Pakistan Government Contemplates Imposing Carbon Tax on EU Exports

The Pakistani government is actively considering the implementation of a carbon tax on exports to the European Union (EU) as a response to the Carbon Border Adjustment Mechanism (CBAM). The CBAM is designed to help the EU achieve its goal of carbon neutrality by 2050, with a focus on curbing carbon emissions from imports. 

Under the Paris Agreement, which has 195 signatories as of June 2021, nations are committed to limiting their CO2 emissions, with flexibility to set their own targets within specified limits. The EU has pledged to reduce emissions by 55% by 2030 compared to 1990 levels, as part of its comprehensive EU Green Deal, which includes a range of tax and non-tax measures aimed at promoting environmental sustainability.

The EU Green Deal outlines strategies to promote resource efficiency, combat climate change, reverse biodiversity loss, and reduce pollution. It encompasses various economic sectors, including transportation, energy, agriculture, and industries such as steel, cement, information and communication technology (ICT), textiles, and chemicals.

The EU introduced the world's first carbon tax on May 16, 2023, as part of the CBAM. This mechanism requires importers of carbon-intensive goods like cement, electricity, fertilizers, iron and steel, aluminum, and hydrogen to pay a charge for the embedded carbon emissions in these products. The charge will be phased in gradually from 2026 to 2034, eventually matching what an EU producer would pay under the EU Emission Trading System (EU ETS).

This carbon tax could have significant implications for countries like Pakistan, where a substantial portion of their exports fall under the category of carbon-intensive goods. For instance, it is estimated that 0.2% of Pakistan's total exports to the EU, valued at $16.83 million, could be adversely affected by the implementation of the carbon tax.

To put these numbers in perspective, during 2022-23, the total export value of selected products amounted to $464.09 million. These products included fertilizers, articles of iron and steel, aluminum, cement, and sodium hydroxide or caustic soda. While these items accounted for only 1.64% of total exports, their export value to the EU was a mere 0.20% of the total, reflecting the potential impact of the carbon tax.

The EU carbon tax is expected to compel importers to purchase carbon certificates equivalent to what EU producers would pay under carbon pricing rules. This could result in increased costs for importing from countries with higher carbon emissions, thus creating an added dimension of competition favoring sustainable production.

Pakistan faces a choice under the CBAM, which allows EU importers to avoid or reduce carbon taxes if they can demonstrate that a similar carbon price has already been paid. In this scenario, Pakistan may need to levy a carbon tax on its carbon-intensive sectors, allowing the government to collect the tax revenue, albeit at the cost of Pakistani exporters.

Several considerations are under discussion, including balancing EU demand for Pakistani products, the ability of Pakistani small and medium-sized enterprises (SMEs) to handle increased taxation, the progressiveness or regressiveness of the tax, and other factors influencing Pakistani firms to adopt sustainable practices.

The Commerce Ministry is exploring two options: the imposition of carbon taxes, which would result in improved state revenue and increased EU demand, but also direct costs for Pakistani exporters; and non-imposition of carbon taxes, which would spare Pakistani exporters direct costs but might lead to market share loss in cases where other countries embrace similar taxation measures.