By Mauro Pisu (OECD), James Roaf (IMF), Florence Jaumotte (IMF), Ian Parry (IMF), Andrew Prag (OECD), Kurt Van Dender (OECD)

In the historic 2015 Paris Agreement, virtually the entire world signed up to the goal of limiting global temperature increases to 1.5-2C above preindustrial levels. Since then, more than 130 countries have set ambitious greenhouse gas emission (GHG) reduction targets to reach net zero GHG emissions by around mid-century.

However, this is where the similarities end, as the detailed targets and policies countries have so far implemented, or plan to implement, to meet those targets differ greatly.

One thing is clear: at the aggregate level, countries’ near-term ambition and policies are insufficient to bring global GHG emissions on track to meet the Paris temperature goals or to reach net zero emissions by mid-century. Without major policy changes, we may be heading for warming of 3C or more. This would be catastrophic, especially for the poorest and most vulnerable. To avoid the Paris temperature goals slipping permanently out of reach, GHG emissions would have to decline by 25-50 percent below recent levels by 2030, requiring a significant acceleration in emission reductions and drastic policy changes.

The current energy crisis adds to these challenges as it has exposed links and short-term trade-offs between safeguarding energy security and climate goals. The search for alternative sources of energy to oil and gas from Russia has shifted relative prices and, in some countries, increased the use of more polluting fossil fuels, such as coal, at least temporarily. At the same time, the crisis could become a major accelerator of the clean energy transition over the longer-term. For that to happen, international cooperation remains critical to ensure energy security and overcome policymakers’ concerns that other countries may not do their fair share in cutting emissions and relatedly that their industries might lose competitiveness. Aligning energy security with climate goals requires stronger international co-operation underpinned by a shared understanding of the impact of the diverse mitigation policy approaches countries are pursing.

To curtail emissions, countries might use carbon pricing – either via carbon taxes or emissions trading schemes – or other price-based incentives like tradeable emissions standards, feebates and feed-in tariffs for renewable electricity. Or they might use non-pricing instruments such as regulations and green investment and technology subsidies. In fact, countries typically use a combination of these measures, according to their individual circumstances. Identifying the individual and combined effects of the many measures composing countries’ mitigation policy mixes is challenging.

In a new report, the IMF and OECD have joined forces to support the German G7 Presidency on these issues. The report focuses on three key areas to improve the comparison of the impacts of different mitigation policy approaches on emissions and the broader economy:

• Stocktaking of mitigation policies. Identifying and documenting countries’ diverse policy approaches requires systematically collecting information on a larger set of mitigation policies in more countries and sectors, and at a more granular level, than is currently possible. Such information, covering price-based and non-price-based policies, will provide much additional information for policy makers and will be key to estimating the emission reduction effects of policies in a consistent way across countries and sectors. Such a stocktaking can build on and go beyond the inputs from already available stocktakes such as OECD’s Effective Carbon Rates, Taxing Energy Use, International Programme for Action on Climate (IPAC), and Environmental Policy Stringency index (Figure 1). A new stocktake can provide more detailed information on the emission coverage and enlarging the set of mitigation policies being covered.

Figure 1. OECD Environmental Policy Stringency and stocktaking of climate change policies

  A. The 2021 Environmental Policy Stringency Index

 

B. EPS sub-indicators across countries, 2020

• Agreeing on and implementing a clear methodology for estimating the impact of policies on emissions. This would strengthen countries’ capacity to monitor progress towards climate change targets and improve the comparability of reporting such progress. Figure 2 shows a stylized example for such policy comparisons, applied to G20 economies. Different policy combinations currently planned for 2030 are mapped onto a common base of emissions reductions. These policies can then be compared to a common metric (such as the “carbon price equivalent”, which is the carbon price that would achieve the same overall mitigation effect as a package of other policies). As shown in the chart, countries differ strongly both in the mix of policies and in their overall effectiveness, with most countries’ stated policies still falling short of their Nationally Determined Contributions, let alone their longer-term net-zero targets.

Figure 2. Estimated economywide CO2 reductions

• Assessing the broader economic effects of different climate policies, including cross-country spillovers. Understanding these effects would help to design policy approaches that allay concerns about competitiveness, carbon leakage, and burden sharing of global mitigation efforts. Figure 3 shows for example that different climate policies by the G7 countries, in the electricity sector (on the left) or in both the electricity and energy intensive and trade exposed sectors (on the right), are associated with different impacts on their international trade shares (i.e. they have different competitiveness effects). In the electricity sector, different policies have relatively similar effects, except feed-in subsidies that would reduce emissions while avoiding losses in trade shares. Feed-in subsidies policy, however, would cause comparatively higher GDP costs because of the need to finance the subsidy by raising taxes. In the energy intensive and trade exposed industries, policy makes a major difference: regulation affords firms less flexibility than a carbon price and model simulations suggest this results in a significant negative effect on trade shares of hard-to-decarbonize industries, contrary to carbon pricing.

Figure 3. Effect of pricing and non-pricing climate policies on the international trade share of energy intensive and trade exposed industries in G7 countries

Percentage point deviation from baseline in 2030

The methodologies discussed in this new paper are still work-in-progress but they provide a sound framework for comparing mitigation efforts and a roadmap to advance work supporting international policy co-operation initiatives. These could include: the Climate Club established by Germany’s G7 Presidency; the International Carbon Price Floor proposal put forward by IMF staff; the OECD’s Inclusive Forum on Carbon Mitigation Approaches (which will undertake stocktaking, mapping and estimating the effectiveness of mitigation policies); the UNFCCC’s Enhanced Transparency Framework; carbon border adjustment mechanisms and other mitigation initiatives discussed in international fora.

By Filippo Maria D’Arcangelo, Mauro Pisu (OECD Economics Department), and Anasuya Raj, Kurt Van Dender (OECD Centre for Tax Policy and Administration)

Limiting global warming and avoiding its potentially catastrophic damages hinges on reaching net-zero emissions by mid-century (IPCC, 2022). Achieving this ambitious global target requires a wide range of mitigation policies to overcome market failures, path dependencies and coordination problems (D’Arcangelo et al., 2022).

Carbon pricing can play an important role in a well-coordinated mitigation policy mix for two main reasons. First, in many instances, carbon pricing can induce lower emissions at lower economic costs than alternative mitigation policies. Second, it can generate additional government revenues, at least until emissions start falling appreciably.

Available evidence on the responsiveness of CO2 emissions and government revenues to carbon pricing is fragmented and difficult to compare across countries and sectors. Thus, tracking and comparing countries’ progress towards emission reduction targets and assessing the contribution of carbon pricing to emission reductions is challenging. We tackle this challenge in our recent paper, Estimating the CO2 emission and revenue effects of carbon pricing: new evidence from a cross-country dataset.

The paper provides fresh evidence on the long-run responsiveness of CO2 emissions and government revenues to carbon pricing within a unified framework across countries, sectors and fuels. The analysis relies on the OECD Effective Carbon Rates (ECR) database, containing comprehensive and detailed information on instruments pricing carbon emissions from energy use in 44 OECD and G20 countries. The ECR database contains data on carbon taxes, permit prices resulting from emissions trading systems, and fuel excise taxes and covers about 80% of global CO2 emissions from energy use.

Broad-based carbon pricing is an effective measure to reduce emissions in most sectors and will accelerate coal phase-out

Baseline estimates suggest that a EUR 10 per tonne of CO2 increase in carbon prices decreases CO2 emissions from fossil fuels by 3.7% on average in the long term. Policy simulations indicate that introducing a EUR 60 per tonne of CO2 global carbon price floor (about three times the 2018 average effective carbon rate) would lower total CO2 emissions from fossil fuels by about 17% compared to 2018 levels, after firms and people have fully adjusted to the increase in ECRs. This is a sizeable reduction in emissions but far from what is required to reach net-zero.

Estimates of the responsiveness of CO2 emissions to carbon pricing vary across sectors and fuels. For example, emissions in the buildings sector are about three times less responsive to carbon pricing than those in the agriculture and fisheries sector. Increasing carbon prices can be expected to have the largest effects on emissions from the Electricity and Industry sectors (Figure 1) due to a confluence of factors: the low carbon prices these sectors still face in most countries; their high emission responsiveness compared to other sectors; and their large share in total emissions. A high price floor in the Road transport sector, where effective carbon rates are already elevated due to excise taxes, would also contribute substantially to reducing emissions.

Emissions from coal are more responsive to carbon pricing than those from all other types of fossil fuels. Even mild, broad-based carbon prices would contribute significantly to coal phase-out, given its high responsiveness to carbon pricing: a floor of EUR 60 per tonne of CO2 can be expected to reduce global emissions from coal by half.

Figure 1: Effect of different ECR floors on emissions by sector

Broadening carbon pricing to unpriced emissions has large effects on emissions and revenues in some countries

Moderate increases in carbon pricing would initially translate into large government revenue increases, as carbon prices are still generally low. Globally, carbon-related revenues could triple, relative to 2018 levels, with a EUR 60 global carbon price floor. Over time, if carbon price floors keep on increasing, these carbon-related revenues would dwindle in tandem with the reduction of emissions.

The broadened coverage of carbon pricing to currently unpriced emissions would contribute to around two thirds of the total estimated effects on emissions and revenues. Emission-intensive countries that do not yet price a large share of their emissions would observe a larger reduction in emissions and greatly contribute to the increase in fiscal revenues.

Figure 2: Impacts of a EUR 60 ECR floor on carbon-related revenues

Easing the substitution of clean energy sources for fossil fuels requires policies complementary to carbon pricing

The estimated responsiveness of emissions to carbon pricing suggests that even large carbon prices (about EUR 1000 per tonne by late 2030s) will not suffice to meet net-zero emission targets.

Complementing steady but moderate increases in ECRs with policies that markedly increase the emission responsiveness to carbon pricing is crucial to put emissions on a downward path towards net-zero targets. In this respect, innovation and reallocation-friendly policies have a major role to play, as they can ease the substitution of clean energy sources for fossil fuels, thus reducing emission abatement costs and making carbon price more effective. For instance, policy simulations show that an emission responsiveness twice as large as the baseline estimate, combined with an ECR floor of EUR 40 on priced and unpriced emissions, would result in the same emission reduction as the baseline responsiveness estimates combined with an ECR floor of EUR 175 on priced emissions and EUR 60 on unpriced emissions.

References

D’Arcangelo, F.M., Ilai Levin, Alessia Pagani, Mauro Pisu, and Åsa Johansson (2022), “A framework to decarbonise the economy”, OECD Economic Policy Papers, No. 31, OECD Publishing, Paris, https://doi.org/10.1787/4e4d973d-en.

IPCC, 2022: Climate Change 2022: Mitigation of Climate Change. Contribution of Working Group III to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change. Cambridge University Press, Cambridge, UK and New York, NY, USA. doi: 10.1017/9781009157926.