## 1. Broader Reforms to the Pricing of Road Transport

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### Introduction and context
- The COVID-19 pandemic has not altered the global need for rapidly transitioning to zero carbon energy systems.
- A global emissions pathway consistent with limiting future global warming to 1.5°C–2°C above preindustrial levels requires cutting global fossil fuel CO2 and other GHGs by 25–50 percent below 2018 levels by 2030, with progressively deeper emissions reductions thereafter.
- Global CO2 emissions in 2020 are projected to be about 8 percent lower than in 2019; emissions are likely to start rising again in 2021 as economies recover.
- Carbon pricing is highlighted as a key instrument for achieving emissions reductions and generating revenue amid heightened fiscal pressures.

### Shortfall in mitigation pledges and international mechanisms
- Current mitigation pledges fall well short of temperature stabilization goals: pledges by 190 parties would cut global emissions in 2030 by about one third of the emissions reductions consistent with the 2°C target.
- IMF staff propose a carbon price floor arrangement among large emitters as an additional international mechanism to complement the Paris process.
- Parties are required to submit revised climate strategies ahead of COP 26 in Glasgow in 2021.

### Macroeconomic risks from climate change
- By 2100, studies suggest warming could permanently lower global GDP by 5 to 25 percent below GDP levels with no climate change.

### UK mitigation framework, targets, and progress
- Statutory framework: government sets five-yearly carbon budgets twelve years in advance to 2050; CCC reports annual progress.
- Strengthened targets:
  - Cut emissions 57 percent below 1990 levels by 2030 (pledge in 2019).
  - Net-zero GHG emissions target for 2050 (legally binding).
- Sectoral measures:
  - Planned ban on sale of new gasoline, diesel, hybrid, and plug-in electric hybrid cars and vans by 2030.
  - Coal generation plants (without CCS) phased out by 2025.
- Emissions trends:
  - Total GHG emissions are now 42 percent lower than in 1990.
  - Emissions per capita moved from 25 percent above European OECD countries to about ten percent below.
  - Two-thirds of GHG reduction from CO2 reductions; methane reductions account for one quarter; remaining ten percent mostly from lower nitrous oxide emissions.
  - Transport accounts for about 27 percent of total GHGs, has made virtually no contribution to reductions since 1990, and increased by about five percent since 2013.
- EVs and infrastructure:
  - EVs are currently less than 1 percent of the on-road vehicle fleet.
  - Estimated 2.5 million charging stations needed by 2035; currently there are 11,000 charging stations.
- Carbon budgets:
  - UK met first and second carbon budgets (2008–12, 2013–17) and is on track to outperform the third (2018–22).
  - CCC finds Clean Growth Strategy lacks policy specifics needed for fourth (2023–27) and fifth (2028–32) carbon budgets; these budgets are too loose given net-zero 2050 commitment.

### Current policy framework, distortions, and political constraints
- Layering of instruments creates variation in carbon prices across sectors and fuels, increasing costs for a given emissions reduction.
- Key figures:
  - EU ETS allowance price equivalent to £27 per ton (power generation and large industrial firms).
  - CPS currently £18 per ton for power generation.
  - CCL rates: 0.811 pence/kWh electricity, 0.406 pence/kWh natural gas, 2.175 pence/kg LPG; CCL equivalent about £25 per ton CO2 for electricity and £20 per ton for gas.
  - CCL ratio moving from 2.9:1 (electricity:gas) in 2018 to parity in 2025.
  - VED first-year fixed charge £140 for all non-EVs; new fleet average excise (fixed plus variable) £317 in 2019; subsequent years flat and unrelated to CO2 for petrol/diesel vehicles.
  - EU new vehicle fleet target: 95 grams CO2 per km in 2021; about 60 g per km in 2030.
  - Fuel excise taxes: 58 pence per liter for gasoline and diesel; equivalent carbon taxes £246 per ton CO2 for gasoline and £213 per ton for diesel.
  - Fuel duty currently raises about 1.4 percent of GDP and about 70 percent of total fiscal revenue from transportation; nominal fuel duty frozen since 2010/11 implying real reduction of about 15 percent.
  - Forgone cumulative revenues of over £46 billion since 2011 due to freezing.
- Political acceptability has led to scaling back planned carbon-price increases (e.g., freezing CPS).
- Example impact of an additional $50 (£38) per ton carbon price in 2030:
  - UK natural gas prices increase by 35 percent.
  - Retail electricity prices increase by 10 percent.
  - Gasoline prices increase by 6 percent.

### Economywide carbon pricing: design, uncertainty, and revenue potential
- Core proposal: a uniform carbon pricing scheme reinforced with sectoral measures.
- Target carbon price: rise to at least £60 (US $75) per ton by 2030.
  - Current CO2 prices in power and industrial sector about £40 per ton.
- Preferred instrument: carbon tax that:
  - (i) promotes full range of mitigation opportunities;
  - (ii) provides price certainty for clean-technology investment;
  - (iii) provides a direct revenue source for the Treasury;
  - (iv) allows reinforcing sectoral measures;
  - (v) reforms current pricing schemes that burden the power sector.
- ETS alternative: can mimic a tax if combined with a robust price floor and full allowance auctions.
- Uncertainty in required price:
  - Empirical price elasticities range between -0.5 to -0.8.
  - About 60 carbon pricing schemes exist; prices mostly around $5 to $25 per ton.
  - Existing and prospective schemes cover only a fifth of global GHGs.
  - A carbon price of £60 (US $75) per ton alone would cut emissions 18 percent below baseline levels in 2030, while 26 percent reductions are needed to meet the UK 2030 pledge.
  - Cross-country variation: some G20 countries require prices above $75 per ton; others below $25 per ton.
  - External estimate: uniform carbon price of at least €70 (£64) per ton to deliver a 50 percent reduction in emissions by 2030 if acting in isolation.

- Revenue and distribution:
  - A carbon price of £60 per ton in 2030 would raise additional annual revenues of around 0.8 percent of GDP in 2030 (relative to a zero-carbon price and accounting for erosion of pre-existing fuel tax bases).
  - Household burden: a £60 (US $75) per ton carbon tax imposes a burden of 0.9 percent of consumption for the average UK household in 2030 (relative to no tax).
  - Regressivity: bottom income quintile bears a burden 2.7 times as large (relative to consumption) as the top income quintile.
  - Recommendation: revenue recycling via targeted compensation packages should disproportionately benefit low-income households; revenue best used to decrease distortionary taxes such as labor income tax or to fund public investments.

### Transportation sector: limits of carbon pricing, feebates, and revenue implications of EV penetration
- Carbon pricing provides modest incentive for shifting to ZEVs:
  - A £60 per ton carbon price increases the price of a new vehicle with average fleetwide emission rate by about £1,000 relative to a ZEV (about 3.5 percent of vehicle purchase price).
- Feebates (revenue-neutral sliding scale of fees/rebates by emission intensity):
  - Incentivize reductions in emissions intensity without a first-order tax burden.
  - Particularly attractive for phase-out of ICE vehicles.
  - Can strengthen decarbonization incentives in industry while largely avoiding pressure for BCA.
  - Variants could promote clean heating adoption and reductions in agricultural emissions.
  - Feebates less efficient than carbon pricing absent other frictions because they do not reduce overall demand (e.g., vehicle use), but more flexible and cost-effective than regulations.
- Feebate quantitative illustration:
  - Feebates with a carbon price of £300 per ton would provide an EV subsidy of £4,694 at current fleetwide average emission rates.
  - Feebate design: fee = CO2 price × (vehicle CO2 per km − fleet average CO2 per km) × discounted lifetime km.
  - Vehicle assumptions: discounted lifetime mileage 131,600 km based on 16 year life; vehicles driven on average 1,145 km a year; annual reduction in driving of 3%; discount rate 5%.
  - Pivot points: 119 and 65 g CO2/km based on new UK fleet average for 2017 and EU target for 2030 respectively.
- Fiscal implication of EV penetration:
  - Finding: 0.3 percent of GDP by 2030 with penetration of EVs.
  - Assumptions: EV sales share linear increase to 60 percent by 2030; 7 percent of vehicle fleet replaced each year; on-road fleet EV share about 20 percent in 2030.
  - If near-zero transport emissions by 2050 are met, fuel duty receipts would tend towards zero.
  - Complementary reforms: km-based charges and pay-as-you-drive (PAYD) auto insurance can address other transport externalities and maintain revenue as fuel tax bases erode.

### Road pricing, congestion externalities, and PAYD insurance
- External congestion costs:
  - External cost less than 3.5 pence per vehicle km for about 75 percent of driving in 2015.
  - External costs: 92 pence/km when volume-capacity ratio is 0.75–1; 196 pence/km when ratio is over 1.
  - Averaged across road classes estimated external costs were 14.3 pence per km.
- Km-based taxes and monitoring:
  - Km-based taxes varying by location and time can efficiently manage congestion for given road capacity.
  - GPS and metering technologies enable location- and time-varying billing; administrative costs higher than fuel taxes.
  - Km-based taxes provide a robust revenue base unaffected by transportation decarbonization.
  - Transition options: subsidize/tax vehicles with/without monitoring capacity; expand congestion-charging zones as a bottom-up approach.
- PAYD automobile insurance:
  - Transition from lump-sum to PAYD (premiums proportional to annual km) would reduce driving and internalize accident externalities.
  - PAYD would raise marginal cost of driving by around 4 pence per km on average and reduce average accident risk.
  - Government incentives may be needed to overcome coordination problems among insurers.

- Quantitative congestion bands (Km-Based Taxes Needed to Internalize Congestion Externalities, 2015):
  - Congestion band 1: volume-capacity ratio <.25; share 0.43; marginal external congestion cost 1.4 pence/km (2018£); lifetime tax payments a: £1,850.
  - Congestion band 2: ratio .25 - .50; share 0.31; marginal cost 3.4 pence/km; lifetime tax payments a: £4,471.
  - Congestion band 3: ratio .5 - .75; share 0.17; marginal cost 11.5 pence/km; lifetime tax payments a: £15,110.
  - Congestion band 4: ratio .75 - 1; share 0.07; marginal cost 91.7 pence/km; lifetime tax payments a: £120,729.
  - Congestion band 5: ratio >1; share 0.02; marginal cost 195.9 pence/km; lifetime tax payments a: £257,802.
  - Average: marginal external congestion cost 14.3 pence/km (2018£); lifetime tax payments a: £18,810.
  - Note a: Assumes annual average driving of 1,145 km all within a given congestion band and consumer discount rate of 5 percent.

### Post‑Brexit emissions pricing options and interactions with EU ETS
- UK proposal to replace EU ETS:
  - Cover same emissions sources as current EU ETS.
  - Cut emissions cap by 5 percent.
  - Fixed auction reserve price £15 per ton of CO2 (with price ceilings to be specified).
- No-deal Brexit option: carbon tax replacing EU ETS set comparable to EU ETS price; infra-marginal exemptions for sources previously granted free allowances; CPS for electricity generators remains.
- Interaction with EU ETS:
  - Domestic reductions may be offset if EU ETS cap fixed, lowering EU allowance price.
  - Exception if Market Stability Reserve (MSR) is triggered and allowances withdrawn permanently rather than returned to ETS.
  - Linking UK ETS to EU ETS could provide efficiency and smoother transition but may take a decade.

### Industry impacts: illustrative effects on steel and cement
- Steel:
  - About 40 percent of steel produced via integrated process producing about two tons CO2 per ton steel.
  - Alternatives (electrified scrap-based, direct reduction + electric furnace, CCS) produce about 0.3–0.4 tons CO2 per ton steel.
  - At carbon price £40/ton CO2:
    - Integrated production cost increases about £80/ton of steel (about 20 percent of recent steel prices).
    - Alternative technologies cost increase about £15/ton.
  - Feebate (industry average 1 ton CO2/ton steel) at £40/ton:
    - Cost increase for integrated production £40/ton.
    - Subsidy for alternative technologies about £25/ton.
- Cement:
  - Traditional kilns produce about 1 ton CO2 per ton cement; process emissions ~70 percent of these emissions.
  - Alternatives: state-of-the-art plants reduce non-process emissions; CCS variants reduce emissions by about 55 percent (post-combustion) or about 85 percent (oxy-combustion) with capital cost increases of about 25 percent and about 100 percent respectively.
  - At carbon price £40/ton CO2:
    - Traditional production cost increases about £40/ton of cement, or about 70 percent.
    - More efficient plants price increase £28/ton.
    - CCS-fitted plants price increase £6–20/ton.
  - Feebate with price £40/ton:
    - Traditional production cost increase £4/ton.
    - Subsidy to more efficient plants £8/ton.
    - Subsidy to CCS-fitted plants £16–30/ton.
- Comparative implication: carbon pricing produces larger first-order cost increases for high-emission incumbents; feebates impose smaller cost increases on incumbents and provide explicit subsidies to lower-emission alternatives.

### Key numeric findings and policy-relevant figures (preserved exactly)
- Required emissions cuts: 25–50 percent below 2018 levels by 2030.
- Projected change in global CO2 emissions for 2020: about 8 percent lower than in 2019.
- Coverage of current pledges: about one third of the emissions reductions consistent with the 2°C target.
- Net GHG emissions need to decline to zero by 2050 for the 1.5°C target or by 2070 for the 2°C target (IPCC 2018).
- Potential long-run GDP impact by 2100 from warming: 5 to 25 percent permanent reduction below no-climate-change GDP.
- Target carbon price: at least £60 (US $75) per ton by 2030.
- Current CO2 prices in power and industrial sector: about £40 per ton.
- Example higher feebate price used in illustration: £300 per ton yielding EV subsidy £4,694.
- Revenue impact: additional annual revenues of around 0.8 percent of GDP in 2030 from a £60 per ton carbon price.
- Household burden: 0.9 percent of consumption for the average UK household in 2030 from a £60/US $75 per ton carbon tax.
- Regressivity: bottom income quintile burden 2.7 times that of top quintile.
- Fuel excise taxes: 58 pence per liter for gasoline and diesel; equivalent carbon taxes £246 per ton CO2 for gasoline and £213 per ton for diesel.
- Fuel duty revenue: about 1.4 percent of GDP; nominal duty frozen since 2010/11 implying real reduction of about 15 percent; forgone cumulative revenues over £46 billion since 2011.
- EV penetration fiscal finding: 0.3 percent of GDP by 2030 with penetration of EVs.
- EV assumptions: EV sales share linear increase to 60 percent by 2030; 7 percent of vehicle fleet replaced each year; on-road fleet EV share about 20 percent in 2030.
- Congestion average external cost: 14.3 pence/km (2018£); lifetime tax payments a: £18,810 (average).
- Steel emissions and costs: integrated process ~2 tons CO2/ton steel; integrated cost increase £80/ton at £40/ton CO2; alternative tech cost increase ~£15/ton.
- Cement emissions and costs: traditional process ~1 ton CO2/ton cement; carbon price £40/ton increases traditional cost ~£40/ton (about 70 percent).

*wpiea2020268-print-pdf; canonical URL: https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020268-print-pdf.pdf*

### 1. Broader Reforms to the Pricing of Road Transport .............................................................22

### 1. Broader Reforms to the Pricing of Road Transport .............................................................22

### Introduction and context
- The COVID-19 pandemic has not altered the global need for rapidly transitioning to zero carbon energy systems.
- A global emissions pathway consistent with limiting future global warming to 1.5°C–2°C above preindustrial levels—the central objective of the 2015 Paris Agreement—would require cutting global fossil fuel carbon dioxide (CO2) and other greenhouse gases (GHGs) by 25–50 percent below 2018 levels by 2030, with progressively deeper emissions reductions thereafter.
- Global CO2 emissions in 2020 are projected to be about 8 percent lower than in 2019, due to both lower GDP and structural shifts in the economy (e.g., more remote working), but emissions are likely to start rising again in 2021 as economies recover and some of the structural shifts are partially reversed.
- With governments likely to bring forward investment plans to help boost their economies, the pandemic has added to the urgency of ensuring that this new investment is appropriately allocated to low-carbon technologies.
- Carbon pricing is highlighted as a key instrument for achieving emissions reductions and generating new revenue at a time of heightened fiscal pressures resulting from the crisis.

### Shortfall in current mitigation pledges and international mechanisms
- At a global level, current mitigation pledges for the 2015 Paris Agreement fall well short of temperature stabilization goals.
- Even if fully implemented, pledges by 190 parties would cut global emissions in 2030 by about one third of the emissions reductions consistent with the 2°C target (let alone the 1.5°C target).
- The principal reason for this shortfall is that mitigation possibilities in large emitting emerging market economies are not optimally exploited from a global perspective, in part reflecting their differentiated responsibilities.
- Parties are required to submit revised climate strategies ahead of COP 26 in Glasgow in 2021, which are expected to have enhanced mitigation ambition.
- IMF staff have proposed a carbon price floor arrangement among large emitters as an additional international mechanism to complement the Paris process.

### Macroeconomic risks from climate change
- Climate change poses highly uncertain macroeconomic risks at the global and national level.
- By 2100 studies suggest warming could be permanently lowering global GDP by anything from 5 to 25 percent below GDP levels with no climate change (reflecting, for example, rising damages).

### Key numeric findings and policy-relevant figures (preserved exactly as presented)
- Required emissions cuts: 25–50 percent below 2018 levels by 2030.
- Projected change in global CO2 emissions for 2020: about 8 percent lower than in 2019.
- Coverage of current pledges: about one third of the emissions reductions consistent with the 2°C target.
- Net GHG emissions need to decline to zero by 2050 for the 1.5°C target or by 2070 for the 2°C target (IPCC 2018).
- Potential long-run GDP impact by 2100 from warming: 5 to 25 percent permanent reduction below no-climate-change GDP.

*Source: wpiea2020268-print-pdf; canonical URL: https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020268-print-pdf.pdf*

### 1.5 degrees

### 1.5 degrees

### Climate risks and policy context
- Overriding concern: tail risks (e.g., runaway warming from release of underground methane, collapsing ice sheets) that are difficult to incorporate in standard damage estimates.
- World Economic Forum ranks climate change as the greatest threat to the planet.
- Transition risks arise as economies are restructured to eliminate emissions from fossil fuels and other sources.
- Timeliness: a thorough reconsideration of mitigation policy is especially timely for the UK with the end of the Brexit transition period.

### Proposed domestic mitigation framework (summary)
- Core proposal: a uniform carbon pricing scheme reinforced with powerful measures at the sectoral level.
- Target carbon price: a price rising steadily from current levels to at least £60 (US $75) per ton by 2030.
  - Current CO2 prices in the power and industrial sector are currently about £40 per ton (so would rise by a further £20 per ton), while prices are modest or zero for other sectors.
- Preferred instrument: a carbon tax that:
  - (i) promotes the full range of mitigation opportunities;
  - (ii) provides certainty over emissions prices to promote clean-technology investment;
  - (iii) provides a direct and robust source of revenue for the Treasury;
  - (iv) allows reinforcing measures to reduce emissions;
  - (v) reforms the current set of pricing schemes that disproportionately burdens the power sector.
- Alternative: a domestic ETS can largely mimic the advantages of a tax if combined with a robust price floor and full allowance auctions.
- Complementary sectoral policies are essential:
  - To address sector-specific factors (financing constraints, incomplete markets).
  - To reinforce carbon pricing when acceptability constraints limit carbon-price increases.
  - To meet sectoral targets that are more ambitious than nationwide targets.

### Sectoral reinforcing instrument: feebates
- Feebates: revenue-neutral sliding scale of fees on products/activities with above-average emission rates and rebates for below-average emission rates.
- Advantages:
  - Provide strong incentives to reduce emissions intensity without a politically challenging first-order tax burden on households and firms.
  - Unlike subsidies, do not create a revenue loss for government.
  - Particularly attractive for progressive phase-out of internal combustion engine (ICE) vehicles.
  - Can strengthen decarbonization incentives in industry while largely avoiding pressure for a border carbon adjustment (BCA) or other compensation mechanisms.
  - Variants could promote adoption of clean heating systems in buildings and reductions in agricultural emissions.
- Efficiency note: absent other frictions, feebates are less efficient than carbon pricing because they do not promote the same demand responses (e.g., reductions in vehicle use), but they are more flexible and cost-effective than regulations.

### International pricing and UK role as COP26 President
- The UK could promote dialogue on an international carbon price floor and pricing of fuels used for international transportation.
- International coordination required: a price floor should complement the Paris Agreement, cover large emitters, impose stricter requirements on advanced countries, and allow national flexibility (e.g., policies with equivalent emissions outcomes).
- Pricing is needed for international maritime and aviation emissions—for upfront funding of clean technology development and to establish deployment price signals.

### Background on UK emissions objectives and targets
- Statutory framework: government required to set, twelve years in advance, five-yearly carbon budgets out to 2050, with the Committee on Climate Change (CCC) reporting annual progress.
- Strengthened targets:
  - In 2019 the UK pledged to cut emissions 57 percent below 1990 levels by 2030.
  - Net-zero GHG emissions target for 2050 (first major world economy to set a legally binding net-zero target).
- Supplementary sectoral targets:
  - Planned ban on sale of new gasoline, diesel, hybrid, and plug-in electric hybrid cars and vans by 2030—only EVs and hydrogen (or alternative) vehicles allowed.
  - Coal generation plants (without carbon capture and storage) will be phased out by 2025.

### Emissions trends and consumption vs production
- Total GHG emissions are now 42 percent lower than in 1990.
- Emissions per capita: started 25 percent above European OECD countries and now about ten percent below it.
- Two-thirds of the GHG reduction came from reductions in CO2 emissions.
- Reductions in methane emissions account for a further quarter of the total GHG reduction; methane emissions broadly flat since 2013.
- Remaining ten percent of the reduction mostly from lower nitrous oxide emissions related to production of nitric and adipic acids.
- Transport sector:
  - Accounts for about 27 percent of total GHGs.
  - Transport emissions have made virtually no contribution to reducing GHG emissions since 1990 and have increased by about five percent since 2013.
- Consumption-based vs production-based emissions:
  - Consumption-based GHG emissions fell by around 10 percent from 1997 to 2016.
  - Production-based emissions fell by 36 percent over comparable periods.
  - UK imports have more embodied CO2 than exports, so consumption-based CO2 emissions exceed production-based emissions.
- EVs and infrastructure:
  - EVs are currently less than 1 percent of the on-road vehicle fleet.
  - An estimated 2.5 million charging stations will be needed to accommodate EVs by 2035 (currently there are 11,000 charging stations).

### Progress relative to carbon budgets and policy adequacy
- The UK met the first and second carbon budgets (2008–12 and 2013–17) and is on track to outperform the third (2018–22) budget.
- The CCC concluded the government's Clean Growth Strategy lacks the policy specifics needed to achieve the fourth (2023–27) and fifth (2028–32) carbon budgets.
- The fourth and fifth carbon budgets were set prior to the net-zero 2050 commitment and are now too loose to be consistent with carbon neutrality.
- Clarifying future policies is urgent given lead times needed for necessary investments.

### Current policy framework: multiple overlapping instruments (key figures)
- EU ETS (power generation and large industrial firms): CO2 allowance price currently equivalent to £27 per ton.
- Carbon Price Floor (CPF) and Carbon Price Support (CPS) for power generation: CPS currently £18 per ton.
- Climate Change Levy (CCL) on firms’ energy consumption:
  - Current rates: 0.811 pence per kilo-watthour (kWh) for electricity, 0.406 pence per kWh for natural gas, and 2.175 pence per kg for LPG.
  - CCL currently equivalent to about £25 per ton of CO2 for electricity and £20 per ton for gas.
  - Starting in 2019, CCL rates to be rebalanced gradually moving from a ratio of 2.9:1 (electricity:gas) in 2018 to parity in 2025.
- Vehicle excise duties (VED) first year:
  - Fixed charge of £140 for all non-EVs (first year).
  - Charges vary from £0 for EVs to £2,000 across 13 vehicle classifications.
  - New fleet average (fixed plus variable) excise was £317 in 2019.
  - After first year VED payment is flat in subsequent years and unrelated to CO2 emissions for petrol or diesel vehicles.
- EU CO2 emission rate standards for new vehicle fleets: 2021 target 95 grams CO2 per km; falling to about 60 g per km in 2030.
- Fuel excise taxes: currently 58 pence per liter for both gasoline and diesel.
  - Equivalent carbon taxes: £246 per ton of CO2 for gasoline and £213 per ton for diesel (though these taxes largely reflect other, non-carbon externalities).
- Fuel duty role:
  - Fuel duty currently raises about 1.4 percent of GDP, or about 70 percent of total fiscal revenue from transportation.
  - Nominal fuel duty frozen since 2010/11, implying a reduction in real terms of about 15 percent.
  - Continued freezing implied forgone cumulative revenues of over £46 billion since 2011.
- Current pricing coverage and distortions:
  - Power and industry: direct emissions price around £40 per ton.
  - Households: household consumption of natural gas is currently not subject to carbon pricing and faces low taxation; VAT rate on domestic energy consumption is 5 percent rather than the standard 20 percent.
  - The layering of policies causes substantial variation in carbon prices across sectors and fuels, making the current framework excessively costly for a given total emissions reduction.

### Political acceptability and administrative challenges
- Acceptability constraints have led to scaling back planned carbon-price increases (e.g., freezing the CPS) to limit burdens on households and firms.
- Example impact: an additional $50 (£38) per ton carbon price in 2030 would increase UK natural gas prices by 35 percent, retail electricity prices by 10 percent, and gasoline prices by 6 percent.
- Administrative complexities:
  - Duplication and coordination difficulties across multiple mitigation instruments.
  - Some instruments operate at the EU level (e.g., EU ETS) and are not under UK sole discretion.
  - CPS adjustments do not affect household, industrial, and transportation sectors comprehensively.
- VED reform: recent reforms created more differentiation only for first-year rates; flat subsequent-year payments reduce long-term CO2 sensitivity and make the system less differentiated overall.

*Source: IEA (2020), IPCC (2018), and IMF staff calculations.*

### 0.3 percent of GDP by 2030 with penetration of EVs.

### wpiea2020268-print-pdf - 0.3 percent of GDP by 2030 with penetration of EVs.

### Fiscal and emissions implications of EV penetration and fuel duties
- Finding: 0.3 percent of GDP by 2030 with penetration of EVs.  
- If the Government meets the CCC recommendation of near-zero emissions from transport by 2050, then fuel duty receipts would tend towards zero.
- Authors’ calculation assumptions: linear increase in the annual EV sales share to 60 percent by 2030 (based on CCC projections) and 7 percent of the vehicle fleet is replaced each year—these assumptions imply an EV share in the on-road fleet of about 20 percent in 2030.

### Interaction with EU-level instruments and Market Stability Reserve (MSR)
- Domestic reductions in power sector and industrial emissions may be offset at the EU level if the EU ETS cap is fixed—UK mitigation policies simply lower the EU ETS allowance price in that case.
- Exception: if the Market Stability Reserve (MSR) is triggered and the resulting allowances withdrawn under the MSR were permanently retired (rather than put back later into the ETS), offsetting could be avoided.

### Post‑Brexit emissions pricing options overview
- UK proposal to replace EU ETS includes plans to: (i) cover the same emissions sources as the current EU ETS; (ii) cut the emissions cap by 5 percent; and (iii) have a fixed auction reserve price, set at £15 per ton of CO2 (along with price ceilings to be specified).
- In case of a no-deal Brexit, a carbon tax would replace the EU ETS and would: (i) be set at a level comparable with the EU ETS price; (ii) allow infra-marginal exemptions for emissions sources granted free allowances under the EU ETS; and (iii) maintain the level of total carbon pricing across the UK economy at similar levels.
- The CPS for electricity generators would remain in place.

### Economywide carbon pricing: roles, design tradeoffs, and alternatives
- Carbon pricing roles: promote behavioral responses to reduce emissions per unit (e.g., per kWh, per ton of steel, per km) and reduce overall demand for energy.
- Well-designed carbon pricing requires: comprehensive coverage; a robust and predictable emissions price; exploiting fiscal opportunities; ensuring compatibility with reinforcing sectoral instruments.
- Carbon tax features: integrates charges into existing road fuel excises and applies similar charges to domestic supply of oil products, coal, and natural gas; tax rate can ramp up automatically; revenues collected by the Treasury and allocable to environmental spending or general purposes; sectoral instruments can further reduce emissions without changing the carbon tax rate.
- ETS features: can mimic a carbon tax if allowances are fully auctioned and a price floor is used; an ETS can be extended midstream to suppliers of fuels for buildings and transportation; an ETS may build on existing EU ETS capacity and align caps with carbon budgets.
- Linking a UK ETS to the EU ETS: could be more efficient due to larger pool and liquidity; would smooth transition and mitigate competitiveness concerns; linking could take a decade (Swiss experience); linkage would not prevent UK unilateral measures from lowering EU ETS prices unless offset by MSR withdrawals.

### Uncertainty in the price needed to meet emissions targets
- IMF staff tool projects emissions, fiscal, and economic impacts using fuel use, post-COVID GDP projections, and assumptions about: (i) income elasticity of demand for energy products; (ii) technological progress improving energy efficiency and renewable productivity; (iii) future international energy prices.
- Empirical price elasticities range between -0.5 to -0.8.
- About 60 carbon pricing schemes exist; prices are mostly around $5 to $25 per ton. Existing and prospective pricing schemes cover only a fifth of global GHGs.
- By itself, a carbon price in the order of £60 (US $75) per ton would not be enough to meet the UK’s 57 percent emissions reduction target for 2030.
  - A £60 carbon price would cut emissions 18 percent below baseline levels in 2030 whereas reductions of 26 percent are needed to meet the UK emissions pledge.
- Cross-country variation: some G20 countries would require prices above $75 per ton to meet targets (e.g., France, Italy, Korea) while others would require prices below $25 per ton (e.g., China, India, South Africa).
- Example external estimate: Chen and others (2020) estimate a uniform carbon price of at least €70 (£64) per ton to deliver a 50 percent reduction in emissions by 2030 if acting in isolation and relying solely on carbon prices.

### Revenue potential and distributional impacts of a carbon price
- A carbon price of £60 per ton in 2030 would raise additional annual revenues (relative to a zero-carbon price and accounting for the erosion of pre-existing fuel tax bases) of around 0.8 percent of GDP in 2030.
- Distributional impacts: a £60 (US $75) per ton carbon tax imposes a burden of 0.9 percent of consumption for the average UK household in 2030 (relative to no tax)—somewhat less than burdens in US, Canada, China, and India.
- Regressivity: burden in the UK is more severe—bottom income quintile bears a burden 2.7 times as large (relative to consumption) as the top income quintile, reflecting higher consumption of natural gas and electricity among low-income households.
- Policy recommendation: revenue recycling via targeted compensation packages should disproportionately benefit low-income households and can be used to finance climate reforms, cut distortionary taxes, or fund public investments. To maximize efficiency, revenue should be used to decrease (or avoid raising) distortionary taxes such as the labor income tax, or to address public investment gaps.

### Transportation sector: carbon pricing limits and feebates
- A carbon price provides a modest incentive for shifting to zero emission vehicles (ZEVs).
  - Example: a £60 per ton carbon price increases the price of a new vehicle with average fleetwide emission rate by about £1,000 relative to a ZEV (based on assumptions below), or about 3.5 percent of the vehicle purchase price.
- Rapid transition to ZEVs will likely require stronger pricing incentives and expanded EV charging infrastructure.
- Feebate design: sliding fees for vehicles with above-average emission rates and sliding rebates for vehicles with below-average rates; fee equals product of: (i) a CO2 price; (ii) difference between vehicle’s CO2 per km and the average CO2 per km of the nationwide new vehicle fleet; and (iii) discounted lifetime km of the average vehicle.
- Feebate attractions:
  - Promote a wide range of behavioral responses (high-to-low emission ICEs, ICEs to biofuel/hydrogen, ICEs to EVs).
  - Cost-effective: same incremental reward for reducing emissions across vehicle choices.
  - Revenue-neutral if pivot point equals new fleetwide average emission rate observed in preceding year—no net loss of government revenue.
  - Do not impose a new tax burden on households on average.
  - Easily integrated into existing formulas such as VED schedules—no new capacity needed for implementation in the UK.
- Quantitative illustration: feebates with a carbon price of £300 per ton would provide an EV subsidy of £4,694 at current fleetwide average emission rates; over time subsidies decline in proportion with declines in fleetwide average emission rate.
- Complementary reforms: km-based charges varying with congestion and pay-as-you-drive auto insurance can address other transport externalities and maintain revenue as fuel tax bases erode.

### Key quantitative items and assumptions cited
- 0.3 percent of GDP by 2030 with penetration of EVs.
- EV sales share linear increase to 60 percent by 2030; 7 percent of vehicle fleet replaced each year; on-road fleet EV share about 20 percent in 2030.
- UK ETS proposal: cut emissions cap by 5 percent; fixed auction reserve price £15 per ton of CO2.
- Carbon price examples: £60 per ton (US $75); £300 per ton (feebate illustration); €70 (£64) per ton (Chen and others estimate); Ireland increasing carbon tax to $95 per ton by 2030.
- Revenue impact: additional annual revenues of around 0.8 percent of GDP in 2030 from a £60 per ton carbon price.
- Household burden: 0.9 percent of consumption for the average UK household in 2030 from a £60/US $75 per ton carbon tax.
- Regressivity: bottom income quintile burden 2.7 times that of top quintile.
- Vehicle feebate assumptions for discounted lifetime mileage: 131,600 km based on 16 year life; vehicles driven on average 1,145 km a year; annual reduction in driving of 3%; discount rate 5%. Pivot points: 119 and 65 g CO2/km based on new UK fleet average for 2017 and EU target for 2030 respectively.
- Example vehicle impacts (selected lines from table): Electric change in purchase price, £: -4,694 under feebate pivot 119 g CO2/km with £/ton CO2 = 300; Total/average registrations 2,586; average new car emissions 119 g CO2/km.

*Italic source attribution: wpiea2020268-print-pdf - 0.3 percent of GDP by 2030 with penetration of EVs.*

### Box 1. Broader Reforms to the Pricing of Road Transport

### Box 1. Broader Reforms to the Pricing of Road Transport

### External costs of congestion
- Traffic congestion imposes large external costs on road users because motorists do not account for their impact on slowing road speeds for other road users.
- The external cost (the cost one vehicle imposes on other road users) was less than 3.5 pence per vehicle km for about 75 percent of driving in the UK in 2015.
- External costs increase sharply as the traffic volume to road capacity ratio approaches unity: external costs were 92 and 196 pence per km when this ratio is 0.75–1 and over 1 respectively.
- Averaged across road classes estimated external costs were 14.3 pence per km.

### Km-based taxes and monitoring
- Congestion can be efficiently managed (for given road capacity) through km-based taxes varying by location and time of day.
- Per km tolls on busy roads that progressively rise and fall over the rush hour exploit behavioral responses for reducing congestion (e.g., shifting departure time, using off-peak travel, using less congested roads, switching to public transport, carpooling, reducing trip frequency).
- Developments in metering technologies such as global positioning systems imply that people’s driving could be tracked and billed accordingly.
- Km-based charging might be promoted through subsidizing/taxing vehicles with/without monitoring capacity during a transition period with monitoring capacity eventually becoming mandatory.
- Unlike fuel taxes, km-based taxes provide a robust general revenue base which would be unaffected by decarbonization of transportation and is especially valuable given fiscal pressures from the COVID-19 crisis.
- Administrative costs would be higher than for collecting fuel taxes, due to the need to charge individuals rather than fuel distributors.
- An alternative, bottom-up approach would be to progressively expand congestion-charging zones (e.g., in London), though this would be far less comprehensive than a nationwide charging system.
- Note: the marginal external congestion cost would decline sharply in response to km-based taxes but this is not considered in the calculations below.

### Transition to pay-as-you-drive (PAYD) automobile insurance
- Transitioning from lump-sum to pay-as-you-drive (PAYD) automobile insurance, under which premiums vary in proportion to the policyholder’s annual km, would further reduce driving and help to internalize traffic accident externalities.
- Motorists do not account for various accident risks to others posed by their own driving (e.g., injury risks to pedestrians and to other vehicle occupants in multi-vehicle collisions, third-party property and medical costs).
- Existing rating factors, as determined by insurance companies, could be used to set per km charges for different drivers as an (albeit imperfect) proxy for external accident risk: drivers with prior crash records, for example, would pay higher variable charges and would have the greatest incentives to drive less.
- The transition to PAYD could occur on a voluntary basis, with the government kickstarting the process using tax incentives.
- Drivers with below-average annual km would have the strongest incentives to take up PAYD and as they switched, premiums would rise for the remaining pool of drivers with lump-sum insurance, encouraging further shifting to PAYD.
- On average, PAYD would raise the marginal cost of driving by around 4 pence per km (while reducing the average accident risk for all drivers).
- Government incentives may be needed to overcome obstacles to the private development of PAYD. When an insurer charges by the km, its costs are reduced to the extent that its own customers reduce their accident risk by driving less. However, the costs to other insurance companies also are lowered because the risk of multi-car accidents for their own customers is lower, but savings cannot be captured by the company offering the km-based insurance.

### Quantitative estimates (Km-Based Taxes Needed to Internalize Congestion Externalities, 2015)
- Congestion band 1
  - volume-capacity ratio: <.25
  - share in nationwide traffic km: 0.43
  - marginal external congestion cost: 1.4 pence/km (2018£)
  - lifetime tax payments a: £1,850
- Congestion band 2
  - volume-capacity ratio: .25 - .50
  - share in nationwide traffic km: 0.31
  - marginal external congestion cost: 3.4 pence/km (2018£)
  - lifetime tax payments a: £4,471
- Congestion band 3
  - volume-capacity ratio: .5 - .75
  - share in nationwide traffic km: 0.17
  - marginal external congestion cost: 11.5 pence/km (2018£)
  - lifetime tax payments a: £15,110
- Congestion band 4
  - volume-capacity ratio: .75 - 1
  - share in nationwide traffic km: 0.07
  - marginal external congestion cost: 91.7 pence/km (2018£)
  - lifetime tax payments a: £120,729
- Congestion band 5
  - volume-capacity ratio: >1
  - share in nationwide traffic km: 0.02
  - marginal external congestion cost: 195.9 pence/km (2018£)
  - lifetime tax payments a: £257,802
- Average
  - marginal external congestion cost: 14.3 pence/km (2018£)
  - lifetime tax payments a: £18,810

- Note a: Assumes annual average driving of 1,145 km all within a given congestion band and consumer discount rate of 5 percent.
- Assuming an annual insurance payment of £500 and 11,450 km driven per year (PAYD illustrative calculation).

*Source. UK DOT 2018.*

### Box 3. Illustrative Impacts of Carbon Pricing and Feebates on Production Costs for Steel

### Box 3. Illustrative Impacts of Carbon Pricing and Feebates on Production Costs for Steel and Cement

### Steel: production processes and emissions
- About 40 percent of steel is produced using an integrated process (coking coal → blast furnace → oxygen furnace).
- The integrated process produces about two tons of CO2 per ton of steel.
- Alternatives:
  - Electrified process using scrap metal (currently about 60 percent of production).
  - Emerging technologies (e.g., carbon capture and storage (CCS), electric furnace fed with iron made by direct reduction).
- These alternatives produce CO2 emissions of about 0.3–0.4 tons per ton of steel.

### Steel: illustrative cost impacts at carbon price £40/ton CO2 and under feebates
- Carbon price of £40/ton CO2:
  - Increases the cost of integrated production by about £80/ton of steel through the first-order transfer payment (about 20 percent of recent steel prices).
  - Increases the cost under alternative technologies by about £15/ton of steel.
- Feebate (given current industry average emission rate of 1 ton of CO2 per ton of steel):
  - Cost increase for integrated production would be £40 per ton of output.
  - Alternative technologies would receive a subsidy of about £25 per ton of output.

### Cement: production processes, emissions, and alternatives
- About 90 percent of cement is produced using traditional kilns to decompose calcium carbonate into clinker and CO2, then mills mix clinker with other minerals.
- The traditional process produces about 1 ton of CO2 per one ton of cement, with process emissions contributing about 70 percent of these emissions.
- Alternatives:
  - State-of-the-art plants in energy efficiency (currently about 10 percent of production) largely eliminate non-process emissions.
  - CCS variants:
    - Post-combustion: reduces emissions about 55 percent; increases capital costs by about 25 percent.
    - Oxy-combustion: reduces emissions about 85 percent; increases capital costs by about 100 percent.

### Cement: illustrative cost impacts at carbon price £40/ton CO2 and under feebates
- Carbon price of £40/ton CO2:
  - Increases the cost of traditional production about £40 per ton of cement, or about 70 percent.
  - Increases the price of more efficient plants by £28 per ton of output through the first-order transfer payment.
  - Increases the price of CCS-fitted plants by £6–20 per ton of output through the first-order transfer payment.
- Feebate with price £40/ton CO2:
  - Increases the cost of traditional production by £4 per ton of cement.
  - Provides a subsidy to more efficient plants of £8 per ton of output.
  - Provides a subsidy to CCS-fitted plants of £16–30 per ton of output.

### Comparative implications of carbon pricing versus feebates (industry-first-order effects)
- Carbon pricing at £40/ton CO2:
  - Produces larger first-order increases in production costs for high-emission incumbent technologies (e.g., £80/ton for integrated steel; £40/ton for traditional cement).
  - Raises costs for lower-emission alternatives but by smaller absolute amounts (e.g., about £15/ton for alternative steel technologies; £6–20/ton for CCS-fitted cement).
- Feebates anchored at £40/ton CO2:
  - Impose smaller cost increases on incumbent high-emission producers (e.g., £40/ton for integrated steel; £4/ton for traditional cement).
  - Provide explicit subsidies to lower-emission alternatives (e.g., about £25/ton for alternative steel; £8 and £16–30/ton for efficient and CCS-fitted cement respectively).
- Notes on technology switching and industry dynamics:
  - Technology switching is more likely to take the form of retrofitting existing plants rather than scrapping and rebuilding, since existing steel factories can potentially produce for several decades.
  - Incentives to switch will vary across plants with local fuel and electricity prices.

*Source: van Ruijven and others (2016) (western European averages), EC 2018, and IMF staff calculations.*

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_Source: https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020268-print-pdf.pdf_