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.

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Review on Energy Matters

How Fiscal Policy Can Help Battle Climate Change

Efforts to control atmospheric accumulations of greenhouse gases that threaten to heat up the planet are in their infancy. Although the International Monetary Fund is not an environmental organization, environmental issues matter for the organization's mission when they have major implications for macroeconomic performance and fiscal policy. Climate change clearly passes both these tests. 

A new book, Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers, provides practical guidelines for the design of fiscal policies (carbon taxes and emissions trading systems with allowance auctions) to reduce greenhouse gases.

Providing incentives

Not only are these instruments potentially the most effective at exploiting emission reduction opportunities in the near and longer term, but they can also generate for many countries a valuable new source of government revenue. The chapters, written by leading experts, explain the case for fiscal policies over other approaches; how these policies can be implemented; reasonable levels for emissions prices; policies for the forest sector; appropriate policy for developing countries; the most promising fiscal instruments for climate finance; and lessons to be drawn from prior policy experience.

This is essential reading for policymakers in finance and environment ministries in developed and developing countries alike, and others grappling with balancing environmental and development concerns.

Purchase your copy:

• IMF Bookstore: Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers
• Amazon: Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers 

Also available to IMF eLibrary subscribers: 

• Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers

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Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers by International Monetary Fund (IMF)
My rating: 5 of 5 stars

Clearly written book on how taxes and other instruments can help in the battle against climate change by reducing energy-related carbon dioxide emissions (which account for about 70% of projected greenhouse gas emissions). By some of the leading experts in the field.

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