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Global Tax Program

Environmental Tax

  • Climate change threatens to erode decades of development progress. As a response, 196 countries adopted the Paris Agreement to transition to “net-zero” global emissions by mid-century and, thereby, limit global warming to well below 2 degrees Celsius compared to pre-industrial levels. This full decarbonization requires an unprecedented economic transformation. To induce this transformation while safeguarding economic development, most economists point to tax reforms as a key policy instrument:

    • Environmental taxation can contribute to multiple Sustainable Developing Goals (SDGs). Environmental tax reforms can have multiple co-benefits beyond climate (Heine and Black 2019). For example, the reduction in fossil fuel consumption induced by excise taxes on fuels or carbon reduces local air pollution, contributing to SDG3 (Good Health and Well-Being and SDG15 on Life and Land). Similarly, there is evidence of the effectiveness of gasoline taxes in controlling the growth of motor transport, reducing road congestion and road accidents; thus, supporting SDG11 (Sustainable Cities and Communities). There is increasing evidence, too, that environmental taxes can raise revenue at lower costs to the economy than some conventional taxes. For example, using taxes on carbon and fuel instead of payroll taxes can reduce the shadow economy and support formal employment, influencing SDG8 (Decent work and Economic Growth).
    • Environmental taxes improve the efficiency of domestic resource mobilization. Countries pioneering these reforms have found that environmental taxes can generate substantial revenues, even in the medium term. They can do so while increasing economic efficiency: they incorporate social costs into product prices, using the power of the private market for reducing these problems. There is also rising evidence that environmental taxes contract output and employment less than conventional ones – especially in developing countries (Schroder 2022; Burns et al 2021, Timilsina et al 2021). Another factor is the interplay with expenditure policy. In many countries, rising environmental problems exacerbate the need for additional government expenditures. Spending on environmental clean-up is important but over-relying on public expenditures in addressing social costs can worsen already strained fiscal space and put further pressure on raising conventional taxes. This is where environmental taxes help mobilize private-sector solutions.  Environmental taxes, thus, create a triple win for fiscal policy: the revenue generated, the efficiency improvements to the tax system, and the reduction in the need for raising conventional taxes to finance public expenditures for addressing the same social costs.
    • Environmental taxes can help developing countries cost-effectively achieve low-carbon transformation while supporting an inclusive and equitable growth pathway. Particularly in lower-income countries, environmental fiscal reforms can be pro-poor and improve equality (SDG1 & SDG 10). Firstly, this is because richer, urban households tend to have more energy-intensive lifestyles (Dorband et al 2019) and, secondly, because the structural change induced by environmental taxes can increase the labor intensity of production (Wiebe and Malerba 2021, ILO and IDB 2020) raising the relative return to labor (Goulder et al 2019, Timilsina et al 2021). If revenues are used to improve access to core infrastructure, this progressivity can be further strengthened, particularly benefitting poor, rural households (Dorband et al 2022).

    However, large gaps in environmental taxation persist globally. While 23% of global greenhouse gas (GHG) emissions are now covered by 68 explicit carbon pricing instruments, most carbon prices remain inefficiently low (World Bank 2022). 60% of carbon emissions from energy use in 44 OECD and G20 countries are neither covered by fuel taxes nor by carbon pricing instruments. (OECD, 2021).  However, not only do direct carbon prices remain below their desired range to internalize the social costs of carbon but also global fossil fuel subsidies continue to place a negative indirect price on carbon emissions (WB, 2022) and are far from decreasing. According to joint OECD-IEA estimates, support for fossil fuels in 51 countries worldwide almost doubled to 697.2 USD billion in 2021 from 362.4 USD billion in 2020 (OECD and IEA 2022).

  • The Global Tax Program’s Environmental Tax Workstream provides critical insights to countries considering tax reforms that enhance growth and steer their economies onto a green, resilient, and inclusive development path. Through this workstream, GTP fosters substantive collaboration and coordination with internal and external partners on environmental taxation, climate change mitigation, and sustainable development. The workstream supports the development of tools, knowledge activities and country engagements on environmental taxation so that developing countries are enabled to design evidence-based green tax reforms and make informed fiscal decisions concerning environmental tax reforms. Some of the main tools developed within the GTP are as follows:

    • Climate Policy Assessment Tool (CPAT):

    The Climate Policy Assessment Tool (CPAT) is jointly developed by the World Bank Group (WBG) and the International Monetary Fund (IMF). CPAT enables countries to design evidence-based green tax reforms and take informed fiscal decisions.

    CPAT allows the rapid estimation of macro-level impacts of carbon pricing and fossil fuel subsidy reforms. This includes 1) effects on GDP and revenues; 2) energy consumption and greenhouse gas emissions; 3) local pollutants (particulate matter, nitrogen oxides, sulfur dioxide, non-methane volatile organic compounds); 4) equity impacts between income groups and the rural/urban divide, including from revenue uses; and 5) development of climate co-benefits, such as reduction in mortality and morbidity from improved air quality, road safety and road congestion.

    CPAT helps compare a wide range of policies, including carbon taxes, emissions trading systems, coal excise taxes, road fuels taxes, power feebate, electricity excises, electricity emissions tax and renewable subsidies.

    This tool is user-friendly (it can be run by generalist economists without requiring specialized training in modeling or new software), easily shareable (in a moderately-sized Excel spreadsheet), and modular (to be expanded or narrowed to include specific focus areas).

    Figure 1. CPAT Interface: Example

    interface screenshot from the CPAT tool

    All these features reduce the barriers for policymakers to design and compare green fiscal reforms, helping them achieve their climate mitigation goals and development objectives jointly.

    • Multi-Regional Input Output (MRIO) Tool: Sectoral employment, skills & just transitions

    The MRIO model with price-endogenous technology simulates sectoral employment effects of comprehensive environmental tax reforms to help understand how specific tax, spending and investment policy packages induce structural changes in sectoral output and employment. The tool allows decision-makers to explore various policy scenarios, such as which industries can be viable and grow in a low-carbon future, how many jobs can be created and lost, and which types of occupations and skill sets will be needed as their economies transition.

    While the MRIO is a standalone tool, it directly adds to CPAT by informing broader distributional outcomes. Many country projects employ the tools together. For example, using the MRIO, CPAT can include equity impacts of shifting tax burdens between fuel and income taxes.

    Well-planned targeted social and labor market interventions can facilitate and ease the reallocations between occupations or regions and reduce frictional costs. In aggregate, carbon tax reforms can have net-positive employment multipliers (Schroder 2022). But the underlying sectoral heterogeneities can be large and will depend on policy design. While net job creation inherently benefits those lower-income groups that were more likely to lose their jobs during the Coronavirus pandemic, sectoral reallocation will entail various distributional and equity effects, across income groups, skill levels and occupations and spatially, between provinces and countries, necessitating policymakers to preemptively step in. The MRIO tool helps facilitate and inform such accompanying social and industrial policies.

     

    Examples of country engagements:

    • The CPAT tool and related diagnostics have been deployed at the WBG to inform country engagements regarding the macroeconomic, health and distributional effects of climate fiscal policies. CPAT has been piloted in more than 40 country engagements, in the Americas, Asia, Africa and Europe. The demand for this tool from other countries is growing.
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               Presentations: Miria Pigato | Dirk Heine Lorenzo Forni | Goran Dominioni | Ekaterina Vostroknutova

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