How does decarbonization change the fiscal equation?

This paper explores the fiscal implications for countries of global climate mitigation in the medium term. If climate action is unilateral, it might be limited in scope and rely more on subsidies and spending to avert political constraints. This can put fiscal sustainability at risk. Coordinated carbon pricing or other mitigation policy can more effectively put the world on a path to 1.5 to 2°C above pre-industrial temperatures, as agreed in Paris in 2015, while helping manage fiscal and political constraints. Coordination could be initiated by large players, such as China, the United States, India, the African Union, and the European Union. The authors find that the implications for fiscal revenues over time are shaped by a combination of rising carbon prices, the gradual erosion of existing fuel tax bases, and possible revenue sharing arrangements. Public spending rises during the transition to build green public infrastructure, promote innovation, and support clean technology deployment, although much of this spending could be more efficiently financed through higher sectoral prices and taxes rather than through the general budget. Countries will also need funds for compensating vulnerable households, industries, and poor countries. With well-designed climate-fiscal policy relying on carbon pricing, global decarbonization will have anything from moderately positive to moderately negative impacts on fiscal balances in high-income countries. For middle and low-income countries, net fiscal impacts are generally positive and significant. Hence, as mitigation strategies improve fiscal balances, they can accommodate development spending needs. Revenue sharing at the global level would make an historical contribution to breaching the financial divide between rich and poor countries.