Countries will need a new mix of policies with carbon pricing at the center if they hope to deliver on global climate goals while avoiding soaring public debt, according to the IMF’s Fiscal Monitor report released on Wednesday, in Marrakesh, Morocco.
“Current national objectives and policies will fail to deliver net zero emissions, with potentially catastrophic consequences,” Vitor Gaspar, director of the IMF’s Fiscal Affairs Department, told a press briefing.
Scaling up the current mix of climate policies, which relies mainly on subsidies and other spending measures, could increase public debt by as much as 50 percentage points of gross domestic product by 2050, he said.
Worldwide, debt levels are generally elevated, and borrowing costs are climbing, making it more difficult for countries to devote adequate budget space to climate action.
Gaspar urged major players such as China, India, the United States, the African Union, and the European Union to take a cooperative approach when they meet next month at COP 28.
The report takes stock of mitigation policies across countries and presents the trilemma facing policymakers of balancing between achieving climate goals, debt sustainability, and political feasibility.
New insights from the report shows that the only way to achieve these joint goals is through a carefully calibrated mix of revenue and spending-based policies.
Carbon pricing is a necessary instrument and should be part of the policy mix. However, it is not sufficient and should be complemented by policies to address market failures and catalyze private financing and investment in low-carbon technologies. Robust fiscal transfers are needed to protect vulnerable households, workers, and communities during the green transition.
The fiscal cost of policy mix varies and could become challenging particularly for emerging market and developing economies already experiencing high debt and rising interest costs, alongside large adaptation and development needs.
The report takes stock of mitigation policies across countries and presents the trilemma facing policymakers of balancing between achieving climate goals, debt sustainability, and political feasibility.
Navigating fiscal challenges
To navigate these challenges, countries with limited fiscal space should build tax capacity to mobilize revenues and improve spending efficiency.
Policies should encourage the private sector to play an increasing role in financing and investing in climate actions. Global coordination to push forward pragmatic global carbon pricing, enhance external financial support, and facilitate knowledge transfers of established low-carbon technologies are essential to support climate efforts for developing economies.
For all countries it is becoming more challenging to balance the fiscal equation.
First, debts are generally elevated and borrowing costs are rising. Given that effective interest rates on public debt lag market rates, the effect will likely be very persistent.
Second, public expectations about the role of the budget have expanded over time, in part from the experience during COVID 19. Priority policy goals include the eradication of poverty and hunger, climate change, digitalization and artificial intelligence, competitiveness, and growth and much else.
Third, there is a widespread aversion to taxation. So much so that it is not a great exaggeration to speak about political red lines on taxation.
The Fiscal Monitor – Climate Cross-Roads looks at the fiscal implications from the green transition. The baseline is business as usual (BAU).
Under such assumption it is possible to identify ambition gaps – the difference between countries’ own nationally defined contributions and what is required to deliver on the Paris agreement goals – and policy gaps – the difference between the national targets and the outcomes achievable under BAU.
The Fiscal Monitor shows that scaling-up the current policy mix – heavy on subsidies and other components of public spending – to deliver net zero leads to an accumulation of public debt by 40 to 50 percentage points of GDP for a representative advanced economy and for a representative emerging market economy.
The Fiscal Monitor argues that to circumvent this terrible trade-off it is necessary to rely on a combination of policy instruments. Carbon pricing (carbon taxation) is a necessary component of the policy mix, but it is not sufficient.
It must be complemented by instruments aimed at correcting remaining market failures. One relevant example relates to the production, diffusion, and adoption of green technologies.
Fiscal support is also necessary to facilitate the unavoidable costly adjustments undergone by vulnerable households, workers, communities and corporations.
