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If revenues from carbon taxes are used to reduce other pre-existing taxes, such as income tax, the overall costs of carbon pricing are lower than if revenues are transferred lump-sum to firms or households (Goulder, 1995; Bovenberg, 1999). Detailed analyses that take into account the full range of existing tax distortions suggest that a green fiscal reform might even create economic gains (see, e.g., Parry and Bento, 2000; Parry et al., 2014).5
Such gains may also arise when
countries harbour a large informal economy, prone to tax evasion. Energy taxation and environmental fiscal reform are particularly appealing in low- and middle- income countries where substantial informal economies make relying on corporate and personal income tax more difficult, and where administrative capacity is weak (Besley and Persson, 2014). In such countries, income taxes tend to encourage informal activities, so reducing income taxes and raising more revenue from energy taxes can increase economic efficiency (Bento et al., 2018).
6.4 Addressing the broader fiscal policy framework: policy packages, coordination and alignment
The effectiveness of fiscal policies in the energy sector can be increased if other market failures and barriers are addressed by complementary policies. For example, capital markets, innovation and network externalities are typically larger for new and emerging technologies, including low-carbon technologies. As upfront capital costs are often higher for renewable than for fossil projects, low-carbon investment in developing countries is particularly affected by macroeconomic and policy risks (Waissbein et al., 2013; Hirth and Steckel, 2016; Rodríguez-Manotas et al., 2018). Technology support, innovation and de-risking policies can address these barriers and strengthen the environmental impact of carbon pricing (Kalkuhl et al., 2012; Schmidt, 2014; Dressler et al., 2018; see also Chapter 7).
Better alignment of broad tax policy can help reduce carbon emissions. Subsidies or tax deductions related to commuting (Su and DeSalvo, 2008), company cars (Harding, 2014) and the aviation sector (Gössling et al., 2017) are common in many developed countries and tend to encourage carbon-intensive transport choices. Replacing property taxes with land value taxes can reduce urban sprawl and increase housing density, which in turn reduces the need for longer commutes (Banzhaf and Lavery, 2010).
Policy coordination extends across sectors. Increasing carbon prices in the energy sector can increase emissions from land-use change due to increased bioenergy production, if the associated emissions are not properly accounted for (Searchinger et al., 2009; Haberl et al., 2012). Consistent policies and price signals across sectors can significantly mitigate GHG emissions and help manage future risks associated with rising carbon prices (Golub et al., 2017; 2018 and Lubowski and Piris- Cabezas, 2017). Fiscal policies such as ecological fiscal transfers, contingent on environmental performance, can also play a role in the land-use sector. They could be a way to implement REDD+6
when international
pay-for-performance or carbon market finance flows to the national or state government level (Loft et al., 2016). There is growing experience with ecological fiscal transfers, including transfers of tax revenues to support protected areas and forests in Portugal (Santos et al., 2012), several Brazilian states (May et al., 2011) and India (Busch and Mukherjee, 2018). Land taxes on agricultural land can also help reduce agricultural land use and deforestation (Kalkuhl and Edenhofer, 2017).
6.5 Conclusion
This chapter provides two important insights. Firstly, while governments frequently use excise taxes on energy and fuels for raising public revenues, fiscal policy in most countries is currently not geared towards delivering the transition to a low-carbon economy. Core climate policies are not in place, existing carbon rates are too low and inconsistent, and broad fiscal systems are not well aligned with decarbonization. Secondly, this need not be the case. Increasing the costs of carbon-intensive energy to steer investment and behaviour towards low-carbon options and allocating carbon tax revenues to create a fiscal system that supports inclusive sustainable development are entirely within reach. Decisions on how to use revenue are critical to building public support and harnessing the full power of price-based policy to cut carbon emissions.
5 The first case, where costs of climate policy are reduced when revenues from carbon pricing are used to reduce pre-existing distortionary taxes, is called ‘weak double dividend’. The second case, where climate policy creates economic gains through reduction of distortionary taxes, even when the environmental effects are not accounted for, is called ‘strong double dividend’.
6 Reducing Emissions from Deforestation and Forest Degradation, as well as conservation, sustainable management of forests and enhancement of forest carbon stocks.
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