FORESPOLICYBRIEF:CarbonTaxestoSolvetheSovereignDebtCrisis1
FORES POLICY BRIEF
Carbon Taxes to Solve theSovereign Debt Crisis
By Ulrika Stavlöt
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As many governments face thechallenge of implementingnecessary fiscal consolidation while avoiding slowing down therecovery, carbon pricing is an attractive alternative. It couldfinance substantial parts of thefiscal consolidation with fewerdistortions than most other formsof taxation, while the tax burden isshared with fossil fuel producers.Reductions in debt and in carbonemissions (and carbon tax revenues)may move in parallel.
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Ulrika Stavlöt is the research director atFORES
The global financial crisis and the followingeconomic collapse resulted in a sharpdeterioration of public finances in mostindustrialised countries. According to theEEAG (2011) the debt-to-GDP ratio in theG7 countries is expected to increase by 40percentage points by 2015 as compared tothe pre-crisis level in 2007. Part of theincrease in deficits can be attributed toautomatic stabilisers, in particular to adrop in tax revenues and, to a lesser degree,to increases in public spending. Part can beattributed to fiscal stimulus packages likeKeynesian recovery programmes andgenerous bank rescue operations.
Double need for urgent action
The recent years economic and politicaldiscussion has been centred on how thesovereign debt crisis in Europe and how theunsustainable fiscal developments in theUnited States will evolve. Although there isa strong consensus on the need toundertake strong measures to reducedeficits and stabilise public debt, fiscalconsolidation in 2011 is still expected to bemodest in advanced economies. As a result,the adjustment required to restore debtratios to prudent debt levels remains
FORESPOLICYBRIEF:CarbonTaxestoSolvetheSovereignDebtCrisis2
substantial, especially in advancedeconomies (IMF, 2011a).Parallel to the policy debate on the contentand intensity of fiscal correction measuresthe international debate on the problem of global warming has resurfaced after beingtemporarily subdued by the turmoil of theglobal financial crisis. Estimates from theInternational Energy Agency claim that,despite the most serious global recessionfor 80 years, greenhouse gas emissionsincreased by a record amount last year(The Guardian, 2011). This means that thetwo-degree target of global warming will bealmost out of reach. To mitigate thegreenhouse effect drastic measures andinternational cooperation are necessary and urgent. Although the current economic crisistemporarily shifted focus off the problemsof global warming, the crisis also providesopportune circumstances to fixinefficiencies on resource allocation. Theglobal need for fiscal consolidation and thesearch for efficient fiscal correctionmeasures may in fact facilitateinternational agreements that previously would have been politically infeasible.The governments face the challenge of implementing necessary fiscal policy measures while avoiding significantly slowing down the recovery in domesticdemand and creating another round of contraction. Reduced public spending and broadened tax bases notwithstanding, new taxes and increasing tax rates areinevitable, while tax cuts to stimulategrowth become less viable. Given aninternationally coordinated policy implementation, a carbon pricing makes very good sense from a fiscal perspective as well as from an environmental perspective.
Carbon tax – the fiscalperspective
Starting with the fiscal perspective, aconsumption tax, such as a carbon tax
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, hassome distinct advantages in general over anincome tax and is therefore advocated by
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Carbon tax is here used as synonymous withall forms of public pricing of carbon. For thefollowing arguments it does not matter whether there is a cap on emissions andemission rights are auctioned off by the state toemitters resulting in a certain price - or if acarbon tax is decided ex-ante hoping toachieve a certain level of emissions. In practicepublic carbon pricing through emission tradingis in many cases more politically feasible andefficient than a carbon tax.
FORESPOLICYBRIEF:CarbonTaxestoSolvetheSovereignDebtCrisis3
many economists. All taxes affect theallocation of resources. However, whereasan income tax distorts good behaviour andcauses people to work less and pursuemore leisure activities, a consumption taxdiscourages consumer spending andencourages people to save more.Differently put, the benefit of consumptiontaxes over income taxes is that they do notdistort the intertemporal allocation of consumption. There is also empiricalevidence that confirm that consumptiontaxes affect growth less than income taxes(See Milesi-Ferretti and Roubini, 1998, foran overview of the literature).
Correcting the market failures
A carbon consumption tax has all theadvantages of a consumption tax.
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However, in addition it corrects for themarket failure of carbon emissions. Thus,instead of distorting economic activity as
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Like other flat taxes, a carbon consumptiontax can be regressive with respect to income,i.e. the tax imposes a greater burden on low-income than on high-income households sincelow-income household consume more of theirincome. This is a common objection toreplacing the income tax with a consumptiontax. However, by allocating some of the taxrevenues to compensate the less affluent, thenegative implications of the incomedistribution can be offset.
most other taxes do, a carbon taxinternalises the marginal externalitiesfrom global warming and thereby reallocates resources more efficiently. Which brings us to the environmentalperspective of carbon taxes. The basicpolicy conclusion of the Stern Review isthat a worldwide tax on the consumptionof carbon wouldhold global warming tosafe levels.By means of imposing a price on carbonemissions the demand for fossil fuels would decrease and the development of renewable-energy technologies wouldaccelerate. Depending on the reaction of the suppliers and thus on the elasticity of the supply curve, the reduced demand forfossil fuels reduces emissions andmitigates global warming. Since it seemsreasonable that the supply curve, at least inthe long run, is elastic, the price of fossilfuels increases, and, according to standardtax analysis, the tax burden is shared between consumers and fossil fuelproducers.
A global tax more efficient
Economic theory provides two importantinsights on how an optimal carbon tax
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FORES POLICY BRIEF Carbon Taxes to Solve the Sovereign Debt Crisis
As many governments face the challenge of implementing necessary fiscal consolidation while avoiding slowing down the recovery, carbon pricing is an attractive alternative. It could finance substantial parts of the fiscal consolidation with fewer distortions than…
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