Will the CBAM fill the UK’s fiscal gap?
Winters, L.A and Zhang, D (2024) Will the CBAM fill the UK’s fiscal gap?, CITP Briefing Paper 10
Published 12 February 2024
- The Carbon Border Adjustment Mechanism (CBAM) is not aimed at raising money, but in the current climate, ‘every little helps’, so people are asking whether it will raise significant revenue for the public purse.
- We know little about the UK’s plans for its CBAM beyond the basic structure and coverage, but we can base estimates of its revenue potential by assuming that it mirrors the EU’s.
- Based on the European Commission estimate that the EU CBAM could generate around €2 billion revenue in 2028, UK revenue for that year would probably not exceed £0.17 billion!
- Part of the reason it is so low is that we assume the UK’s domestic price for greenhouse gas emissions will not exceed the EU’s. This means that, EU suppliers, from which over half of UK imports of the affected goods come, will pay nothing.
- We also consider two private sector estimates of the EU’s CBAM revenues for 2030 and 2040. These rely on many unknowns and are probably rather exaggerated.
- One such unknown is the extent to which other countries will raise their carbon price towards EU/UK levels and thus divert revenues to themselves. Many countries or regions already have carbon pricing initiatives but, at present, typically at very low levels.
- One expressed objective of the EU CBAM is to encourage decarbonisation elsewhere in the world. We do not know how much will occur, but any that does will reduce CBAM charges per unit of imports. If all other countries align their prices with the EU’s, global decarbonisation will be greatly advanced, a success(!), but the CBAM will raise no revenue.
The United Kingdom (UK) has now announced its intention to introduce a Carbon Border Adjustment Mechanism (CBAM) with charges entering into force in 2027. There are virtually no details yet but the indications are that it will mirror quite closely the European Union’s CBAM, which has already entered an information-gathering phase and will start (very gradually) to levy actual charges in January 2026.
The EU CBAM covers imports of cement, iron and steel, aluminium, fertilisers, electricity and hydrogen and requires importers of these goods into the EU to pay a charge for the emissions embodied in their imports at the same rate as EU domestic producers pay under the Emissions Trading Scheme (ETS). To the extent that overseas producers have already paid a charge for emissions in their home countries, that will be subtracted from the charge levied by the EU. The UK scheme will have the same approach, but based, of course, on the domestic charges made under the UK’s ETS, and covering the same goods as the EU except for electricity and adding glass and ceramics.
In the current fiscally constrained circumstances, it is reasonable to ask ‘how much revenue might the UK’s CBAM announced in December raise?’ The answer is very nearly ‘think of a number and halve it’! Revenue predictions are highly uncertain because they depend on so many unknown variables and behavioural responses. It is too early for any UK estimates – although presumably, the Office for Budgetary Responsibility has to have a shot before the budget on 6th March 2024.
There are, however, estimates for the European Union, which has already started its CBAM implementation, from which we might derive a very rough estimate for the UK. In summary, we argue that because its emissions charge is unlikely to exceed the EU’s, the UK is unlikely to charge CBAM fees on any imports from the EU and we note that large shares of UK imports of CBAM-regulated products come from the EU. Consequently, the UK will raise revenue on less than one-tenth of the imports on which the EU will do so, so that the revenue it raises is very unlikely to exceed 10 percent of the predictions for the EU. That doesn’t completely solve the problem, however, because those predictions are very widely dispersed.
For the EU, the European Commission estimates revenues of around €2 billion for 2028,1 Wood Mackenzie, say $9 billion a year by 2030, and S&P ‘more than US$80 billion per year by 2040.’ The origins of some of the differences are easily described, although, in the absence of details of the calculations, not exactly quantifiable.2
Thanks to Michael Gasiorek, Peter Homes, Charlotte Humma and Emily Lydgate for comments on an earlier draft.
Facts and assumptions
The EU’s CBAM revenue collection will be phased in gradually over 2026-2034, so that it collects only 10% of the nominal total due in 2028, 48.5% in 2030 and 100% from 2034.
The different sources appear to make different assumptions about how the CBAM will be extended beyond the current coverage of six products: the Commission allows for no extension while WoodMac and S&P seem to assume extension to the full set of products covered by the EU Emissions Trading Scheme (ETS), adding a further nine broad groups. The latter accords with the European Parliament’s wish list – ‘The CBAM's product scope should be extended to cover all EU ETS sectors by 2030’ – but not with the Commission’s more measured commitment.3 In addition, S&P notes that there has been discussion of extending coverage within the currently covered sectors to some downstream products and indirect emissions.
The different estimates make different assumptions about the price of carbon emissions in the EU in their target years - €80 per tonne of CO2 for 2028 (Commission) and €183.9 in 2040 (S&P). The CBAM tops up the emissions cost in imports to that paid by the EU’s domestic producers, so this is a crucial number in the calculations.
The CBAM is intended to apply transaction by transaction to the emissions embodied in any covered import. That may be difficult to discover even when the mechanism is working fully, but in advance, it is basically impossible to know. S&P say they use a ‘global average emissions intensity’ by product. This seems too high, for reasons we explain below.
Where an exporter’s emissions are unknown, the CBAM will be levied on the basis of a benchmark from the EU. S&P pitch this at the EU average intensity rather than the average for the worst 10% of EU plants, which the Commission has talked about. This seems likely to underestimate the charges payable.
As noted above, imports will not have to pay CBAM charges to the extent that their producers have already paid for emissions in their home countries. Many countries or regions already have carbon pricing initiatives including ETSs and carbon taxes. For example, China’s national ETS began operating in 2021 targeting power generation sectors and is the world's largest in terms of covered emissions. New Zealand introduced its ETS in 2008 covering forestry, waste, domestic aviation, transport, buildings, industry and power generation sectors. Canada has also implemented a few regional and national carbon pricing initiatives. For instance, Quebec’s ETS was launched in 2013 covering transport, buildings, industry and power generation sectors.
Overall, as presented in the Carbon Pricing Dashboard provided by the World Bank, 73 carbon pricing initiatives had been implemented in 2023, covering 39 national jurisdictions. These initiatives cover 23% of global Green House Gas (GHG) emissions, although the treatment of exceptions within the scheme (e.g. the EU’s free allowances) is unclear. We do not know how the EU will define which charges are eligible for remission by the EU, but other countries’ charges will reduce EU revenue one-for-one. The current rates are generally small, so the effects will not be large, but it is not clear what the different forecasters assume here.
One expressed objective of the EU CBAM is to encourage decarbonisation elsewhere in the world. We do not know how much will occur as firms seek to avoid CBAM charges, but we do know that any that does occur will reduce charges per unit of imports.
Moreover, even if the CBAM induces no changes in emissions, exporting countries could capture the emissions fees for themselves by raising their rates or introducing their own charges for emissions. In addition to the cases noted above, various countries have legally confirmed and will soon launch their own carbon pricing measures, e.g., like Brazil, Colombia and Nigeria. It seems reasonable to expect that, even if for no other reason than capturing revenue, partner countries will increasingly levy their own emissions charges and raise them towards EU levels.
Some governments (notably, it seems, the USA’s) are allergic to any carbon pricing, so one might think that revenue losses due to their introducing carbon charges would be limited. But exactly those countries – again notably the USA – will very probably push for exemption from the CBAM on the grounds that their own regulatory policies curtail emissions and impose similar costs on producers as the CBAM. It is a very complex issue to calculate the equivalence between regulations and an explicit charge, especially since efforts to reduce emissions ought to reap their own reward in terms of reducing the CBAM charges due. However, on purely political grounds, there seems to be some probability that such claims for equivalence will prevail. When we come to consider the UK, a much smaller economy than the EU and politically closer to the USA, the granting of equivalence seems rather plausible.
A further ‘danger’ to the revenue stream is so-called carbon shuffling, whereby producers devote their ‘cleanest’ plants or production lines to serving the EU, so that what goes to the EU is materially less emissions-intensive than the producer’s average. This is bad for emissions abatement, and also for revenue.
The CBAM is going to raise the prices of the products it regulates in the EU because it will raise import prices, and the corresponding phasing out of free allowances in the ETS will raise domestic costs. Economists are fairly used to (I refrain from saying are good at) predicting changes in trade patterns as a result of price and cost changes. But there are at least two major complications to consider.
First, the ETS is levied on a firm/plant basis. If these firms produce many products, how the free allowances are allocated over products is unknown, and, in particular, we do not know how they will be allocated as the supply of free allocations gradually dries up when the CBAM replaces them. Thus, predicting price and output changes is very uncertain.
Second, the EU has not yet decided whether it will rebate ETS charges on EU exports. If it does not, EU exports will lose competitiveness around the world as free allowances are phased out and this is bound to feedback into domestic sales and activities and thus onto imports. While this will not reduce the revenue raised on the back of imports per se, it will reduce the revenues raised from the ETS, offsetting CBAM collections, and one could argue that they ought to be set against the CBAM. The question of export rebates is very fraught: failing to levy charges on emissions in EU exports seems inimical to EU climate ambitions, while levying them has potentially serious consequences for competitiveness.
What about the UK?
Finally, how can we move from predictions for the EU to predicting the revenue that the UK CBAM might generate? We know next to nothing about the UK CBAM beyond its coverage, which includes all the sectors in the EU CBAM except electricity and with glass and ceramics added. The government’s brief statement seems to suggest that it will be modelled pretty closely on the EU’s CBAM, so we will assume here it is a direct copy.
In April 2023, weak macroeconomic prospects, especially in manufacturing, led the UK ETS carbon price to start to fall below the EU’s, see Figure 1. In mid-year, the UK Government made a surprise issue of additional permits and promised issues over the period to 2027, and subsequently, it’s declining enthusiasm for active climate policy became evident. As a result, the gap between the UK and EU prices remained large over 2023. By the end of the year, it was about £27/tonne - £33/tonne compared with £60/tonne in the EU. Although the gap may be contracting in 2024, it is still around £20/ton according to the latest data. The UK Government talks a good long-term game on emissions abatement, but overall, we believe it reasonable to assume that the UK will persistently price emissions at or below the EU level. This means that, even if EU suppliers to the UK have to provide all the CBAM paperwork, they will pay nothing additional for emissions.
Table 1 presents data on UK and EU imports of the EU’s six CBAM products – definitions are in the notes to the table. Assuming that neither the UK nor the EU charges CBAMs on each other’s exports (as S&P explicitly assume for the EU), the table shows imports from other countries in value and in quantity terms. (We present quantity data because energy costs seem likely to be related to gross weight.) The value of UK imports never exceeds 10% of that of the EU in value terms or 7% in quantity terms. This implies that if the UK’s CBAM were a mere scaled replica of the EU’s, revenues would be less than 10% of the EU’s.
Table 1: Imports other than from UK or EU+, 2022
|Iron & Steel
Sources: HMRC and Eurostat;
Notes: EU+ is countries applying the EU’s CBAM (EU, Norway, Iceland, Lichtenstein and Switzerland).
Products defined as in the EU CBAM (EUR-Lex - Ares(2023)4079551 - EN - EUR-Lex (europa.eu)).
EU+ data converted to sterling at 2022 average exchange rate of 1.173.
* Quantity units are kilograms
** Quantity units are terawatt hours
Electricity is not part of the UK CBAM, but since no UK imports come from outside the EU+ countries, that is not significant. In addition, the UK includes glass and ceramics, but as yet with no precise definitions. To approximate what this might add, we look at UK imports from outside the EU+ countries in HS chapters 69 and 70 (ceramic products and glass and glassware respectively): this is about £1.77 billion in 2022. Containing several highly processed products, these chapters almost certainly exceed the coverage of the CBAM and so exaggerate the base on which CBAM revenues could be raised. We do not know the energy intensity of such imports, but overall, this addition seems unlikely to add much more revenue.
Based on the European Commission estimate that the EU CBAM could generate around €2 billion revenue in 2028, the number for the UK would probably not exceed £0.17 billion.4 Even compared with customs revenue of £5.5 billion in 2022-23, this is small, and compared with the government’s current overall financial gap for 2022-23 of £131 billion it is vanishingly so. Revenues will undoubtedly increase in later years, but as we have suggested above, the WoodMac and S&P estimates of €9 billion and €80 billion for the EU in later years seem over-optimistic in terms of how rapidly the CBAM will extend to other products, how much carbon shuffling is likely to occur and the extent to which other countries will forego the revenue available if they introduce their own charges.
To conclude, estimates of the EU’s revenues from its CBAM vary substantially with forecasters’ assumptions about the details of the CBAM, the carbon price, the energy intensity of imports and the reactions of trade to the new charges. The UK’s CBAM is even less well defined, but by comparing the amounts of trade on which UK and EU CBAM charges will be levied, it seems unlikely that the UK will raise more than 10 percent of the EU’s revenues.
These estimates are hugely uncertain, but it is certain that the UK CBAM as currently conceived will not fill much of the UK’s fiscal gap over the next decade. However, that is not the point of the CBAM; it is there to aid decarbonisation; and, if the UK could bring itself to align its ETS and CBAM with the EU’s, to avoid UK exporters from having to do the paperwork and pay the cost of the EU’s CBAM. A CBAM that completely succeeded in inducing other countries to decarbonise – or merely co-existed with their autonomous decarbonisation - would raise nothing!
- This is based on the EU getting ‘own resources’ of €1.5 billion, where this is 75% of the total.
- The two private sector forecasters are, understandably, coy about exactly how their models work and the assumptions they make.
- This says that by the end of 2025 ‘the Commission will undertake a full review of the implementation of the CBAM.’ It will ‘look carefully into the possibility of extending CBAM to other goods and sectors covered by the EU ETS at risk of carbon leakage (see Article 30(2) of the CBAM Regulation). An extension of the CBAM scope requires a legislative proposal from the Commission followed by an amendment of the CBAM Regulation to be adopted by the European Parliament and Council.’
- The number is converted to sterling at 2022 average exchange rate of 1.173.