy towards an ecological transition, we must alter the current incentive structure. The ecologically necessary must become economically profitable. Effective carbon pricing creates financial incentives for polluters to reduce emissions. The European Union has put in place the world’s first international emissions trading system in 2005. Although the EU ETS has been criticized for several shortcomings, including high price volatility and an over-allocation of free permits, it is an auspicious tool to reduce CO2 emissions. To make the cap-and-trade instrument more effective, the caps must be reduced, and a carbon price floor be implemented. Furthermore, a decisive and rapid agreement on the European Carbon Border Adjustment Mechanism (CBAM), which is a core element of the “Fit for 55” package, is vital to ensure that the climate objectives of the EU are not undermined by production relocating to countries with less ambitious policies. It also induces other world regions to put their own carbon pricing schemes into place and sets the scene for a global climate club. Carbon taxes on the emissions not covered by the European Trading System are desperately needed in order to catalyze climate change mitigation. Sweden, for instance, implemented a carbon tax more than 30 years ago and demonstrates that effective carbon pricing schemes can be both an ecological and an economic success-story. Effective carbon pricing schemes in the European Union are indispensable to accelerate climate change mitigation and demonstrate to the world that ecological ambition and economic success are not opposites, but obligatory conditions to thrive in the 21st century.
Carbon Pricing and the EU Fit for 55
Altering the current economic incentive structure is essential to catalyze climate change mitigation. Economists widely agree that carbon pricing is the single most effective way for countries to reduce their emissions. On the one hand, it creates financial incentives for polluters to reduce emissions (e.g. using a bike rather than driving a car), on the other hand, it generates revenues which can be used to accelerate the green transition (e.g. ramping up renewable energy sources).
The “Fit for 55” legislative package, put forward by the European Commission in 2021, aims to reduce net greenhouse gas emissions by at least 55% by 2030, from 1990 levels. Carbon pricing schemes are indispensable to reach this target. Core elements of the proposal include the extension and strengthening of the EU Emissions Trading System (EU ETS), the implementation of a European Carbon Border Adjustment Mechanism (CBAM) and the revision of the Effort Sharing Regulation (ESR). Since the current policies do not reflect the urgency of the climate crisis, it is necessary to strive for more ambition and transformative changes immediately.
The European Emissions Trading System (EU ETS)
The European Union put in place the world’s first international emissions trading system in 2005. The EU ETS covers approximately 45% of overall GHG emissions in the EU and operates under a ‘cap-and-trade’ system. The main features are the emission cap (a ceiling on the maximum amount of CO2 emissions) and the trading of EU emission allowances (CO2 certificates). Since its introduction, emissions from the ETS sectors have been cut by around 43% which clearly shows the effectiveness of the instrument.
A current European Commission proposal aims to revise the EU ETS. According to the proposal, emissions from the current ETS sectors ought to be reduced by 61% by 2030. To reach this target, the EC aims to lower the emissions cap. Furthermore, the Commission proposes to extend emissions trading in new sectors where sharper reductions are needed to reach the 2030 target. Under the proposal, emissions from maritime transport will be included in the existing EU ETS, while emissions from fuels used in road transport and buildings will be covered by a new, separate ETS. These adjustments are necessary to deliver on the ambitious reduction targets that are written into the legal framework by the European Climate Law. However, the suggested speed of phasing-out free allowances and the time span for the revision implementation do not reflect the urgency of the crisis. EU-policymakers must therefore ramp up the pace and ambition of their legislative proposal. Furthermore, to reduce the price volatility and ensure a large enough steering effect, the EU must introduce ETS carbon price floors . As Bruegel, a renowned European think tank, demonstrates, price floors make the system both more transparent and predictable, which increases its effectiveness. NGOs, national governments, and the civil society must pressure the European decisionmakers to agree on a final revision of the current directive before the EP summer recess that starts in July 2022.
European Carbon Border Adjustment Mechanism (CBAM)
Another key element of the “Fit for 55” package is the implementation of a European Carbon Border Adjustment Mechanism (CBAM). The overarching goal of CBAM is to ensure that the climate objectives of the EU are not undermined by production being relocated to countries with less ambitious policies. The introduction of CBAM aims to equalize the price of carbon between domestic products and imports. EU importers will be obliged to buy carbon certificates corresponding to the carbon price that would have been paid, had the goods been produced under the EU's carbon pricing rules. As proposed by the EC in July 2021, CBAM will apply to imports of electricity, cement, fertilizers, iron, steel and aluminium. These sectors represent over 90% of industrial CO2 emissions of the European Union.
While the implementation of the EC’s proposal is long overdue, NGOs such as WWF and the Carbon Market Watch put forward an array of suggestions to make the current proposal more effective. First and foremost, it is essential to enlarge the scope of CBAM to cover all high emission industrial sectors. Moreover, indirect emissions that occur in the production of the electricity used in the manufacturing process in the country of origin must be addressed since this incentivizes producers to switch to renewable energy sources. To ensure that the EU increases its contribution to the decarbonization of developing economies, CBAM revenues must be recycled towards green investments in the global south. This redistribution of revenues sends a strong message to trading partners and leverages the EU’s position in global climate negotiations. CBAM must be the starting point for a global climate club - a coalition of nations that commit themselves to a minimum carbon price and mechanisms to penalize countries that do not participate. This will overcome free riding in international climate policy. The implementation of CBAM has significant implications on the global economic system and incentivizes other countries to implement similar carbon pricing schemes as the EU. China, for instance, introduced its own emissions trading system in 2021. Canada and Japan are planning their own carbon border adjustment initiatives. The USA, responsible for one quarter of all historical CO2 emissions, must also follow suit. Horizontal diffusion of effective carbon pricing schemes is needed to keep the 1.5° Celsius temperature target alive.
Revision of Effort Sharing Regulation (ESR)
The Effort Sharing Regulation (ESR) sets binding national targets for the emissions currently not covered by the EU ETS. It encompasses around 55% of overall GHG emissions in the EU. ESR targets are different for each country, depending on their GDP per capita and the cost-effectiveness of reducing emissions. In order to reach the 55% reduction target by 2030, the EC proposes a revision of the ESR. According to the proposal, sectors covered by the ESR should achieve a collective reduction of 40 % by 2030 compared to 2005.
While it is clear that the current targets for the various member states do not reflect the urgency of the climate crisis, the ESR reform must also close existing loopholes that undermine the law’s effectiveness. It has to ensure that decisions on, for example, agricultural subsidies, public transport infrastructure, building renovations and waste collection, support the transition to carbon-free societies. In a joint report by environmental NGOs, an array of policy solutions are proposed to modify the current EC proposal. Above all, enhanced governance mechanisms are needed to guarantee compliance and transparency. In the future, every EU citizen must have the opportunity to see how each country is contributing towards climate change. By publicly disclosing the yearly compliance checks, the EC ensures that leaders are held accountable. Member states also should be incentivized to overachieve on their targets by receiving additional funds if they do so.
Moreover, carbon taxes for the emissions not covered by the EU ETS are needed to accelerate climate change mitigation in the various member states. Sweden, for instance, implemented a carbon tax more than 30 years ago and demonstrates that effective pricing schemes can be both an ecological and an economic success story. Therefore, European leaders must take urgent action and implement incrementally increasing carbon taxes in their respective jurisdictions. The EC must support the various member states by providing funds and knowledge – essentially nudging them to take bold and immediate actions.
Ecological Necessity and Economic Prudence
Saving the planet must become a profitable economic endeavor. Effective carbon pricing provides an incentive structure that protects our climate and fosters the creation of green jobs. The EU, with nearly one quarter of global historical CO2 emissions, has a tremendous responsibility to push forward and show the world, not least of all the developing countries, that ecological ambition and economic success are no opposites, but obligatory conditions to thrive in the 21st century. Since there is no time for delay, it is absolutely vital that the EU delivers on its promises and adapts the aforementioned key elements of the “Fit for 55” package before the 2022 summer recess of the European Parliament.
The EU ETS has proven to be effective. It needs to be extended in scope, tightened in the emission cap and abbreviated in phasing-out free allowances. The implementation of CBAM addresses the challenge of carbon leakage and incentivizes other world regions to introduce effective carbon pricing schemes in their respective jurisdictions. Thus, it sets the scene for a global climate club – an undertaking that the European Union must prioritize in its diplomatic efforts. The revision of the ESR must reflect the urgency of the climate crisis. Enhanced compliance and transparency ensure that emissions from the non-ETS sectors, which account for more than half of EU’s GHG emissions, are significantly reduced.
The EU wields unique, and highly penetrating power to transform global markets unilaterally. It has done so in the areas of competition regulation, data protection, online hate speech as well as consumer health and safety. The implementation of effective carbon pricing in the EU has the potential of becoming one more manifestation of the so-called “Brussels effect”, a term used to describe the spill-over of rules outside the European Union. The world desperately needs a “Green Brussels Effect”. As Ursula von der Leyen put it in her presentation of the European Green Deal: “This is Europe’s man on the moon moment.”
Works Cited
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