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Acknowledgements
We would like to thank members of the Working Group of Public Finance for their comments and, in alphabetical order, John Caruana, Christiane Nickel and Philipp Rother.
Aris Avgousti
Central Bank of Cyprus, Nicosia, Cyprus; email: ArisAvgousti@centralbank.cy
Francesco Caprioli
Banca d’Italia, Rome, Italy; email: Francesco.Caprioli@bancaditalia.it
Giacomo Caracciolo
Banca d’Italia, Rome, Italy; email: giacomo.caracciolo@bancaditalia.it
Marion Corchard
Banque de France, Paris, France; email: Marion.COCHARD@banque-france.fr
Pietro Dallari
European Central Bank, Frankfurt am Main, Germany; email: Pietro.Dallari@ecb.europa.eu
Mar Delgado-Téllez
European Central Bank, Frankfurt am Main, Germany; email: Mar.Delgado_Tellez@ecb.europa.eu
Marien Ferdinandusse
European Central Bank, Frankfurt am Main, Germany; email: marien.ferdinandusse@ecb.europa.eu
Daniela Filip
European Central Bank, Frankfurt am Main, Germany; email: Marinela.Daniela_Filip@ecb.europa.eu
Doris Prammer
Oesterreichische Nationalbank, Vienna, Austria; email: doris.prammer@oenb.at
Katja Schmidt
Banque de France, Paris, France; email: katja.schmidt@banque-france.fr
Anastasia Theofilakou
Bank of Greece, Athens, Greece; email: atheofilakou@bankofgreece.gr
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[1] The outbreak of war in Ukraine in early 2022 and the ensuing energy crisis have put the energy transition at a crossroads. On the one hand, it may accelerate the use of renewable energy. On the other, it may postpone planned decarbonisation efforts or even increase the use of dirtier” energy sources such as coal in the short term. Moreover, mitigation measures to limit energy price increases could imply higher emissions.
[2] Studies assessing the economic impact of climate change commonly estimate damage functions, which account for the output loss as a function of changes in global temperature (see, for example, Pindyck, 2013).
[3] A small number (about 3%) of unique events is responsible for the majority (about 60%) of economic losses. In this regard, there is high variability in the figures across years. Overall, the average annual (inflation-corrected) losses in the EU27 have increased over time from around €9.5 billion in 1981-90 to €14.5 billion in 2011-20 (equivalent to 0.06-0.10% of GDP).
[4] The fiscal costs of physical risks can differ compared with the costs of transition risks depending on the adaptation capacity (e.g. coastal protection) and mitigation capacity of each economy (see also CEPSZEW, 2010). However, the overall cost may be higher, as some of the costs might fall on the private sector via insurance.
[5] For the United States, annual hurricane damage amounted to 0.16% of GDP in 2006 and is expected to rise to 0.22% in 2075. Annual estimated federal spending for relief and recovery ranges from 0.1% of GDP in 2016 to 0.13% in 2075 (CBO, 2016). Focusing on the direct fiscal effects of adaptation in the EU, Osberghaus and Reif (2010) find higher costs for transport infrastructure and flood protection.
[6] The database covers various types of natural disaster, including earthquakes, floods, wildfires, landslides, droughts and severe storms.
[7] Data for newer Member States have typically only been available since the mid-1990s.
[8] It is hard to identify one indicator that is always better than the rest at capturing the likely effects of extreme weather events on public finances. A synthetic indicator provides a valuable alternative.
[9] This corresponds to around 10% of the original sample.
[10] Clearly, this does not rule out that the fiscal position of local municipalities, and, more generally, economic activities located in the area exposed to the natural hazard can still suffer significant losses.
[11] For an overview of the price effects of climate change, see Breitenfellner et al. (2022).
[12] The Paris Agreement is a legally binding international treaty on climate change, which was adopted by 196 parties in December 2015. Its goal is to limit global warning to well below 2 (preferably 1.5) degrees Celsius compared with pre-industrial levels. To achieve this goal, countries must submit, as of 2020, so-called nationally determined contributions every five years outlining concrete climate action plans. In addition, countries are invited to formulate long-term strategies to better guide their nationally determined contributions. As of 2024, countries will need to regularly report on progress made.
[13] Forster et al. (2020) estimate that the direct effect of the pandemic-related restrictions on the reduction of CO2 emissions will be negligible compared with a baseline scenario in which countries meet their stated nationally determined contributions.
[14] The Effort Sharing Regulation (ESR) was set up in 2014 to complement the EU ETS via annual national targets for the non-EU ETS sectors and to support the economy-wide reduction of emissions by 2030. Progress towards achieving the targets is assessed annually. In case of persistent shortfalls, a penalty in the form of higher reduction obligations is applied.
[15] The EU ETS is analysed in Section 3.4.
[16] As part of the Fit for 55” package, a more ambitious emissions reduction target has been proposed for the sectors covered by the ESR, namely a reduction of 40% in EU emissions by 2030 compared with 2005, as well as amended national targets.
[17] These estimates are based on the assumption that existing climate change policies will remain in place, but no new measures are assumed to have been adopted.
[18] Even limiting global warming to just below 2°C, using the IPCC estimates for a necessary 25% decline in CO2 emissions by 2030, would require an annual reduction in emissions of around 3%.
[19] Friedlingstein et al. (2021) and Andrew and Peters (2021).
[20] See also Hepburn et al. (2020) and Bahar (2020).
[21] In Austria, for example, subsidies are provided for the transition from oil heating to cleaner” heating systems, while in Portugal personal income deductions are applied for the purchase of energy-efficient heat pumps for personal use. In Latvia, some EU ETS revenues and EU funds (structural and RRF) are earmarked for the renovation of buildings (roof, basement and wall insulation) and the upgrading of windows (rather than the replacement of water or heating systems). If efficiency targets are met, the loans are converted to grants.
[22] Examples are CITE (an income tax credit scheme for expenditures related to certain energy or heatefficient renovationprojects for private dwellings) in France, tax credits from corporate income tax (e.g. in Greece forthe leasingof low-emission company cars and construction of publicly available electric charging stations, in Hungary for the construction of electric charging stations and investments in energy efficiency targets, and in Malta for investments in technological solutions that provide higher energy efficiency) and a reduced VAT rate for energy-efficient expenditure on residential buildings (e.g. in Cyprus and Hungary).
[23] For coal in particular, the low effective tax rate reflects its coverage by the EU ETS via the energy sector.
[24] This privilege is enshrined in the Energy Taxation Directive, which allows lower minimum tax rates for diesel than petrol.
[25] In Greece, the tax exemption holds only for tool cars (i.e. cars provided to employees to serve the company’s needs), whereas tax exemptions do not apply to company cars provided to managers.
[26] This difference mainly seems due to the energy surcharge (EEG-Umlage), which is reduced/waived for (energy-intensive) industries.
[27] Public expenditure in support of fossil fuels may incentivise higher emissions and/or higher levels of resource extraction. Such measures can lower investment incentives for environmentally friendly products or technologies. While the examples above give an indication of the importance of environmentally harmful expenditure, they do not fulfil the requirement for a fully fledged database to assess and compare the order of magnitude across countries.
[28] The OECD classifies expenditure based on the support provided for the production and consumption of fossil fuels as well as for general services. The latter refers to public transfers mainly associated with past production activities of fossil fuels and industry-wide funding. In this analysis, transfers that do not provide direct support for fossil fuel production and/or consumption are not reported (for example, those related to the rehabilitation of old mining regions).
[29] The COVID-19 period is not covered in this section, as the reduction in GHG emissions owing to the cyclical downturn could give a distorted view of the harmful expenditure policies in place.
[30] Based also on the OECD database of public transfers in support of fossil fuels (information available in March 2021).
[31] Following the sharp increase in the international prices of oil and other commodities as of mid-2021, several EU countries introduced measures to compensate consumers for the direct effects of higher energy costs. For more details on the measures in each EU country, see Sgaravatti et al. (2022).
[32] The public sector agencies in Malta responsible for energy and water distribution are partly financed by the government through a subvention. Although the subvention for energy producers is earmarked for sustaining spare capacity, securing supply and supporting feed-in tariffs for the use of renewable energy sources, without public support, the entities could operate at a loss and would hence need to adjust tariffs and operating costs.
[33] In Finland, according to Treasury data (WGPF), the compensation for EU ETS indirect costs for energy-intensive industries was €29.1 million in 2019.
[34] In some countries, including Germany and the Netherlands, emergency measures to cope with the reduction of gas supplies from Russia include an increase in the use of coal in their energy mix.
[35] The COVID-19 pandemic resulted in a sharp decline in environmental taxes in 2020 owing to the cyclical downturn and reduced mobility following the adoption of strict containment measures. Environmental tax revenues are expected to pick up in 2021, reflecting the V-shaped economic recovery and the gradual relaxation of social distancing measures. Given these pandemic-related fluctuations, this section covers pre-pandemic developments.
[36] See Energy Taxation Directive 2003/96/EC.
[37] Information based on European Commission (2021e).
[38] Based on the country notes from the OECD’s Taxing Energy Use 2019 and national sources (WGPF). In Latvia, taxes apply to CO2 emissions in combustion installations that fall below the threshold for inclusion in the EU ETS and are part of the Natural Resources Tax Law (see the country note for Latvia from the OECD’s Taxing Energy Use 2019).
[39] The national carbon pricing scheme introduced in Germany in 2021 covers the transport and buildings sector. The carbon tax rate will rise to €55/tCO2 by 2025 via auctioned allowances. The revenues are earmarked for the German Energy and Climate Fund.
[40] In the Netherlands, the price is expected to rise to €125-150/tCO2 in 2030. See Luxembourg Budgetary Plan 2021 and Netherlands Budgetary Plan 2021.
[41] In the Czech Republic, although there is no explicit carbon tax, several legislative proposals for carbon taxation have been put forward in recent years.
[42] See World Bank Carbon Pricing Dashboard (data as of 1 November 2020).
[43] The implicit tax rate reflects to some extent the production structure of the economy, namely it is more difficult for countries that rely on energy-intensive industries to impose higher energy taxes.
[44] In Latvia, the Natural Resources Tax covers both principles: polluter pays” and is exempted when environmental requirements are met. For example, the tax exempt applies for bio-mass materials, as well as for collected tyres. In 2020, exemptions amounted to EUR 247 million, representing 0.8% of GDP, which was almost seven times the total revenue from the Natural Resources Tax in the government budget. The amount of exemptions is expected to rise in the coming years. This might imply an achievement of climate objectives, although this is not directly reflected in budget revenue.
[45] To foster the effectiveness of the EU ETS, the European Commission put forward in July 2021 the Fit for 55 package” which includes a proposal to extend the EU ETS to more sectors such as road transport, building, and maritime transport. Moreover, to better shield internationally competing industries in the EU, discussion on a carbon border adjustment mechanism are on-going. The European Commission package foresees a gradual annual reduction by 10% of free emissions allowances over a ten-year period.
[46] During the period 2013-2020 (Phase 3 of the EU ETS), the cap for stationary installations was reduced by 1.74% per year. This factor will increase to 2.2% over the period 2021-2030, although under the Fit for 55 package it may increase further to 4.2% annually.
[47] This overview of different climate change policies does not allow for an assessment to be made about their effectiveness. For a more detailed analysis, see, for example, IMF (2019) and the literature cited therein.
[48] The green investment needs mentioned in this section do not include the additional investment required to achieve the REPowerEU plan presented on 18 May 2022. REPowerEU aims to mobilise around €300 billion of funding between 2022 and 2030 (2.1% of 2021 EU GDP) on top of the needed investment to fulfil the Fit for 55 objectives. The largest share of funding will come from unused RRF loans (€225 billion or 75% of the total) (European Commission, 2022c).
[49] These estimates may be lower than actual needs, as they do not include greater adaptation needs in the future (for example to take into account the increased frequency of extreme weather events) or investment needs to increase energy independence from external fossil fuel producers; moreover, the investment needed to achieve wider environmental objectives (€130 billion) is consistent with the previous emissions reduction target of 40% (European Commission, 2020a).
[50] For simplicity, we refer to activities that substantially contribute to environmental objectives as sustainable” or green” activities. See European Commission (2020c).
[51] The EU GBS must be approved by the European Parliament and European Council expected in 2022 and followed by an implementation period prior to entry into force.
[52] For further details on the establishment of the EU GBS, see European Commission (2021c) and European Parliament (2022a).
[53] The flexibility consists of using state auditors or other public entities instead of registered external reviewers to review the allocation report, as is common practice among the EU Member States already issuing green bonds. There is also an exemption from having to demonstrate project-level EU taxonomy alignment for certain public expenditure programmes. See European Commission (2021c).
[54] The Green Bond Principles (GBPs) dominate the market in part due to their less strict requirements than the Climate Bonds Standard (CBS). On the one hand, the GBPs define a clear process for project selection and fund allocation, but they do not provide a clear definition of green economic activities and only recommend a third-party external review. On the other hand, the CBS, in addition to the requirements of the GBPs, includes a taxonomy that defines green economic activities and requires green bonds to be certified by approved external reviewers. The latter has more in common with the EU GBS. For more information, see European Parliament (2022b).
[55] For the NGEU green bond issuance, the European Commission adopted the existing ICMA green bond framework instead of its EU GBS based on the EU taxonomy since the EU GBS regulation is still under negotiation and is, therefore, not yet applicable. Nevertheless, it has been aligned, to the extent feasible, with the proposed EU GBS.
[56] The 11 EU countries that issued sovereign green bonds at some point between 2016 and 2021 are PL, FR, BE, IE, LT, NL, DE, HU, SE, ES, IT, and LV.
[57] See OECD (2018) and OECD (2019) for detailed discussions on the carbon pricing gap and the benchmark. The OECD also replicated the exercise with a less strict benchmark of €30/tCO2.
[58] A carbon price is an important component of the EU’s strategy against climate change. Other instruments are fines on pollution or subsidies for not polluting.
[59] In the various scenarios proposed by the European Commission (2020d), which differ in the importance of the policy instruments(including regulatory policies), the required carbon price varies between €32/tCO2 and €65/tCO2.
[60] For developing countries, empirical evidence shows a tendency towards proportional or progressive effects (Wang et al., 2016), possibly explained by the lack of affordability of energy for poor households.
[61] For transport policies such as fuel and car taxes Pyddoke et al. (2021) find that welfare losses in Sweden are larger the lower households’ income; Bureau (2011) concludes that carbon taxes on car fuels in France are regressive before revenue recycling.
[62] Andersson and Atkinson (2020) find that the Swedish carbon tax on transport fuel is regressive when measured against annual income but progressive when measured against lifetime income.
[63] Caprioli, F. and Caracciolo, G. (2022), The distributional effects of carbon taxation in Italy”, mimeo.
[64] The carbon taxation scheme does not generate enough revenue to make every quintile better off, so that we focus on schemes which remain feasible for the government without increasing public debt. In the absence of this constraint, the redistribution would favour the first two quintiles even more.
[65] Aggregate EU14 plus the United Kingdom includes: Belgium, Denmark, Germany, Ireland, Greece, Spain, France, Italy, Luxembourg, Netherlands, Austria, Portugal, Finland, Sweden and the United Kingdom. Carbon leakage rate is defined as the proportion of the decrease in country emissions due to a climate tax that is offset by an increase in emissions in the rest of the world.
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