International Monetary Fund Executive Board

Statement on behalf of the Southern Cone Chair

March 2008

1. In recent years a broad consensus has emerged about the potentially considerable macroeconomic implications of climate change (CC) associated with carbon emissions. Both in the near and long term, under current  policies, significant weather changes —including the possibility of catastrophic ones— are bound to have a dramatic impact on global living conditions and broad economic patterns. We concur that, in this context, fiscal instruments can have a central role in mitigating CC and adapting to its remaining effects. The staff report provides a useful overview of the theoretical and practical aspects of the fiscal responses to CC. Therefore, we welcome this discussion to clarify matters related with the choice of instruments, the need to articulate a global response, and, notably, the role of the Fund in this field.

2. Several administrative and fiscal instruments can be considered to address the consequences of CC. In principle there are advantages from adequate use of regulatory measures in this area, which can seek to limit externalities directly, and thus provide greater certainty on meeting mitigation  objectives. One can think of the analogy with speed limits, which are the most straightforward way to improve transit security. That said, however, we can agree that carbon pricing, whereby an appropriate “price” is charged for emissions, is better targeted, since it can induce lower emissions and charge for them —thus contributing both to mitigation and to the coverage of adaptation costs. Theoretically, the “carbon price”, intended to internalize the cost deriving from CC, should be set at level where the marginal social cost of mitigation is equal to the marginal social benefit from reducing damage; and carbon pricing can be implemented through carbon taxes, cap-and-trade, or hybrids of the two. A main guiding principle is that, to ensure efficiency, the carbon price should be levied at the same specific rate on all emissions, irrespective of their source. At the same time, several real-world factors have an influence on the choice of instruments and on the manner of implementation.

3. Although cap-and-trade may provide greater certainty on aggregate emissions, ways can be explored to apply carbon taxes in a transparent and simple way. Further on the choice between taxes and cap-and-trade, it is not immediately evident to us that the equivalence between both instruments breaks down when abatement costs are uncertain (paragraph 26). One would think that, on the contrary, known abatement costs would have to be the basis for adequate taxing. The staff’s comments would we welcomed. Additionally, in actual fiscal policy, currently no country has a carbon tax as such, apart from excise taxes on petroleum products. In practice, the latter serve different purposes, from raising revenue to favoring the use of certain kinds fuels against others. The downward pressure on rates, originated in international tax competition, is another major element to consider. Therefore, there seems to be merit in considering a second-best, more feasible solution (“broad-but-shallow”, instead of “narrow-and-deep”, as put by the staff) in the form of minimum tax rates.

4. The previous considerations imply that, given the cross-border nature of CC, the discussion on implementation of carbon pricing comes down to a problem of international coordination, which has several aspects:

  • There are asymmetries in the impact of emissions. Given their stock nature, high-income economies will account for most of the damage of CC in the coming years. This brings up the need to study cross-country transfer schemes to address fairness concerns, given that CC effects can be more dramatic in low-income countries —and adaptation costs considerably more significant as a percentage of GDP.
  • At the same time, we note the projection that, in a few years, most  emissions will be originated outside the OECD, which further strengthens the case for coordination. Noncooperation currently results in too little mitigation, and it is essential to keep in mind that incomplete participation is also undesirable —therefore the need to discuss realistic arrangements, like the possibility of a minimum tax mentioned in the previous paragraph.
  • Effective coordination requires transparent and streamlined fiscal systems to ensure effectiveness and comparability —thus promoting cooperation. As highlighted by the staff, “there is scope in many countries for taking  inventory of significant measures in place, so as to assess their coherence, transparency, and effectiveness”. The existence of diverse fiscal and other instruments of energy policy complicates cross-country comparisons.  Importantly, fuel subsidies, as well as relief mechanisms (explicit and implicit) would need to be revised internationally. In this regard, elimination of subsidies must take into consideration the availability of “clean” substitutes, to prevent, for instance, a substitution of wood for kerosene in cooking. Also, while in general we agree that earmarking introduces and element rigidity in fiscal management, in this case it could make carbon taxes more acceptable by providing assurances that the revenues raised will be used for specific adaptation to, and compensation for, CC. For cross-border carbon transactions, we see merit in considering selective border tax  adjustments (BTA), which can help to preserve mitigation associated with domestic consumption, as well as international competitiveness. It should be clarified that these need not be WTOinconsistent, as long as they do not hide export subsidies.
  • Assessing the fiscal costs of adaptation is key to an international agreement on carbon pricing. Currently the estimates vary widely. Also, appropriate instruments should be chosen to promote efficient technological innovation geared to dealing with CC, as discussed in Section III.G.

5. In this context, despite the urgency to address the consequences of CC, the staff paper suggests that work in this area is incipient, and that the Fund can, and must, make a significant contribution within its fiscal expertise and budget envelope, leaving other associated aspects to the World Bank, the International Energy Agency, and other institutions. We agree that  addressing for the fiscal impact of CC is not unlike preparing for population ageing —a matter in which the Fund is fully engaged. Crucially, the Fund’s universal membership can provide a platform for effective international cooperation. The coordination difficulties flagged by the staff, especially the transpaency issues, resemble the “prisoner’s dilemma”, with institutions like the Fund contributing to resolving it through adequate communication. This can be embodied in technical assistance about the design of fiscal instruments for mitigation, and in bilateral surveillance —with advice in this respect focused on promoting harmonized fiscal practices and assessing the potential impact of climate risks. The most challenging effort, however, is to facilitate international cooperation as part of the Fund’s multilateral surveillance work. Encouraging fulfillment of commitments in the context of the United Nations Framework Convention on Climate Change (UNFCCC), and the development of institutional structures within a successor to the Kyoto
Protocol, are key in this respect. In sum, policy design to address CC effects is technically complex, fiscal costs are sizable and difficult to measure, and  international coordination poses daunting challenges, and therefore work should start in earnest.

6. Finally, we would appreciate the inclusion of acronym lists in all staff papers to facilitate reading.

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