How to reform the carbon tax

For more details on the GMK Center study “Carbon Pricing and Financing Decarbonization in Ukraine and the EU,”  follow the link.

How to stimulate decarbonization in Ukraine? The standard recipe from “experts” of various grant projects is to increase the price of emissions. Why? Because the price of emissions in Ukraine is lower than in the EU. In my opinion, this is a dangerous simplification and a path to economic decline. I will explain why below.

First, a direct comparison of emission prices on the European market and the Ukrainian market is incorrect. Even at the current level of CO2 tax in Ukraine, Ukrainian producers may pay more for emissions than some of their European competitors. Strange as it may seem, this is a fact.

European companies do not pay the full cost of carbon emissions, but only the part that is not covered by free allowances. Free allowances are allocated on a calendar year basis in accordance with industry benchmarks and historical production volumes. The average need to purchase allowances in the cement industry is only 5.2% of total emissions, and in the chemical industry, 18.0%.

For a number of industries, historically high production volumes have resulted in surplus free allowances, i.e., when the volume of free allowances exceeds the actual volume of emissions. This trend was widespread before the start of Phase 4 (2021–2030) and continues for some companies today.

In the steel industry, the total level of emissions covered by free allowances was 103% in 2024. This means that some companies not only paid nothing for emissions, but on the contrary, had the opportunity to sell surplus allowances and receive additional income from this.

Secondly, in the EU, the emissions trading system (EU ETS) serves to accumulate resources for financing decarbonization projects. The proceeds from the sale of quotas in the EU, which are received by member states, are earmarked for climate projects. Part of the revenue is also directed to three special funds that finance green transition projects. This is in addition to seven other funds with a total budget of €424 billion for 2021–2027.

In other words, the EU ETS sends a signal to economic agents, strengthening the incentive to decarbonize, while funds outside this system reduce barriers to investment and costs associated with the green transition.

In Ukraine, however, the emissions tax is exclusively a fiscal instrument that drains financial resources from businesses, reducing opportunities for decarbonization. Therefore, I am convinced that emissions payments in Ukraine should also be targeted — aimed at financing decarbonization projects.

Ukraine needs €102 billion in investments by 2030 to achieve its NDC targets. But it is clear that our country does not have the resources for this. Even if the carbon tax is increased to €10/t, it will take 88 years for financing instruments to provide at least 50% of the investment required by 2030. Therefore, access to European decarbonization financing funds is critical for successful decarbonization. Why is there no public discussion about this? It is unclear!

Thirdly, high emission prices are not the only condition for decarbonization. In addition to a decarbonization financing system, market conditions are needed where businesses can count on a return on their investments. This includes, in particular, the absence of restrictions on capital movement, protection of the market from imports and carbon leakage, market readiness, and sufficient demand for green products, etc.

Successful decarbonization also requires a fundamentally different approach to regulation. We are currently seeing this in the European Union, where approaches to market regulation are being reformed. This became necessary after the delay and suspension of many decarbonization projects, even with ample opportunities to raise capital and state participation in financing such projects.

Undoubtedly, Ukraine needs a new carbon pricing system design for successful decarbonisation. What format should it have? Of course, it should be an emissions trading system (ETS), as this was a condition of the Ukraine-EU Association Agreement. It should be a system with parameters similar to the EU ETS, as it is worth considering the future integration of the Ukrainian system into the European one.

However, the Ukrainian ETS must take into account the specific characteristics of Ukraine, namely:

• The main task is to adapt Ukrainian businesses to joining the European system in the future.
• Gradual implementation and price increases, preventing excessive financial pressure on businesses.
• Introduction of a Ukrainian carbon border adjustment mechanism, reimbursement of carbon payments for exports, compensation for indirect emission costs following the EU example.
• Abolition of the carbon tax for industries that will be included in the Ukrainian emissions trading system.
• Targeted use of revenues for decarbonization projects, as the issue of carbon pricing is inseparable from the issue of carbon finance.

Ukraine must move in lockstep with the EU to achieve the same results as European countries, but in its own way and using the best European experience.