Friday, July 10, 2015

Tackling Climate Change Through Prices

This is an important year for galvanizing action on climate change. “Getting prices right” is convenient shorthand for the idea of using fiscal instruments to ensure that the prices that firms and consumers pay for fuel reflect the full costs to society of their use, which requires adjusting market prices by an appropriate set of “corrective” taxes.

In practice, many countries, far from charging for environmental damage, actually subsidize the use of fossil fuels. For many others, energy taxes—if currently implemented at all—are often not well targeted at sources of environmental harm, nor set at levels that appropriately reflect environmental damage. Clearly there is much scope for policy reform in this area, but there are also huge challenges, both practical and analytical.

From a practical perspective, higher energy prices burden households and firms and, even with well-intentioned compensation schemes, can be fiercely resisted. These challenges—not to understate them—are largely beyond the scope of this book; however, a complementary volume (Clements and others, 2013) distills lessons to be drawn from case studies of energy price reforms. Moreover, getting energy prices right need not increase the overall tax burden; higher fuel taxes could partially replace broader taxes on income or consumption (or environmentally blunt taxes on energy), broadening support for the policy. Where new revenue sources might be needed, corrective energy taxes are an especially attractive option because, unlike most other options, they improve economic efficiency by addressing a market failure.

The main focus here is on assessing the analytical challenges, that is, the pricing that needs to be put into practice. For the vast majority of countries, there has been no attempt to measure the magnitude of environmental damage across fossil fuel products—yet these measures are critical for actionable guidance to be given on how countries can get energy prices right.

The corrective energy tax estimates presented in this book should be treated with a good deal of caution, given data gaps, and controversies—for example, about the valuation of climate damage and the link between air quality and mortality risk. Nonetheless, the estimates provide a valuable starting point for dialogue about policy reform, scrutiny of the key uncertainties, and cross-country comparisons estimated on a consistent basis.

Moreover, the impact of alternative assumptions on corrective tax estimates can be derived from accompanying spreadsheets. Although tax assessments may change significantly as evidence evolves and data improve, the basic findings—most notably, the strong case for substantially higher taxes on coal and motor fuels in many countries—are likely to remain robust.

Main Findings

The main policy messages include the following:
  • Coal use is pervasively undercharged, not only for carbon emissions, but also for the health costs of local air pollution. 
  • Air pollution damage from natural gas is modest relative to that from coal, but significant tax increases are still needed to reflect carbon emissions. 
  • Higher taxes on motor fuels are warranted in many countries, though more to reflect the costs of traffic congestion and accidents than carbon emissions and local air pollution. 
  • Corrective taxes can yield substantial reductions in pollution-related deaths and in CO2emissions, and large revenue gains:
    • Fuel tax reform can reduce worldwide deaths from outdoor, fossil fuel, air pollution by 63 percent
    • Tax reforms could reduce CO2emissions by 23 percent globally
    • Potential revenue from implementing corrective taxes averages 2.6 percent of GDP globally
    • In short, the case for substantially higher energy taxes does not rest on climate change alone. Decisive action need not wait on global coordination.

CDG event with IMF Managing Director Christine Lagarde

Comments from Nancy Birsall

Review on Energy Matters