Carbon border tax adjustment

1.1 The Relevance of Carbon Leakage

The above-mentioned differences between unilateral carbon pricing policies across countries

result in a phenomenon widely discussed in the empirical literature and political context as

carbon leakage. Görlach and Zelljadt (2018, p. 13) refer to different approaches used in the

literature to define the term and summarize that “carbon leakage means that part of the emission

reduction achieved through climate policies is offset by an emission increase somewhere else (in

another country or in another sector).”5 The scientific literature identifies three main channels

through which carbon leakage can occur. First, carbon prices affect domestic suppliers targeted

by the policy, particularly those producing carbon-intensive goods, by raising their production

costs. This leads to a competitive disadvantage compared to producers subject to lower or no

carbon pricing regimes and results in higher quantities produced in regions or sectors with less

stringent regulations. While in this case the reallocation of production activities only occurs

among already existing facilities, the second channel refers to the establishment of new capacities

in regions or sectors with lower or no carbon pricing in the long run. Lower competitiveness2 Carbon Border Tax Adjustment

of domestic firms, resulting from the above mentioned production channel, leads to decreasing

returns on investment making it less profitable to invest in production facilities in markets subject

to stricter regulations. Therefore, investments are redirected towards regions or sectors with less

ambitious climate policies where hence higher production capacities and consequently higher

production volumes and emissions can be observed. The third channel affects the resource

markets. Higher carbon prices lead to increased prices for fossil fuels and result in reduced

demand for these commodities. If the reaction on the demand side is strong enough and the

supply of fossil fuels remains unchanged, the global fossil fuel price will decline and lead to a

higher demand and increasing emissions in countries with less stringent climate policies.5 These

three channels are also illustrated in Figure 1. A fourth and less discussed channel of carbon

leakage deals with technology spillovers, which result in negative leakage rates. In this context,

carbon pricing regimes are generally assumed to induce innovation and the development of new

and less carbon-intensive technologies thereby improving the competitiveness of companies

subject to carbon pricing and reducing carbon leakage.6 These innovations might also spill-over

to third countries and further enhance emission reductions abroad.7

The extent to which overall carbon emissions increase due to geographical or sectoral shifts

of production activities depends on several factors specific to the respective markets or sectors.

The two main aspects influencing the leakage rate, as identified in the literature, are the carbon

intensities and exposure to trade. While carbon intensities define the financial burden imposed

by carbon pricing policies, trade exposure can serve as an indicator for competition among firms.Carbon Border Tax Adjustment 3

The latter can, together with the demand elasticities, significantly affect the degree to which

companies can pass on the costs incurred by the policy.68 As shown above, carbon leakage is

generally considered to have a negative effect on the outcome of climate policies. This can be

explained by its potential to reduce the effectiveness of unilateral policies. Emission reductions

achieved as a result of more stringent regulations in one region or sector are offset by increases

elsewhere, rather than being actually abated, leading to a situation in which the overall effect

on global emissions is significantly reduced. Furthermore, it is suggested that carbon leakage

impairs the efficiency of global climate change mitigation efforts.5 Considering that carbon

pricing regimes might increase production costs in the short run and affect investment decisions

in the long run, the competitiveness of domestic companies is a central aspect of the political

discussion. Especially the production and investment channels through which carbon leakage

might occur are considered problematic and are targeted by additional policies.6

1.2 Carbon Border Tax Adjustments in Theory and Practice

In the recent years, economists and politicians have searched for an adequate instrument to

address carbon leakage and its direct and indirect consequences as presented above. In this

context, different policy instruments and designs have been analysed. Consequently, a broad

strand of literature has emerged on so-called ’Carbon Border Tax Adjustments’ or ’Border

Carbon Adjustments’ as integrated measures to already existing carbon pricing policies. CBTAs

constitute levies imposed on imports produced by foreign suppliers or rebates applied to exports

of domestic companies adjusting for differences in unilateral carbon prices. In some cases, both

approaches can be combined.6 Therefore, the special feature of this policy instrument is that it

can address not only domestic but also foreign firms and provide an “effective extension of the

carbon pricing regime to entities outside the implementing jurisdiction” (Ward et al., 2015, p.

41)6. However, some concerns are addressed in connection with CBTAs. First, tariffs imposed

on emissions embodied in foreign products might be considered by trade partners affected by

CBTAs as a measure to protect domestic industries and could lead to the implementation of

countermeasures, potentially leading to trade disputes among countries. Second, there is a risk

of non-conformity with WTO trade rules, which could act as a possible legal barrier for the

implementation of CBTA policies.9,10 Both aspects will be discussed in more detail in Section

4. Finally, potential negative effects on downstream industries, the problem of ’reshuffling of4 Carbon Border Tax Adjustment

emissions’ and the unequal distribution of the burden imposed by the policy between developed

and developing countries are of particular concern when it comes to the implementation of

CBTAs.10,11 These topics will be presented in Section 2.

So far, this mechanism has been mostly analysed and discussed based on theoretical considera-

tions due to the rare real-world cases in which such an instrument was actually implemented.6

However, the topic gained more practical relevance when the EU presented the ’Fit-for-55 pack-

age’ in July 2021 announcing the implementation of a ’Carbon Border Adjustment Mechanism’

along with other actions aimed at ensuring the achievement of the EU’s climate change mitigation

targets.12 The Council of the EU reached an agreement on a general design of the policy in

March 2022.13 Subsequently, the draft for the regulation was acknowledged by the EuropeanCarbon Border Tax Adjustment 5

Parliament and the Council of the EU in December of the same year.14 The regulation for the EU

CBAM entered into force in May 2023. The policy begins with a transitional phase covering

the period from October 2023 until December 2025 during which the obligation of importing

companies falling under the CBAM is limited to reporting requirements. This will be extended

under the definitive regime starting in January 2026, when the levies on the embodied carbon

contents will actually be charged.15 A timeline of the implementation process of the EU CBAM

is provided in Figure 2.

Through the CBAM, the EU aims to strengthen the price signal of its domestic carbon pricing

policies, such as the EU ETS, and to address carbon leakage. Furthermore, the policy should

incentivize firms to invest in more sustainable technologies, thereby contributing to a further

reduction of GHG emissions and achieving the EU’s emission targets. The EU perceives that

such impulses will not be limited to EU domestic companies but will also spill-over to entities in

third countries and hence fostering emission reductions abroad as well. The free allocation of

emission allowances under the EU ETS, which has been used by the EU so far to address carbon

leakage, shall be gradually phased out with the implementation of the EU CBAM.15

2 Background

The idea of controlling for differences in the national efforts undertaken to mitigate climate

change, especially the reduction of carbon emissions, was already discussed in 1996 by Hoel,

who argued in favor of import and export adjustments as a complement to uniform carbon

taxes.16 Throughout the subsequent years, CBTAs have been extensively discussed and analyzed

in the empirical literature. A primary focus in the debate on CBTAs has been on so-called EITE

industries, which are particularly energy-intensive and exposed to international trade increasing

the risk of carbon leakage in these sectors.9,17 Since CBTAs have not been widely adopted in

practice, most economic studies analyzing the impact of CBTAs use assumptions, estimates, and

theoretical models, which are then applied to and fed with data.11 The ability to conduct direct

comparisons of these studies is limited by differences in the aggregation level of data, underlying

models, and by variations in the geographical regions considered. The discussion of CBTAs

has brought about a wide range of proposals for policy designs, each connected with different

strengths and weaknesses when it comes to the legal, economic, or environmental implications.6 Carbon Border Tax Adjustment

As mentioned in the previous section, the adjustments can apply to either imports or exports, or

on both. Therefore, the literature mainly distinguishes between three main categories of CBTAs:

import taxes, export rebates, and FBAs (terms adopted from Fischer and Fox, 2012).18

2.1 Main Types of Carbon Border Tax Adjustments

Import taxes represent levies based on the carbon content of products that are imported from

abroad as a complement to the domestic emission price. While this procedure adjusts for

differences in carbon prices within the domestic market as shown in Figure 3, companies might

still face competitive disadvantages with regard to exports to foreign countries. Therefore, it

can be expected that the demand for domestic products might increase, while imports might

decrease as a consequence of the price adjustments. Conversely, the increased production in

the home market, might come at the cost of increased domestic emissions. Since this form of

CBTAs focuses solely on imports, no quantitative effects on exports or on foreign demand can

be anticipated.18

Export rebates are price adjustments on products that are exported, based on the amount of

the domestic carbon price paid, as illustrated in Figure 3 The main target of this form of

CBTAs is to increase the competitiveness of domestic companies in foreign markets, while the

full carbon price applies domestically. Therefore, export rebates might increase the quantities

sold to foreign consumers and decrease their demand for goods produced abroad. Similar to theCarbon Border Tax Adjustment 7

import taxes presented above, increased domestic production might lead to higher emissions

in the country implementing the export rebate. Since the national carbon price still applies to

products consumed domestically, export rebates are expected to have no quantitative effects on

domestic demand and imports.18

FBAs constitute a combination of import taxes and export rebates. Consequently, FBAs could

recover the competitiveness of domestic companies in the home as well as in foreign markets,

while also probably leading to increased domestic emissions from higher production volumes.18

Table 1 illustrates how the policy design might affect bilateral trade flows and demand for

domestic and foreign products. From an economic and political point of view, it is also of

interest how different forms of CBTA perform with regard to reestablishing the competitiveness

of domestic companies as well as promoting further emission reductions. A CGE analysis

conducted by Fischer and Fox (2012) for the United States shows that FBA outperforms partial

border adjustments for imports and exports in terms of competitiveness aspects, as measured

by avoided losses in production and net exports, compared to a scenario with only a carbon

tax and no CBTA in place, although the magnitude of the effects differs between sectors. In

most sectors, FBAs were also found to be more effective in achieving additional emission

reductions compared to export rebates and import taxes alone.18 An analysis conducted by

Monjon and Quirion (2011a) for the EU, suggests that, in most model specifications, CBTAs are

able to reduce carbon leakage more than other policies considered. The effect was found to be

particularly strong for FBAs for which negative leakage rates were estimated for all policy and

model specifications.20 Comparing different analyses contributing to an Energy Modeling Forum

study (EMF 29), Böhringer et al. (2012) find similar outcomes for the implementation of a FBA

as presented above. FBAs were able to reduce carbon leakage across all studies considered while

at the same time cutting emission reductions in the regulating country and reducing the increase

of emissions in non-regulating countries. Furthermore, FBAs were found to mitigate some of the

production losses of EITE industries in the respective countries. The output of EITE industries

in non-regulating countries was found to be lower under a FBA policy.17

2.2 Further Components of Carbon Border Tax Adjustment Policies

While import taxes, export rebates and FBAs constitute the three broad categories of CBTAs, the

policy proposals analyzed in the literature are further refined in terms of emission considered and

the calculation of the tariff rates for the case of import taxes. Emissions are usually divided into

three scopes: direct emissions (scope 1), indirect emissions from electricity (scope 2) and other

indirect emissions (scope 3).21 Theoretically, emissions from all three scopes can be captured by

a CBTA. However, concerns mainly in regards to practicability prevent all three scopes being part

of the actual policy proposals discussed in the literature.11,19 Many empirical studies focus on two

options in which either only direct or both, scope 1 and scope 2, emissions are included.17,20,22

Böhringer et al. (2021) analyze empirical data for the years 2000 until 2014 for OECD and

Non-OECD countries. They show that in the given period the relative share of Non-OECD

EITE industries in overall emissions in Non-OECD countries has increased.23 These insights

might promote those arguing in favour of a CBTA implementation, since these sectors are most

likely primarily targeted by such a policy. Nevertheless, they find that at the same time the direct

emissions of EITE industries have decreased in relative and absolute terms in OECD and in

Non-OECD countries23 probably making a CBTA addressing only direct emissions less effective.

The data also reveals that the importance of electricity generation has increased when it comes

to the composition of overall emissions in Non-OECD countries23 potentially supporting the

option to capture scope 2 emissions by a CBTA as well. However, Böhringer et al. (2021) show

that the share of Non-OECD EITE sectors in total electricity consumption has declined with

Non-EITE sectors gaining more importance in this context23 which probably might also impair

the effectiveness of CBTA policies including both, scope 1 and scope 2 emissions but addressing

only EITE industries.

Several approaches are proposed for the calculation of the tariff rates associated with the

implementation of import taxes which can be subdivided in two broad types: fixed values for

importing entities and product-specific tariffs based on the actual embodied carbon content.

Fixed values can be implemented in the form of average emission intensities calculated forCarbon Border Tax Adjustment 9

a specific country, region or sector.17,19,22 The average values applied can either refer to the

domestic or foreign carbon intensities.19 Those arguing in favour of using the actual emission

embodied in products, claim that it increases the incentives of suppliers to reduce their own

emissions since these abatements are directly related to lower tariff payments for exports to

regions with a CBTA in place. This rationale is not limited to scope 1 but also considered to be

valid for scope 2 emissions, as it is assumed that taxing actual electricity-related emissions might

induce suppliers to buy green-energy certificates and thereby lowering their scope 2 emissions.22

Böhringer et al. (2017) use a CGE model to analyse how the outcome of import taxes varies

with different emission scopes considered and approaches used to calculate the tariff rate. For

both dimensions, two options are considered and used in different combinations. As emission

scopes, direct and indirect electricity-related emissions are considered, while the tariff rate is

either calculated based on regional averages in the foreign country or the actual embodied carbon

content. All forms of import taxes considered were able to reduce carbon leakage, while all

scenarios using firm-targeted tariffs were able to reduce leakage rates more than their counterparts

using average values. Similar findings are presented for emission reductions in EITE trade flows

from unregulated to regulated regions indicating that goods with lower carbon intensities are

imported to regions implementing a CBTA. All import taxes were also found to reduce EITE

trade flows from unregulated regions as also suggested by Table 1. The import reductions were

found to be lower for those policies using the companies’ actual emissions for either one or both

emission scopes included. Their analysis also shows that the production losses of domestic EITE

sectors are less pronounced with import taxes in place. The avoided reductions in production

volumes are particularly large when both scope 1 and scope 2 emissions are charged based on

firm-targeted tariffs.22

2.3 Challenges associated with Carbon Border Tax Adjustments

CBTAs might also negatively affect downstream industries through increased costs for raw

materials and other inputs captured by CBTAs.10 This might decrease their competitiveness in

domestic as well as in foreign markets and could consequently induce a relocation of production

activities in these sectors. A further extension of CBTAs to such products might constitute a

possible solution to such unintended outcomes. Another critical aspect discussed in the literature

is the issue of so-called ’reshuffling of emissions’ describing the phenomenon that only goods10 Carbon Border Tax Adjustment

with low carbon contents are exported to regions regulated by means of CBTA policies while

those products with high embodied carbon emissions are sold to countries without CBTAs in

place possibly leading to redirection of trade flows among countries.11,24,25 Similar findings are

also presented by Böhringer et al. (2021) who estimated by means of a CGE analysis for the

period between 2000 and 2014 that the carbon embodied in trade among Non-OECD countries

increases once a carbon pricing policy is jointly implemented in OECD countries. A further

increase can be observed in simulations using a scenario in which this carbon pricing scheme is

complemented by an import tax.23

Beyond environmental and competitiveness concerns, CBTAs are often criticized for shifting

the burden of climate policies from industrialized to developing countries.17 In this context, it

is usually assumed that developed countries are those implementing carbon pricing and CBTA

policies. Böhringer et al. (2012; 2021) argue, that unilateral climate policies such as carbon

pricing schemes have negative effects on the terms of trade of third countries which are even

increased when these countries are subject to a CBTA. This is also shown by estimations of the

Fisher-price-index for trade flows between OECD and Non-OECD countries under the scenario

of a carbon tax and those with an additional border adjustment mechanism.17,23 The burden

shifting effect can also be observed for estimations of the GDP in regulating and non-regulating

countries for both scenarios. While both groups of countries face GDP losses in most of the

studies analysed by Böhringer et al. (2012), it can be observed that most of the simulations show

a reduction of these losses for regulating countries and an increase in non-regulation regions once

a CBTA is implemented.17 This underlines that countries might improve their economic situation

by implementing a CBTA at the expense of countries without such regulations in place.17,23

3 Practical Implementation

As the previous sections have hinted at, there is a large body of literature analysing policy options

when it comes to CBTAs, ranging from first to second best policies, cost efficient measures,

equally distributed shares of the abatement burden policies, and more. There is however way less

scientific emphasis on foresighted guidance regarding affected firms. Understanding, adapting to,

and utilizing the changing business environment is crucial for a successful long-term transition

into a sustainable future. This section therefore aims at providing the reader with a comprehensiveCarbon Border Tax Adjustment 11

overview of urgent issues regarding the practical implementation of CBTAs into business as

usual from a firms perspective. Note that in all that follows, it should be further distinguished

from which point of view an agent is considering such issues. The main difference in motives and

monetary incentives is caused by the affiliation of a firm. If the firm belongs to the coalition (or

large open economy) that implements a CBTA policy (e.g. CBAM), the implications for actions

to be taken differ from a firm in a non-coalition economy. Here, we mainly focus on agents

inside a policy area, since the legal framework affects them directly and poses challenges to be

overcome. There is however also literature on strategic decision making processes of non-EU

exporting firms. Huang, Liu and Zhao (2022) for example develop an evolutionary dynamic

game of strategic interaction to model how agents from third countries, mainly Chinese firms,

would best respond to the implementation of CBAM. Their main insight in that regard is that,

especially in carbon intensive industries, cost and competitive pressure will rise significantly,

making strategic adaptations such as investments in low-carbon technologies, data transparency

and more efficient supply chains necessary.26 Furthermore, every case should be considered

separately by additional information about spatial and geopolitical circumstances, political

frameworks, trade relations and more.1 This wiki entry therefore can be seen as a starting point

with general information for affected agents that need to take action, compulsory.

3.1 CBAM – Basics and Requirements

With the European CBAM being the largest and most debated practical policy example of a

CBTA, it provides a well suited example of what such regulations demand from firms. The first

practical challenge is imposed by the need to constantly keep informed on legal regulations and

changes in reporting obligations.28 This circumstance is not an unknown cost factor, especially

for larger firms. The extensive regulatory body of CBAM and the complexity of global supply

chains however are expected to cause additional layers of expenses to this cost factor. For every

firm inside the EU buying intermediate products on international markets, Regulation (EU)

2023/95615 and Regulation (EU) 2023/177329 should be well examined by the legal department

(if existent), as they provide details on definitions and how the CBAM should be implemented.

Even if a firms product is currently not affected by CBAM, keeping up to date with policy

1 For readers interested in the implications of CBAM for practitioners outside the EU, we recommend reviewing

Shi, Laurenceson and Liu (2024), as they examine challenges and opportunities the policy imposes for Chinese

and Australian practitioners and analyze the dynamic trade relation using a SWOT and PEST approach.27 Strategic

cooperation with the emphasis on fostering transformative sustainable innovation and trade is the main focus.2712 Carbon Border Tax Adjustment

development can prove important if amendments are to be made by the EU.

As the broad timeline in figure 2 shows, at the time this wiki entry is written, a transitional period

with less strict regulations is in effect. During this phase only a limited scope of application is

binding. For example, cars (which usually are products containing a large amount of steel) are non

affected goods, since they are not declared in Annex I of the Regulation (EU) 2023/956.

15,30 Basic

materials and primary products like iron, steel, aluminium, cement, fertilizers and electricity

are currently the main targeted industries by CBAM.31 Article 30 however clearly declares the

possibility of broadening the scope of application and instructs the commission to consider

such extensions.15,30 Furthermore, starting in the second half of the transitional phase in 2025,

importers (or their chosen customs representatives) can start applying for CBAM permits.30 To

continue this starting guidance for affected firms, some of the vocabulary defined in Article

III of the Regulation (EU) 2023/956 needs to be introduced. According to this, declarants

are individuals or entities responsible for making declarations to customs authorities on behalf

of an importer regarding goods being brought into the European Union. Under the CBAM,

declarants must ensure accurate reporting of the CO2 emissions embedded in imported goods

and any carbon price associated with those emissions. Customs representatives act on behalf of

importers in fulfilling customs formalities, including those related to the CBAM. They can either

act in a direct capacity (acting in the name and on behalf of the importer) or in an indirect capacity

(acting in their own name but on behalf of the importer). They can be used by companies lacking

the internal expertise to manage the complex requirements of customs procedures, including

those specific to the CBAM. The existence of declarants and customs representatives can be

justified by the ambition to streamline and professionalize this process and ensuring compliance

with the manifold regulatory obligations. Importers are the entities bringing goods into the EU

from non-EU countries, meaning the firms mainly addressed by this article.15,30 Declarants and

customs representatives must be registered in the relevant national customs databases and the

CBAM transitional registry2, which is established by the European Commission. Importers need

to apply for registration under CBAM through the CBAM registry to submit quarterly emissions

reports.28,30

The first quarterly report was due at the end of January 2024, since it has to be submitted one

month after the quarter has ended at the latest. Due to technical issues, the substantial amount of

2 The CBAM transitional registry will be transferred into the final register. Access to the register and further

information from the European Commission can be found under the following link: CBAM – European CommissionCarbon Border Tax Adjustment 13

input such a report requires and the ambition of policy makers to foster acceptance and policy

compliance among agents, penalty payments in the case of failure to report were not imposed in

the beginning of the reporting phase.30 Furthermore, the price of the penalty payment can vary

according to case specific circumstances. If detailed evidence can be provided that the importer

has taken all necessary steps to comply with the obligations, customs authorities have margin for

generosity.30 Articles 32 to 35 represent the relevant regulations for CBAM reporting. Article

35(2) defines the following mandatory contents of a CBAM report:15

1. The total quantity of each type of good, reported in megawatt-hours for electricity and

in tonnes for other goods, categorized by the installations that produced the goods in the

country of origin.

2. The actual total embedded emissions, expressed in tonnes of CO2-equivalent emissions

per megawatt-hour of electricity or per tonne of each type of good, calculated according to

the methodologies outlined in Regulation (EU) 2023/956 and Regulation (EU) 2023/1773.

3. The total indirect emissions, calculated in accordance with the implementing act (Regula-

tion (EU) 2023/1773).

4. The carbon price paid in the country of origin for the embedded emissions associated with

the imported goods, considering any available export rebates or other carbon prices.

Fulfilling the reporting requirements poses a major challenge for practitioners. As the transitional

phase is currently running (see figure 2), there might be amendments to the definite regime

beginning in 2026. In what follows a brief overview of the challenges and approaches is given.

3.2 Data and Methodology

The complexity of this topic traces back to the difficulty in determining the complete embodied

carbon content of a commodity. The academic literature maps these embodied emissions into

three scopes: (1) direct emissions and CO2-equivalents from owned and controlled company

sources, (2) indirect emissions embodied in all energy sources used by the firm and (3) all

indirect emissions embodied in intermediate products (inputs).32 The sum of these three scopes

yields the carbon footprint of a product.32 The economic literature has used CGE models,

different policy scenarios and simulations to conclude that CBTAs addressing all three scopes

of embodied carbon content is more cost efficient from a global welfare perspective in fighting14 Carbon Border Tax Adjustment

climate change than only using scope 1 and/or scope 222,33,34, even though the extensive data and

legal requirements prove to be more costly at the industry level.32

In the case of the European CBAM, Annex IV distinguishes commodities between simple goods

(goods that emit CO2 or other greenhouse gases only during their production process, without

the need to account for embedded emissions from inputs or precursors) and complex goods

(goods that are not simple goods).15 Especially the determination of embodied emissions of

complex goods is demanding and requires data that is not in the possession of the importer. For

producers from third countries outside the scope of CBAM who want to continue exporting to

European importers, this means they need to develop and invest in the necessary monitoring and

data infrastructure, if not existent already.30 Creating an incentive to do so is part of the EU’s

strategy to achieve progress in fighting climate change on a global level from the perspective

of a large open economy. For importers the reporting obligations require to obtain data from

their suppliers, who are not directly beholden by any regulation to make this data available.

Especially in complex value chains where intermediate inputs have grey emissions itself, this

iterative data seeking approach might not be feasible without simplifying assumptions or default

values.30 In anticipation of any potential penalties, an importer should be able to prove that they

have tried their best to obtain the information from their suppliers or negotiate to incorporate

corresponding agreements into trade treaties.30 When it comes to complex goods, only indirect

emissions of intermediate goods that are defined as important for the system boundaries of the

production process are to be taken into account (Annex IV(3) – Regulation (EU) 2023/956).15

Annex IV(3) also refers to the exempted intermediate products being listed in the implementing

act (Regulation (EU) 2023/1773) according to Article 7(7).15

.

For practitioners it is also important to understand how direct and indirect emission should be

calculated and which methodology is allowed. Since Article 4(3) of the implementing act only

allowed different methodological approaches during the transitional phase until the end of July

2024, the third quarter of 2024 is the first reporting period in which the EU method needs to be

used.30 To ensure that their reports meet regulatory requirements, the most important equations

for affected firms are equations 3.1 and 3.2, which cover the calculation of direct emissions from

the production process and indirect emissions from intermediate goods (in the case of complex

goods). Practitioners need to understand and apply this equation to correctly determine the

emissions of their products and ensure that their reports meet regulatory requirements.Carbon Border Tax Adjustment 15

For simple goods, Annex IV No. 3 of Regulation (EU) 2023/956 specifies the Specific Embedded

Emissions of the goods, measured in CO2-equivalents per tonne (SEEg ) as shown in equation

3.1:

AttrEmg

SEEg =

emissions will likely be based on default values per product category, reducing the burden on

businesses but potentially sacrificing precision.47

Alarmingly, 60% of decision-makers in companies that import specific products like iron,

steel, cement, aluminum, electricity, fertilizers, and hydrogen from non-EU countries are not

familiar with CBAM according to a survey by Deloitte in 2023. Furthermore, nearly a third

of affected companies were entirely unprepared for CBAM’s introduction just two months

before its scheduled start (see figure 2). Additionally, 56% of respondents expect CBAM toCarbon Border Tax Adjustment 23

have significant financial impacts on their businesses.54 Lack of information and preparation

of companies on CBAM could be a barrier to sustainability as this could lead to a high risk of

misreporting or miscalculation of emissions. It could also provide an incentive for designing and

exploiting gaps.

The administrative load associated with CBAM is substantial, as already explanied in section 3.

For instance, companies must submit self-declarations, which involve the labor-intensive task of

calculating emissions, particularly when determining actual emissions – a process that itself adds

administrative complexity. Moreover, authorized declarants must adhere to strict documentation

and retention obligations concerning the data used to calculate embedded emissions. They are

also required to ensure that the total embedded emissions reported in their CBAM declarations

are verified by an accredited verifier.31

This administrative burden raises concerns about potential hidden discrimination against im-

porters. According to WTO jurisprudence, measures that impose additional administrative

burdens could violate the principle of national treatment under GATT if they result in less favor-

able treatment of imported goods. Whether such less favorable treatment exists must be assessed

on a case-by-case basis, considering the design, structure, and anticipated application of the

measure. The key issue is whether the measure negatively impacts the competitive opportunities

of imported goods relative to similar domestic goods. Different regulations for imported and

domestic goods do not inherently constitute discrimination; what matters is whether the same

competitive opportunities for imported goods are effectively ensured.31 This could appear as a

clear barrier, when the compatibility of CBAM with WTO law remains questionable.

However, it is not unlikely that the additional administrative requirements under CBAM could

increase importers’ operating costs and thus impair the competitiveness of imported goods,

potentially constituting a less favorable treatment. Certain elements of the CBAM draft could

lead to the discrimination of foreign goods. For example, a conflict with the Most-Favored-

Nation (MFN) principle6 might arise if a CO2 price paid in the country of origin is credited but

other cost-effective emission reduction measures are not. In terms of national treatment, the

increased administrative burden for EU importers, compared to EU producers under the EU ETS,

is a concern. The compatibility of CBAM with the GATT will likely depend on whether the

6 The Most-Favored-Nation (MFN) principle is one of the main principles of the WTO. It means that there must be no

discrimination between trading partners and things like benefits or special favours have to be done for all WTO

members equally.5724 Carbon Border Tax Adjustment

measure can be justified under Article XX of the GATT, which involves a two-step test: first,

determining whether CBAM can be subsumed under one of the protected objectives, thereby

providing provisional justification.31

Moreover, the Federation of German Industries (BDI) and the Association of German Chambers

of Industry and Commerce (DIHK) have called for adjustments to alleviate the burden on small

and medium-sized enterprises and to address the prevailing legal uncertainties. They suggest

measures such as higher de minimis thresholds or extended use of default values. However, such

adjustments could compromise sustainability or limit it if thresholds are raised. Overburdening

companies could lead to incorrect reporting or even missing CBAM reports, increasing the

risk of errors. Furthermore, the high level of coordination required with suppliers adds to the

administrative burden.52

4.5 Legal, political, and trade-related challenges of implementing CBAM

The introduction of CBAM by the EU is not only a significant policy move but also a highly

political one, with complex implications for international trade and climate law. One critical

aspect of CBAM is its approach to crediting foreign GHG emission reduction efforts, which

could significantly impact the effectiveness of climate policies in third countries.47,58 Border

measures like CBAM are controversial within the context of international trade agreements, and

their political feasibility remains uncertain.45 The rapidly evolving policy landscape has yet to

fully address the legal concerns surrounding CBTA, including fears of trade retaliation, potential

disputes within the WTO, and questions about their compatibility with international climate

change treaties.43 Implementing a CBTA raises concerns about possible retaliatory tariffs or even

trade wars, underscoring the importance of carefully designing the policy.48 The type and breadth

of emissions included, the industries targeted, and the countries to which the policy applies are

all crucial factors. To ensure successful implementation, these decisions must be defensible, and

there is a strong argument for developing a CBTA in collaboration with other countries rather

than as a unilateral policy.

CBTAs that only cover imports (like CBAM) may be easier to negotiate as they generate public

revenues, which could be redistributed to exporting countries, potentially reducing perceptions

of protectionism.20 However, the CBAM faces strong criticism and risks igniting trade conflicts

within the WTO. Several countries have already expressed opposition to CBAM, demandingCarbon Border Tax Adjustment 25

exemptions or threatening legal action and retaliatory measures.52 There is also a danger that

third countries might not accept CBAM as an imposition and interference in non-EU affairs,

which is a risk for trade conflicts.59 This could be a barrier for sustainability when there are many

countries not accepting CBAM.

For a border adjustment to be acceptable to trade partners and compliant with WTO rules, it

should avoid arbitrary discrimination or disguised trade restrictions. As long as foreign firms

do not pay a higher CO2 price than European firms with the same specific emissions, a border

adjustment would not constitute arbitrary discrimination. Nonetheless, if foreign producers can

demonstrate that they are losing market share due to EU climate policy, they may use this in a

potential WTO case or resort to trade retaliation.44

The EU has faced criticism for potentially discriminating against countries that do not follow

its climate model, potentially breaching international trade and climate law. By only crediting

direct carbon pricing instruments like carbon taxes or ETS, the EU CBAM has been accused

of discriminating against exporting states that employ different regulatory approaches. This

approach could be seen as inconsistent with the flexibility required under the GATT and in-

ternational climate agreements like the Paris Agreement, which emphasize the principle of

Common but Differentiated Responsibilities and Respective Capabilities (CBDR-RC). Moreover,

pushing states to adopt direct carbon pricing instead of alternative climate policies suited to their

institutional environments could result in ineffective climate regulation abroad. Critics argue

that the EU’s narrow crediting approach under CBAM may pressure its trading partners to adopt

a policy instrument that is not well-suited to their contexts, especially in developing countries

with weaker administrative capacities. This could undermine effective climate regulation in

these countries and erode the EU’s international climate leadership.58 Poorer nations, which

may lack the capacity to implement such policies, could find themselves at a disadvantage.48

WTO rules further constrain the design of CBAM, and even if these rules are respected, the legal

uncertainties could lead to protracted disputes and spark new trade tensions. Critics question

whether the benefits of a carbon border adjustment outweigh the substantial political and legal

risks60, warning of the potential for it to become a tool for green protectionism.47,61 Nonetheless,

the exclusion of indirect carbon pricing instruments, which represent a significant share of global

carbon pricing efforts, is problematic. This exclusion is more likely to be viewed as discrimina-

tory under international trade law, particularly because it penalizes developing countries that rely

heavily on indirect carbon pricing, rather than acknowledging their differentiated responsibilities26 Carbon Border Tax Adjustment

and capabilities as required by international climate law.58

The CBAM proposal also raises several complex WTO-related issues, particularly regarding

key provisions of the GATT, such as the Most-Favored-Nation principle (Article I), National

Treatment (Article III), and General Exceptions (Article XX). While supplementing the EU ETS

is essential, the CBAM proposal carries risks, especially due to its limited scope covering only

basic materials and its potential inconsistency with central WTO principles. Instead of expanding

CBAM in a technically complex and legally challenging manner, it is recommended to enhance

its effectiveness indirectly by integrating non-price-based instruments focused on transformative

research and innovation support. Dedicating CBAM revenues to a major EU mission to promote

new, energy-efficient production technologies and support technology transfer to the Global

South could contribute significantly.31

Finally, the design features of CBTA — such as coverage, adjustment levels, and overall structure

— are crucial for ensuring WTO compatibility, feasibility, and political acceptability. Fremerey et

al. (2022) have suggested creating a “two-speed” WTO, linking membership to climate-specific

goals, which could integrate climate efforts into broader trade liberalization discussions. This

approach could bring like-minded countries together within the WTO framework, but its success

would hinge on key players like for example the United States as this would have a strong

pull effect on other countries.53 Still, such a framework might be a potential future driver of

sustainability and the concept of a CBTA.VI Carbon Border Tax Adjustment