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Appendix

Environmental Border Pricing

Appendix Assisted · economics, business

Moving to an Environmental Border Adjustment Mechanism (EBAM).

Rationale

Market prices for traded goods systematically understate their true cost of production. When a tonne of steel is manufactured in a jurisdiction with no carbon price, no pollution controls, and no environmental permitting requirements, it arrives at the UK border carrying an implicit subsidy — the unpaid cost of the environmental damage caused by its production. The domestic producer who pays the UK Emissions Trading Scheme price (~£50/tCO₂ in 2025), the Climate Change Levy, landfill taxes, and regulatory compliance costs is competing against an import whose price reflects none of these.

This is not a market functioning correctly. It is a market systematically mispricing a class of inputs — environmental costs — and in doing so generating three harmful outcomes. First, it penalises domestic producers who bear environmental costs, creating an incentive to offshore production to jurisdictions with weaker standards. Second, it rewards pollution: the cheapest goods on global markets are often the dirtiest, because their prices exclude the damage they cause. Third, it undermines climate policy: the UK's territorial emissions have fallen 54% since 1990, but consumption-based emissions (including imports) have fallen only 24%, because much of the reduction reflects relocation of dirty production rather than genuine abatement. The UK now imports roughly as much embedded carbon as it produces domestically — approximately 404 MtCO₂e in import-embedded emissions against 371 MtCO₂e in territorial emissions (DEFRA, 2022; DESNZ, 2024).

The principle of environmental border pricing is straightforward: goods entering the UK should carry a price that reflects the environmental costs their production imposed, equivalent to the costs borne by domestic producers for equivalent goods. This is not protectionism — it is the removal of a pollution subsidy. It corrects a market failure rather than creating a distortion, and it applies equally to all imports regardless of origin. Importers who can demonstrate that equivalent carbon or environmental costs were paid in the country of production receive full credit, ensuring the mechanism rewards clean production wherever it occurs.

The UK government's own policy appraisal framework implicitly endorses this logic. DESNZ carbon values used for Green Book appraisal set the 2025 non-traded carbon value at £273/tCO₂e (2022 prices), rising to approximately £294/tCO₂e by 2030 and £317/tCO₂e by 2035. These represent the marginal abatement cost required to achieve net zero by 2050. The current UK ETS price of ~£50/tCO₂e — and the zero price on most imports — sits at roughly one-fifth of this value, implying that four-fifths of the true environmental cost remains unpriced in both domestic and international markets.

Current UK Environmental Cost Architecture

UK domestic producers face environmental costs through multiple overlapping instruments, none of which apply to imports:

The UK Emissions Trading Scheme covers approximately 1,000 stationary installations (power generation, energy-intensive industry, aviation), roughly 25% of UK territorial emissions. Allowance prices traded at £30–60/tCO₂ through 2023–2025, with auction revenue of £2.6 billion in 2024. Free allocation — currently around 40 million allowances annually — shields energy-intensive sectors from the full cost, though phase-out in CBAM-covered sectors begins in 2027.

The Carbon Price Support adds £18/tCO₂ on fossil fuels used in electricity generation, frozen at this rate since 2016. Combined with the UK ETS, this creates an effective carbon price floor for the power sector of approximately £68–73/tCO₂.

The Climate Change Levy taxes non-domestic energy consumption at £0.00775/kWh (equalised across electricity and gas from April 2024), generating approximately £1.2 billion annually. Energy-intensive industries holding Climate Change Agreements receive 89–92% discounts.

Additional instruments include Landfill Tax (£126.15/tonne standard rate, £486 million revenue), Plastic Packaging Tax (£223.69/tonne, £259 million), Aggregates Levy (£359 million), water abstraction charges, environmental permitting fees, and compliance costs for Industrial Emissions Directive standards.

Total UK environmental tax revenue in 2024 was £54.3 billion (1.9% of GDP), though this includes fuel duty and vehicle excise duty which are partly fiscal rather than purely environmental instruments. The narrower set of industry-facing environmental levies (ETS auctions, CCL, CPS, landfill tax, aggregates levy, plastic packaging tax) totals approximately £5.5 billion, yielding an effective rate of roughly £55/tCO₂e across covered emissions.

The UK Carbon Border Adjustment Mechanism

The UK Government confirmed in the Autumn Budget 2024 that a Carbon Border Adjustment Mechanism will take effect from 1 January 2027, covering aluminium, cement, fertiliser, hydrogen, and iron and steel. The mechanism is administered by HMRC as a tax rather than a certificate-based system, with a £50,000 annual import threshold and a choice between verified actual emissions data and government-published default values.

The OBR-certified revenue projection is modest: approximately £30 million in 2026–27, rising to £140–180 million by 2028–29, reflecting three design features that constrain early revenue. First, the CBAM rate is set at the UK ETS quarterly auction price minus a free allocation adjustment, and the 9-year phase-out (2027–2035) removes only approximately 2.5–10% of free allowances in the early years. Second, importers receive carbon price relief for equivalent charges paid abroad — and a substantial share of CBAM goods enter from the EU, where producers already pay the EU ETS price (typically higher than the UK ETS). Third, the May 2025 UK-EU Summit committed both parties to linking their emissions trading systems, which would ultimately exempt EU-origin goods from UK CBAM charges.

Glass and ceramics were dropped from the 2027 launch scope following consultation. Indirect emissions (Scope 2) are deferred until at least 2029. The government committed to keeping sectoral scope under review.

The EU CBAM and International Context

The EU CBAM entered its definitive financial phase on 1 January 2026, covering cement, iron and steel, aluminium, fertilisers, hydrogen, and electricity. It represents the world's first operational carbon border adjustment, with over 4,100 authorised declarants in the first week. The EU's free allocation phase-out runs from 2.5% (2026) to 100% (2034), with the steepest acceleration occurring between 2029 (22.5%) and 2034.

In December 2025, the European Commission proposed extending CBAM to approximately 180 downstream steel and aluminium products from 2028, and laid out a roadmap for further extension to chemicals and refined petroleum. The Commission's review report envisages coverage of substantially all ETS sectors by the early 2030s.

Several other jurisdictions are at various stages of CBAM consideration. Australia's Carbon Leakage Review (February 2026) recommended a CBAM-style scheme for cement. Japan is expanding domestic carbon pricing through the GX-ETS (mandatory from FY2026) and a planned upstream carbon levy from FY2028, though without a border adjustment component. The G7 Climate Club, now with 46 member states, provides a cooperation framework but without binding carbon price floors.

Russia filed the first formal WTO dispute against the EU CBAM in May 2025. No ruling is expected for several years given the inoperative WTO Appellate Body. The prevailing legal consensus is that well-designed CBAMs — set at domestic carbon cost equivalence, with credit for foreign carbon prices, and using product-level rather than country-level rates — satisfy GATT Article XX environmental exceptions, though this has not been tested in dispute resolution.

Revenue Potential Under Different Approaches

We examined three broad approaches to environmental border pricing, each yielding substantially different revenue profiles.

Approach 1: The confirmed narrow CBAM. Covering five sectors with a 9-year free allocation phase-out and UK ETS-based pricing, this generates approximately £0.2–1.5 billion per year at maturity (2033–2035), depending on carbon price levels and whether UK-EU ETS linking exempts EU imports. This is a carbon leakage prevention tool rather than a significant revenue instrument.

Approach 2: Expanded sectoral CBAM. Adding chemicals, glass, ceramics, downstream metals, refined petroleum, and plastics roughly triples the chargeable emissions base from ~10 MtCO₂ (non-EU) to ~20–25 MtCO₂. At projected 2035 carbon prices of £120–150/tCO₂ with fully phased-out free allocations, annual revenue reaches approximately £2.5–3.5 billion. If UK-EU ETS linking is not completed and EU imports remain chargeable, this rises toward £4–5 billion, though this scenario is increasingly unlikely given the formal linking negotiations underway.

Approach 3: Comprehensive environmental cost equivalence.

Introducing an Environmental Border Adjustment Mechanism (EBAM). Applying the UK's aggregate effective environmental tax rate (~£55/tCO₂e from industry-facing levies, or ~£146/tCO₂e including all environmental taxes) across all 404 MtCO₂e of import-embedded emissions would yield £20–59 billion annually. However, this is illustrative rather than implementable: embedded emissions in complex manufactured goods, electronics, textiles, and services cannot be measured with sufficient precision to serve as a tax base, and the WTO defensibility of such a broad mechanism is untested. The UK government's own CBAM consultation excluded certain sectors specifically because of the difficulty of ascertaining embodied emissions at product level.

For fiscal planning purposes, a realistic steady-state estimate for an expanded UK CBAM by 2035 sits at £3–4 billion per year under central assumptions (linked ETS, expanded scope, carbon prices of €126–150/tCO₂). This could reach £5 billion under optimistic conditions (broader scope, higher carbon prices, slower linking) or fall to £1–2 billion under conservative conditions (narrow scope, linked ETS with EU exemptions reducing the chargeable base). These estimates are subject to significant uncertainty from carbon price volatility, trade pattern shifts, behavioural responses reducing import volumes, and the pace of carbon pricing adoption by UK trading partners (which generates credits reducing CBAM liability).

Structural Reform Implications

Environmental border pricing does not need to be justified by revenue generation. Its primary function is to correct a market failure: the systematic underpricing of environmental damage in internationally traded goods. Three structural benefits flow from this correction independent of fiscal proceeds.

First, it supports UK productive capacity in energy-intensive sectors — steel, cement, glass, ceramics, chemicals — that face existential competitive pressure from imports produced without equivalent environmental costs. UK steel import penetration reached 70% in 2024; cement imports now account for 32% of UK sales. These trends are driven partly by the asymmetric environmental cost burden. Border pricing does not guarantee the survival of these industries, but it removes the thumb currently on the scale against them.

Second, it creates a price signal that reaches beyond UK borders. When importers face a border charge calibrated to carbon content, their upstream suppliers face a financial incentive to decarbonise production methods — regardless of whether their home government imposes a carbon price. This "exported price signal" is one of the EU CBAM's stated objectives and is already driving carbon pricing adoption discussions in Turkey, India, Indonesia, and Vietnam.

Third, it aligns the UK's trade regime with its climate commitments. The UK's net zero 2050 target is measured against territorial emissions, but consumption-based emissions — which include imports — are the true measure of the country's climate impact. A border that is porous to embedded carbon is inconsistent with a domestic regime that prices it. Environmental border pricing closes this gap incrementally, moving the UK toward a position where the carbon price signal applies consistently to all goods consumed domestically, regardless of where they are produced.

These benefits are real and immediate. The fiscal revenue — likely £3–4 billion per year at maturity — is a welcome by-product but should not be the basis for programme expenditure commitments given the significant uncertainties involved. This programme therefore accounts for no EBAM-related revenue in its fiscal framework, while recognising that environmental border pricing represents one of the largest untapped fiscal and environmental policy instruments available to a future government.

Sources

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Structural Measure

International Competitiveness

Published 18 May 2026