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EMISSIONS GAP REPORT 2018 – BRIDGING THE GAP: FISCAL REFORMS FOR THE LOW-CARBON TRANSITION


Focusing on particularly carbon-intensive goods (e.g. cement and steel) and conducting an ex ante evaluation on trade impacts can help overcome these downsides and make border carbon adjustments more effective in reducing carbon leakage.


Carbon tariffs are not necessarily compatible with World Trade Organization rules, although they could be covered by Article XX of the General Agreement on Tariffs and Trade (GATT), which stipulates that trade policies can be used for achieving environmental goals if no other policies are feasible that are less distortive to trade (Cosbey et al., 2012). Even so, retaliation can pose an economic risk if carbon tariffs are implemented by countries with a small share on the international market (Hagen and Schneider, 2017; Böhringer and Rutherford, 2017).


6.3.3 Political and behavioural factors


Ensuring broad and stable support for carbon pricing and the phasing-out of fossil fuel subsidies requires more than addressing distributional, competitiveness and leakage impacts. A number of additional success factors can be identified (Klenert et al., 2018a) and table 6.1 provides country examples for addressing these. The challenge is particularly significant where trust in government is limited (Klenert et al., 2018a; Rafaty, 2018). And yet, where trust is strong, there is a tendency for citizens to question problems if policy solutions challenge their world views, e.g. on the State’s role in the economy (“solution aversion”) (Campbell and Kay, 2014; Cherry et al., 2017). Designing policies that are consistent with the prevailing world views of specific societal groups therefore requires extensive communication and consultation prior to implementation.


To secure popular support for carbon pricing, the public needs to be informed about its positive effect on emissions reduction targets, as well as the co-benefits of cleaner air, health and fiscal sustainability (Hsu et al., 2008; Bristow et al., 2010; Kallbekken et al., 2011; Baranzini et al., 2014; Baranzini and Carattini, 2017). Timing is also important: a gradual reform is more likely to be successful than sudden and drastic price increases. Similarly, if several fossil fuel subsidies are being reformed, this can best be done by sequencing the reforms (Beaton et al., 2013; Rentschler and Bazilian, 2017b). Language matters too, with terms such as ‘fee’ or ‘contribution’ likely to meet with popular support compared with ‘tax’ (Kallbekken et al., 2011; Drews and van den Bergh, 2016; Baranzini and Carattini, 2017).


Carbon pricing and fossil fuel subsidy reform generate public revenues, the use of which can strongly impact support for carbon pricing. This is discussed in the section 6.3.4.


6.3.4 Use revenues from carbon pricing to foster sustainable development


Raising revenue through energy tax reforms relaxes constraints on broader fiscal policy, creating opportunities to stimulate more productive and socially inclusive economic development. With respect to carbon pricing, its potential for contributing to public budgets is illustrated in figure 6.2b. In developing and emerging economies, where tax revenue-to-gross domestic product (GDP) ratios rarely exceed 20 percent, an additional €60/ tCO2


carbon price on top of existing measures would


generate revenues worth more than 2 percent of gross domestic product (GDP). These revenues would not be available under non-fiscal climate policies like emission standards or ETS that do not auction permits.


The way these new revenues are used has an effect on the economy and equity, and therefore relates directly to the economic and political arguments for tax-based environment policy. Revenues can be deployed in various ways. Policy packages that combine carbon pricing with political or legal commitments to particular forms of spending have been found to increase the political appeal of, and public support for, fiscal reforms. However, because revenues from environmental taxes might be insufficient or too high for a specific spending objective, legal earmarking of these revenue sources for particular spending items increases the risk of inefficient tax and spending patterns. Maintaining some flexibility for adjusting spending decisions, e.g. through political commitment to policy packages, is therefore important. Options for such policy packages include:


1. Cutting personal or corporate income taxes. 2. Cash transfers.


3. Investment projects aimed at poor or disadvantaged regions or neighbourhoods, or regions traditionally dependent on fossil resource extraction (e.g. coal).


4. Temporarily assisting energy-intensive industries facing strong international competition.


5. Supporting low-carbon technologies or spending that increases environmental quality.


Table 6.2 gives an overview of spending options, including some country-specific examples. Choosing a particular option should be guided by the economic circumstances and political and social priorities of the respective jurisdiction. Some countries, such as Chile, Mexico and Viet Nam, have not earmarked environmental tax revenues or committed to simultaneous tax cuts. Sweden used a soft earmarking approach, reflecting a political commitment to reduce other taxes, in particular labour taxes. The revenue from ETS is more often allocated to green spending than that of carbon taxes and excise taxes and discussions on carbon taxes and excise taxes are more often embedded in broader tax policy reform efforts.


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