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### Context and emissions targets
- Germany adopted the Climate Change Act (CCA) in 2019, setting emissions targets of a 55 percent reduction from the 1990 level by 2030 and attaining net zero emissions by 2050.
- After the constitutional court ruling in May 2021, the CCA was amended in late June 2021, tightening targets to:
  - 65 percent reduction in GHG emissions below the 1990 level by 2030, and
  - net zero emissions by 2045.
- The revised CCA sets an annual path of aggregate emissions through 2040 and revised annual sectoral targets through 2030.

### Climate Action Program (CAP) 2030 — design and instruments
- Four key components:
  - National Emission Trading System (ETS):
    - Operational January 1, 2021, covering CO2 emissions from transportation and heating fuels with initial price of €25/tonne of CO2.
    - Carbon pricing scheduled to increase to €55 by 2025 in a step-wise manner.
    - From 2026 auctions introduced with an emissions cap declining over time; initial price range €55 to €65 per tonne; path amendable once parliament approves revised CCA.
    - National ETS supplements the EU ETS; allowances auctioned with revenues re-invested in climate measures or returned to taxpayers.
  - Sectoral measures for buildings, transportation, energy, agriculture, and industry:
    - Tax incentives for energy-efficient modernization of buildings; increase EVs and public charging points; expand renewable energy generation and industrial use; phase out coal; encourage climate-friendly agriculture; explore carbon storage.
  - Compensation for households and firms:
    - Renewable energy surcharge reduced; tax relief for long-distance commuters; higher housing allowances.
  - Monitoring and correction mechanism:
    - Annual sectoral progress assessment; remedial action plans if statutory targets not met; “climate cabinet” reviews effectiveness, efficiency, and targeting annually.

### Objectives and organization of the paper
- Three key questions:
  - Are there policy measures that can enhance effectiveness, cost-effectiveness, and acceptability of Germany’s mitigation strategy?
  - What is the distributional impact of higher carbon pricing?
  - How best to address emissions leakage and competitiveness losses from higher domestic costs?
- Paper organization summarized: Section II—global/national emissions trends; Section III—Germany’s targets and policies; Section IV—policy enhancement options; Section V—distributional and leakage analysis; Section VI—conclusion.

### Global and national emissions trends — key findings
- To contain projected warming to 1.5–2.0 C above pre-industrial levels, global CO2 and other GHG emissions must be cut 25–50 percent below 2019 levels by 2030 followed by a rapid move towards net zero emissions.
- Global emissions declined by around 6 percent in 2020 from 2019 due to COVID-19 but likely to rise in 2021 as economies recover.
- By 2100 warming could permanently lower global GDP by anywhere between 5 and 25 percent relative to a path with no climate change; tail risks pose severe threats.
- Germany:
  - GHGs in 2019 were 36 percent below 1990 levels and 6 percent below 2018 levels.
  - Between 1990 and 2019, GHG emissions fell: energy by 45 percent, industry by 34 percent, buildings by 42 percent, agriculture by 11 percent, waste management by 76 percent; transportation emissions remained about unchanged.
  - Projected in a BAU scenario to remain among the top ten global emitters in 2030 in absolute and per capita CO2 emissions (IMF staff projections).

### Germany — emissions composition and electricity sources (exact 2019/2018 values)
- Total 2019 GHGs: 805 million tonnes of CO2 equivalent. Sector shares:
  - Energy (principally power generation and district heating): 32 percent
  - Industry: 23 percent
  - Transport: 20 percent
  - Buildings: 15 percent
  - Agriculture: 9 percent
- Electricity generation shares:
  - Coal: 28 percent
  - Natural gas: 15 percent
  - Nuclear: 12 percent
  - Renewables (including hydro, biomass, other renewables): 40 percent
- Nearly half of electricity generation from renewables was mostly onshore wind.
- LULUCF sector absorbed 27 million tonnes of CO2 in 2018.

### International and EU context — targets and pricing signals
- Paris Agreement goal: contain warming to well below 2.0 C; parties submitted NDCs ahead of COP26.
- Current 2030 commitments would achieve only two-thirds of emissions reductions needed even for a 2.0 C target.
- Getting on track requires measures equivalent to a global carbon price around $75 per tonne by 2030; current global average price is $3 per ton.
- EU-level: revised EU NDC goal is cutting GHGs 55 percent below 1990 levels by 2030 and carbon neutrality by 2050; EU Green Deal seeks to mobilize €1 trillion.
- EU ETS covers about 45 percent of total EU GHGs; cap declines by 2.2 percent a year (to be tightened); EU allowance prices rose to around €50 per tonne by June 2021; MSR withdraws allowances when banked allowances exceed thresholds.

### Germany — national targets, sectoral targets and CAP 2030 specifics
- CCA revised June 2021 tightened targets to:
  - 65 percent reduction in GHGs below 1990 by 2030
  - 88 percent reduction by 2040
  - Net zero emissions by 2045
- CCA sectoral and technology targets (1990 emissions, 2019 outcome, 2030 target):
  - Energy (power): 1990 emissions 466 mn tonnes CO2 equivalent; 2019 outcome -45.4 percent; 2030 emissions target -77 percent
  - Industry: 1990 emissions 284 mn tonnes; 2019 outcome -33.9 percent; 2030 target -58 percent
  - Transport: 1990 emissions 163 mn tonnes; 2019 outcome -0.3 percent; 2030 target -48 percent
  - Buildings: 1990 emissions 210 mn tonnes; 2019 outcome -42.0 percent; 2030 target -68 percent
  - Agriculture: 1990 emissions 90 mn tonnes; 2019 outcome -24.2 percent; 2030 target -37 percent
  - Other (e.g., landfill): 1990 emissions 38 mn tonnes; 2019 outcome -75.6 percent; 2030 target -89 percent
  - Total (1990 emissions 1,251 mn tonnes): 2019 outcome -35.7 percent; 2030 target At least -65 percent
- Renewable energy and EV targets:
  - Share of gross electricity generation: 2018 outcome 42.1 percent; 2030 target 65 percent
  - Share of gross final energy consumption: 2018 outcome 17.1 percent; 2030 target 30 percent
  - Number of registered electric passenger vehicles — 2030 target: 7-10 million
- CAP 2030 centerpiece: national ETS launched January 1, 2021. Key features:
  - Coverage: suppliers of domestically produced and imported fuels for transport and building sectors (heating oil, LPG, natural gas, coal, gasoline, diesel).
  - Prices: 2021-2025 fixed price rising from €25 to €55 per tonne of CO2 (no cap); in 2026 auctions introduced with a price collar of €55-65 per tonne CO2. From 2027 onwards retention of a price collar is to be determined.
  - Caps: From 2026 onwards caps on allowable emissions will be introduced and will decline in line with Germany’s emissions targets.
  - Revenue use: revenues earmarked for climate measures (incentivizing low-carbon transport, energy-efficient buildings, reduced renewable energy surcharge, higher commuter allowance for long-distance commuters).
- Additional CAP 2030 measures and public investment:
  - Subsidies for wind and solar; switching from coal to gas; retiring coal plants; EV incentives; annual circulation taxes tied to vehicle emission rates; energy-efficient building refurbishment incentives; phasing out oil-based heating from 2026.
  - EV charging stations target one million by 2030; VAT on train tickets lowered from 19 to 7 percent; extra funding around €1-2 billion per year for transit infrastructure; power grid expansion aligned with renewables.
  - R&D: carbon-saving technologies for industry, battery cells for EVs, laboratories for sector coupling.
  - Just transition assistance: household and firm compensation and €40 billion for developing new economic structures in coal regions through 2038.

### Policy options for enhancing mitigation — cross-sector carbon pricing
- Carbon pricing advantages:
  - Across-the-board incentive to reduce energy use and shift fuels; equalizes marginal abatement cost; mobilizes revenues; reduces local air pollution mortality; administratively straightforward for mature institutions.
- Coverage and trading limitations:
  - National ETS combined with EU ETS means fossil fuel emissions in Germany are comprehensively covered by pricing schemes, but current frameworks prevent trading between national ETS and EU ETS, stopping equalization of marginal abatement costs across all sectors.
- Price uncertainty concerns and recommendation:
  - EU ETS allowance prices have been volatile; national ETS prices from 2027 onwards are uncertain.
  - Recommendation: national ETS could incorporate an automatically escalating price floor after expiration of the price collar in 2026.
- Required prices to meet targets (IMF staff modeling):
  - Power sector targets (covered by EU ETS) could be met under a price of €100 per tonne in 2030.
  - Even a price of €150 per tonne appears inadequate to meet transport and building sector targets and is only just sufficient to achieve the target in industry.
  - Prices consistent with emissions targets are much higher in the domestic than the EU ETS sector because emissions respond less to prices in the building and transport sectors.
- EU-level reforms proposed:
  - Extend EU ETS so aggregate emissions from power, industry, transport, and buildings are subject to one aggregate cap with a common emissions price across sectors.
  - Allow member states to re-allocate emissions reductions from transport/buildings to power/industry to lower national mitigation costs (currently precluded by EU burden sharing rules).
  - Establish an exogenous and escalating price floor for the EU ETS (Germany could push for a robust price floor via MSR reform).
  - In absence of EU reforms, Germany could impose a domestic surcharge on emissions covered by the EU ETS to equalize combined price on power/industrial emissions with a target ramping over time (analogous to U.K. Carbon Price Floor or Netherlands planned target rising from €30 per tonne in 2021 to €125 per tonne in 2030).

### Policy options — fiscal instruments at the sectoral level
- Rationale:
  - Meeting sectoral targets solely with carbon pricing would require very high prices and can trigger public resistance; reinforcing sectoral instruments appropriate where sectors are less responsive to prices (transport, buildings). Sectoral instruments should be flexible and allow cost-minimizing choices.
- Feebates (revenue-neutral tax-subsidy schemes):
  - Advantages: more flexible and cost-effective than pure regulations when paired with trading; complement regulations by rewarding firms going beyond standards; maintain revenue neutrality as average fleet emission rate updates; do not require new data beyond existing emission-rate programs; CO2 price in feebates adjustable if EV penetration targets unmet.
  - Vehicle feebate formula: {CO2 price} × {vehicle’s CO2/km – industry average CO2/km} × {average lifetime km driven per vehicle}.
  - Illustration:
    - A feebate with price of €700 per tonne of CO2 would provide the same EV subsidy as at present, but apply a tax of €7,400 to a vehicle with 200 g CO2/km (an increase of around €4,500).
    - Subsidies for EVs would decline over time as average fleet emissions decline.
    - A feebate with a rising price sufficient to shift new vehicle sales to 100 percent EVs by 2030 would reduce road fuel emissions 30 percent below otherwise projected levels for 2030; deeper reductions continue after 2030 as fleet turnover continues.
- Other transportation fiscal reforms:
  - Introduce per-km charges that vary with congestion.
  - Promote market-driven transition to pay-as-you-drive auto insurance.

### Box 2 — Broader reforms to the pricing of road transport (highlights)
- Congestion management: km-based taxes and metering:
  - Km-based taxes varying by location and time of day can manage congestion efficiently.
  - Metering technologies (GPS) enable tracking and billing by driving; transition could subsidize vehicles with monitoring capacity and tax those without.
  - Km-based taxes provide a robust general revenue base unaffected by transport decarbonization; administrative costs higher than fuel taxes.
  - Alternative: expand congestion-charging zones (less comprehensive).
- Pay-as-you-drive (PAYD) automobile insurance:
  - PAYD varies premiums by annual km and internalizes accident externalities.
  - Existing rating factors could proxy external accident risk; transition voluntary with tax incentives.
  - On average, PAYD would raise marginal cost of driving by around 4 cents per km.
  - PAYD example assumes annual insurance payment of €500 and 11,450 km driven per year.
- Transition design and policy levers:
  - Subsidize monitoring-equipped vehicles and tax those without during transition; make monitoring capacity mandatory eventually; use tax incentives to encourage voluntary PAYD adoption; staged rollout from congestion zones to nationwide km-based charging.

### Supporting policies — R&D, infrastructure, forestry feebates
- Market failures justify public investment and technology policies to address knowledge spillovers and network externalities.
- Targeted green technologies for public support:
  - Carbon capture and storage (CCUS), smart grids, batteries to store intermittent renewable power.
- Infrastructure priorities:
  - Grid expansion to address north-south transmission bottlenecks; Network Development Plan 2019-2030 referenced for extra-high-voltage needs.
  - Transportation charging infrastructure: current public charging stations 35 thousand (including less than 3 thousand fast charging units); government plans to increase to 1 million by 2035; frontloading could speed EV adoption.
- Afforestation feebate example:
  - Under a €50 feebate, fully stocking a treeless hectare with new trees yields discounted payments that increase hectare value by about €2,000 (about 10 percent of average agricultural land value in Germany).
  - Calculation assumptions: planting sequesters an additional 3 tonnes of CO2 each year over a 20-year growth cycle with payments discounted at 5 percent; agricultural land values equivalent to €22,500 per hectare in 2016.
- Feebates applied to forestry — design details:
  - Use rental payments rather than one-off payments to address permanence risk.
  - Rental payments should equal carbon price × interest rate × number of years in a period.
  - Partial exemptions for timber harvested for long-lived wood products may be warranted.
  - Monitoring/verification: combine satellite, aerial (LIDAR) and targeted on-the-ground sampling; measure above ground carbon only to keep costs down; limit ground sampling frequency to control administrative costs.

### Distributional impacts, revenue use, and firm leakage concerns
- Energy price impacts under a uniform carbon price of US $50 per tonne in 2030 (compared to BAU levels in 2030):
  - Coal prices increase 91 percent.
  - Gas prices increase 23 percent.
  - Retail electricity prices increase 9 percent.
  - Retail gasoline prices increase 8 percent.
  - Note: BAU prices for coal, gas, and electricity in Germany in 2030 are higher than in most other G20 countries, so percent increases tend to be lower in Germany.
- Household incidence methodology:
  - Direct impact: additional household expenditure from higher pricing of natural gas, electricity, gasoline, diesel, and oil, accounting for demand reductions.
  - Indirect impact: indirect price increases for other consumer goods assuming full pass-through using World Input-Output tables (demand responses for these products are ignored).
  - Consumption composition by income quintile from Household Budget Survey by Eurostat, supplemented with CPI weights.
- Incidence results for raising carbon price by $50, $75, and $100 per tonne of CO2 by 2030 (burden calculation excludes use of carbon price revenue):
  - Direct impact is moderately regressive. Example under a carbon price of $100:
    - Lowest income group: impact of 2 percent of consumption.
    - Highest income group: impact of 1.6 percent of consumption.
  - Regressive direct impact driven largely by spending on recreation and tourism, transportation equipment, and transportation services.
  - Progressive indirect impact largely offsets regressive direct effect, making overall impact broadly neutral.
- Compensation and revenue:
  - Fully compensating the lowest quintile for raising carbon price by $100 per ton would require revenues of 0.1 percent of GDP.
  - Estimated carbon revenue is 0.75 percent of GDP.
  - CAP 2030 commitments: all additional revenue re-invested in climate action measures or returned to taxpayers; renewable energy surcharge reduced; subsidies for long-distance commuters increased (35 cents per km for distances of 21 km or more); housing benefits raised; additional budget support for building refurbishment and cheaper public transportation.
  - Broader compensation mechanism could reduce labor tax burden on lower-income households, potentially improving labor supply.
- Firms and carbon leakage:
  - Empirical evidence mixed; a recent study estimates Germany’s leakage rate around 0.22 (a reduction of 100 tonnes domestically accompanied by increase of 25 tonnes abroad).
  - Most econometric studies find existing carbon pricing policies, notably the EU’s ETS, have not resulted in carbon leakage.
  - EU plans a BCA slated for introduction in 2023 to address impacts on vulnerable firms.
    - BCA mechanics: importers pay an import tax or purchase emissions allowances; exports might receive rebates for carbon pricing on fuel and electricity inputs.
    - A $120 per tonne BCA applied to EITE industries at the EU level would have raised revenues of about 0.2 percent of GDP at the EU and German level in 2015.
    - Limiting BCA to EITE industries could lessen administrative complexity and legal risks.
    - Concerns: WTO legal challenges or retaliation by trading partners.
  - EITE industries account for about 85 percent of emissions from manufacturing in the EU-27.
- International coordination options:
  - International Carbon Pricing Floor (ICPF) could address leakage and deter weaker unilateral ambition.
  - Minilateral approaches: small groups agree on goals with differentiated price floors and transparent transfer mechanisms to accommodate developing countries.

### Sectoral burden analysis and feebate comparisons (illustrative examples)
- Conceptual framework:
  - Carbon pricing reduces emissions via reduced emissions intensity (∆E_int) and reduced output (∆E_out); burdens include economic efficiency cost and transfer payments.
  - Feebates reduce emissions intensity with approximately no impact on output; require higher prices on emissions to achieve equivalent reductions, implying higher efficiency costs but lower overall burden due to absence of transfer payment.
  - EU ETS free allowances compensate transfer payments but are lump-sum and do not prevent large increases in unit production costs.
- Illustrative impacts (steel and cement):
  - Steel:
    - Traditional integrated process emissions: about two tons of CO2 per ton of steel; alternatives produce about 0.3–0.4 tons per ton.
    - A carbon price of $50/ton CO2 would increase cost of integrated production by about $100/ton of steel (about one sixth of recent steel prices) and increase cost under alternative technologies by about $20/ton.
    - Under a feebate (industry average 1 ton CO2 per ton): cost for integrated production increases $50/ton; alternative technologies receive subsidy about $30/ton.
  - Cement:
    - About 90 percent of cement produced using traditional kilns; process produces about 1 ton of CO2 per ton of cement; process emissions contribute about 70 percent.
    - Alternatives: state-of-the-art plants (~10 percent of production); post-combustion CCUS reduces emissions about 55 percent; oxy-combustion reduces emissions about 85 percent.
    - Capital cost increases: post-combustion about 25 percent; oxy-combustion about 100 percent.
    - A carbon price of $50/ton CO2 would increase cost of traditional production about $50/ton of cement (about 40 percent); increase price of more efficient and CCUS-fitted plants by $30, and $8–25 per ton respectively through first-order transfer payment.
    - Under a feebate with price $50/ton CO2: traditional production cost would increase by $5/ton; subsidies to more efficient and CCUS-fitted plants would be $10 and $18–35 per ton respectively.
  - Price context: cement prices currently around $125 per ton.

### Key recommendations and conclusions
- Use multiple, complementary mitigation instruments given uncertainty about individual instruments’ effects and feasibility.
- Strengthen carbon pricing:
  - Specify a schedule of carbon prices over a longer time horizon to signal efficient allocation to clean technologies.
  - Domestic ETS could incorporate an automatically escalating price floor after expiration of the price collar.
- Reduce gaps in marginal abatement costs across sectors:
  - Apply higher carbon pricing in sectors with relatively low abatement cost (power and industry).
  - At EU level, push for a robust price floor under the EU ETS via MSR reform and extension of ETS to transport and buildings.
  - Alternatively, apply a domestic carbon surcharge to emissions covered by the EU ETS.
- Introduce feebates:
  - Revenue-neutral sliding scale of fees on above-average emission products and rebates for below-average emission products; complement sectoral policies.
- Frontload public investment and support green technologies:
  - Public sector catalytic role through infrastructure investment, co-funding for projects with large upfront costs, and risk sharing.
- Fiscal measures to protect vulnerable households and firms:
  - Overall impact of carbon price increases estimated broadly neutral in Germany: direct effect regressive but progressive indirect effect mitigates distributional impact.
  - Use carbon pricing revenue to reduce labor tax for lower-income earners or fund targeted compensation.
- BCAs and international coordination:
  - EU BCA in 2023 could alleviate leakage concerns for vulnerable firms but carries WTO/legal/retaliation risks.
  - ICPF or minilateral approaches offer alternatives for coordinated price floors and leakage mitigation.

*Italic: Source — wpiea2021241-print-pdf*

### Introduction ...........................................................................................................

### Introduction

### Context and emissions targets
- Despite a substantial reduction in greenhouse gas (GHG) emissions, Germany remains a large global emitter.
- Germany adopted the Climate Change Act (CCA) in 2019, setting the emissions targets of a 55 percent reduction from the 1990 level by 2030 and attaining net zero emissions by 2050.
- Following the constitutional court ruling in May 2021, the CCA was amended in late June 2021, tightening targets to:
  - 65 percent reduction in GHG emissions below the 1990 level by 2030, and
  - net zero emissions by 2045.
- The revised CCA sets an annual path of aggregate emissions through 2040 and revised annual sectoral targets through 2030.

### Climate Action Program (CAP) 2030 — four key components
- The CAP 2030 lays out multi-pronged measures to achieve the emissions targets, comprising four key components:
  - Introduction of a national Emission Trading System (ETS):
    - On January 1, 2021, a national ETS covering CO2 emissions from transportation and heating fuels became operational, with a price of €25/tonne of CO2.
    - Carbon pricing is scheduled to increase to €55 by 2025 in a step-wise manner.
    - From 2026 onwards, an emissions cap will be set, which will decline over time in line with 2030 emissions targets, but with an initial price range of €55 to €65 per tonne.
    - The path of carbon prices can be amended once the parliament has approved the revised CCA.
    - The national ETS supplements the EU ETS, which covers energy (i.e., power generation/district heating, industry, and domestic aviation).
    - Allowances in the national ETS will be auctioned with revenues re-invested in climate measures or returned to taxpayers.
  - Measures to encourage GHG reductions in buildings, transportation, energy, agriculture, and industry:
    - Policies include tax incentives for energy-efficient modernization of buildings, increasing the number of electric vehicles (EVs) and public charging points, expanding renewable energy generation and increasing its use in industry, phasing out coal, encouraging climate-friendly agriculture, and exploring options for carbon storage.
  - Compensation for households and firms for the expected price increase:
    - The renewable energy surcharge, which is part of electricity bills, has been reduced.
    - Tax relief for long-distance commuters and higher housing allowances have also been provided.
  - Monitoring and correction mechanism:
    - Each year, the government will assess progress towards the 2030 climate targets in individual sectors.
    - If a particular sector is not complying with its statutory targets, the ministry with lead responsibility will present the climate cabinet with a remedial action plan.
    - As part of the CAP2030, the government set up a “climate cabinet” in April 2019, tasked with reviewing annually the effectiveness, efficiency, and targeting of climate measures.

### Objectives of the paper
- The paper aims to address three key questions:
  - Are there policy measures that can enhance the effectiveness, cost-effectiveness, and acceptability of Germany’s mitigation strategy?
  - What is the distributional impact of higher carbon pricing?
  - How best to address concerns about emissions leakage and losses in competitiveness through increases in cost of domestic relative to foreign products?

### Organization of the paper
- Section II: background on emissions trends at the global and national level.
- Section III: Germany’s emissions targets and mitigation policies at the EU and national level.
- Section IV: options for enhancing the mitigation policies both at the cross-sectional and sectoral level.
- Section V: analysis of the distributional impact of higher carbon prices on households and discussion of potential carbon leakages and the impact of higher carbon prices on firms’ competitiveness.

*wpiea2021241-print-pdf - Introduction ...........................................................................................................*

### Section VI concludes.

### Section VI concludes.

### Global and national emissions trends — key findings
- To contain projected warming to 1.5
o–2
o C above pre-industrial levels, global CO2 and other GHG emissions must be cut 25–50 percent below 2019 levels by 2030 followed by a rapid move towards net zero emissions.  
- Global emissions declined by around 6 percent in 2020 from 2019 due to the COVID-19 crisis, but are likely to start rising again in 2021 as economies recover.  
- Studies suggest that by 2100 warming could permanently lower the level of global GDP by anywhere between 5 and 25 percent relative to a path with no climate change. Tail risks (e.g., runaway methane release, collapsing ice sheets) pose particularly severe, difficult-to-quantify threats.  
- Germany: GHGs in 2019 were 36 percent below 1990 levels and 6 percent below 2018 levels. Between 1990 and 2019, GHG emissions from energy fell by 45 percent, industry by 34 percent, buildings by 42 percent, agriculture by 11 percent, and waste management by 76 percent; transportation emissions remained about unchanged.  
- Germany projected in a BAU scenario to remain among the top ten global emitters in 2030 in absolute and per capita CO2 emissions (IMF staff projections).  

### Germany — emissions composition and electricity sources (exact 2019/2018 values)
- Total 2019 GHGs: 805 million tonnes of CO2 equivalent. Sector shares:
  - Energy (principally power generation and district heating): 32 percent
  - Industry: 23 percent
  - Transport: 20 percent
  - Buildings: 15 percent
  - Agriculture: 9 percent
- Electricity generation shares:
  - Coal: 28 percent
  - Natural gas: 15 percent
  - Nuclear: 12 percent
  - Renewables (including hydro, biomass, other renewables): 40 percent
- Nearly half of electricity generation from renewables was mostly onshore wind.  
- LULUCF sector absorbed 27 million tonnes of CO2 in 2018.

### International and EU context — targets and pricing signals
- Paris Agreement seeks to contain global warming to well below 2
o C; parties submitted NDCs and revised NDCs ahead of COP26 (November 2021). Several parties pledged emissions neutrality by 2050.  
- Current 2030 commitments would achieve only two-thirds of the emissions reductions needed even for a 2
o C target. Getting on track requires phasing in measures equivalent to a global carbon price of around $75 per tonne by 2030; current global average price is $3 per ton.  
- EU-level: revised EU NDC goal is cutting GHGs 55 percent below 1990 levels by 2030 and carbon neutrality by 2050. The EU Green Deal seeks to mobilize €1 trillion.  
- EU ETS: covers about 45 percent of total EU GHGs. Cap currently declines by 2.2 percent a year (to be tightened). EU allowance prices had risen to around €50 per tonne by June 2021. Market Stability Reserve (MSR) withdraws allowances when banked allowances exceed thresholds.

### Germany — national targets, policies, and instruments
- Climate Change Act (CCA) original targets aligned to at least a 55 percent reduction below 1990 levels by 2030 and net zero by 2050. Following a constitutional court ruling, June 2021 revisions tightened targets to:
  - 65 percent reduction in GHGs below 1990 by 2030
  - 88 percent reduction by 2040
  - Net zero emissions by 2045
- CCA sectoral and technology targets (1990 emissions, 2019 outcome, 2030 target):
  - Energy (power): 1990 emissions 466 mn tonnes CO2 equivalent; 2019 outcome -45.4 percent; 2030 emissions target -77 percent
  - Industry: 1990 emissions 284 mn tonnes; 2019 outcome -33.9 percent; 2030 target -58 percent
  - Transport: 1990 emissions 163 mn tonnes; 2019 outcome -0.3 percent; 2030 target -48 percent
  - Buildings: 1990 emissions 210 mn tonnes; 2019 outcome -42.0 percent; 2030 target -68 percent
  - Agriculture: 1990 emissions 90 mn tonnes; 2019 outcome -24.2 percent; 2030 target -37 percent
  - Other (e.g., landfill): 1990 emissions 38 mn tonnes; 2019 outcome -75.6 percent; 2030 target -89 percent
  - Total (1990 emissions 1,251 mn tonnes): 2019 outcome -35.7 percent; 2030 target At least -65 percent
- Renewable energy and EV targets:
  - Share of gross electricity generation: 2018 outcome 42.1 percent; 2030 target 65 percent
  - Share of gross final energy consumption: 2018 outcome 17.1 percent; 2030 target 30 percent
  - Number of registered electric passenger vehicles — 2030 target: 7-10 million
- CAP 2030 centerpiece: national ETS launched January 1, 2021. Key features:
  - Coverage: suppliers of domestically produced and imported fuels for transport and building sectors (heating oil, LPG, natural gas, coal, gasoline, diesel).
  - Prices: 2021-2025 fixed price rising from €25 to €55 per tonne of CO2 (no cap); in 2026 auctions introduced with a price collar of €55-65 per tonne CO2. From 2027 onwards retention of a price collar is to be determined.
  - Caps: From 2026 onwards caps on allowable emissions will be introduced and will decline in line with Germany’s emissions targets.
  - Revenue use: revenues earmarked for climate measures (incentivizing low-carbon transport, energy-efficient buildings, reduced renewable energy surcharge, higher commuter allowance for long-distance commuters).
- Additional CAP 2030 measures:
  - Subsidies for wind and solar, switching from coal to gas, retiring coal plants; enhanced incentives for EVs and annual circulation taxes tied to vehicle emission rates; energy-efficient building refurbishment incentives; phasing out oil-based heating from 2026; measures for climate-friendly agriculture.
  - Public investment: EV charging stations target one million by 2030; VAT on train tickets lowered from 19 to 7 percent; extra funding around €1-2 billion per year for transit infrastructure; power grid expansion in line with renewables.
  - R&D: carbon-saving technologies for industry, battery cells for EVs, laboratories for sector coupling.
  - Just transition assistance: household and firm compensation and €40 billion for developing new economic structures in coal regions through 2038.

### Policy options for enhancing mitigation — Cross-sector carbon pricing
- Carbon pricing advantages: across-the-board incentive to reduce energy use and shift fuels, equalizes marginal abatement cost, mobilizes revenues, reduces local air pollution mortality, administratively straightforward for mature institutions.  
- Coverage: national ETS combined with EU ETS means fossil fuel emissions in Germany are comprehensively covered by pricing schemes, but current frameworks prevent trading between national ETS and EU ETS, stopping equalization of marginal abatement costs across all sectors.  
- Price uncertainty concerns: EU ETS allowance prices have been volatile; national ETS prices from 2027 onwards are uncertain. Recommendation: national ETS could incorporate an automatically escalating price floor after expiration of the price collar in 2026.  
- Required prices to meet targets: IMF staff modeling indicates:
  - Power sector targets (covered by EU ETS) could be met under a price of €100 per tonne in 2030.
  - Even a price of €150 per tonne appears inadequate to meet transport and building sector targets and is only just sufficient to achieve the target in industry.
  - Prices consistent with emissions targets are much higher in the domestic than the EU ETS sector because emissions respond less to prices in the building and transport sectors.
- EU-level reforms proposed:
  - Extend EU ETS so aggregate emissions from power, industry, transport, and buildings are subject to one aggregate cap with a common emissions price across sectors (would require compensation for member states with less stringent current targets).
  - Allow member states to re-allocate emissions reductions from transport/buildings to power/industry to lower national mitigation costs (currently precluded by EU burden sharing rules).
  - Establish an exogenous and escalating price floor for the EU ETS (Germany could push for a robust price floor via MSR reform).
  - In absence of EU reforms, Germany could impose a domestic surcharge on emissions covered by the EU ETS to equalize combined price on power/industrial emissions with a target ramping over time (analogous to U.K. Carbon Price Floor or Netherlands planned target rising from €30 per tonne in 2021 to €125 per tonne in 2030).

### Policy options — Fiscal instruments at the sectoral level
- Rationale: meeting sectoral targets solely with carbon pricing would require very high prices and can trigger public resistance; reinforcing sectoral instruments can be appropriate where sectors are less responsive to prices (e.g., transport, buildings). Sectoral instruments should be flexible and allow cost-minimizing choices by firms and households.
- Feebates (revenue-neutral tax-subsidy schemes) advantages:
  - More flexible and cost-effective than pure regulations when paired with appropriate trading provisions.
  - Can complement existing regulations by rewarding firms going beyond standards.
  - Maintain revenue neutrality as the average fleet emission rate updates.
  - Do not require new data or administrative capacity beyond existing emission-rate programs.
  - CO2 price in feebates can be adjusted if EV penetration targets are not met.
- Feebate illustration for vehicles:
  - Feebate formula: {CO2 price} × {vehicle’s CO2/km – industry average CO2/km} × {average lifetime km driven per vehicle}.
  - Example: a feebate with price of €700 per tonne of CO2 would provide the same EV subsidy as at present, but apply a tax of €7,400 to a vehicle with 200 g CO2/km (an increase of around €4,500). Subsidies for EVs would decline over time as average fleet emissions decline.
  - A feebate with a rising price sufficient to shift new vehicle sales to 100 percent EVs by 2030 would reduce road fuel emissions 30 percent below otherwise projected levels for 2030; deeper reductions continue after 2030 as fleet turnover continues.
- Other transportation fiscal reforms:
  - Introduce per-km charges that vary with congestion (higher charges in congested conditions).
  - Promote market-driven transition to pay-as-you-drive auto insurance.

*Italic: Source — wpiea2021241-print-pdf - Section VI concludes.*

### Box 2. Broader Reforms to the Pricing of Road Transport

### Box 2. Broader Reforms to the Pricing of Road Transport

### Congestion management: km-based taxes and metering
- 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 to reduce congestion (e.g., setting off before or after the peak of the rush hour; shifting to off-peak travel, less congested roads, or 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.
- 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.

### 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 cents 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, but savings to other insurers from lower multi-car accident risk cannot be captured by the company offering km-based insurance.
- The PAYD example calculation assumes an annual insurance payment of €500 and 11,450 km driven per year.

### Transition design and policy levers
- Policy levers to promote km-based charging and PAYD include:
  - Subsidizing vehicles equipped with monitoring capacity and taxing those without during a transition period.
  - Making monitoring capacity eventually mandatory.
  - Using tax incentives to kickstart voluntary adoption of PAYD insurance.
- A staged rollout could start with congestion-charging zones and expand toward nationwide km-based charging, recognizing trade-offs in comprehensiveness and administrative complexity.

*Source: wpiea2021241-print-pdf - Box 2. Broader Reforms to the Pricing of Road Transport*

### Annex II explains the CO

### Annex II explains the CO

### C. Other Supporting Policies
- Market failures at different stages of developing and deploying emissions-saving technologies warrant public investment and technology policies.
- Public investment can address:
  - Knowledge spillovers in shifting to new technologies.
  - Network externalities associated with clean technology infrastructure (example: reluctance of one electricity producer to extend the power grid if other producers can also benefit).
- Example calculation for afforestation feebate:
  - Fully stocking a treeless hectare with new trees under a €50 feebate results in a flow of payments that, in discounted terms, would increase the value of the hectare by about €2,000 (this is about 10 percent of average agricultural land value in Germany).
  - Calculation assumptions: planting sequesters an additional 3 tonnes of CO2 each year over a 20-year growth cycle with payments discounted at 5 percent. Agricultural land values were equivalent to €22,500 per hectare in 2016.

### Green technologies
- Government should increase public support for R&D and deployment of green technologies to address market failures and generate positive spillovers.
- Target areas for direct support:
  - Carbon capture and storage (CCUS).
  - Smart grids.
  - Batteries to store intermittent renewable power.
- Rationale and design:
  - Support socially beneficial but not yet commercially viable technologies.
  - Government deployment support can promote learning by doing and reduce early-stage production costs.
  - Government support should be gradually phased out as technologies become widely adopted.

### Infrastructure
- Upgraded infrastructure is needed to support expansion of green energy supply and promote usage.
- Electricity grid considerations:
  - Largest share of renewable energy from wind, generated mostly in Germany's north and north-east.
  - Metropolitan and industrial centers are primarily in the south and west; north-south transmission lines face bottlenecks and rising costs when transporting and stabilizing power from volatile renewables.
  - Grid expansion should be prioritized.
  - Reference: Network Development Plan 2019-2030 assesses extra-high-voltage grid expansion/upgrades needed over the next 10 to 15 years.
- Transportation infrastructure:
  - Current public charging stations: 35 thousand (including less than 3 thousand fast charging units).
  - Government plans to increase public charging stations to 1 million by 2035.
  - Frontloading such investment could encourage speedier adoption of electric cars and crowd in private investment.

### D. Mitigating the Impact of Carbon Pricing on Households and Firms
- Energy price impacts under a uniform carbon price of US $50 per tonne in 2030 (compared to BAU levels in 2030):
  - Coal prices increase 91 percent.
  - Gas prices increase 23 percent.
  - Retail electricity prices increase 9 percent.
  - Retail gasoline prices increase 8 percent.
  - Note: BAU prices for coal, gas, and electricity in Germany in 2030 are higher than in most other G20 countries, so percent increases tend to be lower in Germany.
- Household incidence methodology:
  - Direct impact: additional household expenditure from higher pricing of natural gas, electricity, gasoline, diesel, and oil, accounting for demand reductions.
  - Indirect impact: indirect price increases for other consumer goods assuming full pass-through from producers to consumers using the World Input-Output tables (demand responses for these products are ignored).
  - Consumption composition by income quintile calculated using the Household Budget Survey by Eurostat, supplemented with CPI weights.
- Incidence results for raising carbon price by $50, $75, and $100 per tonne of CO2 by 2030 (consumption survey data by income quintile; burden calculation excludes use of carbon price revenue):
  - Direct impact is moderately regressive. Example under a carbon price of $100:
    - Lowest income group: impact of 2 percent of consumption.
    - Highest income group: impact of 1.6 percent of consumption.
  - Regressive direct impact driven largely by spending on recreation and tourism, transportation equipment, and transportation services.
  - Progressive indirect impact largely offsets regressive direct effect, making overall impact broadly neutral.
- Compensation and revenue:
  - Compensating the lowest quintile fully for the effect of raising carbon price by $100 per ton would require revenues of 0.1 percent of GDP.
  - Estimated carbon revenue is 0.75 percent of GDP.
  - Government commitments and measures:
    - All additional revenue from carbon pricing will be re-invested in climate action measures or returned to taxpayers.
    - CAP 2030 measures: renewable energy surcharge reduced, subsidies for long-distance commuters increased (35 cents per km for distances of 21 km or more), and housing benefits raised.
    - Additional budget support for refurbishing buildings to increase energy efficiency and making public transportation cheaper.
  - Broader compensation mechanism could reduce labor tax burden on lower-income households, potentially improving labor supply.

- Firms and carbon leakage concerns:
  - Evidence mixed; a recent study estimates Germany’s leakage rate around 0.22 (a reduction of 100 tonnes domestically would be accompanied by an increase of 25 tonnes abroad).
  - Most econometric studies find existing carbon pricing policies, notably the EU’s ETS, have not resulted in carbon leakage.
  - Countries are considering border carbon adjustments (BCAs).
  - EU plans a BCA slated for introduction in 2023 to address impacts on vulnerable firms.
    - BCA mechanics: importers pay an import tax or purchase emissions allowances; exports might receive rebates for the impact of carbon pricing on fuel and electricity inputs.
    - A $120 per tonne BCA applied to EITE industries at the EU level would have raised revenues of about 0.2 percent of GDP at the EU and German level in 2015.
    - Limiting the BCA to EITE industries could lessen administrative complexity and legal risks.
    - Concerns: possible legal challenges at the WTO, or retaliation by trading partners.
  - EITE industries account for about 85 percent of the emissions from manufacturing in the EU-27.
- International coordinated approaches:
  - International Carbon Pricing Floor (ICPF) could address concerns deterring stronger unilateral ambition.
  - Minilateral approach: small group of countries agree on global goal and act simultaneously; can be designed with differentiated price floors and transparent transfer mechanisms to accommodate developing countries and politically difficult participants.

### Conclusion (key recommendations and findings)
- Use multiple, complementary mitigation instruments given uncertainty about effects and feasibility of individual instruments.
- Fiscal instruments, alongside EU and national ETSs, can help Germany meet ambitious emissions targets with greater certainty and cost effectiveness.
- Increasing acceptability of fiscal instruments:
  - Keep feebates revenue neutral or use carbon pricing revenues to fund the green transition or reduce taxes on labor.
- Specific policy recommendations:
  - Further strengthen carbon pricing:
    - A well-specified schedule of carbon prices over a longer time horizon provides signals for efficient allocation to clean technologies.
    - Domestic ETS could incorporate an automatically escalating price floor after expiration of the price collar.
  - Reduce gaps in marginal abatement cost across sectors:
    - Apply higher carbon pricing in sectors with relatively low abatement cost (power and industry).
    - At EU level, push for a robust price floor under the EU ETS through reform of the Market Stability Reserve and extension of the ETS to transportation and buildings.
    - Alternatively, apply a domestic carbon surcharge to emissions covered by the EU ETS.
  - Introduce feebates:
    - Revenue-neutral sliding scale of fees on above-average emission products and rebates for below-average emission products; complement existing sectoral policies.
  - Frontload public investment in green infrastructure and further support green technologies:
    - Public sector catalytic role through infrastructure investment, co-funding for projects with large upfront costs, and risk sharing.
- Fiscal policy to protect vulnerable households and firms:
  - Overall impact of carbon price increases estimated broadly neutral in Germany: direct effect regressive but progressive indirect effect mitigates distributional impact.
  - Government can consider using carbon pricing revenue to reduce labor tax for lower-income earners.
- BCAs and international coordination:
  - Introduction of a BCA at EU level in 2023 could alleviate concerns about carbon leakage and impacts on vulnerable firms but carries WTO/legal/retaliation risks.
  - ICPF with coordinated floor carbon prices is an alternative to address leakage and competitiveness.

### Annex 1. Burden of Carbon Mitigation Policies on Industries (Conceptual analysis and illustrative impacts)
- Conceptual framework:
  - Marginal cost curves for reducing emissions by reducing domestic industry output, reducing emissions intensity of output, and the envelope of these curves.
  - Carbon pricing reduces emissions by ∆E_tot, with ∆E_int from reduced emissions intensity and ∆E_out from reduced output.
  - Burden components under carbon pricing (prior to compensation):
    - Economic efficiency cost of behavioral responses (resource cost of adopting cleaner production methods).
    - Transfer payment (e.g., payments to the government for emission allowances).
  - Alternative instruments (feebates):
    - Feebates reduce emissions intensity and approximately have no impact on output (do not charge for remaining emissions).
    - To achieve equivalent emissions reductions as pure carbon pricing, a higher price on emissions is needed under feebates, implying a higher efficiency cost, but no transfer payment—overall burden generally lower under feebates.
  - EU ETS provides free allowance allocations for EITE firms; this compensates the transfer payment but is lump-sum and does not prevent large increases in unit production costs or divert revenue from government budget.

- Illustrative impacts on production costs for steel and cement (examples use figures from van Reijven and others (2016) unless noted):
  - Steel:
    - Traditional integrated process emissions: about two tons of CO2 per ton of steel.
    - Alternatives produce about 0.3–0.4 tons per ton of steel.
    - A carbon price of $50/ton CO2 would:
      - Increase cost of integrated production by about $100/ton of steel through the first-order transfer payment (about one sixth of recent steel prices).
      - Increase cost under alternative technologies by about $20/ton of steel.
    - Under a feebate (assumed industry average emission rate of 1 ton CO2 per ton of steel):
      - Cost for integrated production would increase $50 per ton of output.
      - Alternative technologies would receive a subsidy of about $30 per ton of output.
  - Cement:
    - About 90 percent of cement produced using traditional kilns; process produces about 1 ton of CO2 per one ton of cement; process emissions contribute about 70 percent.
    - Alternatives:
      - State-of-the-art plants (about 10 percent of production) largely eliminate non-process emissions.
      - Post-combustion CCUS reduces emissions about 55 percent; oxy-combustion reduces emissions about 85 percent.
      - Capital cost increases: post-combustion about 25 percent; oxy-combustion about 100 percent.
    - A carbon price of $50/ton CO2 would:
      - Increase cost of traditional production about $50 per ton of cement (about 40 percent).
      - Increase price of more efficient and CCUS-fitted plants by $30, and $8–25 per ton of output respectively through the first-order transfer payment.
    - Under a feebate with price $50/ton CO2:
      - Traditional production cost would increase by $5 per ton of cement.
      - Subsidies to more efficient and CCUS-fitted plants would be $10 and $18–35 per ton of output respectively.
- Price context notes:
  - Recent steel prices reference: see www.focus-economics.com/commodities/base-metals/steel-usa.
  - Cement prices currently around $125 per ton.

*Italic: Annex II content extracted from the supplied PDF content unit.*

### Annex 2. Further Design Details for Feebates Applied to Forestry

### Annex 2. Further Design Details for Feebates Applied to Forestry

### Payment design and incentives
- Feebates for the forest sector should involve rental payments, rather than large upfront payments for tree planting, given that changes in carbon storage may not be permanent.
- The problem with one-off, upfront payments is that afforestation may be reversed—for example, a new tree farm receiving an upfront rebate may be subsequently harvested or destroyed (by fires, pests, windstorms), requiring complex, ex-post re-payment procedures to provide adequate incentives for maintaining the land-use change.
- Rental payments should equal the product of the carbon price times, the interest rate, and the number of years in a period.52
- The carbon price would need to rise over time to provide ongoing (rather than one off) increases in carbon storage.
- Partial exemptions from fees may be warranted for timber harvested for wood products (e.g., furniture, houses) because the carbon emissions (released at the end of the product life) will be delayed, perhaps by several decades or more.

### Monitoring, verification, and practical considerations
- Feebates have become more practical with advances in monitoring technologies.
- Forest carbon inventories are estimated through a combination of satellite monitoring, aerial photography, and on-the-ground tree sampling.
- Satellite pictures can be used to measure forest coverage and over time reveal visible land use changes like clear-cutting of intact forest.
- Carbon storage per hectare of forested land is more difficult to verify, as it varies with land productivity, tree species, and forest management practices (e.g., selective harvesting can reduce stored carbon without visible clear cuts).
- Low-level aerial photography along forest boundaries, using technologies like Light Detection and Ranging (LIDAR), can estimate wood volume (therefore implicitly account for selective harvesting and changes in forest management) much more cheaply than on the ground sampling.
- On-the-ground sampling (the most expensive technology) is still needed for densities below a certain threshold—administrative costs might be kept down by, for example, limiting sampling to once every several years.53
- Measuring above ground carbon only (usually about three quarters of the total) could also keep costs down.53

### Implementation trade-offs and operational points
- Use rental payments to align ongoing incentives with the permanence risk of carbon storage.
- Increase carbon price over time to maintain incentives for continued carbon storage rather than one-off gains.
- Consider partial fee exemptions for wood products with long product lives to reflect delayed emissions.
- Combine remote sensing (satellite + aerial/LIDAR) with targeted on-the-ground sampling to balance verification accuracy and administrative cost.

*Annex 2. Further Design Details for Feebates Applied to Forestry*

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_Source: https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021241-print-pdf.pdf_