Modeling the U.S. Climate Agenda: Macro-Climate Trade-offs and Considerations

IMF Working Papers, December 10, 2021

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Context: Run up to the 26th Climate Change Conference and newly unveiled U.S. administration climate targets.
Purpose: Elaborates on the administration’s plans and uses two IMF-developed models to illustrate macro-climate trade-offs.
Core conclusions:
- Subsidies cannot substitute for explicit carbon pricing.
- Even a moderate carbon tax can greatly economize on the overall fiscal cost of the package.
- Front-loading decarbonization of the power sector entails only very marginal economic costs but large environmental benefits.
- Regulations can be effective in the power sector by providing an appropriate shadow cost to carbon, but a carbon tax would be more efficient and easier to administer.
- Transition away from fossil-fueled power generation will require significant labor reallocation across sectors and locations, needing careful handling to limit social costs.

Model 1: A model with endogenous fuel-specific technological change.
- Demonstrates that subsidies are not substitutes for explicit carbon pricing.
- Shows that even a moderate carbon tax greatly economizes on fiscal cost.
Model 2: A rich sectoral model focused on the power sector.
- Finds very marginal economic costs from front-loading decarbonization of the power sector.
- Highlights large accompanying environmental benefits.
- Indicates that regulations can be effective in the power sector by imposing an implicit shadow carbon cost.
- Notes that a carbon tax remains the more efficient and easier-to-administer instrument.

Fiscal and policy trade-offs:
- Subsidies alone are insufficient to achieve efficient decarbonization.
- Carbon pricing (even moderate) reduces the overall fiscal burden of climate policy packages.
Sectoral trade-offs:
- Power sector: Front-loaded decarbonization yields large environmental gains with only marginal economic costs.
- Regulation vs. tax: Regulations can mimic a shadow carbon cost in the power sector; carbon tax is preferred for efficiency and ease of administration.
Labor and distributional considerations:
- Transition away from fossil-fueled power generation implies significant labor reallocation across sectors and locations.
- Managing social costs requires careful policy design to handle reallocation.

Prioritize explicit carbon pricing as a central instrument to economize fiscal cost.
Use regulations in the power sector cautiously—recognize their potential effectiveness but prefer carbon taxation for efficiency and simpler administration.
Anticipate and plan for significant labor reallocation:
- Implement policies to limit social costs associated with transitions across sectors and locations (training, mobility support, targeted assistance).