Press Release No. 19/136

IMF Executive Board Reviews Fiscal Policies for Paris Climate Strategies

May 3, 2019

On March 18, 2019, the Executive Board of the International Monetary Fund (IMF) discussed a paper providing country-level guidance on the role, and design of, fiscal policies for implementing climate mitigation strategies that countries have submitted for the 2015 Paris Agreement and for addressing vulnerabilities in disaster-prone countries.

On the mitigation side, the paper presents a spreadsheet tool for judging the likely impact on emissions, fiscal revenues, local air pollution mortality, and economic welfare impacts of a range of instruments including comprehensive carbon taxes, emissions trading systems, taxes on individual fuels, and incentives for energy efficiency. It analyses possible uses of the revenue from such instruments to, for example, lower the burden on the economy from taxes on labor and capital, or to fund investments for Sustainable Development Goals, as well as the possible distributional impact. The paper also discusses the cases for voluntary carbon price floor arrangements at the regional level, or among large-emitting countries, to reinforce domestic initiatives and help address concerns about competitiveness without resorting to trade penalties on other countries.

The paper stresses that mitigation instruments other than carbon taxes can have an important role if, for example, higher fuel prices are politically difficult or have limited impacts in countries that do not consume coal. One such approach is the use of revenue-neutral tax-subsidy schemes to promote cleaner power generation, shifting to cleaner vehicles, and improvements in energy efficiency without an increase in fuel prices.

On the adaptation side, the paper stresses that a holistic strategy, going well beyond physical climate-proofing investment, is needed in vulnerable countries. Ideally, national strategies would encompass a variety of ways to diversify natural disaster and climate risks, such as building up contingency funds or participating in regional insurance schemes. The risk of future damages also needs to be factored into projections of national output and debt sustainability levels.

The paper considers the role that the IMF can play, working with other organizations, in advising on the implications of climate commitments for countries’ fiscal and macro policy given its expertise, universal membership, and frequent interaction with finance ministers. In turn, finance ministries have a central role in integrating carbon charges into fuel taxes, ensuring carbon pricing revenues are productively used, assisting vulnerable groups, and including climate investments in national budgets.

Executive Board Assessment ^[1]

Executive Directors welcomed the opportunity to consider the fiscal policy implications of implementing the Paris Agreement and how the Fund might help its members meet their mitigation commitments and support those vulnerable to climate risks. They agreed that the Fund has an important role to play in advising its members on fiscal policies to address climate change and its impacts.

Directors welcomed the tool presented in the paper for analyzing policy options for implementing mitigation commitments. They saw it as helpful in assessing, on a country‑by‑country basis, the effectiveness of alternative policies in reducing emissions, as well as their fiscal and economic impacts.

Directors broadly recognized the potential of carbon pricing in effectively reducing emissions and mobilizing revenue resources. Directors noted, however, that other fiscal instruments or regulatory measures could also have an important, and sometimes preferable, role to play, depending on country circumstances and preferences. They agreed that countries’ policy choices would need to take into account various aspects, including efficiency, distributional, and political economy considerations. In this context, some Directors observed that member countries should have discretion to decide and implement policy options as they see appropriate. Directors considered that further analysis of the full range of mitigation instruments would be important to better inform the debate. They also noted that research and development (R&D) and investment in new energy and efficient technologies could play an important role in mitigation efforts, while measures would be needed to relieve vulnerable groups. Regarding carbon price floors, many Directors thought that such arrangements among willing countries could reinforce the Paris process, but some other Directors did not see merit or feasibility in this approach.

Directors emphasized the importance of a holistic approach to promoting resilience in countries vulnerable to natural disasters and climate risks in collaboration with the World Bank and other relevant international organizations. They underscored the need to incorporate ex‑ante resilience‑building in macro‑fiscal and financial frameworks, including through fiscal buffers and climate finance. Directors also encouraged the Fund to work with donors and multilateral development banks in exploring affordable financing options for adaptation investments, especially for low‑income developing countries. Continued Fund advice on cost‑effective adaptation policies and capacity building support in these countries, particularly small states, would be important to help address policy gaps and unlock financing from all possible sources.

Directors recognized that the national mitigation commitments and resilience challenges could have macro‑critical implications, and that the Fund is well‑positioned to support countries in analyzing the fiscal and financial impacts of their policy choices. In this context, many Directors supported the inclusion of the economic implications of countries’ mitigation policies in Fund surveillance. A number of other Directors, however, stressed that the Fund should avoid standardizing such analysis and discussions, and allow individual member countries to decide on the mode of engagement with the Fund in light of their specific circumstances.

Many Directors agreed that staff could periodically update the analysis of the impacts of alternative mitigation policies using the tool staff had developed for cross‑country analysis . A number of Directors, however, cautioned against regular formal update exercises that could go beyond the Fund’s mandate. Directors emphasized the importance of continued close collaboration with other international organizations active in this area, based on each organization’s mandate and comparative advantage, to ensure that the Fund’s work remains complementary to that of others. They also stressed the importance of ensuring close alignment of the different aspects of work undertaken by the Fund in this regard. A number of Directors saw merit in developing a staff guidance note on how to approach climate change in Fund surveillance, focusing in particular on adaptation policies, risk management, and mitigation frameworks.