## ASSESSMENT OF POTENTIAL OUTPUT AND OUTPUT GAP

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---

### Major findings and headline projections
- Potential growth was already slowing before COVID-19; staff estimates the COVID shock will temporarily bring potential growth below 2 percent before a modest recovery to about 2¼ percent in the medium term.
- The estimates yield an output gap of about 2.5-3 percent of GDP in 2020.
- Standard errors across the two approaches encompass a medium-term impact of between 1½ and 5 percent.
- Under a reform scenario (see below), long-run output gains could be about 12 percent when assessed over a 30-year horizon.
- The proposed combined COVID + reforms scenario could return the economy to roughly the pre-COVID path of potential output by 2030.

### Methodologies and baseline pre-COVID estimates
- Two models were used to project pre-COVID potential output:
  - A production function model.
  - A multivariate filter (MVF) that incorporates labor force participation, capacity utilization, and Consensus Forecasts for GDP growth and inflation (as in Alichi, 2015).
- Pre-COVID historical values and forecasts for underlying inputs were used as they existed in January 2020.
- Pre-COVID potential growth decelerated from 7 percent in the mid-1990s to pre-COVID estimates for 2019 of:
  - 2.4 percent (MVF)
  - 2.7 percent (production function)
- Pre-COVID projections: about 2.2–2.4 percent in the 2020’s before declining to about 2 percent per year in the 2030’s (comparable to OECD (2018) and Zoli and others (2018)).

### Labor inputs and demographic drivers
- Total hours worked increased until the late 1990s and have stagnated since; a shrinking population and increase in the share of the elderly would have weighed on growth in the number of workers even absent shocks.
- Hours per worker have been declining; educational attainment has risen substantially, so further large gains are unlikely.
- The models estimate participation propensities for detailed age-gender cohorts that account for education and prior history of participation.

### Heterogeneous and sectoral impacts of COVID-19
- Manufacturing: sharper initial fall due to supply chain disruptions and shutdowns in trading partners; by end-2020 rebounded to exceed its pre-COVID peak.
- Services: milder initial decline but more sluggish recovery; higher reallocation within services than during previous crises.
- A reallocation index (Lilien, 1982) shows overall reallocation during COVID-19 is higher than during the Global Financial Crisis (GFC), surpassed only by the Asian Financial Crisis (AFC).
- The effects have been greatest in relatively low-wage industries, where adaptability to abrupt structural transformation may be lower.
- Potential for scarring: some workers may remain out of the labor force as structural shifts and/or extended periods without employment lead to skills obsolescence.

### Historical recession effects and scaling for COVID-19
- Local projections (Jordà, 2005; Teulings and Zubanov, 2014) estimate previous recessions caused potential output to fall immediately and keep potential growth below pre-recession rates for five-six years before normalizing.
- The medium-term impact in previous recessions primarily reflected lower investment and lower labor force participation; post-recession TFP tended to be resilient.
- Scaling historical recession impacts to the smaller 2020 recession yields an estimated impact on potential output ranging from 2.5 to 3.5 percent:
  - Lower end (2.5 percent) from aggregating impacts across factors of production.
  - Upper end (3.5 percent) from estimating impact using overall output directly.
- The effects on the growth rate of potential output are largest immediately after the shock, with slow normalization driven principally by historically lower investment rates and slower capital accumulation, and secondarily by lower labor force participation.

### Unique transmission channels and mitigating factors
- Factors that may increase scarring:
  - Synchronized global shock (potentially larger impact because potential in other economies is affected).
  - Sudden stop in cash flows for many firms due to early shutdowns.
  - Deeper structural shifts in supply chains and demand across sectors.
  - Large proportion of SME debt in Korea where firms’ cash flows do not cover debt service.
  - Product and labor market rigidities that impede reallocation, especially in services.
- Factors that may mitigate medium-term damage:
  - Large policy response in Korea may buffer the medium-term impact.
  - Korea’s well-developed high-tech industry, strong digital infrastructure, and high rates of digital penetration could produce positive effects via digitalization.
  - Initial data suggest investment has been resilient, supported by strong demand for Korea’s high-tech exports.

### Output gap, inflation, and slack indicators
- Output gap estimated to have widened to about 2.5-3 percent of GDP in 2020.
- This estimate is consistent with:
  - Cumulative projected actual growth in 2019–20 of about 1 percent.
  - Employment and labor force participation below previous trends.
  - Measured capacity utilization in manufacturing below pre-COVID levels.
  - Absence of price pressures reflected in low underlying inflation and below-target inflation expectations.

### Reform scenario and quantified policy implications
- Scenario assumptions for reforms:
  - Raise drivers of productivity to the 75th percentile among OECD countries (based on Kim and Loayza, 2019).
  - Close one third of the male-female labor force participation gap (informed by Dao and others, 2014).
  - Reforms would target: broadening access to advanced education; easing restrictions on hiring and firing of workers on open-ended contracts; improving regulatory quality; strengthening childcare benefits; reducing tax wedges faced by two-earner couples and part-time workers.
- Quantified effects:
  - Possible gains to long-run output about 12 percent over a 30-year horizon.
  - Under a combined COVID + reforms scenario (with prompt implementation), the economy could return to roughly the pre-COVID path of potential output by 2030.
- Timing note: reforms may take several years to be fully implemented and their effects may take several more years to materialize; cumulative impact offsets COVID-19 shock only after several years.

### Policy recommendations and priorities
- Heightened urgency to implement reforms that:
  - Facilitate reallocation of resources toward fast-growing sectors.
  - Increase labor utilization.
- Address long-standing product and labor market restrictions that impede productivity in services and among small firms.
- Reforms highlighted: reduce regulations, increase labor market flexibility, broaden advanced education access, improve regulatory quality, strengthen childcare benefits, and reduce tax wedges for two-earner couples and part-time workers.

*Source: IMF staff assessment, “ASSESSMENT OF POTENTIAL OUTPUT AND OUTPUT GAP,” Republic of Korea report (March 3, 2021).*

---

### Fiscal rules, debt dynamics, and the proposed Korean fiscal framework

### Overview and rationale for fiscal rules
- Incumbent governments may have a bias toward higher present spending, neglecting benefits of prudent fiscal policy for future challenges such as a sudden growth slowdown and population aging.
- Fiscal rules strengthen commitment to prudent fiscal policy; globally, more than 90 countries have adopted some form of fiscal rules (IMF 2018b).

### Elements of a well-designed fiscal rule
- A well-designed fiscal rule usually includes:
  - A debt anchor that establishes medium or long-term fiscal objectives, usually expressed as a debt-to-GDP ratio target.
  - Operational rules (targets or limits on fiscal balances, spending, or revenue) under more direct control of the incumbent government.

### Korea’s Government Fiscal Rule Proposal (October 2020)
- Debt anchor: 60 percent of GDP (gross government debt).
- Operational rule: consolidated deficit ceiling of 3 percent of GDP.
- The debt and deficit targets are “soft” limits governed by formula:
  - [Government debt / 60%] * [Consolidated Fiscal Balance / (-3%)] ≤ 1.                      (1)
- Definitions and baseline numbers:
  - “Government debt” defined as the sum of gross central and local government debt (D1 debt).
  - D1 stood at 37.7 percent of GDP as of end-2019.
  - Consolidated fiscal balance includes social security funds (SSF).
  - Consolidated balance was -0.6 percent of GDP in 2019 and is projected to weaken to -4.4 percent of GDP in 2020.
- Escape clauses and slowdown provision:
  - Escape clauses cover “extraordinary challenges” (e.g., “a war, a large disaster or a global economic crisis”); rule “will not apply for the year, and the ratios are to be recovered gradually over the four years that follow”.
  - Economic slowdown provision: when an economic slowdown requires expanded fiscal spending, the 3 percent consolidated fiscal balance deficit rule will be eased by one percentage point to a four percent deficit.
- Implementation timing:
  - Conditional on parliamentary approval, the proposed rule would take effect from 2025 and is to be reviewed every five years.

### Debt dynamics under the proposed rule
- Consolidated fiscal balance = managed balance + SSF balance.
- Managed balance: difference between non-SSF revenue and expenditure; government has more direct control.
- SSF balance-to-GDP ratio and reserves:
  - In 2019, SSF balance was KRW 42.4 trillion (or 2.2 percent of GDP), mainly reflecting the surplus from the National Pension Fund (NPF).
  - SSF balance-to-GDP ratio expected to gradually decline and turn negative in early 2040s as public pension expenditure increases.
  - SSF reserve assets assumed depleted by around 2057 under status quo.
- How SSF sign affects gross government debt increment:
  - From 2020 to the early 2040s: SSF surplus increases SSF reserve assets; increment in gross government debt equals the size of the managed deficit; when SSF balance is positive, annual increase in gross government debt is larger than the size of the consolidated deficit.
  - From early 2040s to the late-2050s: SSF deficit reduces SSF reserve assets; increment in gross government debt equals size of managed deficit; annual increase in gross government debt is smaller than the size of consolidated deficit.
  - Beyond the late-2050s: SSF reserve assets expected depleted; managed and SSF deficits assumed financed by government debt; increment in gross government debt will equal size of consolidated deficit.

### Projection setup and key assumptions for 2020–2060
- For projections up to 2024, follow the proposed medium-term outlook published in the 2021 budget proposal.
- Government debt expected to rise to about 58 percent of GDP by end-2024.
- Real GDP growth assumptions (MoEF’s 2020–60 medium population growth scenario):
  - 2020s: 2.3 percent per year
  - 2030s: 1.3 percent per year
  - 2040s: 0.8 percent per year
  - 2050s: 0.5 percent per year
- SSF balance assumed to decline from 2.2 percent of GDP in 2019 to around -4.1 percent of GDP in 2060 (status quo, no major pension policy changes).
- Average annual inflation rates assumed to be 1.5 percent.
- For 2025–2060, assume the government will try to maximize its deficits such that equation (1) is always binding, i.e. Debt/60%*Consolidated Deficit/3%=1.

### Projected fiscal path under the proposed rule
- Under the proposed rule and assumptions, government gross debt would peak at around 75 percent of GDP by early 2040s.
- Three-stage projected fiscal path:
  - From 2025 to the early 2040s: Consolidated balance will gradually improve towards -2 percent of GDP; managed balance projected to be around -3.3 percent of GDP during 2025-2040, resulting in a rise in debt-to-GDP ratio over time.
  - From the early 2040s to the late-2050s: Debt-to-GDP ratio projected to decline because SSF balance turns negative and the limit on consolidated deficits implies an increasingly tighter limit on managed deficits.
  - Beyond the late-2050s: SSF reserve assets depleted; debt-to-GDP ratio will rise again because SSF deficits must be financed by government debt (managed balances will be in surplus and offset some SSF deficits).

### Implications for fiscal adjustment
- Managed fiscal balance would increase from an average of -1.5 percent of GDP during 2017-19 to about 1.4 percent of GDP in 2060.
- Adjustment is much larger if compared to the average managed balance of 2020–24 (-5.8 percent of GDP), which is affected by COVID-19 stimulus.
- Example sensitivity: assuming a real interest rate of 0.5 percent annually from 2020–60 implies a consolidation in the primary managed balance by 7.6 percent of GDP by 2060 from the 2020–24 average.

### Staff assessment — Debt anchor and operational target
- IMF’s DSA indicative thresholds: 85 percent of GDP for advanced economies and 60 percent of GDP for emerging economies to signal government debt vulnerability.
- The proposed flexible 60-percent-of-GDP gross debt anchor is considered prudent from a debt sustainability perspective.
- Strict implementation could lead to a peak debt-to-GDP ratio of around 75 percent of GDP in early 2040s — still within “safe” debt thresholds for advanced economies.
- Concerns with the proposed 3% “soft” deficit ceiling:
  - Deficit rules can make fiscal policy procyclical.
  - With annual nominal GDP growth of 3.5~4.5 percent and SSF balances around 1.5 percent of GDP, running a 3 percent consolidated deficit implies a 4.5 percent managed deficit, which stabilizes public debt at a level exceeding the 60 percent anchor.
  - When debt stays above the anchor, equation (1) is more likely to bind, making the “soft” deficit limit effectively “harder” and leaving less space for downturn support.
  - Practical challenge: defining an “economic slowdown” for the slowdown provision and avoiding frequent application.

### Monitoring, escape clauses, and governance
- Independent fiscal councils can monitor fiscal rules; options for Korea include an independent fiscal council or National Assembly Budget Office (NABO).
- Escape clauses should balance flexibility and credibility; eligible circumstances are difficult to define and could include wars, disasters, and global economic crises.
- Recommended review and revision process: revisions to key parameters should be assessed by an independent entity (such as a fiscal council or NABO) and then approved by the parliament.
- Starting implementation in 2025 is broadly appropriate; meeting the proposed rule implies the deficit in 2025 could not exceed 2.9 percent of GDP given a debt-to-GDP ratio of 58.3 percent for 2024 and a deficit-to-GDP ratio of 4 percent for 2024.

### Quantitative literature context
- Quantitative studies emphasize liquidity benefits of government debt for precautionary savings and smoothing taxes/expenditures; costs of higher debt include higher interest rates, crowding out, distortionary taxes, and redistribution favoring richer households.
- Optimal long-term government debt estimates vary widely; many calibrated studies indicate an optimal net debt level that is negative when accounting for multiple costs.
- By a net measure (netting liquid financial assets), Korea’s net government debt position is about -21% of GDP as of 2019 (liquid government assets such as cash, deposit and securities amounted to 59 percent of GDP as of 2019; government debt about 38 percent of GDP).

_Prepared by Si Guo._

---

### An expenditure rule as an alternative to a deficit target

### Expenditure rule design and trade-offs
- Under expenditure rules, revenue fluctuates with the economic cycle, while expenditure growth is subject to a pre-determined ceiling path.
- Fiscal deficit outcomes: deficit is larger in a downturn and smaller in a boom.
- Implementation challenges:
  - Parameters may need updating after major tax policy changes.
  - Expenditure rules can induce lower public investment if governments cut capital spending to comply with ceilings.

### Monitoring and enforcement
- Independent fiscal councils can produce objective assessment reports to raise reputational costs of breaches.
- The government’s proposed rule is based on easily observable targets; monitoring and enforcement are especially important for application of escape clauses and the “slowdown” provision.
- Options for Korea: independent fiscal council or NABO could perform monitoring.

### Escape clauses, transition, and governance
- Escape clauses should be easily observable and demanding to avoid excessive relaxation.
- Application of escape clauses could require confirmation by parliament or approval by an independent fiscal council.
- Transition timing: implementation from 2025 is broadly appropriate; smoother transition if adjustment starts earlier (2023 or 2024) provided recovery is underway.
- Periodic reviews: proposed review every 5 years; recommended that revisions be assessed by an independent entity and approved by parliament.
- Communications: transparent presentation of fiscal pressures from aging and slowing potential growth can build buy-in.

---

### Fiscal policies for reinforcing Korea's climate mitigation strategy

### Strategic objectives and context
- Korea’s climate mitigation objectives:
  - Achieve carbon neutrality by 2050.
  - Reduce greenhouse gas (GHG) emissions 24.4 percent below 2017 levels by 2030.
- Existing measures:
  - Korea’s Emissions Trading System (ETS) covering about three quarters of domestic emissions.
  - Green New Deal (GND) component of the Korean New Deal (KND).
  - Standards for average emission rates of vehicle sales fleets and tax exemptions for EVs and HVs.
  - Renewable portfolio standard (RPS) requiring generators to increase renewable share.

### Recommended national-level reforms for the ETS
- In Phase 4 of the ETS consider:
  - A trajectory of emissions caps fully aligned with meeting the 2030 emissions target.
  - Underpinning the ETS with exogenous and progressively rising price floors and ceilings.
  - Transition to full allowance auctions.
- Expected benefits: better align emissions with long-term carbon neutrality; promote low-carbon investment via robust price signals; improve compatibility with overlapping instruments; raise revenues to fund clean transition and lower taxes on work effort.

### Sectoral instruments: feebates
- Feebates: revenue-neutral sliding scale of fees on products/activities with above-average emission rates and rebates on those with below-average emission rates.
- Advantages:
  - Cost-effectively promote a full range of responses within a sector.
  - Avoid fiscal cost to the government.
  - Avoid significantly higher energy prices.
  - Compatible with existing regulatory standards.
- Variant: feebate to promote carbon storage in the land use sector.

### Korea’s climate ambitions and the Green New Deal (GND)
- GND funding and outcomes:
  - Public funding of KRW 42.7 trillion from 2020 to 2025.
  - Projected to leverage an additional KRW 30.8 trillion in local government and private funding.
  - Projected to create 659,000 jobs.
  - Projects include buildings, tree planting, renewables, green hydrogen, and CCUS.

### Emissions trends and projections
- Global context:
  - Global CO2 and other GHG emissions must be cut 25–50 percent below 2018 levels by 2030 to be on track for 1.5–2oC warming scenarios.
  - Pandemic-induced crisis: global emissions in 2020 projected to fall about 8 percent below 2019 levels.
- Korea-specific:
  - Fossil fuel CO2 emissions projected to increase 5 percent between 2018 and 2030 with currently planned mitigation efforts.
  - Korea’s CO2 emissions increased by 161 percent between 1990 and 2018.
  - GDP projected to increase another 25 percent between 2018 and 2030; energy intensity of GDP expected to fall 19 percent.
  - Without new or strengthened mitigation policies, Korea is projected to be the 7th largest global emitter of CO2 in 2030, and the fourth largest emitter in per capita terms.

### Emissions breakdown and sectoral shares (selected figures)
- Korea’s 2016 GHGs total: 694 million tons.
  - Fossil fuels: 87 percent; Industrial processes: 7 percent; Agriculture: 3 percent; Waste: 2 percent; Fugitive emissions: 1 percent.
- By sector (fossil fuel CO2, 2018): Power generation 55 percent; Industry & Construction 19 percent; Transport 17 percent; Buildings (direct) 9 percent (indirect emissions from electricity use in buildings are 2.5 times the direct emissions).
- By fuel type (fossil fuel CO2, 2018): Coal 48 percent; Oil 33 percent; Natural gas 19 percent.
- Power generation fuel shares, 2018: Coal 38.1 percent; Natural Gas 24.1 percent; Oil 2.5 percent; Nuclear 31.1 percent; Hydro 0.6 percent; Other Renewable 2.7 percent; Biomass 0.9 percent.

### Korea’s ETS design and current operation
- ETS launched in 2015; Phase 3 (2021–2025) applies to 685 companies covering 73 percent of national GHGs (up from 70 percent in Phase 2).
- Phase II cumulative cap: 1,796 MtCO2e (average 599 MtCO2e a year).
- Phase 3 annual average emissions cap reduced 4.7 percent relative to 2017–2019 ETS emissions.
- Allowances largely given away for free (based on 2011–2013 emissions); 10 percent will be auctioned in Phase 3.
- EITE industries will continue to receive 100 percent free allowance allocations.
- Banking, borrowing, and market stability provisions exist; auctions subject to a minimum price based on recent emissions prices.

### Trade and international coordination issues
- Border carbon adjustment (BCA):
  - EU plans to introduce a BCA in 2023; Canada, the UK, and the United States are considering BCAs.
  - BCAs help alleviate adverse impacts on industrial competitiveness and reduce risk of emissions leakage.
  - Korea should consider whether a BCA for EITE industries might be appropriate in future, possibly after early experiences with an EU BCA.
- International carbon price floor (ICPF):
  - An ICPF among large emitters could increase effective carbon prices simultaneously and help address competitiveness and free rider concerns.
  - Korea might contribute to dialogue on an ICPF and other complementary mechanisms.

### Sectoral instruments, price signals, and revenue use
- Feebates for passenger vehicles, electric utilities, industry, buildings, and forestry described with formulas tying fees/rebates to CO2 emission rates and activity measures.
- Illustrative feebate examples:
  - Passenger vehicles: a feebate with a price of $400 per ton CO2 would apply a rebate of $4,000 for EVs and HVs and a fee of $4,000 for a vehicle with CO2 emission rate of 200 g CO2/km.
  - Electric utilities: a feebate with a price of $50 per ton would currently apply a subsidy of 3.5 cents per kWh for zero-carbon electricity, a fee of 1.4 cents per kWh for coal plants, and a subsidy of 1.5 cents per kWh for natural gas generation.
- Revenue and distributional implications:
  - Full allowance auctions in 2019 would have raised about 0.5 percent of GDP.
  - A carbon price of $50 applied to all fossil fuel CO2 in Korea would raise revenues of 1.4 percent of GDP in 2030 with full allowance auctions.
  - Free allowance allocations reduce potential government revenue and can create windfall profits concentrated in higher income groups.

### Price levels, acceptability, and trade-offs
- To meet Korea’s NDC pledge exclusively through carbon pricing would require raising the 2030 CO2 price by more than KRW 83,333 ($75) per ton on all fossil fuel CO2 emissions from the current level ($18 per ton).
- Illustrative impacts of a $50 per ton carbon price in 2030:
  - Coal +156 percent; Natural gas +33 percent; Retail electricity +36 percent; Gasoline +4 percent.
- Policy trade-offs:
  - Higher electricity prices may conflict with electrification strategies.
  - High carbon prices may be politically difficult without a comprehensive package including revenue recycling and assistance to vulnerable groups.

### Comprehensive policy strategy and recommendations
- Combine economy-wide carbon pricing (strengthened ETS with price floor/ceiling and transition to full auctions) with sectoral instruments (feebates, targeted support).
- Use auction revenues to fund the clean energy transition and lower distortionary taxes on work effort.
- Replace tax exemptions for EVs and HVs with a comprehensive, revenue-neutral feebate.
- Consider BCAs for EITE industries at a later stage and contribute to international arrangements among large emitters (e.g., ICPF).
- Conduct stakeholder consultations and public information campaigns; provide assistance for vulnerable households, displaced workers, vulnerable regions, and EITE industries.

*Source: IMF staff analysis as presented in the chapter "An expenditure rule in lieu of a deficit target could be considered to achieve countercyclicality without reliance on a slowdown provision" and "Fiscal policies for reinforcing Korea's climate mitigation strategy" from the cited IMF document.*

---

### Sectoral mitigation instruments and miscellaneous emissions pricing (Annex II highlights)

### Role of sectoral instruments and feebates
- Acceptability constraints on pricing imply a need for sectoral instruments that may diverge in implicit carbon prices across sectors.
- Feebates: revenue-neutral, promote continuous incentives, are administratively compatible where emissions are already monitored, and can be designed to reward multiple mitigation channels.

### Agriculture
- Emissions reductions: reducing livestock herds and reducing crops where intensive fertilizer use occurs.
- Pricing and policy options:
  - Emissions taxes face political opposition and leakage risks.
  - Feebate approaches or combined fee-and-rebate schemes merit study.
  - Demand-side measures (taxes on meat and dairy) could promote dietary shifts.

### Waste
- Emissions arise from bacterial decomposition of organic waste (methane).
- Mitigation responses are straightforward via regulation: capture methane for flaring/use in energy; divert waste for recycling and re-use.
- Fiscal rationale is weaker where public-sector landfills can be regulated.

### Fluorinated (F-) gases
- F-gases have very high global warming potentials.
- Policy recommendation: phase in a tax on HFCs proportional to global warming potential as an administratively straightforward, flexible approach.
- International precedents: Denmark, Norway, Poland, Slovenia, Spain have implemented taxes equivalent to around US$5-40 per tonne of CO2 equivalent.

*Annex II. Pricing Miscellaneous Emissions Sources.*

*Source: IMF staff calculations and analysis in the cited IMF document.*

### References ______________________________________________________________________________ 9

### ASSESSMENT OF POTENTIAL OUTPUT AND OUTPUT GAP

### Major findings and headline projections
- Potential growth was already slowing before COVID-19; staff estimates the COVID shock will temporarily bring potential growth below 2 percent before a modest recovery to about 2¼ percent in the medium term.
- The estimates yield an output gap of about 2.5-3 percent of GDP in 2020.
- Standard errors across the two approaches encompass a medium-term impact of between 1½ and 5 percent.
- Under a reform scenario (see below), long-run output gains could be about 12 percent when assessed over a 30-year horizon.
- The proposed combined COVID + reforms scenario could return the economy to roughly the pre-COVID path of potential output by 2030.

### Methodologies and baseline pre-COVID estimates
- Two models were used to project pre-COVID potential output:
  - A production function model.
  - A multivariate filter (MVF) that incorporates labor force participation, capacity utilization, and Consensus Forecasts for GDP growth and inflation (as in Alichi, 2015).
- Pre-COVID historical values and forecasts for underlying inputs were used as they existed in January 2020.
- Pre-COVID potential growth decelerated from 7 percent in the mid-1990s to pre-COVID estimates for 2019 of:
  - 2.4 percent (MVF)
  - 2.7 percent (production function)
- Pre-COVID projections: about 2.2–2.4 percent in the 2020’s before declining to about 2 percent per year in the 2030’s (comparable to OECD (2018) and Zoli and others (2018)).

### Labor inputs and demographic drivers
- Total hours worked increased until the late 1990s and have stagnated since; a shrinking population and increase in the share of the elderly would have weighed on growth in the number of workers even absent shocks.
- Hours per worker have been declining; educational attainment has risen substantially, so further large gains are unlikely.
- The models estimate participation propensities for detailed age-gender cohorts that account for education and prior history of participation.

### Heterogeneous and sectoral impacts of COVID-19
- The COVID-19 shock produced heterogeneous impacts across industries:
  - Manufacturing: sharper initial fall due to supply chain disruptions and shutdowns in trading partners; by end-2020 rebounded to exceed its pre-COVID peak.
  - Services: milder initial decline but more sluggish recovery; higher reallocation within services than during previous crises.
- A reallocation index (Lilien, 1982) shows overall reallocation during COVID-19 is higher than during the Global Financial Crisis (GFC), surpassed only by the Asian Financial Crisis (AFC).
- The effects have been greatest in relatively low-wage industries, where adaptability to abrupt structural transformation may be lower.
- Potential for scarring: some workers may remain out of the labor force as structural shifts and/or extended periods without employment lead to skills obsolescence.

### Historical recession effects and scaling for COVID-19
- Local projections (Jordà, 2005; Teulings and Zubanov, 2014) estimate previous recessions caused potential output to fall immediately and keep potential growth below pre-recession rates for five-six years before normalizing.
- The medium-term impact in previous recessions primarily reflected lower investment and lower labor force participation; post-recession TFP tended to be resilient.
- Scaling historical recession impacts to the smaller 2020 recession yields an estimated impact on potential output ranging from 2.5 to 3.5 percent:
  - Lower end (2.5 percent) from aggregating impacts across factors of production.
  - Upper end (3.5 percent) from estimating impact using overall output directly.
- The effects on the growth rate of potential output are largest immediately after the shock, with slow normalization driven principally by historically lower investment rates and slower capital accumulation, and secondarily by lower labor force participation.

### Unique transmission channels and mitigating factors
- Factors that may increase scarring:
  - Synchronized global shock (potentially larger impact because potential in other economies is affected).
  - Sudden stop in cash flows for many firms due to early shutdowns.
  - Deeper structural shifts in supply chains and demand across sectors.
  - Large proportion of SME debt in Korea where firms’ cash flows do not cover debt service.
  - Product and labor market rigidities that impede reallocation, especially in services.
- Factors that may mitigate medium-term damage:
  - Large policy response in Korea may buffer the medium-term impact.
  - Korea’s well-developed high-tech industry, strong digital infrastructure, and high rates of digital penetration could produce positive effects via digitalization.
  - Initial data suggest investment has been resilient, supported by strong demand for Korea’s high-tech exports.

### Output gap, inflation, and slack indicators
- Output gap estimated to have widened to about 2.5-3 percent of GDP in 2020.
- This estimate is consistent with:
  - Cumulative projected actual growth in 2019–20 of about 1 percent.
  - Employment and labor force participation below previous trends.
  - Measured capacity utilization in manufacturing below pre-COVID levels.
  - Absence of price pressures reflected in low underlying inflation and below-target inflation expectations.

### Reform scenario and quantified policy implications
- Scenario assumptions for reforms:
  - Raise drivers of productivity to the 75th percentile among OECD countries (based on Kim and Loayza, 2019).
  - Close one third of the male-female labor force participation gap (informed by Dao and others, 2014).
  - Reforms would target: broadening access to advanced education; easing restrictions on hiring and firing of workers on open-ended contracts; improving regulatory quality; strengthening childcare benefits; reducing tax wedges faced by two-earner couples and part-time workers.
- Quantified effects:
  - Possible gains to long-run output about 12 percent over a 30-year horizon.
  - Under a combined COVID + reforms scenario (with prompt implementation), the economy could return to roughly the pre-COVID path of potential output by 2030.
- Timing note: reforms may take several years to be fully implemented and their effects may take several more years to materialize; cumulative impact offsets COVID-19 shock only after several years.

### Policy recommendations and priorities
- Heightened urgency to implement reforms that:
  - Facilitate reallocation of resources toward fast-growing sectors.
  - Increase labor utilization.
- Address long-standing product and labor market restrictions that impede productivity in services and among small firms.
- Reforms highlighted: reduce regulations, increase labor market flexibility, broaden advanced education access, improve regulatory quality, strengthen childcare benefits, and reduce tax wedges for two-earner couples and part-time workers.

*Source: IMF staff assessment, “ASSESSMENT OF POTENTIAL OUTPUT AND OUTPUT GAP,” Republic of Korea report (March 3, 2021).*

### 1.      Fiscal rules are widely used to discipline fiscal policy discretion. At the conceptual level,

### Fiscal rules are widely used to discipline fiscal policy discretion. At the conceptual level,

### Overview
- Incumbent governments may have a bias toward higher present spending, neglecting benefits of prudent fiscal policy for future challenges such as a sudden growth slowdown and population aging.
- This bias can lead to suboptimal fiscal outcomes, including excessive deficits and higher government debt.
- Fiscal rules strengthen commitment to prudent fiscal policy; globally, more than 90 countries have adopted some form of fiscal rules (IMF 2018b).

### Elements of a well-designed fiscal rule
- A well-designed fiscal rule usually includes:
  - A debt anchor that establishes medium or long-term fiscal objectives, usually expressed as a debt-to-GDP ratio target (key indicator for fiscal sustainability and easily observable).
  - Operational rules (targets or limits on fiscal balances, spending, or revenue) under more direct control of the incumbent government.

### Korea’s Government Fiscal Rule Proposal
- The Proposed Rule (October 2020):
  - Debt anchor: 60 percent of GDP (gross government debt).
  - Operational rule: consolidated deficit ceiling of 3 percent of GDP.
  - The debt and deficit targets are “soft” limits governed by formula:
    - [Government debt / 60%] * [Consolidated Fiscal Balance / (-3%)] ≤ 1.                      (1)
- Definitions and baseline numbers:
  - “Government debt” defined as the sum of gross central and local government debt (D1 debt).
  - D1 stood at 37.7 percent of GDP as of end-2019.
  - Consolidated fiscal balance includes social security funds (SSF).
  - Consolidated balance was -0.6 percent of GDP in 2019 and is projected to weaken to -4.4 percent of GDP in 2020.
- Escape clauses and slowdown provision:
  - Escape clauses cover “extraordinary challenges” (e.g., “a war, a large disaster or a global economic crisis”); rule “will not apply for the year, and the ratios are to be recovered gradually over the four years that follow”.
  - Economic slowdown provision: when an economic slowdown requires expanded fiscal spending, the 3 percent consolidated fiscal balance deficit rule will be eased by one percentage point to a four percent deficit.
- Implementation timing:
  - Conditional on parliamentary approval, the proposed rule would take effect from 2025 and is to be reviewed every five years.

### Debt dynamics under the proposed rule
- Consolidated deficit vs. debt-creating managed deficit:
  - Consolidated fiscal balance = managed balance + SSF balance.
  - Managed balance: difference between non-SSF revenue and expenditure; government has more direct control.
  - SSF accounts tied to existing legislation; government has less control.
  - In 2019, SSF balance was KRW 42.4 trillion (or 2.2 percent of GDP), mainly reflecting the surplus from the National Pension Fund (NPF).
  - SSF balance-to-GDP ratio expected to gradually decline and turn negative in early 2040s as public pension expenditure increases.
- How SSF sign affects gross government debt increment:
  - From 2020 to the early 2040s:
    - Annual SSF balance expected to be positive.
    - SSF surplus in year t increases SSF reserve assets from year t-1 to t.
    - Increment in gross government debt between year t-1 and t equals the size of the managed deficit in year t.
    - When SSF balance is positive, annual increase in gross government debt is larger than the size of the consolidated deficit.
  - From early 2040s to the late-2050s:
    - Annual SSF balance expected to be negative.
    - SSF deficit in year t reduces SSF reserve assets.
    - Increment in gross government debt between year t-1 and t equals the size of the managed deficit.
    - Annual increase in gross government debt is smaller than the size of consolidated deficit.
  - Beyond the late-2050s:
    - Annual SSF balance expected to be negative and SSF reserve assets expected to have been depleted.
    - Managed and SSF deficits assumed to be financed by government debt.
    - Increment in gross government debt between year t-1 and t will be equal to the size of consolidated deficit.
- Projection setup and key assumptions for 2020–2060:
  - For projections up to 2024, follow the proposed medium-term outlook published in the 2021 budget proposal.
  - Government debt expected to rise to about 58 percent of GDP by end-2024.
  - Real GDP growth assumptions (MoEF’s 2020–60 medium population growth scenario):
    - 2020s: 2.3 percent per year
    - 2030s: 1.3 percent per year
    - 2040s: 0.8 percent per year
    - 2050s: 0.5 percent per year
  - SSF balance assumed to decline from 2.2 percent of GDP in 2019 to around -4.1 percent of GDP in 2060 (status quo, no major pension policy changes).
  - SSF reserve assets assumed depleted by around 2057, beyond which annual SSF deficits financed by government debt.
  - Average annual inflation rates assumed to be 1.5 percent.
  - For 2025–2060, assume the government will try to maximize its deficits such that equation (1) is always binding, i.e. Debt/60%*Consolidated Deficit/3%=1.
    - Rationale: declining SSF balance during 2020–2060 implies merely keeping (1) binding will require a non-trivial increase in managed balance.
    - More aggressive consolidation efforts are possible but considered a less natural assumption.

### Projected fiscal path under the proposed rule
- Peak and stages:
  - Under the proposed rule and assumptions, government gross debt would peak at around 75 percent of GDP by early 2040s.
  - This demonstrates equation (1) imposes a flexible ceiling: when consolidated balance is higher than -3 percent of GDP, debt-to-GDP ratio can exceed 60 percent of GDP without violating the rule.
- Three-stage projected fiscal path:
  - From 2025 to the early 2040s:
    - Consolidated balance will gradually improve towards -2 percent of GDP as rising debt-to-GDP ratio tightens the deficit constraint via (1).
    - Because SSF expected to be in surplus till late 2030s, the debt-creating managed balance will be mostly lower than the consolidated balance.
    - Managed balance projected to be around -3.3 percent of GDP during 2025-2040, resulting in a rise in debt-to-GDP ratio over time.
  - From the early 2040s to the late-2050s:
    - Debt-to-GDP ratio projected to decline because SSF balance turns negative and the limit on consolidated deficits implies an increasingly tighter limit on managed deficits.
  - Beyond the late-2050s:
    - SSF reserve assets depleted; debt-to-GDP ratio will rise again because SSF deficits must be financed by government debt (managed balances will be in surplus and offset some SSF deficits).

### Implications for fiscal adjustment
- Projected consolidation magnitude:
  - Managed fiscal balance would increase from an average of -1.5 percent of GDP during 2017-19 to about 1.4 percent of GDP in 2060.
  - Adjustment is much larger if compared to the average managed balance of 2020–24 (-5.8 percent of GDP), which is affected by COVID-19 stimulus.
  - Example sensitivity: assuming a real interest rate of 0.5 percent annually from 2020–60 implies a consolidation in the primary managed balance by 7.6 percent of GDP by 2060 from the 2020–24 average.

### Staff assessment — Debt anchor
- No single “right” debt level for an advanced economy like Korea.
- IMF’s DSA indicative thresholds: 85 percent of GDP for advanced economies and 60 percent of GDP for emerging economies to signal government debt vulnerability.
- The proposed flexible 60-percent-of-GDP gross debt anchor:
  - Considered prudent from a debt sustainability perspective.
  - Strict implementation could lead to a peak debt-to-GDP ratio of around 75 percent of GDP in early 2040s — still within “safe” debt thresholds for advanced economies.
  - From the optimal-debt literature perspective (often suggesting negative optimal net debt), a 60-percent-of-GDP gross debt may be slightly preferred over a higher debt anchor, though this is not definitive.

### Staff assessment — Operational target: the proposed 3% “soft” deficit ceiling
- General concern: deficit rules can make fiscal policy procyclical.
  - Political pressure may push government to run deficits close to the limit, leaving limited room for support during recessions and preventing automatic saving in booms.
  - This concern is salient for Korea given growth volatility and limited room for monetary policy in a prolonged low-interest-rate environment.
- The “soft” deficit nature does not fully address procyclicality concerns:
  - With annual nominal GDP growth of 3.5~4.5 percent and SSF balances around 1.5 percent of GDP, running a 3 percent consolidated deficit implies a 4.5 percent managed deficit, which stabilizes public debt at a level exceeding the 60 percent anchor.
  - When debt stays above the anchor, equation (1) is more likely to bind, making the “soft” deficit limit effectively “harder” and leaving less space for downturn support.
- The scope for countercyclical policy hinges on the “slowdown” provision design:
  - Practical challenges: how to define an “economic slowdown” to allow flexibility for cyclical downturns while avoiding excessive use in “normal” times.
  - Risk: in the context of structural deceleration from income convergence and a shrinking working-age population, pressures could arise to apply the provision frequently, even during cyclical robustness.
  - Another design challenge: how to achieve fiscal savings in “good” times to avoid procyclicality during upswings.

### Quantitative literature context (Box 1) — key points
- Quantitative studies emphasize liquidity benefits of government debt for precautionary savings and smoothing taxes/expenditures.
- Costs of higher debt include:
  - Higher interest rates and crowding out private investment.
  - Higher interest payments financed via distortionary taxes.
  - Redistribution favoring richer households, exacerbating inequality.
- Optimal long-term government debt estimates vary widely (from -100% of GDP to 145% of GDP) depending on model details; many calibrated studies (mostly for the U.S.) indicate an optimal net debt level that is negative when accounting for multiple costs.
- Caveats for applying literature results to Korea:
  - Most studies calibrated to U.S. economy.
  - Literature typically refers to “net” debt; suitable net debt measure should net out liquid financial assets.
  - By that measure, Korea’s net government debt position is about -21% of GDP as of 2019 (liquid government assets such as cash, deposit and securities amounted to 59 percent of GDP as of 2019; government debt about 38 percent of GDP).

_Prepared by Si Guo._

### 18.      An expenditure rule in lieu of a deficit target could be considered to achieve

### An expenditure rule in lieu of a deficit target could be considered to achieve countercyclicality without reliance on a slowdown provision

### Expenditure rule design and trade-offs
- Under expenditure rules, revenue fluctuates with the economic cycle, while expenditure growth is subject to a pre-determined ceiling path.
- Fiscal deficit outcomes under an expenditure rule:
  - Deficit is larger in a downturn to allow fiscal policy to mitigate the cycle.
  - Deficit is smaller in a boom.
- Key implementation challenges relative to deficit rules:
  - Parameters of an expenditure rule (e.g., the growth rate of the expenditure ceiling) may need updating in response to major tax policy changes so expenditure targets remain aligned with the new revenue outlooks.
  - Expenditure rules can induce lower public investment if governments cut capital spending to remain in compliance with the expenditure ceiling (IMF 2018a).

### Monitoring and enforcement
- Independent fiscal councils have been created in several countries (Netherlands, Chile, Colombia, Sweden) to help monitor fiscal rules.
- Enforcement is challenging; objective and well-communicated assessment reports from a dedicated fiscal council can raise reputational costs of a breach and create incentives for compliance.
- A simple and transparent fiscal rule facilitates monitoring and enforcement.
- Options for Korea:
  - Monitoring role could be performed by an independent fiscal council outside government.
  - National Assembly Budget Office (NABO) could take on the monitoring role.
- The government’s proposed fiscal rule is based on easily observable fiscal targets (debt and deficit); monitoring and enforcement are especially important for:
  - Proper application of escape clauses.
  - Proper application of the “slowdown” provision.

### Provisions to relax the rule (escape clauses)
- Escape clauses should balance flexibility and credibility, allowing temporary deviation in rare events outside government control.
- Defining eligible circumstances is difficult in practice:
  - Natural disasters and national security contingencies can be explicitly specified.
  - Major recessions typically fall into an “exceptional circumstances” category that is often not well defined and prone to differing interpretations.
- The Korean government’s proposed fiscal rule includes escape clauses for:
  - Wars, disasters, and a global economic crisis.
- The rule also includes a provision to relax the deficit target in case of economic slowdowns.
- Criteria for identifying an “economic slowdown” should be:
  - Easily observable.
  - Demanding, to avoid excessive relaxation for relatively minor cyclical fluctuations.
- Application of escape clauses:
  - Could be subject to confirmation by parliament or require approval by an independent fiscal council or similar external entity to bolster credibility and ensure political buy-in.

### Transition issues and timing
- Starting implementation of the fiscal rule from 2025 onward, as proposed by the government, is broadly appropriate to allow sufficient and flexible fiscal support in the aftermath of the COVID-19 shock until the economy has recovered.
- Medium-term budget outlook in the 2021 budget proposal forecasts:
  - debt-to-GDP ratio of 58.3 percent for 2024.
  - deficit-to-GDP ratio of 4 percent for 2024.
- To meet the proposed rule (as expressed in equation (1)), the deficit in 2025 could not exceed 2.9 percent of GDP, implying a nontrivial fiscal tightening relative to 2024.
- A smoother transition path could be achieved if adjustment starts earlier (i.e., in 2023 or 2024), provided the recovery from the COVID-19 shock is well underway by then.

### Periodic reviews and governance
- The proposed rule allows for a review of debt and deficit target parameters every 5 years.
- Currently, revision of the rule appears delegated to the executive branch.
- Recommended process:
  - Revisions to key parameters should be assessed by an independent entity (such as a fiscal council or NABO).
  - Then approved by the parliament.

### Communications and long-term fiscal pressures
- Given demographic changes, the proposed rule will likely imply over time:
  - A non-trivial reduction in non-SSF spending or
  - An increase in public revenue collection (as share of GDP).
- Transparent and intuitive presentation of increasing fiscal pressure from population aging and slowing potential growth can help generate broader understanding and buy-in for a fiscal rule in Korea.

---

### Fiscal policies for reinforcing Korea's climate mitigation strategy

### Strategic objectives and context
- Korea’s climate mitigation objectives highlighted:
  - Achieve carbon neutrality by 2050.
  - Reduce greenhouse gas (GHG) emissions 24.4 percent below 2017 levels by 2030.
- Existing and announced policy measures:
  - Korea’s Emissions Trading System (ETS)—the largest in scale outside the EU—covering about three quarters of domestic emissions.
  - Green New Deal (GND) component of the Korean New Deal (KND).
  - Standards for average emission rates of vehicle sales fleets and tax exemptions for EVs and HVs.
  - Renewable portfolio standard (RPS) requiring generators to increase renewable share.

### Recommended national-level reforms for ETS
- In Phase 4 of the ETS consider:
  - A trajectory of emissions caps fully aligned with meeting the 2030 emissions target.
  - Underpinning the ETS with exogenous and progressively rising price floors and ceilings.
  - Transition to full allowance auctions.
- Expected benefits of these reforms:
  - Better align emissions with long-term carbon neutrality.
  - Promote across-the-board incentives for low-carbon investment via a robust price signal.
  - Improve compatibility with overlapping instruments (e.g., RPS).
  - Raise additional revenues to promote innovation in green industries, fund the clean energy transition, and lower taxes on work effort.

### Sectoral instruments: feebates
- Feebates proposed as a complement to the ETS in transport, power, industrial, and building sectors.
- Mechanism:
  - Revenue-neutral sliding scale of fees on products/activities with above-average emission rates.
  - Sliding scale of rebates on products/activities with below-average emission rates.
- Advantages of feebates:
  - Cost-effectively promote full range of responses for reducing emissions intensity within a sector.
  - Avoid a fiscal cost to the government.
  - Avoid significantly higher energy prices.
  - Compatible with existing regulatory standards.
- Variant: feebate to promote carbon storage in the land use sector.
- Note: Some elements of a feebate already apply in transportation.

### Korea’s climate ambitions and the Green New Deal
- Green New Deal (GND) specifics:
  - Public funding of KRW 42.7 trillion from 2020 to 2025 for green projects.
  - Projected to leverage an additional KRW 30.8 trillion in local government and private funding.
  - Projected to create 659,000 jobs.
  - GND projects include buildings, tree planting, renewables, green hydrogen, and CCUS.
- KND broader focus: become a global digital leader, transition to a green economy, and enhance social inclusiveness.

### Emissions trends and projections
- Global context:
  - Global CO2 and other GHG emissions must be cut 25–50 percent below 2018 levels by 2030 to be on track for 1.5–2oC warming scenarios.
  - Pandemic-induced crisis: global emissions in 2020 projected to fall about 8 percent below 2019 levels; without strong mitigation policies, global emissions likely to rise again in 2021 as economies recover.
- Korea-specific projections and history:
  - Fossil fuel CO2 emissions are projected to increase 5 percent between 2018 and 2030 with currently planned mitigation efforts.
  - Korea’s CO2 emissions increased by 161 percent between 1990 and 2018.
  - GDP projected to increase another 25 percent between 2018 and 2030; energy intensity of GDP expected to fall 19 percent.
  - Without new or strengthened mitigation policies, Korea is projected to be the 7th largest global emitter of CO2 in 2030, and the fourth largest emitter in per capita terms.

### Emissions breakdown and sectoral shares
- Korea’s 2016 GHGs total: 694 million tons.
  - Fossil fuels accounted for 87 percent of GHGs in 2016.
  - Industrial processes: 7 percent.
  - Agriculture: 3 percent.
  - Waste: 2 percent.
  - Fugitive emissions: 1 percent.
- By sector (fossil fuel CO2, 2018):
  - Power generation: 55 percent.
  - Industry & Construction: 19 percent.
  - Transport: 17 percent.
  - Buildings (direct): 9 percent (indirect emissions from electricity use in buildings are 2.5 times the direct emissions).
- By fuel type (fossil fuel CO2, 2018):
  - Coal: 48 percent.
  - Oil: 33 percent.
  - Natural gas: 19 percent.
- Power generation fuel shares, 2018:
  - Coal: 38.1 percent.
  - Natural Gas: 24.1 percent.
  - Oil: 2.5 percent.
  - Nuclear: 31.1 percent.
  - Hydro: 0.6 percent.
  - Other Renewable: 2.7 percent.
  - Biomass: 0.9 percent.

### Korea’s ETS design and current operation
- ETS launched in 2015; first national ETS in East Asia.
- Phase 3 (2021–2025) details:
  - Applies to 685 companies covering 73 percent of national GHGs (up from 70 percent in Phase 2).
  - The ETS cap cumulated over the three years of Phase II was 1,796 MtCO2e, or on average 599 MtCO2e a year.
  - In Phase 3 the annual average emissions cap will be reduced 4.7 percent relative to 2017–2019 ETS emissions.
  - Allowances largely given away for free (based on companies’ 2011–2013 emissions); 10 percent will be auctioned in Phase 3.
  - EITE industries will continue to receive 100 percent free allowance allocations.
  - Auctions are subject to a minimum price based on recent emissions prices.
  - Banking, borrowing, and other market stability provisions are designed to limit allowance price volatility.

### Trade and international coordination issues
- Border carbon adjustment (BCA):
  - EU plans to introduce a BCA in 2023; Canada, the UK, and the United States are currently considering BCAs.
  - BCAs help alleviate adverse impacts on industrial competitiveness from carbon-price-induced increases in energy prices and reduce the risk of emissions leakage.
  - Korea should consider whether a BCA for energy-intensive, trade-exposed (EITE) industries might be appropriate in future, possibly after early experiences with an EU BCA.
- International coordination:
  - Ongoing debate on complementary international mechanisms to the Paris Agreement to scale up action among key emitters.
  - One potential mechanism: an international carbon price floor (ICPF) among large emitters.
  - Korea might usefully contribute to international dialogue on an ICPF and other complementary mechanisms.

*Source: IMF staff analysis as presented in the chapter "An expenditure rule in lieu of a deficit target could be considered to achieve countercyclicality without reliance on a slowdown provision" and "Fiscal policies for reinforcing Korea's climate mitigation strategy" from the cited IMF document.*

### 7.      Other policies provide additional incentives for renewables, low emission vehicles, and

### 7.      Other policies provide additional incentives for renewables, low emission vehicles, and 

### Existing sectoral policies and standards
- Renewable Portfolio Standard (RPS) in place since 2012:
  - Requires the 23 major electric utilities (i.e., those with over 500MW) to increase their renewable share in the electricity mix to 10 percent by 2022.
- Vehicle emissions standards:
  - Passenger vehicles: 97 grams (g) of CO2 per km by 2020 for 80 percent of the new vehicle fleet.
  - Light trucks: 166 g CO2 per km by 2020 for 20 percent of the new vehicle fleet.
  - Future tightening: standards will tighten to 89 (cars) or 158 (trucks) g CO2 per km by 2025, and 70 (cars) or 146 (trucks) g CO2 per km by 2030.
  - Credit trading is permitted among manufacturers.
- Fiscal incentives for EVs and HVs:
  - Exemption of local acquisition tax (7 percent of vehicle price), which can save up to KRW 1.4 million.
  - Exemption of national individual consumption tax (5 percent of vehicle price), which can save up to KWR 3 million for an EV and KWR 4 million for an HV.
- Buildings and industry:
  - Gradual application of stricter energy conservation designs to new structures.
  - Industry focus on energy efficiency and clean fuel and materials.

### Fuel excises, undercharging, and local externalities
- Coal tax:
  - Recently increased to KRW 46 per kg, equivalent to US$2 per gigajoule (GJ) or $21 per ton CO2.
  - Estimated local air pollution damages from coal use in Korea would warrant a tax almost twice as high—these damages are estimated at $3.8 per GJ.
- Fuel excises:
  - Gasoline excise: KRW 770 per liter, equivalent to US$0.64 per liter or $272 per ton CO2.
  - Road diesel excise: KRW 540 per liter, equivalent to $0.45 per liter or $166 per ton CO2.
- Despite excises, retail diesel prices are somewhat less than prices needed to reflect supply costs, non-carbon environmental costs, and general consumption taxes; gasoline prices just about reflect these factors.
- Other countries generally undercharge for coal, gasoline, and diesel fuel before counting global warming costs.

### Role and strengths of carbon pricing (ETS)
- Carbon pricing provides:
  - Across-the-board incentives to reduce energy use and shift to cleaner fuels.
  - Automatic minimization of mitigation costs by equalizing marginal abatement costs.
  - Redirection of new investment to clean technologies (with a robust and rising price signal).
  - Potential to mobilize substantial government revenues for distributional purposes and growth-enhancing tax reform.
  - Substantial domestic environmental benefits, e.g., reductions in local air pollution mortality.
- Korea’s ETS:
  - Has relatively good coverage compared with many other schemes.
  - Can be strengthened because emissions caps are not fully aligned with intermediate mitigation goals, future allowance prices are uncertain, and revenue opportunities are not fully exploited.

### ETS emissions cap trajectories and targets
- Consistency with a linear pathway to emissions neutrality implies tightening the ETS cap:
  - Average cap would be 509 million tons over 2021-2025, or 7 percent below annual emissions in Phase 2.
  - Average cap would be 416 million tons over 2026-2030, or 24 percent below Phase 2.
  - Note: 2020 emissions is the annual cap in Phase 2 scaled up 3 percent due to expanded coverage from 2020.
- On a linear pathway consistent with Korea’s NDC pledge for 2030, the average cap would be 19 percent lower than the Phase 2 average.
- Strengthening options:
  - Scale back the cap by a fixed amount each year (absolute ton reduction or percent reduction).
  - Align trajectory of emissions caps with medium- and long-run emissions targets.

### Price signals, floors, ceilings, and linkage considerations
- Recent allowance prices in the Korean ETS have been broadly in line with comparators, but uncertainty about future prices could delay low-carbon investments.
- Overlapping mitigation instruments (e.g., RPS) can reduce allowance prices given a fixed cap.
- Policy options to increase price certainty:
  - Set a minimum auction price exogenously with a price floor that ramps up predictably over time. If the floor is binding, overlapping instruments can trigger automatic withdrawal of allowances.
  - If caps are tightened, consider an exogenous price ceiling (which adds allowances) to limit backlash risks from high energy prices.
  - Linking the Korean ETS to other trading systems could increase price certainty but would cede price determination largely outside Korea; retaining discretion over domestic price bands may be preferable.

### Fiscal revenue and distributional implications
- Free allowance allocations reduce potential government revenue from auctions:
  - Full allowance auctions in 2019 would have raised revenues of about 0.5 percent of GDP.
- Revenue use opportunities:
  - Revenues could be used to lower distortionary taxes on work effort and business income, incentivize innovation, and support green investment.
  - A carbon price of $50 applied to all fossil fuel CO2 in Korea would raise revenues of 1.4 percent of GDP in 2030 with full allowance auctions.
- Distributional concerns:
  - Free allowances can create windfall profits for firms and shareholders (concentrated in higher income groups) as rents may be passed forward in consumer prices.
  - Assistance to EITE industries might be provided more efficiently via targeted measures rather than free allowances.

### Price levels required for targets and acceptability constraints
- To meet Korea’s NDC pledge exclusively through carbon pricing:
  - Would require raising the 2030 CO2 price by more than KRW 83,333 ($75) per ton on all fossil fuel CO2 emissions from the current level ($18 per ton), and applying similar pricing to other GHGs.
- Emissions responsiveness:
  - CO2 emissions are somewhat more responsive to pricing in Korea than in most other G20 countries due mainly to the higher share of coal in CO2 emissions.
- Acceptability constraints from energy price impacts (illustrative $50 per ton carbon price in 2030):
  - Coal prices would increase 156 percent.
  - Natural gas prices would increase 33 percent.
  - Retail electricity prices would increase 36 percent.
  - Pump prices for gasoline would increase 4 percent.
- Policy trade-offs noted:
  - Higher electricity prices may conflict with long-term decarbonization objectives via electrification of transport and heating.
  - High carbon prices may be politically difficult without a comprehensive package.

### Comprehensive policy strategy and complementary instruments
- Elements to enhance feasibility and acceptability of stronger carbon pricing:
  - Balance national-level pricing with reinforcing sectoral instruments (less efficient but often more politically acceptable).
  - Use carbon pricing revenues transparently and productively—for example, recycling revenues to cut distortionary taxes.
  - Provide assistance for vulnerable groups: low-income households, displaced workers, vulnerable regions, and EITE industries.
  - Conduct extensive stakeholder consultations and public information campaigns on rationale and benefits (e.g., revenue recycling and improved local air quality).
- Policy instruments highlighted:
  - Transition to full allowance auctions to capture fiscal benefits.
  - Consider feebates and sectoral feebate-like measures that reduce emission rates and improve energy efficiency without large impacts on energy prices.
  - Adjust price floor and ceiling trajectories flexibly in response to technology progress and developments in other emitting countries.

### Key numeric figures and benchmarks (selected)
- RPS target: 10 percent renewable share by 2022 for major utilities.
- Vehicle standards: 97 g CO2/km (passenger vehicles, 80 percent of fleet) and 166 g CO2/km (light trucks, 20 percent of fleet) by 2020.
- Tax/incentive amounts:
  - Local acquisition tax exemption: 7 percent of vehicle price; savings up to KRW 1.4 million.
  - National individual consumption tax exemption: 5 percent of vehicle price; savings up to KWR 3 million (EV) and KWR 4 million (HV).
- Fuel/excise and externality metrics:
  - Coal tax: KRW 46 per kg = US$2 per GJ = $21 per ton CO2.
  - Local air pollution damages from coal: $3.8 per GJ.
  - Gasoline excise: KRW 770 per liter = US$0.64 per liter = $272 per ton CO2.
  - Diesel excise: KRW 540 per liter = $0.45 per liter = $166 per ton CO2.
- ETS cap averages for a linear pathway to emissions neutrality:
  - 509 million tons over 2021-2025 (7 percent below Phase 2).
  - 416 million tons over 2026-2030 (24 percent below Phase 2).
  - NDC-consistent average cap would be 19 percent lower than Phase 2 average.
- Fiscal magnitudes:
  - Full allowance auctions in 2019 would have raised about 0.5 percent of GDP.
  - $50 per ton carbon price applied to all fossil fuel CO2 would raise revenues of 1.4 percent of GDP in 2030 with full allowance auctions.
- Price adjustments from illustrative $50/ton carbon price in 2030:
  - Coal +156 percent; Natural gas +33 percent; Retail electricity +36 percent; Gasoline +4 percent.
- Required CO2 price increase to meet NDC via pricing only: more than KRW 83,333 ($75) per ton from current $18 per ton.

*Source: Fund staff estimates and chapter text.*

### 19.      Sectoral mitigation instruments have a critical role to reinforce carbon pricing, though

### 19.      Sectoral mitigation instruments have a critical role to reinforce carbon pricing, though insofar as possible they should rely on the price mechanism to contain costs on the economy

### Acceptability constraints and the role of sectoral instruments
- Acceptability constraints on pricing imply a need for sectoral instruments.
- Even with aggressive carbon pricing, additional instruments may be needed to achieve sectoral targets, especially for sectors with low responsiveness of emissions to pricing (this will imply some divergence in implicit carbon prices across sectors).
- Broader market failures (e.g., associated with clean technology infrastructure networks, or knowledge spillovers from new technologies) may warrant additional policies targeted at specific technologies (e.g., power grid extensions, battery storage).
- Where sectoral instruments aim to mimic behavioral responses induced by pricing, they should be designed flexibly so firms and households can choose cost-minimizing responses for a given emissions reduction.

### Feebates: design features and general advantages
- Feebates apply a sliding scale of fees to products/activities with above-average emission rates and rebates to those with below-average emission rates.
- Revenue neutrality can be maintained by updating the pivot point (the emission rate above/below which fees/rebates apply).
- Feebates:
  - Reduce emissions intensity of products or activities without the same demand response as carbon pricing (they do not pass through carbon tax revenues or allowance rents in higher energy prices).
  - May have greater political traction than pricing.
  - Are the fiscal analogue of emission rate regulations but are automatically cost effective and provide ongoing incentives to reduce emissions.
  - Promote a wider range of mitigation responses than clean technology subsidies and avoid a fiscal cost.
- Feebates should, where possible, rely on price mechanisms to contain overall economic costs and be harmonized across product categories to promote cost effectiveness.

### Transportation (passenger vehicles)
- Feebate formula (passenger vehicles): CO2 price × {CO2/km − CO2/km of the new vehicle fleet} × {lifetime vehicle km of the average vehicle}.
- Certified CO2/km emissions by model type can provide data to assess fees and rebates.
- Advantages of a comprehensive feebate for passenger vehicles:
  - Promotes the full range of behavioral responses: shifting among conventional vehicles and from conventional vehicles to EVs and HVs.
  - Is cost effective as rewards are proportional to reductions in emission rates.
  - Maintains (approximate) revenue neutrality as fees offset rebates when the average CO2/km is updated over time.
- Illustrative numerical examples:
  - A feebate with a price of $400 per ton CO2 would apply a rebate of $4,000 for EVs and HVs and a fee of $4,000 for a vehicle with CO2 emission rate of 200 g CO2/km.
  - These rebates and fees would be twice as high under a feebate with a price of $800 per ton.
  - For comparison, current tax exemptions in Korea provide a subsidy for EVs of up to $4,000.
- Feebate prices can be scaled up if faster fleet adjustment is needed.

### Electric utilities (power sector)
- Current RPS is insufficient to meet renewable energy targets; studies suggest Korea will fall short of meeting a targeted 20 percent renewable energy share by 2030.
- RPS ratio is expected to be raised to meet mid-to-long-term targets: a 20 percent renewable energy share by 2030 and 30 to 35 percent by 2040.
- Feebate formula (utilities): CO2 price × {CO2/kWh − industry-wide average CO2/kWh} × electricity sales.
- A feebate:
  - Cost-effectively and revenue-neutrally promotes responses to reduce emissions per kWh: improving generation efficiency, fuel switching (coal → gas), CCUS, and renewables.
  - Complements RPS by rewarding utilities that go beyond the RPS standard.
  - Can accelerate transition to carbon-free generation, which is critical for emissions reductions in other sectors via electrification.
- Illustrative numerical example for Korea:
  - A feebate with a price of $50 per ton would currently apply:
    - a subsidy of 3.5 cents per kWh for zero-carbon electricity,
    - a fee of 1.4 cents per kWh for coal plants,
    - a subsidy of 1.5 cents per kWh for natural gas generation.
  - Over time, subsidies for renewables and natural gas would decline (natural gas subsidy could eventually turn into a fee), while the fee on coal would increase as average emission rates fall.

### Industry
- Feebate schemes could reinforce incentives for reducing industry emissions if the government faces constraints on carbon pricing.
- Under carbon pricing, industry's burden includes costs of cutting emissions and allowance purchase payments for remaining emissions; under a revenue-neutral feebate the allowance purchase component is absent for the average firm.
- Feebate formula (industry): CO2 price × {CO2/production − industry-wide average CO2/production} × production.
- Feebates could apply to the same firms currently covered by the ETS, limiting additional administration since emissions are already monitored.
- Annex III provides illustrative comparisons of impacts of carbon pricing and feebates on production costs in steel and cement (not reproduced here).

### Buildings and appliances
- Energy efficiency improvements in new and existing buildings and appliances reduce direct and indirect emissions, but may be hindered by market failures (liquidity constraints, owner–renter mismatches, unawareness/uncertainty of savings).
- Korea already sets energy efficiency standards for a wide range of products, provides tax credits for building upgrades, sets building codes, and uses labelling programs; the GND includes incentives for green remodeling and energy-efficient construction.
- Feebate design for appliances:
  - Example feebate formula for sales of energy-consuming products: CO2 price × CO2 per unit of energy × {energy consumption per unit − industry-wide energy consumption per unit for the product} × number of units.
  - For refrigerators, energy consumption unit would be kWh per cubic foot cooled and number of units would be cubic feet.
  - Similar schemes could tax gas- and oil-based heating systems and subsidize electric heat pumps to accelerate zero-carbon heating.
- Feebates avoid fiscal cost, can be harmonized across categories, and provide continuous incentives to exceed current standards.

### Forestry
- Three channels for increasing forest carbon storage: (i) afforestation; (ii) reducing deforestation; (iii) enhanced management of tree farms (larger trees, longer rotations, fertilizing, thinning).
- Expanding forest coverage provides co-benefits: biodiversity preservation, reduced water loss risk, reduced flood/erosion/siltation.
- National feebate program for landowners:
  - Fee: {CO2 rental price} × {carbon storage on their land in a baseline year − stored carbon in the current year}.
  - Rewards all three channels for enhancing carbon storage via reduced fees or increased subsidies (unlike one-off afforestation subsidies).
  - Feebates can be designed to be revenue-neutral in expected terms through appropriate scaling of baselines over time.
  - Feebates should involve rental payments (on an annualized basis, a CO2 price times the interest rate) rather than large one-off payments because carbon storage may not be permanent.
- Forest carbon inventories are estimated via satellite monitoring, aerial photography, and on-the-ground tree sampling.

### Trade and international perspectives (BCAs and coordination)
- Korea, as a large industrialized country and leader on the green transition, might engage in debates on trade and international coordination, including Border Carbon Adjustments (BCAs).
- BCAs have three main rationales:
  - Alleviate adverse impacts on industrial competitiveness from carbon-price-induced energy price increases.
  - Reduce the risk of emissions leakage (overseas emissions increases induced by domestic mitigation policy).
  - Encourage stronger carbon pricing in other countries (limited relevance for unilateral Korea).
- Design considerations and impacts:
  - A BCA would impose charges for embodied carbon in imports and could be limited to products competing with EITE industries; EITE industries account for over 90 percent of emissions embodied in all Korea’s manufacturing exports.
  - A BCA can be more effective at assisting EITE industries than free allowance allocation, since under free allocation the base of compensation declines over time with deeper emissions reductions.
  - Illustrative estimate: A $50 BCA applied by Korea would have raised revenues of about 0.4 percent of GDP in 2015.
- Concerns with BCAs:
  - Administrative burdens if applied broadly; administration is simpler if limited to EITE industries.
  - Design choices: rebates for lower-carbon exporters, adjustments for trading partner mitigation measures, rebates for embodied carbon in exports—these must be practical administratively.
  - Legal risks at the WTO and potential retaliation; limiting BCAs to EITE industries might enhance legal defensibility.
- Recommendation: Authorities should consider whether a BCA might be appropriate following early experiences with the prospective EU BCA, as an interim measure to more comprehensive international pricing. Revenues from a BCA could help fund Korea’s clean energy transition.

*Source: IMF staff calculations.*

### 34.      Although the 2015 Paris Agreement was a landmark achievement in international

### 1korea2021002 - 34.      Although the 2015 Paris Agreement was a landmark achievement in international

### Need for a complementary international mechanism
- The Paris Accord helped galvanize development of country-level mitigation objectives and, in some cases, strong policies to implement these objectives.
- Even if all parties achieved their emissions pledges, this would be cutting global emissions about 10 percent below projected levels for 2030 whereas emissions reductions of 28 percent and 55 percent would be consistent with a linear emissions pathway to 2oC and 1.5oC respectively.
- Difficulties with the Paris Agreement:
  - Many signatories (195) and targets are difficult to compare.
  - Countries acting unilaterally have limited incentives to scale up mitigation due to concerns about competitiveness and free rider issues.
- A complementary international mechanism should:
  - Be effective: contain a concrete plan to deliver the needed emissions reductions by 2030.
  - Facilitate negotiation: be limited to a few key countries and a small number of transparent parameters.

### International carbon price floor (ICPF) among large emitters
- Coverage and focus:
  - An agreement focused on China, the EU, India, and the US would cover nearly 70 percent of global emissions.
  - An agreement focused on the G20 would cover 80 percent of emissions.
- Key attractions of a carbon price floor:
  - (i) An efficient and easily understood parameter.
  - (ii) A simultaneous increase in effective carbon prices would help address competitiveness and free rider concerns and avoid pressure for BCAs.
  - (iii) The arrangement could be designed equitably, with stricter requirements for higher income countries and/or transparent technological or other assistance for lower income countries.
  - (iv) The arrangement might be designed flexibly to accommodate different approaches (e.g., ETSs, combinations of pricing, feebates, regulations) at the national level if they achieved equivalent emissions outcomes as the price floor.
- Effectiveness:
  - An ICPF could be highly effective in scaling up mitigation.
  - Illustration: price floors of $75, $50, and $25 per ton respectively in 2030 for the three largest projected global emitters alone (the United States, China, and India) would be sufficient to keep G20 emissions in line with a 2oC target.
- Policy role for Korea:
  - Korea might usefully contribute to international dialogue among large emitting countries on complementary mechanisms to the Paris Agreement.

### Summary of Recommendations (Korea)
- Achieving Korea’s goals of greening and de-carbonizing its economy will require further strengthening of the current policy framework through a comprehensive package of national (economy-wide) and sectoral measures. Possible elements include:
  - Aligning the trajectory of annual emissions caps with the 2030 emissions target.
  - Underpinning the ETS with an exogenous and automatically rising floor price and ceiling.
  - Transitioning to full auctioning of ETS allowances with revenues used to fund the clean energy transition and/or lower the burden of taxes on work effort.
  - Replacing tax exemptions for EVs and HVs with a more comprehensive, revenue-neutral feebate to enhance incentives for low-emission vehicles.
  - A feebate to reinforce incentives for shifting to carbon free power generation.
  - Feebate schemes for the industrial sector to provide incentives for cleaner technologies with limited impacts on competitiveness and emissions leakage.
  - Feebates to reinforce incentives for switching to carbon free space heating and more energy-efficient appliances and machinery.
  - Considering whether a BCA might be an appropriate instrument for Korea, at some future point, perhaps after early experiences with an EU BCA.
  - Contributing to multilateral dialogue on possible international arrangements among large emitters to complement and reinforce the Paris Agreement.

### Recommended fiscal instruments by sector (from Table 3)
- Economy-wide
  - Align emissions caps in Phase 4 of the ETS with the 2030 emissions target; set an exogenous and progressively rising price floor underpinning the ETS; and transtion to full allowance actions.
  - Auction revenues can be used for: (i) supporting the clean energy transition; (ii) lowering taxes on work effort and investment.
- Power
  - Introduce feebate: a sliding scale of fees/rebates on generators with above/below average CO2/kWh to complement the RPS and accelerate shifting to cleaner fuels, without a new tax burden on the average generator.
- Road transport
  - Implement a fully comprehensive feebate for passenger vehicles: a sliding scale of fees/rebates applied to all vehicles with above/below average CO2/km to build off existing fiscal incentives and complement emissions regulations.
  - The feebate price can be set aggressively to promote EVs and HVs without a new tax burden on the average motorist or fiscal cost.
- Industry
  - Introduce feebates: a sliding scale of fees/rebates on firms with emission rates above/below the industry average emission rate.
  - Feebates can provide powerful incentives for cleaner production processes without a large tax burden on the average firm which lessens concerns about competitiveness and emissions leakage.
- Buildings
  - Supplement energy efficiency regulations and building codes with: (i) a tax-subsidy scheme promoting shifting from natural gas/oil heating systems to electric or other clean fuel systems; (ii) feebates to promote more efficient appliances and lighting.
- Forestry
  - Introduce a nationwide feebate applied to landowners equal to an (annualized) CO2 price times the difference between forest carbon storage on their land in a baseline period and carbon storage in the current period.
  - This promotes the full range of mitigation responses with no burden on the average landowner or fiscal cost to the government.
  - Forest carbon inventories are monitored with satellite and aerial imagery and on the ground sampling.
- Trade/international
  - Consider a BCA for EITE industries (in place of free allowance allocations) but also promote dialogue on a (far more effective) carbon price floor for scaling up action among large emitting countries.

### Korea Green New Deal highlights (Annex I)
- Totals and funding 2020-2025:
  - Totals: 42.7 KRW trillion; Funding 2020-2025, 30.8 (table shows columns "KRW trillion" and "Funding 2020-2025," values shown across projects).
- Selected project examples and numeric targets:
  - Green infrastructure: Employment gains thousands 12.1; Public 18.0; Local government and private 387.
  - Public buildings: 6.2 (thousands employment gains); 243 (local gov/private).
  - Ecosystem restorations (terrestrial, marine, and urban): 2.5 (thousands); 105 (local gov/private).
  - Clean and safe water: 3.4 (thousands); 39 (local gov/private).
  - Low carbon and decentralized energy: 24.3 (thousands); 11.5; 209. Smart grids 220; Advanced metering for 5 million appartments; reducing emissions from diesel generation; underground cables for power/telecommunications in school zones.
  - Renewable energy and fair transition: 9.2 (thousands); 38 (local gov/private). Feasibility studies for offshore wind; support for households, industry, and farmers for renewable investment; support for transitioning coal dependent regions to renewable energy.
  - Expanding electric and hydrogen vehicles: 13.1 (thousands); 151 (local gov/private). Support for: (i) 1.13 million EVs (cars, buses, trucks) charging stations (15,000 rapid, 30,000 slow); (ii) 0.2 million hydrogen vehicles and 450 charging facilities; (iii) fuel cell plants and hydrogen distribution infrastructure; and (iv) scrappage of old diesel cars and the transition.
  - Innovation in green industry: 6.3 (thousands); 1.36; Support: R&D, testing and commercialization for 123 SMEs in environmental and energy sectors; complex of startups; regional hub for green technologies; energy use monitoring technolgies; and facilities preventing fine dust.
  - R&D and financial sector: 2.7 (thousands); 16; Support: commercialization of CCUS by 2023 and technologies for using captured CO2; development of recycling processes; and green businesses and operations.
- Korea ETS design and features (Table A2 highlights)
  - Phases: Launched January 1 2015. 1st phase: 2015-2017. 2nd phase: 2018-2020. 3rd phase: 2021-2025.
  - Coverage (as of 2019): 685 large emitters (for Phase 3); 64 subsectors from 6 sectors; Inclusion thresholds: company >125,000 tons CO2/year, facility >25,000 tons CO2/year; 73 percent of GHGs; All six Kyoto gases (CO2, CH4, N2O, PFCs, HFCs, SF6).
  - Allowance allocation and auctions: Phase 1 free allowances 100, 97, and 90 percent for non-EITE sectors in Phases 1, 2 and 3 respectively; EITE sectors receive 100 percent free allowances in all phases. 3 percent of allowances for non-EITE entities auctioned initially rising to 10 percent in Phase 3. Only non-EITE industries can bid and no one entity can buy more than 30 percent of the total allowances.
  - Offsets: In Phase 3 entities can cover 5 percent of their emissions with offsets with up to half of the offsets from overseas projects.
  - Monitoring and enforcement: Annual emission reports must be submitted within three months from the end of a compliance year with emissions verified by a third-party. Penalties for non-compliance are up to three times the average allowance price in the compliance year.
  - Market stability and institutions: Banking and borrowing rules specified; an Allocation Committee can intervene when market allowance price volatility criteria are met. Institutions involved include Ministry of Environment, Ministry of Economy and Finance, Korea Exchange, Greenhouse Gas Inventory and Research Center.

*Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1korea2021002.pdf*

### Annex II. Pricing Miscellaneous Emissions Sources

### Annex II. Pricing Miscellaneous Emissions Sources

### Agriculture
- Emissions sources and reduction channels:
  - Reducing livestock herds (particularly beef and dairy cattle, but also pigs) reduces methane releases from enteric fermentation and nitrous oxide emissions from manure.
  - Reducing crops reduces nitrous oxide emissions from soils, especially where there is intensive chemical fertilizer use.
  - At the consumer level, shifting from meat and dairy products to plant-based and poultry diets would reinforce mitigation incentives.
- Monitoring and pricing considerations:
  - Direct monitoring of farm level emissions is not currently practical; emissions can be estimated indirectly using farm-level data (on livestock herds, feed, crop production, fertilizer use, and acreage) and default emissions factors.
  - Pricing could be based on proxy estimates of emissions but a compensation scheme for the farm sector may be needed to enhance acceptability and limit emissions leakage.
- Policy options discussed:
  - Emissions taxes: may face strong political opposition and could cause significant emissions leakage by reducing the international competitiveness of Korean farmers.
  - Feebate approach: worth studying, perhaps based on GHG equivalent emission rates per hectare or nutritional value.
  - Combined fee-and-rebate: an emissions fee with revenues recycled to the agricultural sector as a rebate proportional to the value of farm output; administratively could be integrated into collection procedures for business tax regimes for farmers and would cost-effectively promote behavioral responses to reduce emissions intensity.
  - Demand-side measures: taxes on meat and dairy products could promote household-level demand responses, though experiences with ‘sin’ taxes have had mixed success.

### Waste
- Emissions source and mitigation options:
  - Emissions from waste sites arise from bacterial decomposition of organic waste (methane).
  - Mitigation responses are limited and relatively straightforward to specify in regulation: capturing methane for flaring, for use in energy, and diverting waste for recycling and re-use.
- Fiscal vs regulatory rationale:
  - The case for fiscal instruments over regulation is less compelling because landfills are predominantly managed by the public sector and mitigation responses are readily governed by standards.
  - Example regulatory action: the EPA finalized standards to reduce methane emissions from new, modified, and reconstructed municipal solid waste landfills in 2016 though requirements were postponed in 2019.

### Fluorinated (F-) gases
- Characteristics and international context:
  - F-gases are used in refrigerants, foams, aerosols, and fire extinguishers and have warming potentials hundreds of times higher than CO2.
  - Under the 2016 Kigali Agreement, advanced countries are required to reduce HFCs 85 percent (relative to 2011-2013 levels) by 2036 (the United States has not yet ratified the treaty).
  - In 2015, the United States prohibited HFCs for uses where acceptable alternatives were available; enforcement of this rule was suspended in 2018.
- Policy recommendation:
  - Phasing in a tax on HFCs in proportion to the global warming potential of the gas would be an administratively straightforward and flexible way to progressively reduce their use compared with a regulatory approach.
- International precedent and illustrative rates:
  - Denmark, Norway, Poland, Slovenia, Spain, for example, have implemented these taxes with rates equivalent to around US$5-40 per tonne of CO2 equivalent.

*Annex II. Pricing Miscellaneous Emissions Sources.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1korea2021002.pdf_