Fiscal policies

Carbon pricing

While this Topic Guide cannot cover the subject comprehensively, carbon pricing is generally viewed as an essential instrument in the toolbox of fiscal reforms for climate action, albeit primarily through an economic lens. Through either a tax or a cap-and-trade system, carbon pricing places a price on carbon emissions to account for social and environmental costs. As of 2015, there were 38 carbon pricing instruments implemented or scheduled for implementation in 40 national jurisdictions and 20 cities, states and regions amounting to 7 gigatons of CO2e (carbon dioxide equivalent), or 12% of global emissions (World Bank, 2016). Carbon pricing revenues can be used to create positive policy feedback to offset negative feedback from increased prices of carbon-intensive goods. The distribution of revenues from a carbon price to low-income households vulnerable to socioeconomic shocks can help alleviate the burden of the increased costs related to products and services that are carbon-intensive. These can include the lowering of payroll and income taxes, job training, reducing government deficits, direct dividends to households, investing in clean technology innovation or adaptation and addressing regional disparities and inequities (Kennedy et al., 2015).

In countries where carbon pricing is likely to impact the livelihoods of workers in fossil fuel energy production (such as coal in the US), a portion of revenues can be distributed to provide or strengthen an array of socioeconomic, health and infrastructural assistance mechanisms to support the transition to alternative livelihoods (Kaufmann & Krause, 2016). An analysis of $28.3 billion in global revenue from carbon pricing in 2013/14 found 36% was returned to corporate or individual tax payers through tax cuts or direct rebates, 27% was used to subsidise green spending (i.e. energy efficiency or renewable energy) and 26% went to state general funds (Carl & Fedor, 2016). (These numbers are the combined average of carbon tax and cap-and-trade systems. The same paper found cap-and-trade systems – which are fewer in number and produce less overall revenue – tend to allocate a far greater proportion of revenue to ‘green programmes’, whereas carbon tax systems tend to direct revenues to state general funds or refund the revenue through different paths.)

Fossil fuel subsidy reform

The global problem of fossil fuel subsidies is one of the most salient areas of incoherence with low-carbon development and carbon mitigation policy, and it generates significant political challenges. Estimates of fossil fuel subsidies vary considerably, based primarily on whether they include only the cost of lowering the price to customers or if they also internalise environmental cost estimates. The International Monetary Fund has referred to these as ‘pre-tax’ and ‘post-tax’, respectively, and estimates $4.9 trillion in post-tax subsidies in 2013 (Coady et al., 2015). By comparison, renewable energy is subsidised by $100 billion (Global Subsidies Initiative). In 2009, the G20 agreed to phase out fossil fuel subsidies by 2020. However, a 2015 report of G20 fossil fuel subsidies put the total at $444 billion, suggesting progress towards the 2020 goal has been lacking (Bast et al., 2015).

Examples of fossil fuel subsidies on the supplier side include tax breaks, loans and guarantees at favourable rates and access to government land or water at below-market rates. On the demand side they come through price controls, vouchers or grants and other ways of increasing consumption. Fossil fuel subsidies are economically inefficient, reduce tax revenues, increase environmental impacts, are regressive (in that the rich benefit more) and contribute to path dependency on fossil fuels through the development of infrastructure and long-term contracts (Global Commission on the Economy and Climate, 2014). There are ‒ particularly in developing countries where energy access is still a major problem ‒ legitimate governance concerns of ensuring energy access that are given as the rationale for these subsidies.

While multiple studies have shown that government funds would be more efficiently and effectively dedicated to social protection programmes, removing subsidies has proven very challenging, given opposition from energy companies and the risk (perceived or real) of public backlash. Reform attempts have been unsuccessful because of stiff public backlash after subsidies were phased out too quickly (Bolivia) and the lack of an effective public communication strategy (Nigeria). The Indonesian government has faced public pressure despite a compensation scheme, but has progressively managed to lower subsidies from $36 billion in 2012 to $4 billion in 2016 (ADB, 2015). This more recent success has been credited to the expansion of social assistance programmes, which amounted to $1 billion per year in 2015 (ibid.). This demonstrates how programmes that address climate vulnerability can also shift the political economy to be more amenable to low-carbon policies.

Despite the political challenge, many countries have attempted to implement subsidy reforms, with varying degrees of success. Ghana successfully reduced subsidies starting in 2006 following an impact assessment and communications campaign, establishing a new authority and using revenues to compensate poor households to help make the reforms more politically palatable. Tunisia successfully shifted consumer use of fossil fuel water heaters to solar water heaters by using the additional revenues to subsidise the new technology, building public awareness, developing a supply chain and using a state utility to be a debt collector, guarantor and enforcer (Global Commission on the Economy and Climate, 2014).

Several organisations have produced resources to help governments address these challenges. The International Monetary Fund (2013) suggests embedding subsidy reforms within more comprehensive fiscal reforms, providing targeted and credible protection measures for the poor, phasing in price increases appropriately, improving efficiency of state-owned enterprises and delivering a clear communications strategy. Many countries that face serious equity issues also lack social welfare nets for those who need it, so fossil fuel subsidy reform is part of larger structural reforms.