IMF Policy Advice

The IMF and Environmental Policy

December 2, 2013

While economic development is critical for lifting people out of poverty and raising living standards for the broader population, it also causes harmful side effects—particularly for the environment—with potentially sizeable costs for the macro-economy.

For example, rising atmospheric accumulations of greenhouse gases could substantially raise global temperatures, posing considerable risks. Poor air quality is a major human health problem. And road congestion can impose substantial burdens on urban economies, by reducing the productive time of the workforce.

Fiscal instruments (emissions taxes, trading systems with allowance auctions, fuel taxes, charges for scarce road space and water resources, etc.) can and should play a central role in promoting greener growth. These instruments are:

• effective at reducing environmental harm—so long as they are carefully targeted at the source of the problem (e.g., emissions);
  
  
• cost-effective (i.e., they impose the smallest burden on the economy for a given environmental improvement)—so long as the fiscal dividend from these policies is exploited (e.g., revenues are used to strengthen fiscal positions or reduce other taxes that discourage work effort and investment);
  
  
• strike the right balance between environmental benefits and economic costs—so long as they are set to reflect environmental damages.

And there is plenty of scope for fiscal reform. Many countries subsidize the production and consumption of fossil fuels (rather than charging to discourage their use). And even when energy is heavily taxed, these taxes may not be very effective from an environmental perspective (e.g., taxes may be imposed on electricity use or vehicle sales rather than emissions or traffic congestion).

The Fund promotes the use of fiscal reform to address environmental problems through:

• analytical work—for example, staff recently published a collected volume of papers on designing fiscal policy to mitigate greenhouse gases; the IMF assesses the magnitude of energy subsidies; and staff are currently measuring environmental damages to provide guidance on appropriate levels of energy taxes in different countries.
  
  
• technical assistance—to member countries interested in environmental tax reform.
  
  
• outreach activities—including regular presentations by staff at conferences (e.g., UN climate meetings) and events the IMF cosponsors with other international organizations and research institutes (see for example Fiscal Policies and the Green Economy and Economics of Carbon Taxes).

Analytical Work

The IMF's work includes research on 'getting the prices right' (to reflect environmental side effects in energy prices) and providing the right incentives to help countries address climate change and other environmental challenges. Fiscal instruments, either environmental taxes or systems of pollution rights sold by the government, are the most effective instruments for exploiting near and longer-term options for reducing emissions (e.g., investments in renewables and energy efficiency) while at the same time providing a potentially valuable source of government revenue.

The IMF recently published a handbook for policymakers, Fiscal Policy to Mitigate Climate Change, with many practical suggestions for designing and implementing fiscal instruments to reduce greenhouse gas emissions.

A paper prepared for the IMF Board Energy Subsidy Reform: Lessons and Implications measures both direct subsidies for energy, and indirect subsidies from the failure to charge for environmental side effects, and provides practical guidance for implementing subsidy reform.

In work for the G20 in collaboration with the World Bank and others, IMF staff evaluated a range of alternative fiscal instruments as a source of revenue for climate finance, including carbon taxes and other domestic instruments, and charges on international aviation and maritime fuels.

Related work at the IMF covers, for instance, the macroeconomic, fiscal, and financial implications of climate mitigation and adaptation policies; the appropriate design of fuel and other environmental taxes; the measurement of energy subsidies and protection of the poor when they are scaled down; border tax adjustments; and the taxation of resource industries. See, for example:

• Environmental Tax Reform: Principles from Theory and Practice to Date by Dirk Heine, John Norregaard, and Ian W.H. Parry
• Going Green, F&D article by Luc Eyraud and Benedict Clements
• IMF Work on Fiscal Policy and Climate Change
• International Fuel Tax Assessment: An Application to Chile by Ian W.H. Parry and Jon Strand
• Reforming the Tax System to Promote Environmental Objectives: An Application to Mauritius by Ian W.H. Parry
• The Fiscal Implications of Climate Change by the Fiscal Affairs Department, IMF, March 2008
• Petroleum Product Subsidies: Costly, Inequitable, and Rising

• IMF Calls for Global Reform of Energy Subsidies: Sees Major Gains for Economic Growth and the Environment
• Back to Rio—the Road to a Sustainable Economic Future
• IMF Staff Outlines Climate Change Financing Idea
• Factsheet: Climate, Environment and the IMF
• Lagarde on the economic case for climate action