## _112515

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---

### Overview
- The Fund has a role in helping members address climate-change challenges for which fiscal and macroeconomic policies are an important component of the appropriate policy response.
- Over 160 countries submitted greenhouse gas mitigation pledges ahead of the December 2015 Climate Conference in Paris.
- The paper draws on a forthcoming Staff Discussion Note (Farid et al. 2015) and discussions at informal Board meetings on IMF work on climate change on September 30 and November 24, 2015.
- Date on document: NOVEMBER 25, 2015.

### 2015 — Issues for the Paris COP21
- Climate change poses significant economic harm, especially to some of the poorest countries, and presents worrying tail risks.
- Climate change is a global externality requiring global cooperation.
- Over 160 countries submitted Intended Nationally Determined Contributions (INDCs). If implemented, these commitments will substantially reduce projected future warming, though not enough to meet the internationally agreed 2O C target.
- At Paris, parties will seek a legal framework for assessing progress on, and updating, these pledges, and will discuss climate finance.
- Advanced countries pledged to mobilize funds rising to $100 billion a year by 2020, from public and private sources, for climate mitigation and adaptation in developing countries.
- Flows in 2014 have been estimated at $62 billion, with composition in 2014:
  - $23.1 billion Bilateral public finance (e.g., Overseas Development Assistance).
  - $20.4 billion Multilateral public sources (mostly from Multilateral Development Banks).
  - $16.7 billion Private finance (co-financing associated with bilateral and multilateral public sources).
  - $1.6 billion Export credits (mainly for renewable energy).
  - $61.8 billion Total flows.

### National Action — Carbon Pricing as Centerpiece
- Carbon pricing should be the centerpiece of climate mitigation efforts, but instrument choice and national design are critical for meeting objectives at lowest cost.
- CO2 emissions from fossil fuel combustion dominate emissions; twenty countries account for about 80 percent of global CO2 emissions.
- Policymakers can choose among carbon taxes, emissions trading systems (ETSs), regulations for energy efficiency and renewables, etc.; design matters for cost-effectiveness.
- Carbon pricing is preferable to regulation because it:
  - Promotes the full range of mitigation opportunities across sectors.
  - Aligns private cost of emissions with their true social cost.
  - Can raise significant revenue which can be used to reduce more distorting taxes.
  - Is administratively simpler than multiple regulatory programs.
- ETSs can be as efficient as carbon taxes if well-designed and managed, with tax-like features:
  - Auctioning allowances to raise revenue.
  - Including price stability measures, such as price floors and ceilings.
- ETSs typically focus downstream on industrial emissions and should be accompanied by taxes to cover other significant emissions sources (e.g., transport and heating fuels).
- Where regulations are used they should:
  - Promote a broad range of mitigation responses.
  - Promote price-like mechanisms (convert standards into tax/subsidy schemes with fees/rebates).
  - Harmonize explicit or implicit carbon prices across programs and sectors and align them with environmental objectives.
- Early announcement of credible mitigation policies is key to easing transition and providing signals for long-lived low-emission investments.

### Carbon Pricing Design
- Carbon taxes are a practical extension of existing road fuel excises and can be implemented by:
  - Building a carbon charge into excises and extending charges to other petroleum products, coal, and natural gas (point of extraction or refinery gate) with charges/rebates for imported/exported fuel products.
- Administrative and fiscal benefits of carbon taxes may be particularly marked in developing countries where ETS monitoring is constrained and informal sectors are large.
- Current coverage and prices:
  - About 40 countries implement some form of carbon pricing at the national level (counting the EU ETS as 31 countries).
  - Over 20 sub-national governments have carbon pricing schemes.
  - These schemes cover only about 12 percent of global emissions (coverage will roughly double when China introduces pricing on industrial sources in 2017).
  - Prices are typically below $10 per ton.
- Revenue potential and efficient use:
  - Revenue at stake is significant—around 1 percent of GDP or more for large emitters imposing near term carbon prices of $30 per ton.
  - Productive uses of revenues: cut broader taxes on labor and capital; fund new spending or deficit reduction; avoid earmarking for low-value spending or freely allocated allowances in ETSs.
- Domestic environmental benefits:
  - Domestic benefits (e.g., fewer air pollution deaths) implied carbon prices of $57 per ton of CO2 in 2010 (averaged across large emitters), even absent global climate benefits.
  - If all large emitters priced carbon in their own interests, global emissions would fall by over 10 percent.
- Distributional and competitiveness concerns:
  - Higher energy prices burden households; holding down energy prices is inefficient because 90 percent or more of benefits typically leak to higher income groups.
  - Targeted measures (stronger social safety nets) are preferable and require only a fraction of revenues.
  - Energy-intensive, trade-exposed firms face particular challenges; border tax adjustments raise practical, legal, and retaliation risks.
  - Longer-term policy should assist re-allocation away from carbon-intensive sectors (e.g., worker retraining) rather than permanent subsidies.

### Adaptation and Macroeconomic Policies
- Governments must overcome market failures and provide public goods and services to facilitate private sector adjustment.
- For many developing countries and small island states, growth prospects are threatened without effective adaptation.
- Appropriate adaptation policies are inherently local and should be customized to evolving climate impacts by region and sector.
- Developing country governments can face very large adaptation costs; scaling up climate-resilient, low-carbon infrastructure presents an opportunity.
- Management of adaptation spending and financial assistance should be undertaken within a medium-term financial framework consistent with available resources, macro-stability, and debt sustainability.

### Role of the Financial System
- Monitor and address systemic risks:
  - Global climate change can entail significant risks to macro-financial stability through climate damages and stranded assets (e.g., coal reserves becoming uneconomic with carbon pricing).
  - Disruption could affect corporate balance sheet quality.
  - Some financial regulators and central banks have begun considering systemic risks related to climate change, but work is at an early stage and more national-level action is needed.
- Provide an enabling environment to support mitigation and adaptation:
  - Long-term institutional investors can help rebalance and redistribute climate-related risks and maintain financial stability.
  - Hedging instruments (e.g., catastrophe bonds, indexed insurance) can insure against natural disaster risk.
  - Other financial instruments (e.g., green stock indices, green bonds, voluntary de-carbonization initiatives) can re-allocate investment to “green” sectors.
  - Financial sector regulation and supervision should manage climate-related risks to financial stability while enabling safe functioning of institutions, instruments, and markets for hedging risks.
  - Stress-testing of climate risks and macro-financial effects by banks, insurers, and pension funds needs further development; more work is needed to capture these risks in system-wide stress tests.

### Facilitating Global Progress
- Uniform carbon prices across countries are not efficient given different fiscal needs, domestic environmental benefits, and equity considerations (common but differentiated responsibility).
- Political acceptability of carbon pricing differs across countries.
- Carbon price floors are the analog of other tax coordination regimes (e.g., excise floors on alcohol, tobacco and energy products in the EU).
- A climate analog would be a coordinated CO2 price floor among a coalition of willing countries.

### Carbon pricing arrangement: design features and implementation issues
- Recognize the diversity of efficient carbon prices across countries.
- Avoid holding back countries wishing to price emissions more aggressively, for domestic environmental, fiscal, or other reasons.
- Require agreement on just one target (the price floor) rather than multiple emissions targets across countries.
- Involve some monitoring issues (e.g., accounting for special exemptions and changes in broader fiscal provisions affecting energy); these require closer examination, but seem likely to be manageable.
- Ultimately need incentives to promote broader participation and compliance over time.

### Carbon pricing and climate finance
- Carbon pricing could play a central role in meeting targets for climate finance:
  - In developing countries, as an effective way to attract private financial flows for mitigation.
  - Enhance developed countries’ ability to meet their climate finance commitments: 5 percent of the revenue from a $30 per ton carbon charge in 2020 would amount to about $25 billion.
  - A similar amount of revenue could be raised with the same charge applied to international aviation and maritime fuels from advanced countries.
- Rationale for targeting international aviation and maritime fuels:
  - Governments have a weaker claim on the tax base for these fuels than for domestic fuels.
  - These fuels are undertaxed from a fiscal and environmental perspective.
  - Tax administration would be straightforward.

### The Fund's role: scope and priorities
- The Fund is not an environmental organization, but climate change poses significant risks for macroeconomic performance and several of the appropriate policy responses lie within the Fund’s expertise.
- The Fund focuses on the practical design and administration of fiscal instruments for climate policy and broader energy policy.

### Analytical work
- The IMF draws on specialist analysis from other institutions (e.g., the Intergovernmental Panel on Climate Change, the International Energy Agency, the World Bank) and focuses on practical fiscal and energy policy design.
- Fund staff work has quantified, for over 160 countries, the environmental, fiscal, and economic benefits of energy pricing reform, including the removal of subsidies.
- This information helps policymakers craft the specifics of legislation to meet environmental and fiscal objectives and enlightens stakeholders on the case for reform.
- An overarching issue staff intends to analyze is the growth impact of transitioning to a less carbon-intensive economy.

### Technical assistance, surveillance, and training
- The Fund is well positioned to provide technical assistance and training, given its global membership and expertise in:
  - Fuel tax design
  - Tax administration
  - Energy price reform
- Climate and energy policy developments are sometimes discussed in Article IV consultations, and this seems likely to become increasingly common.
- Next steps on further integration in surveillance will be informed by assessing experience with selected pilot countries.

### Promoting dialogue and coordination
- The Fund collaborates with other international organizations (e.g., World Bank, Organisation for Economic Co-operation and Development, and United Nations Environment Programme) to promote policy dialogue among finance ministries.
- Emphasis on the benefits of carbon pricing as one component of an effective tax structure.

### Integrating disaster and climate risks in macroeconomic frameworks
- Low-income and small developing states are especially vulnerable to increasing risks of extreme weather events.
- Staff, collaborating with other international institutions, will work with countries to:
  - Develop comprehensive risk management frameworks to assess risks.
  - Determine the right mix of building domestic buffers versus risk transfer through insurance or financial market instruments.
  - Tailor investment and growth policies to building resilience.

### Incorporating adaptation in medium-term fiscal frameworks
- More analysis of the macroeconomic implications of adaptation policies is needed.
- Where macro-critical, the fiscal costs of adaptation, and the effective use of climate-related financial flows, will need to be integrated in sustainable medium-term fiscal frameworks.

### Financial sector: disclosures, prudential requirements, and stress testing
- Staff work, in close coordination with other institutions (such as the World Bank, Financial Stability Board, and International Association of Insurance Supervisors), will:
  - Enhance understanding of the transmission mechanisms from climate risks to financial stability.
  - Contribute to the design of appropriate disclosure rules for climate risk exposure.
  - Provide technical assistance to promote safe and sound development of markets and instruments to help manage climate-related risks.
  - Contribute to the development of best practices for stress-testing for climate risks.
  - Support ongoing work on globally consistent prudential requirements for the insurance sector, including on a Global Insurance Capital Standard being developed by IAIS to allow for catastrophe risk in capital requirements.

*THE MANAGING DIRECTOR’S STATEMENT ON THE ROLE OF THE FUND IN ADDRESSING CLIMATE CHANGE, NOVEMBER 25, 2015.*

### Section 1

### _112515 - Section 1

### Overview
- The Fund has a role in helping members address climate-change challenges for which fiscal and macroeconomic policies are an important component of the appropriate policy response.
- Over 160 countries submitted greenhouse gas mitigation pledges ahead of the December 2015 Climate Conference in Paris.
- The paper draws on a forthcoming Staff Discussion Note (Farid et al. 2015) and discussions at informal Board meetings on IMF work on climate change on September 30 and November 24, 2015.
- Date on document: NOVEMBER 25, 2015.

### 2015 — Issues for the Paris COP21
- Climate change poses significant economic harm, especially to some of the poorest countries, and presents worrying tail risks.
- Climate change is a global externality requiring global cooperation.
- Over 160 countries submitted Intended Nationally Determined Contributions (INDCs). If implemented, these commitments will substantially reduce projected future warming, though not enough to meet the internationally agreed 2O C target.
- At Paris, parties will seek a legal framework for assessing progress on, and updating, these pledges, and will discuss climate finance.
- Advanced countries pledged to mobilize funds rising to $100 billion a year by 2020, from public and private sources, for climate mitigation and adaptation in developing countries.
- Flows in 2014 have been estimated at $62 billion, with composition in 2014:
  - $23.1 billion Bilateral public finance (e.g., Overseas Development Assistance).
  - $20.4 billion Multilateral public sources (mostly from Multilateral Development Banks).
  - $16.7 billion Private finance (co-financing associated with bilateral and multilateral public sources).
  - $1.6 billion Export credits (mainly for renewable energy).
  - $61.8 billion Total flows.

### National Action — Carbon Pricing as Centerpiece
- Carbon pricing should be the centerpiece of climate mitigation efforts, but instrument choice and national design are critical for meeting objectives at lowest cost.
- CO2 emissions from fossil fuel combustion dominate emissions; twenty countries account for about 80 percent of global CO2 emissions.
- Policymakers can choose among carbon taxes, emissions trading systems (ETSs), regulations for energy efficiency and renewables, etc.; design matters for cost-effectiveness.
- Carbon pricing is preferable to regulation because it:
  - Promotes the full range of mitigation opportunities across sectors.
  - Aligns private cost of emissions with their true social cost.
  - Can raise significant revenue which can be used to reduce more distorting taxes.
  - Is administratively simpler than multiple regulatory programs.
- ETSs can be as efficient as carbon taxes if well-designed and managed, with tax-like features:
  - Auctioning allowances to raise revenue.
  - Including price stability measures, such as price floors and ceilings.
- ETSs typically focus downstream on industrial emissions and should be accompanied by taxes to cover other significant emissions sources (e.g., transport and heating fuels).
- Where regulations are used they should:
  - Promote a broad range of mitigation responses.
  - Promote price-like mechanisms (convert standards into tax/subsidy schemes with fees/rebates).
  - Harmonize explicit or implicit carbon prices across programs and sectors and align them with environmental objectives.
- Early announcement of credible mitigation policies is key to easing transition and providing signals for long-lived low-emission investments.

### Carbon Pricing Design
- Carbon taxes are a practical extension of existing road fuel excises and can be implemented by:
  - Building a carbon charge into excises and extending charges to other petroleum products, coal, and natural gas (point of extraction or refinery gate) with charges/rebates for imported/exported fuel products.
- Administrative and fiscal benefits of carbon taxes may be particularly marked in developing countries where ETS monitoring is constrained and informal sectors are large.
- Current coverage and prices:
  - About 40 countries implement some form of carbon pricing at the national level (counting the EU ETS as 31 countries).
  - Over 20 sub-national governments have carbon pricing schemes.
  - These schemes cover only about 12 percent of global emissions (coverage will roughly double when China introduces pricing on industrial sources in 2017).
  - Prices are typically below $10 per ton.
- Revenue potential and efficient use:
  - Revenue at stake is significant—around 1 percent of GDP or more for large emitters imposing near term carbon prices of $30 per ton.
  - Productive uses of revenues: cut broader taxes on labor and capital; fund new spending or deficit reduction; avoid earmarking for low-value spending or freely allocated allowances in ETSs.
- Domestic environmental benefits:
  - Domestic benefits (e.g., fewer air pollution deaths) implied carbon prices of $57 per ton of CO2 in 2010 (averaged across large emitters), even absent global climate benefits.
  - If all large emitters priced carbon in their own interests, global emissions would fall by over 10 percent.
- Distributional and competitiveness concerns:
  - Higher energy prices burden households; holding down energy prices is inefficient because 90 percent or more of benefits typically leak to higher income groups.
  - Targeted measures (stronger social safety nets) are preferable and require only a fraction of revenues.
  - Energy-intensive, trade-exposed firms face particular challenges; border tax adjustments raise practical, legal, and retaliation risks.
  - Longer-term policy should assist re-allocation away from carbon-intensive sectors (e.g., worker retraining) rather than permanent subsidies.

### Adaptation and Macroeconomic Policies
- Governments must overcome market failures and provide public goods and services to facilitate private sector adjustment.
- For many developing countries and small island states, growth prospects are threatened without effective adaptation.
- Appropriate adaptation policies are inherently local and should be customized to evolving climate impacts by region and sector.
- Developing country governments can face very large adaptation costs; scaling up climate-resilient, low-carbon infrastructure presents an opportunity.
- Management of adaptation spending and financial assistance should be undertaken within a medium-term financial framework consistent with available resources, macro-stability, and debt sustainability.

### Role of the Financial System
- Monitor and address systemic risks:
  - Global climate change can entail significant risks to macro-financial stability through climate damages and stranded assets (e.g., coal reserves becoming uneconomic with carbon pricing).
  - Disruption could affect corporate balance sheet quality.
  - Some financial regulators and central banks have begun considering systemic risks related to climate change, but work is at an early stage and more national-level action is needed.
- Provide an enabling environment to support mitigation and adaptation:
  - Long-term institutional investors can help rebalance and redistribute climate-related risks and maintain financial stability.
  - Hedging instruments (e.g., catastrophe bonds, indexed insurance) can insure against natural disaster risk.
  - Other financial instruments (e.g., green stock indices, green bonds, voluntary de-carbonization initiatives) can re-allocate investment to “green” sectors.
  - Financial sector regulation and supervision should manage climate-related risks to financial stability while enabling safe functioning of institutions, instruments, and markets for hedging risks.
  - Stress-testing of climate risks and macro-financial effects by banks, insurers, and pension funds needs further development; more work is needed to capture these risks in system-wide stress tests.

### Facilitating Global Progress
- Uniform carbon prices across countries are not efficient given different fiscal needs, domestic environmental benefits, and equity considerations (common but differentiated responsibility).
- Political acceptability of carbon pricing differs across countries.
- Carbon price floors are the analog of other tax coordination regimes (e.g., excise floors on alcohol, tobacco and energy products in the EU).
- A climate analog would be a coordinated CO2 price floor among a coalition of willing countries.

*Source: THE MANAGING DIRECTOR’S STATEMENT ON THE ROLE OF THE FUND IN ADDRESSING CLIMATE CHANGE, NOVEMBER 25, 2015.*

### Section 2

### SECTION 2

### Carbon pricing arrangement: design features and implementation issues
- Recognize the diversity of efficient carbon prices across countries.
- Avoid holding back countries wishing to price emissions more aggressively, for domestic environmental, fiscal, or other reasons.
- Require agreement on just one target (the price floor) rather than multiple emissions targets across countries.
- Involve some monitoring issues (e.g., accounting for special exemptions and changes in broader fiscal provisions affecting energy); these require closer examination, but seem likely to be manageable.
- Ultimately need incentives to promote broader participation and compliance over time.

### Carbon pricing and climate finance
- Carbon pricing could play a central role in meeting targets for climate finance:
  - In developing countries, as an effective way to attract private financial flows for mitigation.
  - Enhance developed countries’ ability to meet their climate finance commitments: 5 percent of the revenue from a $30 per ton carbon charge in 2020 would amount to about $25 billion.
  - A similar amount of revenue could be raised with the same charge applied to international aviation and maritime fuels from advanced countries.
- Rationale for targeting international aviation and maritime fuels:
  - Governments have a weaker claim on the tax base for these fuels than for domestic fuels.
  - These fuels are undertaxed from a fiscal and environmental perspective.
  - Tax administration would be straightforward.

### The Fund's role: scope and priorities
- The Fund is not an environmental organization, but climate change poses significant risks for macroeconomic performance and several of the appropriate policy responses lie within the Fund’s expertise.
- The Fund focuses on the practical design and administration of fiscal instruments for climate policy and broader energy policy.

### Analytical work
- The IMF draws on specialist analysis from other institutions (e.g., the Intergovernmental Panel on Climate Change, the International Energy Agency, the World Bank) and focuses on practical fiscal and energy policy design.
- Fund staff work has quantified, for over 160 countries, the environmental, fiscal, and economic benefits of energy pricing reform, including the removal of subsidies.
- This information helps policymakers craft the specifics of legislation to meet environmental and fiscal objectives and enlightens stakeholders on the case for reform.
- An overarching issue staff intends to analyze is the growth impact of transitioning to a less carbon-intensive economy.

### Technical assistance, surveillance, and training
- The Fund is well positioned to provide technical assistance and training, given its global membership and expertise in:
  - Fuel tax design
  - Tax administration
  - Energy price reform
- Climate and energy policy developments are sometimes discussed in Article IV consultations, and this seems likely to become increasingly common.
- Next steps on further integration in surveillance will be informed by assessing experience with selected pilot countries.

### Promoting dialogue and coordination
- The Fund collaborates with other international organizations (e.g., World Bank, Organisation for Economic Co-operation and Development, and United Nations Environment Programme) to promote policy dialogue among finance ministries.
- Emphasis on the benefits of carbon pricing as one component of an effective tax structure.

### Integrating disaster and climate risks in macroeconomic frameworks
- Low-income and small developing states are especially vulnerable to increasing risks of extreme weather events.
- Staff, collaborating with other international institutions, will work with countries to:
  - Develop comprehensive risk management frameworks to assess risks.
  - Determine the right mix of building domestic buffers versus risk transfer through insurance or financial market instruments.
  - Tailor investment and growth policies to building resilience.

### Incorporating adaptation in medium-term fiscal frameworks
- More analysis of the macroeconomic implications of adaptation policies is needed.
- Where macro-critical, the fiscal costs of adaptation, and the effective use of climate-related financial flows, will need to be integrated in sustainable medium-term fiscal frameworks.

### Financial sector: disclosures, prudential requirements, and stress testing
- Staff work, in close coordination with other institutions (such as the World Bank, Financial Stability Board, and International Association of Insurance Supervisors), will:
  - Enhance understanding of the transmission mechanisms from climate risks to financial stability.
  - Contribute to the design of appropriate disclosure rules for climate risk exposure.
  - Provide technical assistance to promote safe and sound development of markets and instruments to help manage climate-related risks.
  - Contribute to the development of best practices for stress-testing for climate risks.
  - Support ongoing work on globally consistent prudential requirements for the insurance sector, including on a Global Insurance Capital Standard being developed by IAIS to allow for catastrophe risk in capital requirements.

*THE MD’S STATEMENT ON THE ROLE OF THE FUND IN ADDRESSING CLIMATE CHANGE—NOVEMBER 2015*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_112515.pdf_