## eucmpea

## Source details

**Canonical URL:** [eucmpea](https://www.imf.org/-/media/files/publications/dp/2020/english/eucmpea.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/dp/2020/english/eucmpea.pdf.md)
- [Structured JSON version](/-/media/files/publications/dp/2020/english/eucmpea.pdf.json)

---

### Executive summary — context and objectives
- Global temperature has increased by about 1°C above pre-industrial levels so far.
- In the absence of further policy action, temperatures are predicted to rise by around 4°C above pre-industrial levels by 2100.
- The EU’s current Paris Agreement commitment is to cut emissions by at least 40 percent by 2030 relative to 1990 levels; the European Green Deal proposes climate neutrality by 2050 and is considering a more stringent intermediate objective of at least 50 percent for 2030.
- The paper assesses macroeconomic and distributional impact of mitigation scaling and proposes enhancements to EU policies using a computable general equilibrium model (Envisage) and a literature review.

### Executive summary — key findings
- The EU reduced GHG emissions by 23 percent relative to the 1990 level by 2017.
- Emissions intensity declined by 84 percent over recent decades.
- Renewables share in energy production increased to 30 percent over the last three decades.
- Under current policies, EU emissions would fall by 33 percent in 2030 relative to 1990.
- Average forecast of economic cost for the EU of a 2°C global temperature increase is about 3 percent of GDP by 2050.
- A well-designed package—more extensive carbon pricing across EU countries and sectors combined with cuts in distortionary taxes and targeted green investment support—would allow the EU to reach more ambitious emission goals with practically no effects on aggregate income.
- Benefits from reducing extreme climate risk and lower air pollution outweigh mitigation costs from a risk-reward perspective.

### Executive summary — core policy recommendations
- Make robust carbon pricing the core:
  - Expand the ETS to other sectors, or impose national-level carbon pricing for non-ETS sectors.
  - Set a uniform carbon price across the EU.
  - Introduce a carbon price floor in the ETS.
  - Discontinue free allowances.
- Discontinue subsidies and tax exemptions to fossil fuels in the EU.
- Use part of carbon-pricing revenue to:
  - Cut distortionary taxes.
  - Compensate the most vulnerable households.
  - Support worker transitions to greener jobs.
- Complement with targeted green investment (infrastructure, R&D, green taxonomy) and ensure social support and communication for vulnerable households.

### Introduction — policy questions and context
- Key questions:
  - Macroeconomic implications of cutting EU carbon emissions by 50 percent by 2030 versus current 40 percent target?
  - Complementarities and trade-offs between carbon pricing and other tools? How to implement robust carbon pricing?
  - How to use carbon-pricing revenues to improve efficiency and political acceptability and address distributional effects?
  - Role of green investment in post-COVID recovery?
- EC proposed European Climate Law in March 2020; EC impact assessment of increasing 2030 target from 40 percent to at least 50 percent (compared with 1990) to be completed in September 2020.
- EC reviewing options including extending ETS to road transport, buildings, maritime and examining BCA; concrete proposals planned by June 2021.
- The EU accounts for about a quarter of world cumulative emissions historically, but for less than 10 percent of current emissions.

### Current EU mitigation framework — facts and design
- Key elements: Emissions Trading System (ETS) and Effort Sharing Regulation (ESR).
- ETS covers about 40 percent of total EU emissions; country shares vary between 21 and 84 percent.
- ETS cap reduces annually so emissions in 2030 align with current ETS reduction target of 43 percent compared to 2005.
- ETS geography: EU, Iceland, Liechtenstein, Norway, United Kingdom (as of 2020); linked with Swiss ETS in January 2020.
- Free allowances allocation details (benchmarks, aviation, power generation derogations).
- 2018 total surplus allowances: 1.6 billion allowances.
- Market Stability Reserve (MSR): 24 percent share placed into MSR until 2023, halved afterwards; starting 2023 MSR reserves in excess of previous year’s auction volume will be permanently invalidated.
- ETS price behavior during COVID-19: initial drop then stabilization at around €20.
- Member states collected €14.1 billion revenue from the ETS in 2018; ETS Directive stipulates at least 50 percent of proceeds should be used to combat climate change; member states used over 80 percent of revenues from 2013 to 2017 for such purposes.
- ESR sets country-specific targets for non-ETS sectors; EU-wide non-ETS goal: reduce emissions by 30 percent by 2030 compared to 2005.
- Renewables targets: 20 percent by 2020 and at least 32 percent by 2030.
- Energy efficiency targets: 20 percent by 2020 and at least 32.5 percent by 2030.

### Green Deal investment framework and recovery
- Green Deal Investment Plan aims to mobilize at least €1 trillion over the next decade.
- Planned funding breakdown:
  - EU budget funds: €503 billion
  - EU budget guarantees expected to generate €279 billion through InvestEU
  - National co-financing: €114 billion
  - ETS revenue: €25 billion
- Just Transition Mechanism: €143 billion for most affected regions.
- Next Generation EU package:
  - Earmarks about a third of resources for climate change mitigation and adaptation across RRF and EU budget top-ups for 2021–2027.
  - Additional allocations: Just Transition Fund €10 billion; European Agriculture Fund for Rural Development €7.5 billion; InvestEU €5.6 billion; R&D €5 billion.
- Estimated total gross investment needed to achieve EU 2030 emissions and renewable targets: between €140–€290 billion per year.

### Annex 1 / Model (Envisage) — analytical approach and assumptions
- Envisage: computable general-equilibrium model for 16 country groups (>180 countries), 27 sectors including 13 energy sectors; nested CES with heterogeneous elasticities.
- Model features: temporary wage rigidities, capital reallocation frictions, trade costs, energy efficiency gains, progressive electrification, declining renewable costs.
- Baseline assumptions:
  - Starting economy-wide average price: about €9 per ton in 2020.
  - GDP and population growth from IMF April 2020 WEO.
  - Energy efficiency improves by 1.5 percent annually.
  - Electrification increases by 50 percent by 2030 (except transport: 75 percent).
  - Cost declines 2014–2030: wind −13 percent, solar −35 percent, other renewables −18 percent.
  - Under assumptions, EU emissions fall by 35 percent relative to 1990 in the baseline “Unchanged policies.”

### Annex 1 — carbon price scenarios and aggregate impacts
- 50 percent emission reduction target requires equilibrium carbon price of €101 per ton by 2030 in baseline “Lump-sum transfers” scenario.
  - Implies €120 increase in annual electricity bill for an average EU citizen (given 2014 electricity consumption values).
  - Carbon pricing revenue ~1.1 percent of EU GDP by 2030.
- 40 percent emission reduction target requires carbon price of €40 and an income loss of 0.3 percent of GDP.
- Lump-sum transfers scenario (50% target): income loss and unemployment impacts shown in model tables (see source for verbatim tables).
- Labor tax cut scenario (50% target): using all carbon revenue to reduce labor taxes yields income 0.4 percent below baseline (substantially recouping losses).
- Renewable subsidy scenario (75 percent cap on subsidy rate): required carbon price falls to €59 per ton; renewable share increases to 48 percent EU average; income in 2030 is 0.2 percentage points higher than lump-sum transfers scenario.

### Distributional impacts and compensation
- Raising carbon price to €100 per ton of CO2 by 2030 analyzed with consumption survey data and Envisage endogenous price/wage effects (analysis may overestimate impacts due to fixed energy consumption assumption and not accounting for revenue use).
- Country examples:
  - France: effect regressive — purchasing power decline about 1½ percent for lowest quintile and about 1¼ percent for highest quintile.
  - Germany: effect about 2 percent of consumption for bottom four quintiles.
- Lump-sum compensation calibrated to fully compensate bottom quintile: requires €374 and €232 per capita yearly dividend in Germany and France respectively; fiscal cost around 0.6 percent of GDP in Germany and 0.4 percent of GDP in France if phased out linearly from second to top quintiles.

### Labor reallocation and transition policies
- Sectoral shifts: coal mining and fossil fuel power generation decline sharply; oil and gas extraction decline; renewable power sectors gain employment.
- Temporary unemployment increase estimated 0.3 to 1 percentage points depending on scenario.
- Policy recommendations for workers: well-targeted active labor market policies (retraining, employment services, transportation stipends, job search assistance), localized investment.

### Carbon leakage, BCA, and global coordination
- Envisage simulation: increase in EU carbon prices raises emissions in the rest of the world by about 15 percent for each unit of EU emissions avoided.
- Empirical leakage estimate: around 13 percent for the EU.
- Table 6 (selected results verbatim in source) highlights:
  - EU-wide Carbon Price (50%): Carbon Leakage to the ROW 14.7 percent; Income 20.9 (percent change from BaU as presented in source table).
  - Border-adj. (50%): figures presented in source table include mixed formatting (see source).
  - Global Carbon Price (47% emissions rel. to 1990): Carbon leakage NA; Income 20.7 (percent change from BaU as presented in source table).
- BCA design notes:
  - Levy equal to EU carbon price minus carbon price at origin; reduces import substitution and generates revenue; measurement and WTO compliance challenges; interim macro measures possible; initial scope could target emission-intensive and trade-exposed sectors.
  - Export treatment is a design choice with trade-offs for domestic emissions and fiscal revenue.

### Feebates and regulatory complements
- Feebates: tax/rebate proportional to product/facility emission difference from sector average; often revenue neutral within a sector.
- Feebate illustrative calibration for vehicles:
  - Feebate CO2 price: €500 per ton of CO2.
  - New vehicle fleetwide CO2 emission rate: 95 grams per km.
  - Lifetime discounted driving: 100,000 km.
  - Subsidy for ZEVs: €4,800.
  - Tax on 150 grams CO2/km vehicle: €2,750.
  - Pivot point declines example: subsidy decline 32 percent when fleetwide average falls to 65 grams CO2/km.
- Feebates are politically acceptable and can be more cost-effective than regulations when harmonized, but less efficient than economy-wide carbon pricing.

### Green investment, market failures, and priorities
- Carbon pricing spurs investment, but public support needed for market failures beyond emission externalities.
- Increase in carbon prices needed to reduce EU emissions by 50 percent would lead to 11 percent annual growth in renewables capital.
- Policy priorities for public support:
  - Retrofitting buildings, charging stations, upgrading electricity grids.
  - Public investment in networks, R&D subsidies, support for early deployment with sunset as technologies mature.
- Scale of investment needed: Green Deal aims to mobilize €1 trillion over next 10 years; estimated gross investment needed between €140–€290 billion per year to meet 2030 targets.
- Green finance: implement EU taxonomy, strengthen reporting and verification to prevent greenwashing; disclosure requirements phased in.

### Governance and industrial policy principles
- Principles: embeddedness, discipline (transparent decision-making, monitoring, conditionality, sunset clauses), accountability (periodic reporting, audits, independent courts, press).
- Efficient and transparent use of public funds critical to preserve political support.

### Selected model numeric outcomes and sensitivities (verbatim-style highlights)
- Baseline “Unchanged policies”: EU emissions fall by 35 percent relative to 1990 (model baseline).
- National Targets (no trade) for 50% target: required average carbon price by 2030: €136 per ton; some countries up to €216 per ton; EU aggregate income fall: 1.2 percent relative to baseline.
- EU-wide trading for 50% target: uniform carbon price €101 per ton in 2030; associated aggregate income loss: 0.9 percent relative to baseline.
- Annex 1 highlights that the 50 percent target with lump-sum transfers yields carbon pricing revenue of about 1.1 percent of EU GDP by 2030.
- Model caveats: transitional income losses driven by wage rigidities and capital reallocation frictions; results sensitive to substitution elasticities and other parameters; Envisage lacks forward-looking behavior and does not incorporate economic value of avoided climate damages.

### Consolidated policy package (from analysis)
- Implement EU-wide uniform carbon pricing (expand ETS or national pricing) combined with welfare-preserving transfers.
- Strengthen ETS price signal via auction price floor and/or MSR reform (price-based activation).
- Phase out free allowances and fossil fuel tax exemptions/subsidies.
- Use carbon pricing revenues to cut distortionary labor taxes and finance critical public investment.
- Provide targeted labor-market policies and regional support for transitions.
- Design progressive household compensation mechanisms (lump-sum or marginal tax reductions).
- Pursue international coordination (carbon price floor across major emitters) and consider BCA to limit leakage where coordination absent.
- Leverage COVID-19 recovery to frontload green investment and set a predictable, gradually increasing carbon price path.

*Source: eucmpea — https://www.imf.org/-/media/files/publications/dp/2020/english/eucmpea.pdf*

### Executive Summary ������������������������������������������������������������������������������������������������������

### Executive Summary

### Context and objectives
- Global temperature has increased by about 1°C above pre-industrial levels so far.
- In the absence of further policy action, temperatures are predicted to rise by around 4°C above pre-industrial levels by 2100.
- The EU’s current Paris Agreement commitment is to cut emissions by at least 40 percent by 2030 relative to 1990 levels; the European Green Deal proposes climate neutrality by 2050 and is considering a more stringent intermediate objective of at least 50 percent for 2030.
- The paper assesses the macroeconomic and distributional impact of options to scale up mitigation and proposes enhancements to existing EU policies, using a computable general equilibrium model (Envisage) and a review of the literature.

### Key findings
- The EU has already reduced GHG emissions by 23 percent relative to the 1990 level by 2017.
- Emissions intensity (emissions per GDP) declined by 84 percent over recent decades.
- The share of renewables in energy production increased to 30 percent over the last three decades.
- Under current policies, EU emissions would fall by 33 percent in 2030 relative to 1990.
- The average forecast of the economic cost for the EU of a 2°C global temperature increase is about 3 percent of GDP by 2050; actual costs could be much higher.
- A well-designed package—more extensive carbon pricing across EU countries and sectors combined with cuts in distortionary taxes and targeted green investment support—would allow the EU to reach more ambitious emission goals with practically no effects on aggregate income.
- From a risk-reward perspective, the benefits of reducing the risk of extreme life-threatening climate events and the health benefits from lower air pollution clearly outweigh the costs of mitigation policies.

### Policy recommendations — core elements
- Make more robust carbon pricing the core of the EU climate package:
  - Expand the emission trading system (ETS) to other economic sectors, or impose national-level carbon pricing for sectors outside the ETS.
  - Set a uniform carbon price across the EU to focus on lowest-cost mitigation opportunities and help avoid carbon leakage between member states.
  - Introduce a carbon price floor in the ETS to provide a predictable price signal for investors.
  - Discontinue the use of free allowances to allow a more efficient use of public resources.
- Discontinue subsidies and tax exemptions to fossil fuels in the EU.

### Complementary instruments and trade-offs
- If raising carbon prices proves politically difficult, consider complementary tools such as feebates, subsidies, or regulations:
  - These instruments reduce the explicit carbon price necessary to achieve climate goals but tend to be less economically efficient because they operate through only a subset of mitigation channels and do not generate fiscal revenue.
- Use part of carbon-pricing revenue to enhance economic efficiency and political acceptability:
  - Cut distortionary taxes.
  - Compensate the most vulnerable households.
  - Support the transition of workers to greener jobs.

### Distributional and sectoral transition policies
- Fiscal transfers can support lower-income member states most exposed to higher carbon prices.
- Within countries, facilitate worker transitions through retraining programs, targeted job-search support, and regional development assistance.
- Mitigate impacts on low-income households through the social support system and clear communication of support schemes to build public support.

### Carbon leakage and international coordination
- Establishing a carbon price floor across all major emitting countries is necessary to tackle global emissions effectively.
- In the absence of international agreements among major emitters, carbon leakage to non-EU countries could undermine the EU’s effort to curb global warming.
- A carbon border adjustment (BCA) mechanism could complement the package to equalize the cost of carbon emissions for domestically produced and imported goods, though operational, legal, and political aspects need consideration.
- The EU currently grants free emission permits to certain firms to reduce leakage; the Green Deal proposes BCA as a more efficient alternative.

### Investment and green recovery
- Large investments are needed for long-term environmental sustainability and can support recovery from the COVID-19 crisis.
- A predictable gradual path to a higher carbon price will spur investment in green technologies and infrastructure and generate fiscal revenue.
- Even under optimal carbon pricing, targeted public support is needed to address market failures beyond emission externalities:
  - Public investment to improve infrastructure including public transportation networks and electricity grids.
  - R&D support to boost research in low-emission technologies.
  - Development of a robust green taxonomy to foster green financing.
- The EU recovery packages, which already have a strong green focus, should integrate these priorities.

### Modeling and analytical approach (overview)
- Quantitative analysis is grounded in a computable general equilibrium model (Envisage) and supported by a literature review.
- The analysis informs the macroeconomic and distributional impacts of different mitigation policy packages and revenue-recycling options.

*Source: Executive Summary, eucmpea - Executive Summary.*

### Introduction

### Introduction

### Key policy questions framed
- What would be the macroeconomic implications of bringing EU carbon emissions down by 50 percent by 2030 (compared to a path based on unchanged policies and to the current goal of 40 percent)? What are the complementarities and trade-offs between carbon pricing and other policy tools to cut emissions? How to implement more robust carbon pricing in the EU?
- How to use carbon pricing revenues to enhance economic efficiency and the political acceptability of higher carbon pricing? How to address the distributional effects of mitigation policies? What complementary policies are needed to ensure a smooth transition to a low carbon economy? How to reduce carbon leakage?
- What is the role of green investment in the policy package? How should it be integrated in the post-COVID recovery effort? How should projects be selected, and what safeguards need to be in place?

### Context and objectives
- The EC proposed a European Climate Law in March 2020 to enshrine the 2050 climate neutrality objective in legislation.
- The EC is conducting an impact assessment of increasing the EU emission reduction target for 2030 from 40 percent to at least 50 percent compared with 1990 levels, to be completed in September 2020.
- The EC is reviewing policy instruments including a possible extension of the ETS to new sectors (road transport, building, maritime) and examining carbon border adjustment mechanisms; concrete policy proposals are planned by June 2021.
- The EU accounts for about a quarter of world cumulative emissions historically, but for less than 10 percent of current emissions.

### Structure of the paper
- Chapter 2: describes current EU policies and future policy plans.
- Chapter 3: discusses possible enhancements to existing policies, with quantitative simulations of economic impacts across EU countries and households.
- Chapter 4: summarizes main policy recommendations.

### Overview of the EU mitigation policy framework
- Key elements: Emissions Trading System (ETS) and Effort Sharing Regulation (ESR), complemented by other EU directives.
- ETS covers emissions from large companies in energy, industry, and aviation (flights within the European Economic Area). The ETS covers about 40 percent of total EU emissions; for individual countries the share varies between 21 and 84 percent.
- For sectors not covered by the ETS, the ESR defines individual national emission reduction targets.

### Emission Trading System (ETS) — design and facts
- The ETS is a cap-and-trade system limiting total specified GHG emissions; the cap is reduced annually so that emissions in 2030 would be in line with the current ETS reduction target of 43 percent compared to 2005 levels.
- The ETS applies to the EU, Iceland, Liechtenstein, Norway, and the United Kingdom (as of 2020); linked with the Swiss ETS in January 2020.
- Free emission allowances allocation:
  - Manufacturing sectors at risk of carbon leakage receive free allowances at 100 percent of a benchmark level.
  - Manufacturing sectors not at risk of leakage receive some free allowances (expected to be eliminated by 2030).
  - Within aviation, 15 percent of allowances are auctioned, 82 percent allocated for free based on benchmarks, and 3 percent constitute a special reserve for new entrants and fast-growing airlines.
  - In power generation, auctioning applies to all emissions with optional derogation for modernization in certain member states.
  - 5 percent of total allowances are freely allocated to new installations and covered installations whose capacity has significantly increased since their free allocation was determined.
- Historical price dynamics and surplus:
  - The implied carbon price was volatile and generally low; the 2008 collapse created a large surplus of allowances.
  - In 2018, total surplus allowances amounted to 1.6 billion allowances, equivalent to all verified emissions that year excluding aviation.
  - Overlapping policies and energy efficiency improvements reduced demand for allowances, fueling surpluses.
- Market Stability Reserve (MSR):
  - Introduced in January 2019 to reduce ETS price volatility by placing a fraction of surplus allowances into a reserve when surplus exceeds a threshold.
  - The share placed in the MSR is set at 24 percent until 2023 and will be halved after that.
  - Permits in MSR are placed back into the ETS if surplus falls below a certain threshold; starting in 2023, MSR reserves in excess of the previous year’s auction volume will be permanently invalidated.
  - Some analyses argue the MSR may not absorb all surpluses and that MSR rules are opaque and complex.
- ETS price behavior during COVID-19: initial drop then stabilization at around €20.
- Revenue and use:
  - Member states collected €14.1 billion revenue from the ETS in 2018.
  - ETS revenues are channeled into national budgets mainly based on historical emissions.
  - ETS Directive stipulates at least 50 percent of proceeds should be used to combat climate change in the EU or third countries; in practice, member states used over 80 percent of the revenues from 2013 to 2017 for such purposes.
  - Proposals exist to channel part of the revenue to the EU budget in the future.

### Effort Sharing Regulation (ESR)
- The ESR sets country-specific targets for non-ETS sectors.
- For the EU as a whole, the goal for non-ETS sectors is to reduce emissions by 30 percent by 2030 compared to 2005 levels.
- Countries with lower GDP per capita have less ambitious targets; the 2030 target is the endpoint of a linear reduction trajectory for 2021–30.
- Member states can use carbon taxes, financial support, regulations, and National Energy and Climate Plans to meet targets.
- Some countries have introduced carbon taxes with varying sectoral coverage and rates; more countries (including Germany and the Netherlands) are planning to adopt national carbon pricing.
- Member states are allowed limited transfers in meeting annual ESR targets: allowed to trade ETS allowances up to 2 percent of each country’s effort sharing emissions in 2005 (Iceland, Luxembourg, and Norway are allowed up to 4 percent); this equates to less than 0.5 percent of emissions from non-ETS sectors.

### Other EU directives: renewables, efficiency, and sustainable finance
- Renewables targets: increase share of renewables in energy consumption to 20 percent by 2020 and to at least 32 percent by 2030.
- Energy efficiency targets: 20 percent improvement by 2020 and at least 32.5 percent by 2030 (2012 Energy Efficiency Directive).
- Energy Performance Criteria and other standards apply to buildings, appliances, and car emissions.
- Sustainable finance:
  - The European Investment Bank pioneered green bonds.
  - EC’s Action Plan on Sustainable Finance introduced taxonomy work, disclosure regulations, and standards; some measures concluded, others ongoing.
  - Investment funds offering green portfolios will be required to use EU climate adaptation and mitigation criteria from end-2021.

### The Green Deal investment framework and recovery
- The Green Deal Investment Plan aims to mobilize at least €1 trillion over the next decade.
- Funding breakdown (planned):
  - EU budget funds: €503 billion
  - EU budget guarantees to the EIB and other institutions expected to generate €279 billion through InvestEU
  - National co-financing: €114 billion
  - ETS revenue: €25 billion (or roughly 20 percent of total ETS revenue)
- Just Transition Mechanism: €143 billion focused on most affected regions for job support and project finance (building renovation, renewable energy, district heating, sustainable transport).
- Next Generation EU package:
  - Earmarks about a third of resources for climate change mitigation and adaptation across RRF and EU budget top-ups for 2021–2027.
  - Additional allocations: Just Transition Fund €10 billion; European Agriculture Fund for Rural Development €7.5 billion; InvestEU program €5.6 billion (focusing on green infrastructure); R&D €5 billion.
  - Disbursements under the RRF conditional on investment plans consistent with National Energy and Climate Plans.
  - Funding sources include transfers and a new EU-wide tax on nonrecycled plastics scheduled for next year.
  - EC is considering extending the ETS to road transport and new sectors and introducing a carbon border adjustment mechanism.

### Analytical approach and focus of the assessment
- The analysis focuses on mitigation policies to allow the EU to cut GHG emissions by 40 to 50 percent in 2030 relative to 1990 levels, consistent with the Paris Agreement or the tentative Green Deal targets.
- Evaluation criteria: impact on carbon and energy prices, macroeconomic aggregates, distributional effects, and spillovers to the rest of the world.
- Methods: simulations from a highly granular general-equilibrium model (Envisage) and a review of the optimal policy literature.
- The estimated carbon price levels needed are broadly consistent with other models; the paper emphasizes tradeoffs and complementarities across policy options rather than absolute price levels.

*Source: eucmpea - Introduction*

### Annex 1 describes the

### eucmpea - Annex 1 describes the

### Introducing EU-wide carbon pricing
- Introducing EU-wide uniform carbon pricing should be a key component of the policy package.
- Carbon pricing aligns marginal abatement costs across all agents, minimizing economic efficiency loss (EC 2014a; IMF 2019a; Parry 2020).
- Carbon prices in the EU currently vary across sectors and countries, generating an inefficient allocation of abatement efforts.
- To improve social acceptance of a uniform carbon price, it can be combined with welfare-preserving transfers.

### Implementation approaches and equivalence
- A cap-and-trade system with full sectoral coverage and a carbon tax are broadly equivalent: given the same sectoral coverage, both can achieve the same carbon prices and raise the same amount of revenue (Goulder and Schein 2013).
- Key differences:
  - Carbon taxes: more certainty about future prices; emissions reduction uncertain.
  - Cap-and-trade: more certainty about quantity of emissions; higher price volatility; potentially higher setup costs.
  - Complementary regulations for sectors already in an ETS can cause a “waterbed effect” where permit prices fall and overall emissions do not decline.
- Unified carbon pricing can be implemented by expanding the EU ETS to all major emitting sectors.
  - A comprehensive cap-and-trade system covering all emissions implies a lower uniform carbon price and smaller aggregate income loss for the same EU-wide reduction in emissions compared to the current framework with limited trade between sectors and countries.
  - Extending the EU ETS is feasible; some jurisdictions have broader systems (Western Climate Initiative, California, New Zealand ETS). Germany will introduce an ETS in transport and building sectors starting in 2021.
  - ETS can be implemented midstream (at the fuel distributor level) based on carbon content of fossil fuels to mitigate administrative burden.
  - If ETS coverage is not extended to all sectors, remove limitations on trade of ETS allowances between member states for non-ETS sectors, or introduce national-level carbon pricing (carbon taxes or national ETSs) for non-ETS sectors.
  - Excess permits from member-state aggressive policies should be cancelled to prevent waterbed effects; introducing a carbon price floor in the ETS is an alternative.

### Price signal strengthening and MSR / price floors
- Under cap-and-trade, endogenous price volatility can undermine political support and investment/R&D.
- Two approaches to stabilize price path:
  - An ETS auction price floor could be set. Price floors exist in other cap-and-trade systems (California, Massachusetts, Quebec, RGGI). Fischer and others (2019) conclude an auction reserve price is legally feasible; political constraints could remain.
  - Strengthen the MSR (Market Stability Reserve): make quantitative allowances consistent with a predictable price floor by replacing the current quantity surplus trigger with a price-based threshold to activate the reserve. The review of the MSR in 2022 is an opportunity to revisit functioning.
- An implicit reserve price already exists in the EU ETS via Article 7(6) of the Auctioning Regulation, but it has not prevented low and volatile carbon prices.

### Phase-out of free allowances and fossil fuel subsidies
- Free allowances to sectors at risk of carbon leakage could be phased out; foregone auction revenues could be used more efficiently for economy-wide benefits.
- Any compensation for the cost of electricity for energy-intensive industries should be removed.
- Remaining subsidies and tax exemptions to fossil fuels in the EU should be discontinued to achieve uniform pricing:
  - Remaining direct subsidies estimated at about $1 billion (Coady and others 2019).
  - Tax exemption estimates range from around $46 billion (foregone consumption tax revenue) up to more than $200 billion when using the highest prevailing rate in member states (EC 2014b).

### Using revenues to enhance economic efficiency and political acceptability
- Carbon pricing generates fiscal revenue from allowance auctions or carbon taxes.
- To maximize economic efficiency, revenue should be used to decrease distortionary taxes (such as labor income tax) or address public investment gaps.
- Model simulations indicate using carbon price revenue to cut labor taxes allows more ambitious emission reduction by 2030 with minimal impact on aggregate income and employment.
- Comparison of revenue uses (summary of simulation results; see Annex 1 for more detail):
  - Rebating revenue to households as lump sum: income loss of 0.9 percent and 0.5 percentage point higher unemployment (Figure 9).
  - Labor tax cut: recoups almost all income losses from higher carbon prices; enhances political acceptability when announced simultaneously with carbon price increase.
  - Subsidy to renewable investment: income loss slightly larger than labor tax cut but smaller than lump-sum transfers; model may understate social returns from R&D and networks; public support should not be tied strictly to carbon revenue.
- Important simulation tables (presented verbatim from source):
  - Table 4. EU: Impact on Income of Emission Reduction Policies, 2030
    - Emissions  (rel. to 1990, percent)  Income  (rel. to BaU, percent)
    - EU-wide Carbon Price (40%) 24020.3
    - EU-wide Carbon Price (50%) 25020.9
    - National Targets (50%) 1 25021.2
    - Source: Authors’ calculations.
    - Note: Carbon price revenue used as lump-sum transfer. Income losses reflect transitional effects due to wage rigidities and capital reallocation frictions. BaU = business as usual (baseline); EU = European Union.
    - 1 No trade is allowed between EU member states.
  - Table 5. EU: Impact on Macroeconomic Aggregates of Revenue Recycling Options, 2030
    - Emissions  (rel. to 1990, percent)  Carbon Price  (2019€ per ton of CO2)  Income  (rel. BaU, percent)  Unemployment  (rel. BaU, ppts)  Energy Share of Renewables  (percent)
    - Unchanged Policies (BaU) 240   11––32.6
    - Lump-sum Transfers 250 101 20.9 0.541.0
    - Labor Tax Cut 250 102 20.4 0.041.2
    - Renewable Subsidy 250   59 20.7 0.147.9
    - Source: IMF staff calculations.
    - Note: Income, unemployment, and capital are expressed as percentage deviations from the baseline. BaU = business as usual (baseline).
- Additional notes:
  - Beyond 2030, carbon pricing revenue would start to decrease as the EU approaches its 2050 goal of net zero emissions because the revenue base will shrink.
  - Empirical estimates suggest the effect of carbon pricing on output and employment in the EU has been close to zero (Metcalf and Stock 2020).

### Complementary instruments: feebates and regulations
- Feebates:
  - Taxes and rebates proportional to difference between firm/product specific and industry average carbon emission rates.
  - Low-emission technologies receive subsidy; high-emission ones pay tax.
  - Usually approximately revenue neutral within a sector; effective at lowering sector emissions but less cost efficient than economy-wide carbon pricing.
  - Can be politically acceptable and impose little burden on average households.
- Regulations:
  - Standards to increase low-emission energy share or improve energy efficiency can yield similar emission reductions if comprehensive.
  - Regulations provide less individual flexibility and generate higher welfare losses for heterogenous consumers/firms; require strong assumptions on future technologies.

### Ensuring equal burden sharing across member states
- Uniform carbon price reduces aggregate EU-level income losses but could impose disproportionate costs on some countries.
- Income cost in lump-sum transfers scenario ranges from 0.5 percent of GDP in France to 1.9 percent in Eastern Europe.
- Intra-EU compensatory transfers can share burden equally while preserving efficiency of uniform pricing; could use EU’s Just Transition Mechanism.
- A transfers system neutralizing income impact across countries would not significantly alter average EU macroeconomic variables.

### Managing the sectoral transition and labor reallocation
- Transition will reallocate employment across sectors: coal mining and fossil fuel power generation decline sharply; oil and gas extraction decline; renewable power sectors gain employment.
- In a world with wage rigidities, temporary unemployment can rise as workers relocate (estimated overall increase in unemployment is 0.3 to 1 percentage points depending on scenario).
- Policies to support workers (not specific jobs/sectors) should be well targeted due to small share and geographical concentration of affected workers.
  - Active labor market policies: re-training (examples: National Retraining Scheme in the United Kingdom; Job-rotation program in Denmark), employment services, transportation stipends, job search assistance, localized investment.

### Distributional impacts across households
- Higher carbon prices affect households directly via energy prices and indirectly via general equilibrium effects on consumption goods and wages.
- Incidence analysis of raising carbon price to €100 per ton of CO2 by 2030 using consumption survey data (with endogenous price/wage changes from Envisage simulations):
  - Analysis may overestimate impact because: energy consumption assumed fixed; burden calculation does not account for use of carbon price revenue.
- Country examples:
  - France: effect is regressive — purchasing power decline about 1½ percent for lowest income quintile and about 1¼ percent for highest quintile (Figure 13).
  - Germany: effect similar for bottom four quintiles at about 2 percent of consumption (Figure 14).
- Compensation options:
  - Lump-sum transfers calibrated to fully compensate bottom quintile: would require €374 and €232 per capita yearly dividend in Germany and France respectively; fiscal cost around 0.6 percent of GDP in Germany and 0.4 percent of GDP in France if dividend phased out linearly from second to top quintiles, substantially less than carbon revenue raised.
  - More elaborate compensation: reduce high marginal tax rates to improve labor supply while compensating households; can be made progressive by larger reductions for lower-income earners.

### Carbon leakage and global coordination
- Potential carbon leakage channels: (1) increased imports or outsourcing of energy-intensive goods as domestic costs rise; (2) global energy prices fall as EU demand declines (second channel relatively small for EU).
- Envisage model simulation: an increase in EU carbon prices would raise emissions in the rest of the world by about 15 percent for each unit of EU emissions avoided (see Table 6).
- Empirical estimates: carbon leakage rate around 13 percent for the EU, higher for some countries.
- Leakage higher for emission-intensive, trade-exposed industries (cement, aluminum, steel, iron) with large carbon price differentials.
- Coordinated global emission reduction (common carbon price) is most effective: abatement at lowest global economic cost; with global price action, EU would need to cut emissions by less (47 percent vs. 50 percent) and have lower output losses.
- Table 6 (verbatim from source):
  - Table 6. EU: Carbon Leakage Under Different Policies, 2030
    - Emissions  (% change rel. to 1990)  Carbon Leakage to the ROW  (percent)  Income  (% change from BaU)
    - Unchanged Policies (BaU) 240 ––
    - EU-wide Carbon Price 250 14.7 20.9
    - Border-adj. (BCA) 25021.120.5
    - Global Carbon Price 247 NA 20.7
    - Source: Authors’ calculation.
    - Note: Carbon leakage is defined as the change in emissions in the rest of the world divided by the decline in emissions in the EU. A positive (negative) sign indicates increasing (decreasing) emissions abroad. BaU = business as usual (baseline); BCA = border carbon adjustment; NA = not applicable; ROW = rest of world.

### Key policy recommendations (extracted from analysis)
- Implement EU-wide uniform carbon pricing as a core policy, combined with welfare-preserving transfers to improve social acceptance.
- Expand ETS coverage to all major emitting sectors or introduce national carbon pricing for non-ETS sectors; consider midstream implementation at fuel distributors.
- Strengthen the ETS price signal via an auction price floor and/or MSR reform (price-based activation threshold).
- Phase out free allowances and electricity cost compensations for energy-intensive industries; remove remaining fossil fuel tax exemptions and subsidies.
- Use carbon pricing revenues to cut distortionary labor taxes or finance critical public investment to recoup income losses and enhance political acceptability.
- Provide well-targeted labor market policies and localized support to smooth worker transitions; prioritize retraining and complementary services.
- Design progressive household compensation mechanisms (lump-sum or reductions in marginal labor tax rates) to protect vulnerable households while preserving efficiency.
- Pursue global coordination (common carbon pricing) and consider border carbon adjustments to limit carbon leakage.

*Italic: Source: eucmpea - Annex 1 describes the — https://www.imf.org/-/media/files/publications/dp/2020/english/eucmpea.pdf*

### introduction of a BCA mechanism as a policy option to reduce carbon leak-

### introduction of a BCA mechanism as a policy option to reduce carbon leak-

### Design and rationale for a Border Carbon Adjustment (BCA)
- A BCA can be designed as a levy on the carbon content of imports equal to the EU carbon price minus the carbon price at origin.
- Expected effects:
  - Reduce leakage by discouraging import substitution of energy intensive goods.
  - Generate fiscal revenue.
  - Provide an incentive for EU trading partners to reduce the carbon content of their exports.
- Limitation: Any type of BCA would eliminate only the leakage embodied in trade. It would not address the potential increase in global fossil fuel consumption induced by the reduction in fossil fuel prices due to lower demand by the EU.

### Practical challenges and design choices
- Political and legal risks:
  - Some trading partners might regard a BCA as protectionist and seek to impose retaliatory trade measures.
  - Compliance with World Trade Organization rules depends on BCA design and has not been legally tested so far.
- Measurement challenges:
  - Measuring the carbon content of traded goods is difficult.
  - Possible interim solution: use “macro measures” such as country or sector averages.
    - Macro measures do not incentivize individual producers to reduce emissions but could incentivize trading partner countries to increase carbon pricing.
    - Over time, individual producers could obtain emissions certifications from internationally recognized institutions.
- Adjusting the levy:
  - Precisely adjusting the border levy for differences in effective carbon taxes implied by trading partners’ carbon mitigation schemes is challenging.
  - Easier when partners rely on explicit price mechanisms (ETS or carbon tax); difficult when costs are implicit via regulations and standards.
- Sectoral scope:
  - Initial application could be limited to emission-intensive and trade-exposed sectors because they account for the largest share of trade-embedded carbon and face the highest carbon leakage rates.
  - Coverage could be extended over time as measurement and administrative costs decline.
- Export treatment:
  - Policy choice: whether to refund the tax paid on the carbon content of EU exports.
    - If exports are exempt: avoids competitiveness impact on domestic producers but increases domestic emissions and foregoes fiscal revenues.
  - Effectiveness of alternative instrument designs (BCAs, carbon price rebates/exemptions) depends on relative emission rates, elasticities of substitution, and consumption volumes.

### Supporting investment and promoting a green recovery
- Need for complementarity:
  - Higher carbon pricing should be complemented with public support to ensure rapid expansion of green technology investment.
- Model-based estimates and implications:
  - The increase in carbon prices needed to reduce EU emissions by 50 percent would lead to 11 percent annual growth in renewables capital (helping to achieve the EU 2030 renewables share goal).
  - Higher prices stimulate innovation in green technologies (evidence: Popp (2002) and Ley, Stucki, and Woerter (2016)).
- Market failures and the role for public support:
  - Green investment is constrained by market failures beyond emission externalities; carbon pricing alone cannot fully correct these.
  - Public support instruments include direct public investment in green R&D and infrastructure, government subsidies and guarantees, and targeted grants especially for small producers.
  - Frontloading investment support while stepping in carbon pricing more gradually could boost aggregate demand in the short term and help close current output gaps.
  - Low interest rates provide opportunities for low-cost funding of green investments with high long-term returns.
- Policy focus areas for green recovery:
  - Examples to prioritize: retrofitting buildings, building charging stations, upgrading electric grids.
  - Exercise caution in funding sectors that will become unsustainable as carbon prices rise.
- Scale of investment needs and targets:
  - The Green Deal aims to mobilize €1 trillion of green investment over the next 10 years.
  - Estimated total (public and private) gross investment needed to achieve the EU’s 2030 emissions and renewable targets: between €140–€290 billion per year.

### Public support priorities and instruments
- Areas with high social returns:
  - Public investment in networks (electricity grids, electric vehicle charging stations, public transport infrastructure, internet broadband).
  - Public provision and subsidies for R&D in green technologies to encourage knowledge spillovers, especially for early-stage technologies.
  - Support for private investment in early deployment to promote learning by doing; public support should be discontinued as technologies mature.
- Financing constraints and targeted support:
  - Financial constraints are acute in the energy sector due to long time horizons and large initial fixed costs.
  - Government grants can help small producers and low-income households (for building efficiency improvements).
  - Path dependency in high-emitting technologies provides a motive to subsidize early deployment (Aghion and others 2016).

### Green finance, taxonomy, and disclosure
- Operationalization of the EU taxonomy of environmentally sustainable activities is key to strengthening green finance.
- Strengthening reporting and verification systems helps prevent “greenwashing.”
  - Improve comparability by requiring a limited number of common indicators (ideally building on existing measures, e.g., emissions reported to the ETS).
  - Introduce disclosure requirements gradually and flexibly.
- Note: Comprehensive carbon pricing is identified as a more effective and less administratively costly way to reorient finance to greener activities.

### Accountability, governance, and principles for industrial policy
- Efficient and transparent use of public funds is critical to preserve political support for large-scale green investment.
- Basic principles for industrial policy:
  - Embeddedness: Understand private sector needs and bottlenecks.
  - Discipline: Transparent decision-making, monitoring and evaluation, unbundling policy roles, tenders, competition, independent performance monitoring, conditionality and sunset clauses.
  - Accountability: Periodic reporting, checks-and-balances including central auditing authorities, independent courts, and the press.

### German Emission Trading System (Box 1) — key operational details
- National ETS for transport and buildings starts pricing greenhouse gas emissions from 2021.
- Operates in parallel to the EU-wide ETS and covers bulk of non-ETS emissions.
- Participants: distributors or suppliers of fuels (a midstream approach).
- To avoid double burden, fuel deliveries to ETS facilities are exempt from the national price.
- System design:
  - Cap-and-trade with annual total emissions limit set by the federal government in line with annual non-ETS targets prescribed by the EU.
  - Allowances are transferable and tradeable.
  - Auctioning vs fixed price:
    - Generally auctioned, but until 2025 sold to companies at a fixed price.
    - Fixed allowance price: 25 euros per unit in 2021 (consistent with the current EU ETS price).
    - Increase to 55 euros in 2025.
    - Auctioned with a price corridor of 55–65 euros in 2026.
    - Market price starting in 2027 (possibly with a corridor to be decided later).

### Domestic environmental co-benefits and modeling (Box 2)
- Domestic co-benefits of carbon mitigation include fewer deaths from local air pollution, reduced traffic congestion, accidents, and other vehicle-related externalities.
- Domestic environmental co-benefits are appropriate to include when evaluating the economic effects of carbon pricing until targeted local instruments are fully implemented.
- The IMF’s mitigation spreadsheet tool:
  - Projects fuel use and emissions by energy sector for 135 countries.
  - Estimates the impact of carbon mitigation policies on emissions, fiscal accounts, and economic welfare.
  - Welfare gain = difference between domestic environmental co-benefits and economic efficiency costs of mitigation policies (changes in consumer and producer surplus in fossil fuel markets, accounting for preexisting fuel taxes).
  - Pollution cost estimates from stationary sources are built from plant-level intake fractions, local mortality rates, relations between mortality and pollution exposure, country-level air pollution emission rates, and willingness to pay to reduce health risk.
  - Local pollution, congestion, and accident externalities from mobile sources are extrapolated nationally.
- Key empirical finding:
  - For most EU countries, the domestic environmental benefits of a (nationwide) €50 carbon price exceed the efficiency costs (Figure 2.1).
  - This is especially true for countries with relatively high local air pollution damages, reflecting underpricing of air pollution costs of coal and under-taxing of gasoline and diesel for the full range of vehicle-related environmental costs.
- Comparable domestic environmental co-benefits would arise from other mitigation policies that produce similar reductions in fossil fuel use.

### Feebates as a political and policy reinforcement for carbon pricing
- Feebates: revenue-neutral sliding scale of fees on above-average emission-rate products/activities and rebates for below-average emission-rate products/activities.
- Examples of feebate application formulas:
  - Vehicles: fee = (1) a CO2 price × (2) the difference between the vehicle’s CO2/km and the fleetwide average CO2/km × (3) the (discounted) lifetime mileage of the average vehicle.
  - Industries: fee = (1) a CO2 price × (2) the difference between the firm’s and the industry average CO2/unit of production × (3) their output.
  - Power generation: fee = (1) a CO2 price × (2) the difference between average CO2/kWh and the industry-wide average CO2/kWh × (3) output.
  - Electricity-using products (refrigerators, heating systems): fee = (1) a per unit energy charge × (2) the difference between their energy consumption rate and the industry-wide energy consumption rate for that good.
- Key features of feebates:
  - Potentially more politically and socially acceptable as they impose little or no burden on the average household and firm.
  - Promote diverse behavioral responses (switching fuels, co-firing biomass, improving generation efficiency, shifting to wind and solar).
  - Less efficient than a carbon price because they do not incentivize reductions in demand for energy.
  - More cost-effective than regulations when feebate prices are harmonized across sectors.
  - Revenue neutral if the pivot point is set to the industry average emission rate and updated over time (unlike subsidies which lose revenue).

*eucmpea - introduction of a BCA mechanism as a policy option to reduce carbon leak-*

### Box 3. Reinforcing Carbon Pricing with Feebates

### Box 3. Reinforcing Carbon Pricing with Feebates

### Feebates: design and illustrative impacts
- Feebates are pay-as-you-go schemes that combine taxes on high-emission products with subsidies for low-emission products, effective if producer and consumer reactions are anticipated correctly.
- Administrative practicality:
  - Feebates can be integrated into existing vehicle tax systems or build off emissions monitoring capacity for generators and industries.
- Illustrative calibration and impacts:
  - Feebate CO2 price: €500 per ton of CO2.
  - Assumed new vehicle fleetwide CO2 emission rate: 95 grams per km (the 2021 EU standard).
  - Lifetime discounted driving assumed: 100,000 km.
  - Under these assumptions:
    - Subsidy for zero-emission vehicles (ZEVs): €4,800.
    - Tax on a 150 grams CO2/km vehicle: €2,750.
  - Pivot point dynamics:
    - Subsidies for ZEVs would decline over time as the pivot point declines; example decline: 32 percent when the fleetwide average falls to 65 grams CO2/km (the 2030 EU standard).
- Common deviations from the recommended feebate design observed in practice:
  - Schemes often are not revenue neutral because pivot points do not automatically update or subsidy outlays do not match taxes collected.
  - Incentives can be weak: example, tax differential between a 150 grams CO2/km vehicle and a ZEV in the United Kingdom is €240.
  - Discontinuous incentive structures can miss mitigation opportunities: example, in France and United Kingdom there is little difference in tax rates for vehicles with emission rates below 130 grams CO2/km.
- Policy note:
  - Where governments have fiscal objectives, feebates can be combined with another revenue-raising instrument (for example, a tax on vehicle sales values).

### International carbon price floor: rationale and design features
- Motivations and expected benefits:
  - Best way to address carbon leakage and competitiveness concerns through international coordination of pricing.
  - Need only cover a limited number of countries; under a uniform carbon price across G20 emitters (who collectively account for 80 percent of global emissions), over 80 percent of the emissions reductions would be in China, India, and the United States alone (see Figure 4.1 in source).
- Equity and flexibility:
  - Could be designed equitably with lower price floor requirements for emerging market economies to reflect lower per capita income and smaller contribution to accumulated atmospheric stock of greenhouse gases.
  - Could accommodate different national approaches (carbon taxes, trading systems, combinations of feebates and regulations) so long as approaches yield equivalent emissions reductions to those from implementing the floor price.
- Illustrative aggregate effectiveness:
  - Example: if advanced and emerging market G20 countries agree to a $50 and $25 carbon price floor, respectively, in 2030 (or their Paris pledge, whichever is more stringent), this would double mitigation effort among G20 countries over and above what is currently pledged, though higher prices would still be needed to reach the 2°C target.
- Enforcement option:
  - Might be enforced through a common border carbon adjustment applied to nonparticipating (middle- and high-income) countries.
- Precedents and governance:
  - Precedents include Canada, where states and provinces are required to meet a federally set carbon price rising to CAN $50 by 2022.
  - Participants would need a governance structure including external verification procedures for tracking effective carbon prices.

### Policy package and conclusions (EU-focused)
- Key elements emphasized for ambitious 2030 emissions reductions:
  - More robust carbon pricing:
    - Options include extending the EU ETS to other major emitting sectors or introducing complementary national carbon pricing frameworks.
    - A uniform EU carbon price combined with transfers across member states would help reduce emissions at a lower economic cost than national-level targets.
    - Carbon prices under the EU ETS should be made more predictable via further strengthening the MSR or introducing a carbon price floor.
  - Effective use of revenue from carbon pricing:
    - Use revenues in part to reduce distortionary taxes (or avoid increases) to offset aggregate income losses from higher carbon prices.
    - Direct revenues to climate-friendly investment and measures to ensure broad public support.
  - Targeted public support to promote green investment:
    - Public investment for infrastructure (public transportation networks, electricity grids), R&D subsidies for green technologies, and development of a robust green taxonomy for green financing.
  - Complementary mitigation instruments:
    - Complement pricing in hard-to-decarbonize sectors like transportation and buildings.
    - Feebates can shift purchases toward low-emission vehicles without a tax burden on the average household.
    - Building standards and finance support for energy efficiency investment help decarbonize buildings.
  - Protecting the vulnerable and facilitating transition:
    - Facilitate worker transitions to greener industries and support most affected regions.
    - Mitigate impacts on low-income households through direct social support and tax system changes.
  - Mechanisms to contain leakage:
    - International carbon price floor among largest emitters is most efficient to reduce leakage and lower global emissions.
    - Absent a floor, a carbon border adjustment mechanism would help prevent carbon leakage (subject to political and design considerations).
- COVID-19 recovery:
  - Recovery presents a window to prioritize public support for green investment to create jobs.
  - Setting a predictable gradually increasing carbon price floor for coming years would strengthen incentives for consumers and investors and provide fiscal revenue.
  - With a well-designed package, the EU can achieve more ambitious emission goals while ensuring a robust recovery.

### Model framework (Envisage) and key assumptions
- Model description:
  - Envisage is a computable general-equilibrium model computing the carbon price needed to achieve a target and its economic impact.
  - Solves dynamic general equilibrium for 16 country groups spanning more than 180 countries, with a detailed input-output matrix of 27 economic sectors, including 13 energy sectors.
  - Sector aggregation via nested constant elasticity of substitution (CES) structure with heterogeneous elasticities.
  - Model features: temporary wage rigidities, frictions in capital reallocation, trade costs, energy efficiency gains over time, progressive electrification, and a declining cost of renewable generation.
- Country groups listed in model: Germany, France, Italy, EU Eastern Europe, other Western Europe, the United Kingdom, the United States, other OECD, China, Russia, OPEC, advanced Asia, other East Asia, South Asia, other Latin America, rest of the world.
- Energy sectors listed: coal, oil, gas, refined oil, nuclear power, coal power, gas power, hydro power, solar power, wind power, oil power, other, electricity transmission and generation.
- Baseline calibration and assumptions:
  - Starting economy-wide average price: about €9 per ton in 2020 (weighted average of current EU ETS price and non-ETS carbon prices).
  - Associated fiscal revenue in baseline transferred as a lump sum to households.
  - GDP and population growth forecasts from the IMF April 2020 World Economic Outlook.
  - Energy efficiency assumed to improve by 1.5 percent annually.
  - Electrification increases by 50 percent by 2030 (in proportion to the 2014 electrification rate) in all sectors except transportation, which sees a 75 percent rise.
  - Modest renewable energy share growth with country-specific targets.
  - Elasticity of substitution between electricity generation technologies set at 3.
  - Assumed costs declines from 2014 to 2030: wind power generation costs decline by 13 percent, solar power by 35 percent, other renewables by 18 percent.
  - Under these assumptions, EU emissions fall by 35 percent relative to 1990 in the baseline labeled “Unchanged policies.”
- Model strengths and limitations:
  - Strength: consistent and complete representation of the global economy with endogenous energy demand and sufficient sectoral detail for multiregion energy and environmental policy assessment.
  - Limitations: lower technological detail than energy-system models; productivity growth exogenous; current version does not have forward-looking behavior and does not incorporate economic value of avoided damages from climate change and air pollution.

### Selected simulation findings and scenario comparisons
- Baseline and scenario framing:
  - Policy scenarios target either a 40 percent reduction of EU emissions by 2030 (current target) or a more ambitious 50 percent reduction, relative to 1990 levels.
- National Targets scenario (no comprehensive intra-EU emissions trade):
  - Required average carbon price across EU countries by 2030: €136 per ton.
  - Some countries (example: France) could face prices up to €216 per ton of CO2 if not allowed to trade permits.
  - Resulting EU aggregate income fall: 1.2 percent compared to the baseline.
- Emissions Trade / EU-wide trading scenario:
  - Full trade in permits across EU countries and sectors to meet a joint 50 percent target lowers required uniform carbon price to €101 per ton in 2030.
  - Associated aggregate income loss: (0.9 percent) relative to baseline, illustrating income gains from an EU-level traded approach.
  - For comparison, other models estimate a range of prices between €65 and €140 for similar emission reductions.
- Other scenario mechanics:
  - “Lump-sum transfers,” “Labor tax cut,” “Renewable subsidy,” “Border-adj.,” “Global Carbon Price,” and “EU Compensatory Transfers” are alternative policy uses of carbon price revenue or market designs examined in the simulations.
- Transitional dynamics:
  - Reported income loss estimates reflect transitional dynamics due to wage rigidities causing temporary unemployment and capital reallocation frictions; steady state income losses would be substantially smaller.
- Uncertainty:
  - Results are subject to considerable uncertainty due to parameter choices (substitution and transformation elasticities) and forecasting over a decade.
  - Marginal abatement cost curve from Envisage falls in the middle of the range across several other computable general-equilibrium models.

*Source: eucmpea - Box 3. Reinforcing Carbon Pricing with Feebates (excerpt) from the provided PDF content.*

### Annex 1. Model Specification and Results

### Annex 1. Model Specification and Results

### Carbon price scenarios and aggregate impacts
- A 50 percent emission reduction target (relative to 1990) requires an equilibrium carbon price of €101 per ton by 2030 in the baseline “Lump-sum transfers” scenario.
  - This implies a €120 increase in the annual electricity bill for an average EU citizen (given 2014 electricity consumption values).
  - The same 50 percent target with lump-sum transfers yields carbon pricing revenue of about 1.1 percent of EU GDP by 2030.
- A more modest emission reduction target of 40 percent would require a carbon price of €40 and an income loss of 0.3 percent of GDP.
- The more ambitious target requires a more-than-proportional increase in carbon prices because cheaper abatement margins are exhausted.

### Labor tax cut and renewable investment subsidy scenarios (50 percent target)
- General framing:
  - Carbon pricing revenue can be recycled to lower distortionary taxation or to incentivize green investment.
  - Scenarios assume domestically collected revenue is either rebated as lump-sum transfers or used for policy alternatives described below.
- Labor tax cut (scenario “Labor tax cut”):
  - If all revenue from carbon taxes is used to reduce labor tax rates, income is only 0.4 percent below the baseline.
  - Recycling revenue to reduce labor taxes offsets a significant share of the negative real income impact from higher carbon prices.
  - With high initial labor tax rates, rigid wages, and unemployment, labor taxes are roughly as distortionary as carbon taxes.
  - During the first years of the policy, income is above the baseline (small carbon taxes are less distortionary and there is more margin to reduce unemployment); as carbon taxes grow, the income path crosses below the baseline.
- Renewable investment subsidy (scenario “Renewable subsidy”):
  - Revenue is used to subsidize investment in solar, wind, and other renewable sources.
  - A 75 percent cap is assumed on the subsidy rate for investment costs; any remaining revenue is transferred to households.
  - Required carbon price falls to €59 per ton.
  - Renewable share in total energy supply increases to 48 percent in the EU on average, compared to 33 percent in the baseline.
  - Income in 2030 is 0.2 percentage points higher than in the scenario with lump-sum transfers, but not as high as in the labor tax cut scenario.
  - The 75 percent subsidy rate leads to an expansion of the renewable energy share to 73 percent in Germany (slightly above its national target of 65 percent).
- Comparative note:
  - An alternative scenario lowering labor taxes by the same amount as the renewable subsidy (not shown) still yields a more benign income impact from cutting labor taxes.

### Supplementary investment policies (Parry and Mylonas model results)
- The model of Parry and Mylonas (2018) estimates required carbon price reductions from additional investment policies (does not calculate full macro output effects). Applied homogeneously across the EU.
  - Raising the share of electric cars to 20 percent of the on-road car fleet by 2030 could lower by 10 percent the required carbon price to reach the current emissions target of 40 percent reduction.
  - Increasing residential housing energy efficiency to the second highest efficiency rating would allow a 32 percent reduction in the carbon price relative to the baseline.
  - Supplementing the two measures with R&D subsidies delivering a 1 percent annual productivity growth (on top of the baseline growth) in renewable energy production would lower the needed carbon price by 40 percent relative to the baseline.

### EU compensatory transfers
- Income cost in the 50-percent emission reduction scenario with lump-sum transfers ranges from 0.5 percent of GDP in France to 1.9 percent in Eastern Europe.
- Intra-EU compensatory transfers that neutralize the income impact across countries would not change the aggregate EU-level income effect relative to the “lump-sum transfers” scenario.

### Border adjustment and global carbon price scenarios
- Carbon leakage:
  - A uniform carbon tax cutting emissions by 50 percent in the EU would increase emissions by 15 percent in the rest of the world for each unit of EU emissions avoided.
- Border carbon adjustment (scenario “Border adjustment”):
  - A levy on the carbon content of imports (based on the carbon intensity of the country of origin) equal to the carbon price applied to EU production can contain carbon leakage.
- Global carbon price (scenario “Global carbon price”):
  - If the entire world implemented policies to reduce global emissions by 50 percent relative to 1990 (allowing international trade in ETS permits), the global price of carbon required would be €93 per ton.
  - For the EU, this global action would raise income by 0.2 percentage points relative to the scenario without international policy action.

### Key model assumptions and sensitivities
- Initial unemployment is assumed equal to the natural unemployment rate, sourced from the IMF World Economic Outlook; the minimum unemployment rate achievable is capped per country (capping rule described in text).
- The impact of revenue recycling and employment calibration materially affects income outcomes.
- The Envisage sectoral aggregation does not provide the granularity to model electrification, housing efficiency, and R&D explicitly; hence Parry and Mylonas (2018) model is used for those counterfactuals but does not capture full general equilibrium macro effects.

*Source: Annex 1. Model Specification and Results*

---


_Source: https://www.imf.org/-/media/files/publications/dp/2020/english/eucmpea.pdf_