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### Global warming and projected impacts
- The year 2023 is turning out to become the warmest one on record.
- Temperatures are likely to increase by more than 1.5 degrees Celsius (°C) above preindustrial levels within the coming five years.
- Under current trends, temperatures could increase by 3°C or more, relative to preindustrial levels, by 2100.
- Projected and observed impacts include:
  - increased morbidity and mortality due to more prevalent infectious diseases and natural disasters;
  - lower productivity in agriculture, fishing, and work exposed to extreme temperature conditions;
  - more frequent disruptions from extreme weather events and rising sea levels;
  - increased likelihood of climatic “tipping points”—such as the melting of glaciers and ice caps—with potential catastrophic consequences.

### International targets and the need for transformation
- Paris Agreement commitments: “hold the increase in the global average temperature to well below 2°C above preindustrial levels” and ideally to 1.5°C.
- Net zero targets: cut greenhouse gas emissions to as close to zero as possible by about midcentury, with remaining emissions captured and stored.
- Transformation required:
  - investment and innovation in green sectors, processes, and products;
  - behavioral changes that decrease emissions but come at the expense of existing brown activities;
  - recognition of new opportunities and risks associated with transition.

### Role of fiscal policy in the green transition
- Fiscal policies central to transformation, including creating a larger role for private sector financing.
- Key levers: spending, taxation, and regulation (or combinations thereof).
- Fiscal policy objectives and constraints:
  - encourage decarbonization by firms and households;
  - mitigate transition costs for households and firms;
  - respect government budget constraints amid elevated debt levels, high inflation, and weak growth prospects;
  - consider international cooperation, especially for low-income countries and small developing states;
  - address risks from rising geopolitical fragmentation to cross-border climate technology diffusion.

### Questions the chapter addresses
- Can countries rely mostly on spending-based climate policies to achieve net zero emissions?
- How can policymakers design politically acceptable climate policies in a cost-effective and fiscally sustainable way?
- How can governments facilitate the green transition among firms?

### Main contributions
- Granular analyses quantifying fiscal impact and public debt implications across country groups during the green transition.
- Assessment of the evolving optimal mix of climate instruments from a macrofiscal perspective considering cost-effectiveness and political acceptability.
- Examination of interactions among public incentives, green investment, and firm adoption of technologies based on microlevel analyses.
- Highlighting the role of international coordination in mitigation policies.

### Are current policies scalable to net zero?
- Combined reduction from existing and planned mitigation policies is estimated at 13 percent across the Group of Twenty, relative to a 2030 baseline with no such policies.
- Required reduction by 2030 to achieve Paris goals: 25–50 percent.
- Emissions concentration:
  - China, the European Union, India, and the United States together account for more than 60 percent of global emissions by 2030.
  - Share of emerging market economies expected to reach almost 70 percent by 2035.
- Carbon pricing and coverage:
  - Carbon-pricing schemes cover only one-quarter of global emissions.
  - The average carbon price is $20 a ton.
- Examples of large spending-based measures:
  - Inflation Reduction Act of 2022: nearly $400 billion over 10 years.
  - European Union: Green Deal Industrial Plan with tax breaks and relaxation of state aid rules.
  - China: scaled up green public investment and subsidized deployment of solar energy under Made in China 2025.
  - Regulations and targets for buildings cited for France, Germany, Italy, Japan, Canada, Korea, South Africa, United States.
- Investment needs:
  - Achieving net zero by 2050 will require additional global investment in mitigation of $2 trillion to $2.5 trillion over the next decade.
  - Private investment—supported by fiscal incentives and regulatory measures—will need to account for the lion’s share given government budget constraints.

### Fiscal constraints and illustrative simulations
- Global public debt ratios projected to rise again in 2023 and continue to increase by 1 percentage point a year over the medium term.
- Fiscal adjustments necessary over the medium term to rebuild buffers, leaving limited resources for climate goals in many instances.
- Representative advanced economy simulation (model combining carbon price and spending-based mitigation):
  - Two spending scenarios:
    - Substantial scaling up (solid blue line): fiscal cost leads to a rise in the debt-to-GDP ratio by 45 percentage points by 2050 and pickup in government borrowing costs; likely unsustainable.
    - Moderate increase (dashed blue line): emissions fall by about 40 percent by 2050 from current levels—insufficient to meet targets.
  - Carbon-pricing-only scenario: would require $280 per ton by 2050 to reach net zero, potentially politically unpalatable and distributionally challenging.
  - Financing note: alternative financing methods (other than carbon taxes or deficit financing) would reduce debt rises.

### Fiscal implications for emerging market and developing economies
- Representative large emerging market economy simulation:
  - Carbon price cap at $45 a ton during 2030–50.
  - Substantial green investment and subsidies to reach net zero by 2060 lead to a surge in the debt-to-GDP ratio of more than 50 percentage points by 2050 (solid red line), with sharp rise in borrowing costs.
  - Moderate increase in spending: emissions fall by 10 percent from current levels—insufficient for net zero (dashed red line).
- Figure 1.5 model notes:
  - Solid lines scale up green public investment and subsidies at 2 percent of GDP a year on average to meet net-zero targets by 2050 (advanced) and 2060 (emerging).
  - Dashed lines have the same carbon price profile and a moderate rise in investment and subsidies.

### Climate adaptation and SDG investment needs
- Small developing states adaptation needs: average 2.7 percent of GDP a year until 2030, in addition to SDG investment.
- Many low-income countries have no fiscal space despite large adaptation needs and relatively low-cost abatement opportunities.
- Figure 1.6 values shown in the source (Annual Investment Needs for Climate Adaptation and Sustainable Development Goals, 2021–40):
  - 2.4
  - 7.8
  - 8.5
  - 0.4
  - 2.7
  - 0.7
  - 2.4
  - 7.8
  - 8.5
  - 0.1
  - 1.0
  - 0.3

### Fiscal challenges for fossil fuel–producing countries
- For a group of 27 fossil fuel producers, fiscal revenue is estimated to decline by 5.5 percent of GDP on average between 2019 and 2040.
- These countries must also reduce domestic emissions from extractive industries, potentially adding fiscal costs.
- Impact on extractive revenues is sensitive to the pace of global decarbonization and possible price-path variations.

### The climate–fiscal–political trilemma and policy mix
- Trilemma among:
  - (1) climate goals (Paris Agreement),
  - (2) fiscal sustainability (containing sovereign debt risks and building buffers),
  - (3) political feasibility (constraints on taxation and spending).
- Trade-offs:
  - Expenditure-heavy approaches can be politically feasible but drive up debt.
  - Moderate measures that continue current emission paths will fail climate goals.
  - Carbon pricing can reduce fiscal pressures and emissions but may be politically unpopular.
- Recommended approach: calibrated mix of policies tailored by country, involving carbon pricing alongside measures addressing distributional and cost-of-living impacts.

### Designing efficient and fiscally responsible policies
- Policy objectives:
  - Encourage private sector behavioral shifts primarily through pricing mechanisms.
  - Choose low-cost, efficient instruments for abatement.
  - Mobilize revenue to support fiscal sustainability.
  - Include complementary measures addressing market failures, facilitating investment and innovation, and improving political acceptability.

### Carbon pricing: role, adoption, and fiscal implications
- Carbon pricing is the principal economywide mitigation instrument (carbon tax or ETS).
- Benefits:
  - Promotes broad behavioral responses to reduce energy use and shift fuels.
  - Incentivizes private sector innovation with a clear, credible rising price path.
  - Raises substantial revenue short to medium term to finance mitigation and distributional objectives.
- Adoption:
  - Carbon-pricing initiatives span 49 advanced and emerging market economies at various government levels.
  - At least 23 additional countries are planning to introduce carbon-pricing schemes.
  - Examples: Sweden (1991 carbon tax), Chile (2014 green taxes), Singapore (2019 carbon tax with scheduled tax path through 2030).
- Limitations:
  - Political hurdles constrain raising prices or expanding coverage.
  - Carbon pricing alone insufficient for hard-to-abate sectors (e.g., buildings).
- Fiscal notes:
  - Fuel excises generate between ½ and 1½ percent of GDP a year in many countries.
  - Explicit fossil fuel price subsidies were $1.3 trillion (1.3 percent of global GDP) in 2022.
  - Including environmental damages and other costs yields a total of $7 trillion (7.1 percent of global GDP) of total subsidies on fossil fuels.

### Sectoral mitigation instruments and complementary policies
- Feebates:
  - Sliding fees and rebates tied to emission rates versus a pivot point; revenue neutral if pivot aligned to averages.
  - Applied in vehicle taxation (The Netherlands, Norway); generally greater public support than carbon pricing.
- Tradable performance standards:
  - Firms meet average carbon emissions per unit output; firms below can purchase credits.
  - Politically acceptable but raise little fiscal revenue; example: Canada’s output-based pricing system.
- Green subsidies, technology requirements, and other sectoral measures:
  - Promote adoption, address network externalities, innovation market failures, and distributional burdens.
  - Complementary policies: public investments, R&D incentives, timebound technology subsidies, targeted assistance, output-based rebates, tax relief, border adjustments.

### Mitigation policy instruments and design considerations
- Carbon pricing:
  - Efficient at reducing emissions and generating revenue but can erode as the tax base shrinks.
  - Example scenario referenced: $50 a ton carbon tax in illustrative modeling.
- Green subsidies:
  - Address underinvestment in R&D and exploit economies of scale.
  - Fiscal cost considerations: large fiscal costs and potential negative spillovers if uncoordinated.
  - Example: United Kingdom Contracts for Difference; Egypt feed-in subsidy reforms (2014−16).
  - Simulation assumption: front-loaded green subsidies ≈ ½ percent of GDP in representative advanced-economy scenario.
- Regulation/minimum standards:
  - Promote narrow behavioral shifts; unlikely to generate fiscal revenue unless made flexible (fees/credits).
  - Colombia since 2023 requires power utilities to procure at least 10 percent renewable electricity sold to end users.
- Border carbon adjustments:
  - Can mitigate competitiveness concerns by charging fees on carbon embodied in imports and offering rebates for exports; must consider WTO rules and administrative burdens.

### Complementary policies to improve effectiveness and feasibility
- Public investment:
  - Market undersupply in infrastructure (clean hydrogen pipelines, carbon capture and storage pipelines, high-voltage transmission, EV charging stations).
  - Global additional public investment: new green investment on clean technologies of 0.4 percent of GDP net of a 0.1 percent decline in fossil fuel investment → about 0.3 percent of GDP a year on average.
  - Example: United States National Electric Vehicle Infrastructure Program: $5 billion over five years.
  - Emerging market simulation assumption: green investment needs ≈ ¾ percent of GDP per year.
- Transfers and social protection:
  - Carbon revenues can fund targeted transfers, social safety nets, or lower other taxes.
  - Transfers assumed in simulations: 30 percent of carbon revenue for both representative advanced and emerging market scenarios.
  - Examples: Oman phased out electricity subsidies in 2021 with low-income protections; Indonesia 2016 fuel reform included targeted support linked to social assistance.
- Competitiveness and carbon leakage:
  - IMF–World Bank Climate Policy Assessment Tool illustrative $50 a ton charge in 2030:
    - Production cost increases for iron and steel: about 5–10 per cent.
    - Production cost increases for cement: about 35–50 percent.
    - Sectoral emissions changes from carbon leakage estimated at 10–30 percent under plausible assumptions.

### Technology diffusion, innovation, and policy support
- Commercially proven technologies can achieve about 90 percent of emission reductions by 2030.
- Frontier technologies (scalable carbon capture and storage) remain early-stage and require public R&D, subsidies, tax incentives, prizes, patents, or combinations.
- Incentives should be time bound, transparently presented, under strong governance, and complemented with carbon pricing.
- Institutional prerequisites: robust legal and regulatory frameworks, property rights enforcement, fair competition, human capital, and ICT/infrastructure investment.

### Debt impact of net-zero policy packages (scenario overview)
- Policy package components: carbon pricing, green public investment, green subsidies, targeted transfers.
- Net-zero operationalization:
  - Advanced economies: 80 percent reduction in 2023 emission levels by 2050; remaining offset by carbon capture and storage.
  - Emerging market economies: 80 percent reduction by 2060; remaining offset by carbon capture and storage.
- Macroeconomic channels:
  - Carbon pricing raises revenues but reduces near-term output.
  - Expenditure measures support short-term output and long-term capacity but raise deficits and borrowing costs.
  - Balance between carbon revenue and expenditures, plus effects on output and interest rates, determine debt dynamics through 2050.

Advanced economies (representative calibrated to Group of Seven averages)
- Carbon pricing trajectory in simulation:
  - $130 a ton by 2030
  - $235 a ton by 2050
  - Note: $235 a ton by 2050 is lower than the $280 a ton by 2050 necessary if carbon pricing were the only instrument.
- Fiscal assumptions:
  - Front-loaded green subsidies ≈ ½ percent of GDP.
  - Transfers ≈ 30 percent of carbon revenue.
- Outcomes:
  - Debt-to-GDP ratio increases by 10–15 percentage points by 2050 relative to “business-as-usual.”
  - Primary deficit rises by 0.4 percent of GDP a year relative to baseline.
  - Interest rate effects relatively muted.

Emerging market and developing economies (representative large emerging market economy)
- Carbon pricing trajectory in simulation:
  - $45 a ton by 2030
  - $150 a ton by 2050
- Features:
  - Lower initial share of green energy and lower initial carbon price yield greater carbon revenue for longer and later peaks in emissions and revenue.
  - Green investment needs assumed at ¾ percent of GDP per year.
  - Transfers assumed at 30 percent of carbon revenue.
  - Emerging markets face a higher risk premium—greater sensitivity of borrowing costs to rising debt.

### Debt and fiscal implications (additional illustrative findings)
- Illustrative scenario results for emerging market economies:
  - Public debt would increase by about 15 percent of GDP by 2050 relative to “business-as-usual,” equivalent to a rise in primary deficits by 0.4 percentage point of GDP a year on average.
  - Simulated rise in debt ranges widely: 8−25 percent of GDP by 2050 depending on public investment, subsidies, transfers, and fossil-fuel-producer status.
- Sensitivity examples:
  - If government transfers are 50 percent of carbon revenue, debt would rise by 25 percentage points of GDP by 2050, with primary deficits rising by 0.6 percentage point of GDP a year on average.
  - Reducing public mitigation investment and subsidy by about ¼ percent of GDP per year reduces the debt increase to 8 percentage points of GDP.
  - Relying primarily on carbon pricing with modest public investment of ¼ percent of GDP per year and no subsidy spending can yield carbon revenues that more than offset investment and transfers, producing a small primary surplus during peak carbon revenue.

### Technology spillovers, bottlenecks, and sequencing
- Green subsidies more effective when learning-by-doing accelerates emission reductions, limits output costs, and contains public debt.
- Bottlenecks (institutional capacity limits, supply-chain disruptions, stranded assets) can limit uptake, reduce subsidy effectiveness, and raise debt-to-GDP further.
- Costs of delay and sequencing:
  - Each year of delay in raising carbon prices increases public debt by 0.8–2.0 percentage points of GDP in advanced economies (depending on speed of subsequent adjustment and assuming spending-based policies scaled up to meet 2050 reductions).
  - For emerging market economies, delays increase debt by about 0.9 percentage point of GDP even if carbon prices catch up quickly.
  - Sequencing: timing carbon tax revenues to coincide with front-loaded subsidy expenditures can contain interim deficits; delaying carbon revenues until after emissions peak reduces revenue base and widens interim deficits.

### Catalyzing private finance, international support, and debt sustainability
- Private climate finance can be catalyzed via subsidies, regulations, improved climate information (data, disclosure, taxonomies), and blended finance; some instruments (government credit guarantees) carry large fiscal risks.
- International climate finance can support technology transfer and expand fiscal space.
- Need tools to incorporate climate actions into debt sustainability analysis given uncertainty from investment needs, substitution elasticities, economic impacts, and uptake of tax credits/subsidies.

### Intergenerational and fiscal-management considerations
- Debt-financed transfers impose higher taxes on future cohorts; balanced-budget policies shift costs contemporaneously.
- Implications:
  - Strengthen fiscal frameworks and institutions to enhance spending efficiency.
  - Improve debt and investment management and practices.
  - Integrate climate considerations into budget processes (“green public financial management”).
- Caution against extrabudgetary operations or earmarking that fragments budgets and creates rigidities.

### Facilitating the green transition in firms: regulation, incentives, and resilience
- Regulatory measures and fiscal incentives encourage firm investments in energy efficiency and low-carbon technologies.
- Firm-level evidence:
  - Firms that set or monitor emissions—especially in energy-intensive or hard-to-abate sectors—are likelier to invest in less-polluting technologies or products.
- Market-based regulatory stringency:
  - EU ETS evidence: permit prices and taxes positively impact investment only in periods of already-high carbon prices and when emissions exceed allowance levels; no significant impact when emissions are within free allowance levels.
  - Implies a reinforcing role between high carbon prices and regulatory measures.
- Firm resilience to higher energy costs (survey evidence from 2022 energy price spike):
  - More than three-quarters of firms in Germany and the United States experienced a rise in energy costs in 2022.
  - In Germany, nearly 20 percent of surveyed firms reported energy costs rising by more than 50 percent during 2022.
  - In the United States, the share reporting an energy cost rise of more than 50 percent was about one-quarter of the share in Germany.
  - Pass-through: more than 40 percent of German firms and 36 percent of US firms passed on a quarter or more of the cost increase.
  - Less than 10 percent of US firms reported cuts in production or employment; a larger share reported increases.
  - 60 percent of US surveyed firms reported reduced profitability, but only 6 percent reported a significant decline.
  - In Germany, 60 percent reported investing or planning to invest in energy efficiency; more than three-quarters reported reducing or planning to reduce energy consumption; only 12 percent reported output loss.

### Firm-level survey implications and policy design lessons
- Firms respond to regulations and fiscal incentives; incentives accelerate the green transition when firms can assess impacts on profitability.
- Policy design lessons:
  - Regulatory measures can facilitate the green transition; firms adapt to stricter regulations by increasing investment.
  - Monitoring climate targets can reinforce higher carbon prices and is associated with higher investment in low-carbon technologies in energy-intensive sectors.
  - Policies must be well communicated (horizon, coverage, eligibility) to reduce uncertainty; uncertainty can hamper investment.
  - Targeting of incentives can minimize fiscal costs because some firms would have invested without incentives.
  - Many firms reported uncertainty about policy impacts; firms using incentives were often already investing in emission reductions.

### Macroeconomic evidence on carbon pricing and GDP (highlights)
- Meta-analysis comparing ex ante and ex post studies on GDP impacts after five years:
  - Simulation-based studies show large variation, skewed toward small negative impacts.
  - Empirical studies show a pattern of mostly positive impacts.
- Example: estimated cumulative GDP impact from a $40 carbon price covering 30 percent of national emissions in EU countries (1990–2019) suggests possible positive impact during six years following reform, but confidence intervals are wide.

### Fossil fuel-exporting countries: dependencies, scenarios, and policy advice (highlights)
- In more than half of fossil fuel-exporting countries, commodity receipts make up more than half of total fiscal revenues.
- A quarter of these countries have fossil fuel exports greater than 25 percent of GDP.
- Under net zero scenarios, some countries could face at least an 80 percent drop in fossil-fuel-related revenues by 2040 (examples cited in source).
- Fiscal policy recommendations:
  - Withdraw explicit fossil fuel subsidies currently estimated at 5.1 percent of GDP on average, and gradually phase in emission pricing.
  - Implement methane fees to reduce emissions efficiently in the extractive sector.
  - Adjust upstream fiscal regimes to shift appropriate risks to government; assess mix of production- and profit-based instruments.
  - Ensure national oil companies diversify with commercial discipline and manage balance-sheet and fiscal risks.
  - Build larger fiscal buffers and strengthen fiscal frameworks; increase savings of fossil fuel revenue in sovereign wealth or stabilization funds to ensure a just transition and reduce procyclicality.

_International Monetary Fund, Fiscal Monitor: Climate Crossroads: Fiscal Policies in a Warming World, Chapter 1 (ch1 - Introduction)._

### Introduction

### ch1 - Introduction

### Global warming and projected impacts
- The year 2023 is turning out to become the warmest one on record.
- According to the World Meteorological Organization, temperatures are likely to increase by more than 1.5 degrees Celsius (°C) above preindustrial levels within the coming five years.
- The Intergovernmental Panel on Climate Change predicts that under current trends, temperatures could increase by 3°C or more, relative to preindustrial levels, by 2100.1
- Projected and observed impacts include:
  - increased morbidity and mortality due to more prevalent infectious diseases and natural disasters;
  - lower productivity in agriculture, fishing, and work exposed to extreme temperature conditions;
  - more frequent disruptions from extreme weather events and rising sea levels;
  - increased likelihood of climatic “tipping points”—such as the melting of glaciers and ice caps—with potential catastrophic consequences (IPCC 2021; Georgieva 2022; McKay and others 2022; Ditlevsen and Ditlevsen 2023).

### International targets and the need for transformation
- In the 2015 Paris Agreement, countries agreed to “hold the increase in the global average temperature to well below 2°C above preindustrial levels” and ideally to 1.5°C.
- Countries have also committed to longer-term targets for net zero emissions—cutting greenhouse gas emissions released into the atmosphere to as close to zero as possible, with the remaining emissions captured and stored—by about midcentury.
- Achieving temperature goals will require a fundamental transformation of consumption, production, and investment by households, firms, and governments, including:
  - investment and innovation in green sectors, processes, and products;
  - behavioral changes that decrease emissions but come at the expense of existing brown activities (Aghion and Howitt 2005; Stern and Valero 2021);
  - recognition of new opportunities and risks associated with transition (Mercure and others 2018; Gourinchas, Schwerhoff, and Spilimbergo 2023).

### Role of fiscal policy in the green transition
- Fiscal policies will play a central role in the transformation, including by creating a larger role for private sector financing (October 2023 Global Financial Stability Report, Chapter 3).
- Key policy levers include spending, taxation, and regulation (or combinations thereof) (Figure 1.2).
- Fiscal policy objectives and constraints highlighted:
  - encourage decarbonization by firms and households;
  - mitigate transition costs for households and firms;
  - respect government budget constraints amid elevated debt levels, high inflation, and weak growth prospects;
  - consider the importance of international cooperation, especially for low-income countries and small developing states with multiple competing development needs;
  - address risks from rising geopolitical fragmentation to cross-border climate technology diffusion (October 2023 World Economic Outlook, Chapter 3).

### Questions addressed in the chapter
- Can countries rely mostly on spending-based climate policies to achieve net zero emissions?
- How can policymakers design politically acceptable climate policies in a cost-effective and fiscally sustainable way?
- How can governments facilitate the green transition among firms?

### Main contributions of the chapter
- Conducting granular analyses to illustrate and quantify the fiscal impact and public debt implications across country groups during the green transition.
- Assessing the evolving optimal mix of climate instruments from a macrofiscal perspective in light of their cost-effectiveness, political acceptability, and other attributes.
- Examining interactions among public incentives, green investment, and adoption of technologies by firms based on microlevel analyses, strengthening the case for using a mix of fiscal instruments.
- While focusing on domestic policies, the chapter highlights the role of international coordination in mitigation policies.

### Are current policies scalable to net zero?
- Using the IMF–World Bank Climate Policy Assessment Tool, the combined reduction in emissions from existing and planned mitigation policies, relative to a 2030 baseline with no such policies, is estimated at 13 percent across the Group of Twenty.
- This 13 percent reduction falls significantly short of the 25–50 percent reduction by 2030 needed to achieve the Paris Agreement’s temperature goals (Black, Parry, and Zhunussova 2023).
- Emissions concentration and importance of EMs:
  - The largest emitters—China, the European Union, India, and the United States—together account for more than 60 percent of global emissions by 2030.
  - The share of emerging market economies is expected to reach almost 70 percent by 2035.
- Carbon pricing and policy mix to date:
  - An increasing number of countries have explicit carbon prices, but carbon-pricing schemes cover only one-quarter of global emissions.
  - The average carbon price is $20 a ton—well below the level of coverage and price needed to achieve net zero goals (IEA 2021; Black and others 2022a).
  - Some large economies rely more on spending-based measures such as public investment in green infrastructure and green subsidies (tax expenditures) to incentivize private investment and adoption of low-carbon technologies.
- Examples cited:
  - The Inflation Reduction Act of 2022 in the United States: described as the largest federal policy to date to tackle climate change, costing nearly $400 billion over 10 years, envisaging higher investment in clean energy and electric vehicles (Bistline, Mehrotra, and Wolfram 2023).
  - The European Union: supplementing carbon pricing with a proposed Green Deal Industrial Plan comprising tax breaks and relaxation of state aid (subsidy) rules to boost renewable investment by the private sector.
  - China: scaled up green public investment and subsidized deployment of solar energy under its Made in China 2025 initiative.
  - Various countries: targets to reduce energy use in buildings (France, Germany, Italy, Japan) and regulations for new buildings to have net zero emissions by 2030 (Canada, Korea, South Africa, United States) (Online Annex 1.1).
- Cost-effectiveness and coverage concerns:
  - Sectoral policies vary in their carbon price equivalents, implying some countries could have achieved the same mitigation goal at lower cost (Black and others 2022b).
  - Achieving net zero by 2050 will require additional global investment in mitigation of $2 trillion to $2.5 trillion over the next decade (International Energy Agency estimate).
  - Given government budget constraints, private investment—supported by fiscal incentives and regulatory measures—will need to account for the lion’s share of this investment.

### Fiscal constraints and illustrative simulations
- Elevated public debt complicates climate policy:
  - Global public debt ratios, after a decline in 2021–22, are projected to rise again in 2023 and to continue to increase by 1 percentage point a year over the medium term, growing faster than foreseen before the pandemic.
  - Fiscal adjustments are necessary over the medium term to rebuild fiscal buffers, leaving limited resources for climate goals in many instances (Figure 1.4).
- Illustrative simulation (Online Annex 1.2) findings for a representative advanced economy:
  - Model setup: combines a carbon price and spending-based mitigation policies, with private sector investment responding to government policies and accounting for the lion’s share of total green investment in the model. Fiscal policies include carbon pricing, green subsidies, public investment, and targeted transfers, as well as standard taxes on consumption, labor, and capital income.
  - Two spending scenarios considered:
    - Substantial scaling up of green investment and subsidies to reach net zero (solid blue line in Figure 1.5).
      - Result: much larger fiscal cost, a significant rise in the debt-to-GDP ratio by 45 percentage points by 2050, and an associated pickup in government borrowing costs.
      - Such rising debt levels of the magnitude projected are likely unsustainable.
      - A gradual erosion of existing fuel tax bases as the economy decarbonizes could exacerbate these risks.
    - Moderate increase in spending to contain the rise in debt (dashed blue line in Figure 1.5).
      - Result: emissions would fall by about 40 percent by 2050 from current levels—insufficient to meet targets.
  - Relying solely on carbon pricing to reach net zero:
    - Would require a higher carbon price—at $280 per ton by 2050 according to simulations in Online Annex 1.2—which might be politically unpalatable in many countries despite carbon pricing’s effectiveness in reducing emissions and generating revenues.
    - High carbon prices could adversely affect output and lead to uneven transition costs among households, making carbon taxes less popular to enact or expand (Känzig 2023; Metcalf 2023).
- Financing note:
  - If countries find alternative ways to finance the spending-based measures (other than through carbon taxes or deficit financing), the rise in debt levels will be smaller.

*Source: International Monetary Fund, Fiscal Monitor: Climate Crossroads: Fiscal Policies in a Warming World, Chapter 1 (ch1 - Introduction).*

### CHAPTER 1 CLIMATe CROSSROAdS: FISCAL POLICIeS IN A WARMINg WORLd

### CHAPTER 1 CLIMATe CROSSROAdS: FISCAL POLICIeS IN A WARMINg WORLd

### Fiscal implications of green transition for emerging market and developing economies
- The green transition would entail additional fiscal costs, especially if they rely on expenditure-based measures.
- Simulation for a representative large emerging market economy:
  - Carbon price cap at $45 a ton during 2030–50.
  - Substantial increase in green investment and subsidies to reach net zero goals by 2060.
  - Result: an unsustainable surge in the debt-to-GDP ratio of more than 50 percentage points by 2050 (solid red line in Figure 1.5), with an associated sharp rise in borrowing costs.
  - A scenario with a more moderate increase in spending: emissions fall by 10 percent from current levels but will not be sufficient to achieve the net zero target (dashed red line in Figure 1.5).
- Model note (Figure 1.5):
  - The figure shows cumulative change in debt-to-GDP relative to a “business-as-usual” scenario based on simulations from a dynamic general equilibrium model.
  - The lines for the advanced economy (large emerging market economy) cap the carbon price at $75 ($45) a ton.
  - The solid lines scale up green public investment and subsidies (at 2 percent of GDP a year on average) to meet the net-zero-emissions target by 2050 (2060 for the emerging market economy), while the dashed lines have the same profile on carbon prices and a moderate rise in investment and subsidies.

### Climate adaptation and SDG investment needs
- Many emerging market and developing economies need to build resilience and adapt to climate change, particularly small developing states.
- Small developing states have the largest needs for climate adaptation, at an average 2.7 percent of GDP a year until 2030, in addition to investment needs to meet other Sustainable Development Goals.
- Many low-income countries have no fiscal space despite large adaptation needs and relatively low-cost abatement opportunities.
- Figure 1.6 (Annual Investment Needs for Climate Adaptation and Sustainable Development Goals, 2021–40) — values shown in the source:
  - 2.4
  - 7.8
  - 8.5
  - 0.4
  - 2.7
  - 0.7
  - 2.4
  - 7.8
  - 8.5
  - 0.1
  - 1.0
  - 0.3
- Note on Figure 1.6:
  - The figure shows investment needs across country groups related to additional climate adaptation needs and, for countries that have not done so, achieving the Sustainable Development Goals (SDGs).
  - SDGs are assumed to be met by 2040 by spending a constant fraction of GDP each year.
  - “SDS+” consists of developing small states as well as countries that have adaptation needs larger than 2.5 percent of GDP for 2021–30.
  - EMs = emerging markets; LIDCs = low-income developing countries.

### Fiscal challenges for fossil fuel–producing countries
- Commodity revenues will decline markedly if the global economy pursues a path toward net zero emissions.
- Mesa Puyo and others (2023) estimate that for a group of 27 fossil fuel producers, fiscal revenue will decline by 5.5 percent of GDP on average between 2019 and 2040.
- These countries also need to reduce domestic emissions including from extractive industries, possibly adding to fiscal costs.
- The scope for using extractive revenues to finance economic development is highly sensitive to the pace of global decarbonization efforts.
- The impact on fossil fuel revenues depends on scenarios of global transition; a given path for global fossil fuel production could be consistent with different price paths, implying a wide range of possible revenue and economic outcomes.

### The climate–fiscal–political trilemma and policy mix
- Policymakers face a trilemma between:
  - (1) climate goals: delivering the Paris Agreement on temperature ceilings,
  - (2) fiscal sustainability: containing sovereign debt risks and building buffers,
  - (3) political feasibility: respecting political constraints on taxation and spending.
- Trade-offs summarized:
  - Relying mostly on expenditure measures can be politically feasible but will cause debt to rise substantially.
  - Continuing current emission paths with only moderate measures will fail to achieve climate goals.
  - Carbon pricing can relax fiscal pressures and reduce emissions but can be politically unpopular.
- The recommended approach: a carefully calibrated mix of policies that varies across countries and involves carbon pricing alongside other measures to address distributional concerns and cost-of-living impacts.

### Designing efficient and fiscally responsible policies
- Policy objectives when designing mitigation packages:
  - Encourage private sector behavioral shifts primarily through pricing mechanisms.
  - Choose low-cost, efficient instruments for abatement to achieve emission reductions.
  - Exploit scope for revenue mobilization to support fiscal sustainability.
  - Include complementary measures to address market failures, facilitate investment, innovation, and technology deployment, and address social, distributional, and political acceptability concerns.

### Carbon pricing: role, adoption, and fiscal implications
- Carbon pricing is necessary but not sufficient to reduce emissions; it is the principal economywide mitigation instrument and can take the form of a carbon tax or an emission trading system (ETS).
- Benefits of carbon pricing:
  - Promotes full range of behavioral responses to reduce energy use and shift to low-carbon fuels.
  - Incentivizes private sector innovation and adoption of low-carbon technologies, especially with a clear and credible rising price path.
  - Over the short to medium term, can raise substantial revenue to finance other mitigation measures and distributional objectives.
- Adoption and examples:
  - Carbon-pricing initiatives currently span 49 advanced and emerging market economies at various government levels, more than double the total one decade ago.
  - At least 23 additional countries are planning to introduce carbon-pricing schemes.
  - Country examples:
    - Sweden introduced a carbon tax in 1991 as part of broader fiscal reforms.
    - Chile introduced green taxes in 2014 as part of a broader tax reform package.
    - Singapore introduced a carbon tax in 2019 and announced the scheduled tax path through 2030.
- Limitations:
  - Overcoming political hurdles makes it difficult to raise carbon prices significantly or expand coverage.
  - Carbon pricing alone will be insufficient for hard-to-abate sectors (for example, buildings require incentives to retrofit old structures).
- Fiscal note on fuel excises and subsidies:
  - In many countries, fuel excises generate between ½ and 1½ percent of GDP a year.
  - Explicit fossil fuel price subsidies were $1.3 trillion (1.3 percent of global GDP) in 2022.
  - Including environmental damages, local air pollution, and traffic congestion yields a total of $7 trillion (7.1 percent of global GDP) of total subsidies on fossil fuels.

### Sectoral mitigation instruments and complementary policies
- Sectoral instruments complement carbon pricing by addressing sector-specific market failures and political acceptability; common instruments include:
  - Feebates:
    - Sliding scale of fees and rebates tied to emission rates versus a pivot point.
    - Encourage decline in emission intensity in a sector; revenue neutral if pivot point aligned with average emission rates and updated.
    - Applied in vehicle taxation in European countries, promoting shifts to electric vehicles (examples: The Netherlands, Norway).
    - Generally have greater public support than carbon pricing.
  - Tradable performance standards:
    - Firms required to meet standards for average carbon emissions per unit of output; firms below standard can purchase credits.
    - Politically acceptable but raise little fiscal revenue and require fluid credit markets.
    - Example: Canada’s federal backstop includes an output-based pricing system concentrating taxation on large emitters.
  - Green subsidies, requirements for green technologies/activities, and other sectoral measures:
    - Can promote adoption and address network externalities, innovation market failures, and distributional burdens.
    - Complementary policies include public investments, R&D incentives, timebound technology subsidies, targeted assistance, output-based rebates, tax relief, and border adjustments.

*Italicized source: CHAPTER 1, CLIMATe CROSSROAdS: FISCAL POLICIeS IN A WARMINg WORLd (PDF chapter).*

### CHAPTER 1 CLIMATe CROSSROAdS: FISCAL POLICIeS IN A WARMINg WORLd

### CHAPTER 1 CLIMATe CROSSROAdS: FISCAL POLICIeS IN A WARMINg WORLd

### Mitigation Policy Instruments and Design Considerations
- Carbon pricing
  - Efficient at reducing emissions and generating fiscal revenues.
  - Can erode over time as the carbon tax base shrinks with decarbonization.
  - Example scenario: a $50 a ton carbon tax used in illustrative modeling.
- Green subsidies
  - Aim to overcome market failures and externalities related to development, deployment, and adoption of low-carbon technologies.
  - Justified to address underinvestment in research and development and to exploit economies of scale for deployment.
  - Fiscal cost considerations: subsidies entail large fiscal costs and can generate negative spillovers and cross-border competitiveness concerns if not carefully designed or coordinated.
  - Example: United Kingdom Contracts for Difference scheme; Egypt’s feed-in subsidy reforms enacted in 2014−16.
  - Simulation assumption: front-loaded green subsidies equivalent to about ½ percent of GDP in the representative advanced-economy scenario.
- Regulation or minimum standards
  - Examples: minimum shares of renewable use for power generators; minimum shares of electric vehicles in vehicle sales fleets.
  - Tend to promote narrow behavioral shifts and are unlikely to generate fiscal revenue.
  - Can be made more flexible by allowing firms to pay fees or purchase credits exceeding requirements.
  - Example: Since 2023, Colombia requires power utilities to procure at least 10 percent of the electricity sold to end users from renewable energy sources.
- Border carbon adjustments
  - Can mitigate competitiveness concerns by charging a fee on carbon embodied in imported products and offering rebates for exports to level the playing field.
  - Need to account for carbon pricing in trading partners, limit administrative burdens, and avoid violating World Trade Organization rules.

### Complementary Policies to Improve Effectiveness and Feasibility
- Public investment
  - Some large-scale infrastructure (clean hydrogen pipelines, carbon capture and storage pipelines, high-voltage transmission lines, EV charging stations) may be undersupplied by the market.
  - Global required additional public investment: new green investment on clean technologies of 0.4 percent of GDP net of the decline in fossil fuel investment of 0.1 percent of GDP is estimated at about 0.3 percent of GDP a year, on average, with upfront capital costs concentrated over the next 20 years and declining thereafter.
  - Example program: United States National Electric Vehicle Infrastructure Program provides $5 billion over five years to expand EV charging infrastructure.
  - Simulation assumption for emerging market economies: green investment needs are larger, at ¾ percent of GDP per year.
- Transfers and social protection
  - Revenues from carbon pricing can be used for targeted transfers to households, social safety nets, or lowering other taxes to compensate for higher energy and indirectly higher goods prices.
  - Transfers assumed in simulations: equivalent to 30 percent of carbon revenue for both representative advanced and emerging market economy scenarios.
  - Examples: Oman phased out electricity subsidies in 2021 while protecting low-income households; Indonesia’s 2016 fuel reform included targeted support linked to its social assistance program.
- Competitiveness and carbon leakage
  - Unilateral climate policies raise production costs for energy-intensive, trade-exposed industries and can induce relocation to countries with laxer emission standards.
  - IMF–World Bank Climate Policy Assessment Tool illustrative results for a $50 a ton carbon charge in 2030:
    - Production cost increases, relative to baseline production costs: about 5–10 per cent for iron and steel.
    - Production cost increases: about 35–50 percent for cement.
    - Changes in sectoral emissions from carbon leakage (moving production to countries with laxer standards) are estimated at 10–30 percent under plausible assumptions.
  - These effects are small relative to economywide emission reductions achieved by the tax.

### Technology Diffusion, Innovation, and Policy Support
- Existing commercially proven technologies
  - According to the International Energy Agency (2020, 2022a), use of known and commercially proven technologies can achieve about 90 percent of the emission reductions necessary to achieve climate goals by 2030.
  - Costs of many technologies have decreased significantly (learning curves); solar power has become the most affordable renewable source of electricity.
- Frontier and early-stage technologies
  - New technologies—such as scalable carbon capture and storage—are necessary in the medium to long term and remain in early stages.
  - Fiscal interventions likely needed: public research and development, research subsidies, tax incentives, prizes, patents, or combinations thereof.
  - Incentives should be carefully designed, time bound, transparently presented in budgets under strong governance frameworks, and complemented with carbon pricing.
  - Risks: uncoordinated green industrial policies can distort trade and investment and risk a “subsidy race” that harms developing countries.
- Institutional prerequisites for technology absorption
  - Robust legal and regulatory frameworks, transparent governance, property rights enforcement, fair competition, human capital development, and investment in ICT and other infrastructure facilitate technology transfer and absorption.

### Debt Impact of Net-Zero Policy Packages (Scenario Overview)
- Policy package composition
  - Combines carbon pricing, green public investment, green subsidies, and targeted transfers.
  - Operationalization of net-zero-emissions target: an 80 percent reduction in 2023 emission levels by 2050 for advanced economies and by 2060 for emerging market economies, with carbon capture and storage assumed to offset the remaining emissions.
  - Private sector expected to fund the majority of investment for decarbonization; public measures complement private capital.
- Macroeconomic channels
  - Carbon pricing increases government revenues but reduces near-term output.
  - Expenditure measures (public investment and subsidies) support short-term output and raise long-term productive capacity.
  - Higher expenditures can raise budget deficits and put upward pressure on interest rates and government borrowing costs through macroeconomic and fiscal channels.
  - Balance between carbon-pricing revenue and expenditure measures, and endogenous effects on output and interest rates, determine debt dynamics through 2050.

Advanced Economies (representative calibrated to average of Group of Seven economies)
- Carbon pricing trajectory in the simulation
  - $130 a ton by 2030
  - $235 a ton by 2050
  - Note: $235 a ton by 2050 is lower than the $280 a ton by 2050 that would be necessary to achieve net zero emissions if carbon pricing were the only instrument used (as discussed in the source).
- Fiscal assumptions
  - Front-loaded green subsidies equivalent to about ½ percent of GDP.
  - Transfers equivalent to 30 percent of carbon revenue.
- Debt and deficit outcomes
  - Debt-to-GDP ratio increases by 10–15 percentage points by 2050, relative to the “business-as-usual” baseline.
  - Primary deficit rises moderately, by 0.4 percent of GDP a year, relative to the baseline.
  - Interest rate effects are relatively muted because government debt rises moderately and lower demand for capital in brown sectors partly offsets higher demand in the green sector.
  - Policy options: countries with fiscal space can pursue the package; others can raise revenues from other taxes or reduce other spending to contain debt increases.

Emerging Market and Developing Economies (representative large emerging market economy)
- Carbon pricing trajectory in the simulation
  - $45 a ton by 2030
  - $150 a ton by 2050
- Distinctive simulation features
  - Lower initial share of green energy than advanced economies.
  - Lower initial carbon price yields greater carbon revenue for a longer period and leads to a later peak in emissions and carbon revenue.
  - Green investment needs assumed at ¾ percent of GDP per year.
  - Transfers assumed at 30 percent of carbon revenue.
  - Emerging markets face a higher risk premium—greater sensitivity of borrowing costs to rising debt levels—than advanced economies.

*Italic: International Monetary Fund | October 2023*

### 1. Advanced Economy

### 1. Advanced Economy

### Debt and Fiscal Implications of Net-Zero Policy Packages
- Illustrative scenario for emerging market economies: public debt would increase by about 15 percent of GDP by 2050 relative to the “business-as-usual” baseline, equivalent to a rise in primary deficits by 0.4 percentage point of GDP a year on average.
- Simulated rise in debt is subject to a wide range of 8−25 percent of GDP by 2050, depending on public investment, subsidies, targeted transfers, and whether countries are fossil fuel producers.
- Composition differences relative to advanced economies: larger contributions from interest costs and higher public investment needs; carbon revenues are higher in emerging market economies.
- Sensitivity examples:
  - If government transfers are 50 percent of the revenue from carbon taxes, debt would rise by 25 percentage points of GDP by 2050, with an increase in primary deficits of 0.6 percentage point of GDP a year on average.
  - If public mitigation investment and subsidy is reduced by about ¼ percent of GDP per year, debt would increase by 8 percentage points of GDP.
  - If climate policies primarily rely on carbon pricing (higher than the baseline) with modest public investment of ¼ percent of GDP per year with no subsidy spending, resulting carbon revenues can more than offset the investment spending and related transfers to households, leading to a small primary surplus, especially during the peak of carbon revenue.

### Technology Spillovers and Investment Bottlenecks
- Green subsidies are more effective when learning-by-doing effects in clean technologies are present, allowing faster emission reductions, limiting output costs, and keeping public debt contained.
- Bottlenecks to green investment—limited institutional capacities, supply-chain disruptions for critical minerals because of geoeconomic fragmentation, and stranded assets in brown sectors—can:
  - Limit rapid uptake of green technology.
  - Make green subsidies less effective.
  - Cause debt-to-GDP ratios to rise further.
- If bottlenecks take the form of adjustment costs on investment, emission targets may not be reached unless more forceful measures (for example, higher carbon prices) are implemented.

### Costs of Delay and Policy Sequencing
- Delaying action on carbon pricing is costly:
  - Each year of delay in raising carbon prices is found to increase public debt by 0.8–2.0 percentage points of GDP in advanced economies, depending on how quickly carbon prices adjust after the initial delays and assuming spending-based policies are scaled up to deliver the same level of emission reductions by 2050.
  - For emerging market economies, delays would still increase debt by about 0.9 percentage point of GDP, even when carbon prices catch up quickly following the initial delay.
- Policy sequencing matters:
  - Combining fiscal instruments strategically can limit the rise in debt.
  - Timing initial carbon tax revenues to coincide with front-loaded expenditures on green subsidies can contain interim deficit impacts.
  - Delaying carbon revenues until after emissions have peaked will decrease the revenue base and widen fiscal deficits in the interim.

### Catalyzing Private Finance, International Support, and Debt Sustainability
- Catalyzing private climate finance can accelerate decarbonization through subsidies, environmental regulations, improved climate information architecture (data, disclosure, taxonomies), and public-private risk sharing (blended finance); some instruments (for example, government credit guarantees) can entail large fiscal risks.
- International climate finance can facilitate trade in low-carbon technologies, scaling up technology transfer, and augmenting fiscal space.
- Tools to incorporate climate actions into debt sustainability analysis are needed because projected debt levels show considerable uncertainty depending on:
  - Investment needs.
  - Elasticity of substitution between energy sources.
  - Economic impact of fiscal policies.
  - Degree of uptake of tax credits and subsidies by firms and households.
- Examples of analytic tools referenced in the chapter (for context in the source):
  - IMF Quantitative Climate Change Risk Assessment Fiscal Tool.
  - IMF Sustainable Development Goals–Climate tool.
  - Tools calibrating fiscal rules considering natural disaster risks.
  - Efforts to improve climate data availability (IMF Climate Change Indicators Dashboard; Data for a Greener World).

### Intergenerational and Fiscal-Management Considerations
- Overlapping-generations analysis: debt-financed transfers to mitigate adverse impacts on current cohorts impose higher taxes on future cohorts to finance future debt service; balanced-budget policies shift costs to contemporaneous generations.
- Rising public debt and scaled-up green public investment point to needs to:
  - Strengthen fiscal frameworks and institutions to enhance spending efficiency.
  - Improve debt and investment management and practices.
  - Integrate climate considerations into existing budget processes (“green public financial management”).
- Caution against alternative systems that fragment budget decision making:
  - Extrabudgetary operations or provisions excluding green investment from fiscal rules risk fragmenting the budget and creating budget rigidities.
  - Project-specific financing can attract private investors but earmarking public resources risks rigidities.

### Facilitating the Green Transition in Firms: Regulation, Incentives, and Resilience
- Regulatory measures and fiscal incentives can encourage firm investments in energy efficiency and low-carbon technologies.
- Firm-level evidence (European Investment Bank Group Survey on Investment and Investment Finance):
  - Firms that set or monitor emissions—particularly those in energy-intensive or hard-to-abate sectors—are among the most likely to invest in new, less-polluting technologies or products.
- Market-based regulatory stringency matters:
  - Analysis of firms regulated under the EU Emissions Trading System suggests permit prices and taxes on greenhouse gas emissions have a significant positive impact on investment only in periods of already-high carbon prices and when emissions exceed allowance levels.
  - Regulations have no significant impact when emissions are within free allowance levels.
  - This indicates a reinforcing role between high carbon prices and market-based regulatory measures: stringent policies can incentivize firm investment when firms must pay for emissions at high carbon prices.
- Firm resilience to higher energy costs:
  - Surveys of firms in Germany and the United States (examining responses to the energy price hike of 2022) are used to assess balance-sheet resilience and likely responses to cost shocks (details and survey results are in Online Annex 1.9 in the source).

_Italic: International Monetary Fund. Fiscal Monitor: Climate Crossroads: Fiscal Policies in a Warming World, October 2023, Chapter 1._

### Annex 1.8). The dependent variable is binary, based on firms’ responses to a

### Annex 1.8). The dependent variable is binary, based on firms’ responses to a

### Environmental Policy Stringency and Firm Investment (Figure 1.16)
- The dependent variable in the panel regression model for 12 European countries during 1995–2020 is changes in fixed assets (in logarithms) as a proxy for investment.
- Each coefficient estimate represents the impact of changes in the OECD’s market-based Environmental Policy Stringency Index for the indicated sample of firms.
- Samples described:
  - “ETS-regulated firms” are those with regulated installations in the EU ETS.
  - “Payable emissions” are the difference between verified emissions and free allowances.
  - “High carbon price” refers to periods when EU carbon price exceeds 75th percentile.
- The whiskers indicate the 95 percent confidence interval for the estimated coefficients.
- Results are consistent with the findings of the 2023 EIB Investment Report.

### Firm-level survey findings on fiscal incentives and resilience (Figures 1.17 and 1.18)
- Surveys conducted in Spring 2023 in collaboration with:
  - Federal Reserve Bank of Atlanta’s Business Inflation Expectations Survey
  - Duke University, Federal Reserve Bank of Richmond, and Federal Reserve Bank of Atlanta CFO Survey
  - Bundesbank Online Panel in Germany
- Figure 1.17: Firms’ Plans for Utilizing Incentives of Recent Climate Policy Packages in United States and Germany, Spring 2023
  - Shows proportions of sampled firms that will use incentives in their country’s policy packages (Inflation Reduction Act for United States; Green Deal Industrial Plans for Germany).
  - Categories shown: Will use IRA/EU Green Deal incentives within three years; Will not use IRA/EU Green Deal incentives; Unsure about using incentives.
  - Bars also distinguish firms “Investing in emission reduction within three years,” “Not investing in emission reduction,” and “Unsure about investing in emission reduction.”
- Figure 1.18: Firms’ Responses to Financial Incentives to Invest in Emission Reduction, Spring 2023
  - Stacked bars reflect proportions of sampled firms that will adjust investment in emission reductions based on incentives (IRA for United States; Green Deal industrial policies for Germany).
  - Vertical bars show the share of firms that report cost as one of the top three constraints on investment in emission reduction.
  - Categories shown: Increase investment; Unsure; Decrease investment; NA/No change.
  - Distinction made between firms reporting “Cost constraint” and “No cost constraint.”

### Empirical and policy implications from firm-level analysis
- Evidence that firms respond to regulations and fiscal incentives, which can accelerate the green transition, especially when firms can calculate the impact of fiscal policies on their profitability from investing in the green transition.
- Key lessons for policy design and implementation:
  - Regulatory measures can facilitate the green transition, with varying effects. Evidence suggests firms adapt to stricter climate regulations by increasing investment.
  - Policies requiring firms to monitor their climate targets could reinforce higher carbon prices and are often associated with higher investment in low-carbon technologies, particularly in energy-intensive sectors.
  - Firms were broadly resilient to the 2022 energy price spikes and likely could adapt to higher energy prices by reducing energy consumption, investing in energy efficiency, and passing higher costs on to consumers or downstream firms.
  - More adverse impacts to certain sectors or localities could occur if shocks are stronger and more persistent, suggesting the need for a mix of instruments to accelerate the green transition.
  - Fiscal incentives, in addition to higher carbon pricing, can encourage firms to invest. Policies need to be well communicated (horizon, coverage, eligibility criteria) to provide certainty; otherwise, policy uncertainty could hamper investment (Berestycki and others 2022).
  - Targeting can help minimize fiscal costs because some energy-intensive firms would have engaged in the same level of investment in green technologies even without fiscal incentives.
- Many firms in Germany reported uncertainty about the impact of policies on their climate-related investment plans.
- Firms taking advantage of fiscal incentives (for example, the US Inflation Reduction Act of 2022 and the EU Green Deal Industrial Plan) were often already investing in emission reductions, especially if they considered cost a major hurdle for investment.

### Macroeconomic evidence on carbon pricing and GDP (Box 1.1 highlights)
- Meta-analysis compares ex ante (simulation-based) and ex post (empirical) studies on GDP impacts after five years (Figure 1.1.1):
  - Simulation-based studies show large variation, somewhat skewed toward negative (although small) impacts.
  - Empirical studies show a pattern of mostly positive impacts.
- Figure 1.1.2: Estimated cumulative impact on GDP from a $40 carbon price covering 30 percent of national emissions in EU countries during 1990–2019:
  - Point estimates suggest the impact on GDP could be positive during the six years following the reform.
  - The carbon tax covers 30 percent of emissions.
  - Confidence intervals are wide; one standard deviation and 90th percentile bands are shown.

### Fossil fuel-exporting countries: dependencies, scenarios, and fiscal policy advice (Box 1.2 highlights)
- In more than half of fossil fuel-exporting countries, receipts from commodities make up more than half of total fiscal revenues.
- A quarter of these countries have fossil fuel exports greater than 25 percent of GDP (Figure 1.2.1).
- Model framework from Baunsgaard and Vernon (2023) uses International Energy Agency (2022b) scenarios: stated-policies scenario; announced-pledges scenario; net zero scenario.
- Under the net zero scenario, some countries could face at least an 80 percent drop in fossil-fuel-related revenues by 2040 (examples cited: Equatorial Guinea, Iraq, and Oman).
- A slower global energy transition could permit certain producers (for example, Iran, Kuwait, and Qatar) to increase market shares.
- Fiscal policy recommendations for fossil fuel producers:
  - Withdraw explicit fossil fuel subsidies currently estimated at 5.1 percent of GDP, on average, and gradually phase in emission pricing policies (Black and others 2023a).
  - Implement methane fees to reduce emissions in the extractive sector efficiently (Parry and others 2022).
  - Adjust upstream fiscal regimes to shift risks associated with the energy transition from investors to government where appropriate; assess mix of production- and profit-based instruments.
  - Ensure national oil companies diversify with commercial discipline, manage balance sheets, and carefully manage associated fiscal risks.
  - Build larger fiscal buffers and strengthen fiscal frameworks; increase savings of fossil fuel revenue in the near term, managed under sovereign wealth funds (savings or stabilization funds) to ensure a just transition, promote intergenerational equity, and reduce procyclicality of fiscal policy (IMF 2012; Basdevant, Hooley, and Imamoglu 2021).

*Sources: EU Emissions Trading System (ETS); European Investment Bank; IMF, World Economic Outlook database; Kalantzis and others, forthcoming; Orbis; OECD; Business Inflation Expectations Survey (Federal Reserve Bank of Atlanta); Bundesbank Online Panel—Firms; CFO Survey (Duke University, Federal Reserve Bank of Richmond, and Federal Reserve Bank of Atlanta); IMF staff estimates and calculations.*

### Box 1.2 (continued)

### Box 1.2 (continued)

### Context and purpose
- The section uses the 2022 energy price spikes, partly driven by Russia’s invasion of Ukraine, as a natural experiment to assess firm resilience to energy price surges and how firms adjust.
- Two firm surveys are analyzed: one among firms in Germany and one among firms in the United States (see Online Annex 1.9 for survey details referenced in the source).

### Survey findings: Germany and the United States
- More than three-quarters of firms in each country experienced a rise in their energy costs in 2022.
- A higher share of firms in energy-intensive industries reported an energy price shock (Figure 1.3.1).
- In Germany:
  - Nearly 20 percent of surveyed firms reported their energy costs as rising by more than 50 percent during 2022.
  - The increase in energy costs was much larger in Germany than in the United States.
- In the United States:
  - The share of firms reporting an energy cost rise of more than 50 percent was about one-quarter of the share in Germany (implied by “four times higher” for Germany).

### Firm responses and resilience
- Pass-through of cost increases:
  - More than 40 percent of surveyed firms in Germany passed on a quarter or more of the cost increase to downstream firms or customers.
  - 36 percent of surveyed firms in the United States passed on a quarter or more of the cost increase.
- Output, employment, investment, and profitability responses (summary of Figure 1.3.2 and accompanying text):
  - Less than 10 percent of surveyed firms in the United States reported a cut in production or employment.
  - An even larger share of US firms reported an increase in either production or employment.
  - The share of surveyed firms reporting a reduction in investment in the United States was somewhat higher than the share reporting an increase, but the majority reported no change.
  - 60 percent of the US firms surveyed reported a reduction in profitability, but only 6 percent indicated that profitability had declined significantly.
  - Overall, balance sheets of US firms surveyed seemed to have remained resilient to the energy price shock.
- Energy efficiency and consumption responses:
  - Most firms that responded to the US survey did not respond to higher energy prices by improving their energy efficiency.
  - In Germany, faced with a larger shock (described as “almost a doubling of nonresidential electricity prices relative to 2021 levels”):
    - 60 percent of surveyed firms reported investing or planning to invest in energy efficiency.
    - More than three-quarters reported reducing or planning to reduce their energy consumption.
    - Only 12 percent of the responding firms reported an output loss.
  - The German firms’ responses indicate resilience achieved through improving energy efficiency and reducing energy consumption.

### Interpretation and implications
- Differences between Germany and the United States in firm responses may be attributable to:
  - The size and the perceived persistence of the shock.
  - The level of government support received.
- The analysis notes that firms in Germany may have considered the energy price shock to be longer lasting and hence warranted investment in energy efficiency.
- The section warns that potential disruptions to firms could be larger if the shocks were more persistent.

*International Monetary Fund | October 2023 — Box 1.2 (continued), CHAPTER 1 CLIMATE CROSSROADS: FISCAL POLICIES IN A WARMING WORLD*

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_Source: https://www.imf.org/-/media/files/publications/fiscal-monitor/2023/october/english/ch1.pdf_