Taxing imports of heavy carbon emitters is gaining momentum — and it could hurt Canadian industry: Report

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The idea of taxing carbon-intensive imports is gaining currency globally and that could hurt Canada’s export-focused industries, despite the country’s own carbon tax, according to a report by Royal Bank of Canada.

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The report, released Aug. 9, set out to analyze the threats posed to the Canadian economy as carbon border adjustment mechanisms become more of a reality in the race for countries to meet their carbon net neutrality goals.

Last month, the European Union proposed a plan to institute levies on imports from a set of industries that have heavy emissions of carbon dioxide, a major culprit of the greenhouse gas effect that warms the Earth’s temperatures. The EU’s plan still needs approval from member countries and wouldn’t begin imposing tariffs until 2026 on goods from five sectors: iron and steel, aluminum, cement, fertilizers, and electricity.

In theory, there shouldn’t be a large impact when it comes to the EU proposal because some of Canada’s heavy carbon-emitting industries such as energy and mining aren’t currently included, said Cynthia Leach, a senior director of RBC’s economic analysis outfit and an author of the report. “But, that (threat) can change over time and there’s a big question mark over the extent to which border carbon taxes can, in practice, align with theory,” Leach said. “There could be a lot of political pressure to use this to further (domestic interests), therefore polluting the intended impacts.”

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This is could become an even broader issue with more widespread adoption of border carbon adjustments, she said.

With the increasingly alarming threat of climate change, countries that have slacked in meeting their climate goals are getting more serious about cutting down their carbon output. A report released by the United Nations’ Intergovernmental Panel on Climate Change on Aug. 9 said human-caused climate change is nearly spiralling out of control with the damages close to irreversible.

Domestic carbon taxes, like the current setup created by the Liberal government, typically don’t account for carbon leakage — the phenomenon of companies producing their goods elsewhere to avoid climate-change levies. Slapping on tariffs to goods from heavy carbon emitters are seen in economist circles as a viable answer to help mitigate climate change, level the playing field and assist companies and countries in achieving net neutrality in their carbon emissions, Leach said.

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The EU’s proposal is the first of its kind to gain footing, though in the fall of 2020, the Canadian federal government announced its intention to explore the feasibility of the country’s own border carbon adjustment mechanism.

It’s a complex instrument to use, Leach said, and there are risks as the development of carbon import taxes is in its nascency. Leach and her co-author Colin Guldimann concluded there is little risk exposure to Canada’s industries under the EU proposal because only about five per cent of total industrial exports are destined for Europe. However, if more countries implement this instrument, the risk could be more significant for the domestic economy. “More than half of the economic value created by eight major Canadian industries is exported,” the report stated.

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Because there is much left to the discretion of a country’s policy-makers in developing a mechanism, it’s unknown how other governments might assess existing “carbon regimes” and account for that in tariffs, which could negatively impact Canadian companies already paying domestic carbon taxes. There’s also the possibility that carbon border adjustments could be used as a trade tool in rewarding or punishing trading partners, the report states.

“Canada absolutely needs to be prepared for this if G7 allies and, particularly, our dominant export market, the U.S., (begins) looking at this,” Leach said, referring to G7 leaders, in June, agreeing to mitigate carbon leakage via trade measures.

On Aug. 10, the U.S. Senate passed President Joe Biden’s US$1 trillion infrastructure spending that includes some plans to support a green transition. It could be a positive signal that the U.S. would help support Canada in developing a North American border carbon adjustment mechanism, which the report recommends, Leach said.

“The time is now to seize upon those opportunities.”

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Financial Post