Speech

Fiscal Policy Instruments and Climate Change, Presentation by Takatoshi Kato, Deputy Managing Director of the International Monetary Fund at Finance Ministers Meeting in Bali, Indonesia

December 11, 2007

Thank you for the invitation to attend and contribute to this important event. We at the IMF very much welcome this, and indeed future, efforts to promote dialogue among Ministers of Finance: their active participation and cooperation is essential to deliver efficient and equitable responses to climate change.

Fiscal instruments, affecting both revenue and expenditure, have a central—indeed indispensable—role to play in both mitigating against, and adapting to, climate change. They cannot provide a complete solution: but taxes and public spending are key to getting the incentives right for households and firms, as well as ensuring a fair distribution of the associated costs and benefits. Let me elaborate on some of the options and choices available.

Emissions of greenhouse gases impose external costs on the global economy and on future generations—arising from long-term climate degradation and changes in the severity, and possibly frequency, of extreme weather events. The extent of these costs, and those arising from any policy response, remain uncertain. But climate changes poses significant macroeconomic challenges for many countries, including many of the most vulnerable. Efficient fiscal policies can help minimize its negative effects.

In relation to mitigation—by which I mean reducing the extent of climate change by lowering greenhouse gas emissions—I would like to stress two points. First, it is essential that effective carbon-pricing policies are implemented, so as to create incentives to reduce greenhouse gas emissions. Here there are a range of policy options available, including carbon taxes, on the one hand, and systems of tradable permits—which give firms the right to emit, up to some fixed amount—on the other. I need not dwell here on the many technical issues that arise in choosing instruments to control emissions—the macroeconomic and fiscal aspects are currently the subject of work at the Fund. What is key is that while there are important differences between them, both methods go to the core of the issue: they can provide strong and credible incentives to reduce emissions and develop alternative technologies.

Second, we need to be sensitive to the distributional impact of carbon-pricing measures—both across and within countries, as well as between generations. However, we must do so in ways that do not undermine the goal of mitigating climate change efficiently. The fact is that in order to reduce emissions the prices of carbon intensive energy sources have to rise, so that we can begin to substitute away from them. Thus it is important, for example, to eliminate subsidies for fossil fuel use, where possible, in favor of measures that more closely target those least able to cope with higher energy prices. Proper energy pricing has long been a concern at the Fund, and climate change lends additional urgency to this focus.

In relation to adaptation, by which I mean actions to reduce the adverse impact of climate change, I would also like to make two points. First, public spending has an important role to play in encouraging households and firms to increase their own resilience, for example through public expenditure on providing the information necessary to make appropriate economic decisions. In addition, it can help reduce countries' risk exposure directly, for example by providing public goods and services, such as infrastructure, coastal protection, education, health and water services, which are themselves more resilient to the impacts of climate change. Importantly, efficient spending on such items may require cooperation at local, regional or global levels.

Second, we should recognize that much adaptation can be achieved in the context of pursuing wider development objectives—for example, improved health and education services. Nevertheless, in some circumstances, adapting to climate change and damages from extreme weather events is likely to impose significant additional costs, not least in the most exposed countries within the developing world. There is a clear need for more investment to promote resilience. Thus we welcome efforts to respond to this challenge in an efficient and equitable way, including through the proposed U.N. adaptation fund.

The range of—and potential for—fiscal measures to respond to the challenge of climate change is wide. And the issues relating to their design and implementation are complex: as are their macroeconomic implications. We at the Fund are currently looking at this, and will be publishing results in our Spring 2008 World Economic Outlook. More generally, we stand ready to cooperate with other international institutions in further studying the macro economic and fiscal implications of—and appropriate responses to—climate change.

Thank you for your kind attention.