EU Carbon Tax Shock For UPSC IAS Exam

Why in the News?

The European Union has begun full implementation of the Carbon Border Adjustment Mechanism (CBAM) from January 1, 2026, marking the world’s first operational carbon border tax.
Indian exports of steel and aluminium, which form a major share of India–EU trade, are expected to face a 15–22 percent increase in landed costs.
The move has triggered concerns in India regarding export competitiveness, equity in climate action, and WTO compatibility.

A carbon tax is a policy instrument that places a financial cost on greenhouse gas emissions, usually calculated per tonne of carbon dioxide emitted.
The core objective of carbon taxation is to discourage carbon-intensive production and encourage adoption of cleaner technologies.
Globally, carbon pricing takes multiple forms:
- Emissions-based tax, where firms pay directly for the volume of emissions generated.
- Goods-based tax, imposed on carbon-intensive products such as coal, steel, or petroleum.
- Cap-and-trade systems, where governments cap total emissions and allow trading of emission permits.
- Carbon tariffs, which tax imports based on their embedded carbon content to prevent carbon leakage.
CBAM represents a shift from domestic carbon pricing to cross-border climate regulation.

CBAM is a climate-linked trade measure introduced by the European Union to impose a carbon price on imports from countries with weaker climate regulations.
It aligns import costs with the EU Emissions Trading System (EU ETS) by requiring importers to purchase CBAM carbon certificates.
The price of these certificates mirrors the auction price of carbon under the EU ETS.
CBAM is part of the EU’s “Fit for 55” package, which aims to reduce greenhouse gas emissions by 55 percent by 2030 compared to 1990 levels.
The mechanism transitioned from a reporting-only phase (2023–2025) to full enforcement in 2026.
It covers carbon-intensive sectors such as:
- Steel and aluminium
- Cement and fertilisers
- Electricity and hydrogen
- Selected energy-intensive industrial inputs

India’s exports to the EU are heavily concentrated in CBAM-covered sectors, especially steel and aluminium.
Indian steel production largely depends on blast furnace technology, which emits significantly more carbon than electric arc furnaces.
The limited availability of steel scrap in India restricts large-scale adoption of low-emission electric arc furnace technology.
Small and medium exporters face low pricing power, making it difficult for them to absorb or pass on CBAM-related costs.
The structural dependence on carbon-intensive legacy infrastructure places Indian producers at a comparative disadvantage.

CBAM is expected to raise the export price of Indian steel and aluminium by 15–22 percent.
Exporters must provide detailed, plant-level emissions data, which is often unavailable, especially among MSMEs.
In the absence of verified emissions data, exporters may be subjected to default emission values, which are typically higher.
Increased compliance costs risk erosion of market share, as EU buyers may switch to lower-carbon suppliers.
The mechanism converts climate compliance into a non-tariff trade barrier, affecting competitiveness.

India argues that CBAM violates the principle of Common but Differentiated Responsibilities (CBDR) under global climate agreements.
The mechanism disproportionately burdens developing countries, which lack access to affordable clean technology and transition finance.
It raises concerns about WTO compatibility, particularly regarding non-discrimination and disguised protectionism.
India has opposed CBAM at multilateral platforms such as the WTO and UNCTAD, calling for dialogue-based solutions.
New Delhi has sought special consideration for MSMEs and developing economies during negotiations.

Electric Arc Furnaces (EAFs) use recycled scrap and emit significantly less carbon than blast furnaces.
Countries like the United States, European Union, and United Kingdom control large scrap reserves, giving their producers a cost advantage.
Scrap-based producers face lower CBAM exposure, reinforcing existing structural inequalities.
Indian producers face a systemic disadvantage due to constrained access to scrap and high transition costs.

Studies suggest CBAM may reduce only around 0.1 percent of global carbon dioxide emissions.
There is a risk of geographical shifting of emissions, rather than actual global emission reduction.
CBAM focuses on taxation rather than technology transfer, limiting its developmental effectiveness.
The absence of climate finance and capacity-building support weakens its credibility as a climate solution.

CBAM sets a precedent for climate-linked trade barriers, encouraging similar measures by the United Kingdom and the United States.
It risks fragmenting the multilateral trading system, undermining consensus-based global trade rules.
The mechanism deepens the North–South divide by transferring climate adjustment costs to exporters.
It signals a shift from cooperative climate action to regulatory enforcement through trade.