Implementing the United States' Domestic and International Climate Mitigation Goals: A Supportive Fiscal Policy Approach
  • 1, International Monetary Fund

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The United States has pledged to become carbon neutral by 2050, meet sectoral objectives (e.g., for carbon free power, electric vehicles) and encourage greater mitigation among large emitting countries and of international transportation emissions. Fiscal policies at the national, sectoral, and international level could play a critical role in implementing these objectives, along with investment, regulatory, and technology policies. Fiscal instruments are cost-effective, can enhance political acceptability, and do not worsen, or could help alleviate, budgetary pressures. Domestically, a fiscal policy package could contain a mix of economy-wide carbon pricing and revenue-neutral feebates (i.e., tax-subsidy schemes) with the latter reinforcing mitigation in the transport, power, industrial, building, forestry, and agricultural sectors. Internationally, a carbon price floor among large emitters (with flexibility to implement equivalent measures) could effectively scale up global mitigation, while levies/feebates offer a practical approach for reducing maritime and aviation emissions.


The United States has pledged to become carbon neutral by 2050, meet sectoral objectives (e.g., for carbon free power, electric vehicles) and encourage greater mitigation among large emitting countries and of international transportation emissions. Fiscal policies at the national, sectoral, and international level could play a critical role in implementing these objectives, along with investment, regulatory, and technology policies. Fiscal instruments are cost-effective, can enhance political acceptability, and do not worsen, or could help alleviate, budgetary pressures. Domestically, a fiscal policy package could contain a mix of economy-wide carbon pricing and revenue-neutral feebates (i.e., tax-subsidy schemes) with the latter reinforcing mitigation in the transport, power, industrial, building, forestry, and agricultural sectors. Internationally, a carbon price floor among large emitters (with flexibility to implement equivalent measures) could effectively scale up global mitigation, while levies/feebates offer a practical approach for reducing maritime and aviation emissions.

I. Introduction

The window of opportunity for containing global climate change to manageable levels is closing rapidly. Global carbon dioxide (CO2) and other greenhouse gas (GHG) emissions must be cut 25-50 percent below 2018 levels by 2030 to be on track with containing projected warming to 1.5°-2oC above preindustrial levels with rapid reductions to emissions neutrality thereafter. Due to the pandemic-induced crisis, projected global emissions in 2020 are about 7 percent below 2019 levels, but without strong mitigation policies emissions are likely to start rising again in 2021 as economies recover (Figure 1). With governments bringing forward investment plans to boost their economies, the pandemic has added to the urgency of ensuring new investment is efficiently allocated to low-carbon technologies—this requires carbon pricing or similar measures.

Figure 1.
Figure 1.

Global Fossil Fuel CO2 Emissions Trends

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: IEA(2020), IMF staff calculations, IPCC (2018). (2018).

The United States is one of several key countries that will determine whether the world stays on track with warming targets. China and the United States account for half of projected baseline CO2 emissions (i.e., emissions in the absence of stronger mitigation policy) worldwide in 2030, and the EU another 7 percent (Figure 2).

Figure 2.
Figure 2.

Country Shares of Baseline CO2 Emissions 2030, percent

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: Updated from IMF (2019a).

The 2015 Paris Agreement is the centerpiece of the international community’s efforts to address climate change. 195 countries signed the agreement, with almost all submitting pledges to reduce GHGs within their borders—these pledges are due for revision ahead of COP 26 in Glasgow, November 2021. Even if all countries achieved their pledges however, this would only cut global emissions in 2030 by about a third of the reductions consistent with 2O2, let alone 1.5oC.2 The United States is rejoining the Paris Agreement in, after withdrawal took effect in November 2020.3

Strong mitigation action in the United States would have large climate, local environmental benefits, and (if pricing is used) fiscal benefits. Climate change is impacting the economy through, for example, record forest fires and increased frequency and intensity of natural disasters.4 If unabated, global climate change could be permanently lowering annual US GDP by several percent by 20505—though the overriding concern is tail risks.6 Determined US actions would significantly affect global emissions and help catalyze more ambitious mitigation in other countries through its leadership role and by helping to alleviate concerns about competitiveness impacts. Even leaving aside the broader macroeconomic benefits, cutting fossil fuel use is beneficial for the US economy as, up to a point, the domestic environmental co-benefits (e.g., particularly reductions in local air pollution mortality) exceed the economic costs.7 To the extent that carbon pricing is part of the mitigation strategy significant revenues could be raised (see below) which could be used, for example, to cut distortionary taxes on labor and capital or fund public investment in clean technology networks.

US GHG emissions (excluding land-use) were 6.7 billion tons in 2018, with 78 percent from fossil fuel CO2 (Figure 3). By sector, power generation accounted for 38 percent of fossil fuel CO2 emissions, industry 22 percent, transport 24 percent, and (direct fuel combustion in residential and commercial) buildings 15 percent. By fuel type, coal accounted for 26 percent of fossil fuel CO2 emissions, oil 42 percent, and natural gas 32 percent.

Figure 3.
Figure 3.

Breakdown of GHG Emissions, 2018

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

The Biden Plan for a Clean Energy Revolution and Environmental Justice8 sets forth ambitious nationwide and sectoral mitigation goals and envisions a largely regulatory and investment approach to make headway on them. The plan seeks to:

  • Achieve zero net CO2 emissions at the national level by 20509 and establish nearer term emissions targets consistent with this goal;

  • Achieve zero net emissions from power generation by 2035 (e.g., through expanding renewables and nuclear);

  • Tighten fuel economy standards to ultimately promote 100 percent deployment of electric vehicles (EVs) for light/medium vehicles and greater EV deployment for heavy vehicles (500,000 new public charging outlets will be provided by 2030);

  • Reduce direct (from gas and oil) and indirect (from electricity) building emissions 50 percent by 2035 through stronger appliance and building efficiency standards, building codes, on-site clean power generation, retrofitting public buildings, and requiring all new buildings are zero carbon by 2030;

  • Reduce methane leaks from oil and gas extraction;

  • Introduce, or scale up, tax incentives for technologies like carbon capture, use and storage (CCUS) and EVs;

  • Impose a border carbon adjustment (BCA), that is, a charge on the carbon content of carbon-intensive imports, applied to goods from countries failing to meet their climate obligations;

  • Invest $400 billion over ten years in research to develop critical technologies (e.g., electricity storage, small-scale nuclear, green hydrogen, CCUS, direct air capture); and

  • Commit $1.7 trillion over ten years in federal funding for mitigation investments (e.g., subsidies for renewables and grid expansions for integrating them, building upgrades).

At the international level, the Biden Plan seeks to promote greater mitigation ambition and stronger agreements to reduce international transportation emissions. Within 100 days, the new administration would convene a summit with major emitters and the aim of strengthening mitigation pledges. And, while the bodies overseeing the international aviation and maritime sectors have developed mitigation targets, the Administration seeks stronger near-term targets and measures to implement them.

Many specific policy actions to implement the Biden Plan need to be fleshed out, but a comprehensive package of fiscal policies could play a critical role alongside proposed public investment, technology, and regulatory policies in promoting effective, cost effective, and acceptable policies without a fiscal cost. Fiscal policies can be implemented at the national, sectoral, and international level.

  • At the national level, a carbon tax or emissions trading system (ETS) would provide across-the-board incentives for clean technology investment and redirecting spending to lower-emitting activities while revenues might be used, for example, in assisting vulnerable groups in the transition and for boosting the economy through financing green investment or cutting taxes on work effort and capital investment—revenues are especially valuable given budgetary trends;10

  • Reinforcing instruments at the sectoral level are needed, given sectoral objectives, uncertainty about the effects of pricing, and likely constraints on its acceptability—feebates (see below), which can be applied to the transportation, power, industry, buildings, forestry, and agricultural sectors, are cost effective, can complement regulatory approaches, avoid the fiscal cost associated with subsidies, and may enhance acceptability by limiting new tax burdens on the average household or firm; and

  • At the international level, a carbon price floor arrangement among large emitters (allowing flexibility in approaches at the national level) could be a highly effective mechanism for scaling up global mitigation, while carbon levy/feebate variants can provide the critical price signal for clean technologies in international aviation and maritime while mobilizing the needed research/investment funds and limiting burdens on industries and consumers.

Pushing on multiple fiscal, regulatory, investment, and technology policies makes sense given uncertainties over the political and legal feasibility of individual instruments and federal-level policies are more efficient and simpler. Carbon pricing—with efficient revenue use and in conjunction with investment and technology policies—is the least costly way to meet the Administration’s emissions goals. If pricing is not feasible, the next best approach is a combination of feebates or regulations (with credit trading provisions) that reduce emissions intensity across the major energy and land use sectors, ideally with implicit emissions prices harmonized across sectors. A balance between the two approaches is appropriate where some, but not the full amount, of carbon pricing is feasible. At the state level, ETSs operate in California (covering most emissions sources) and in the Northeastern states (covering power generation) and most states have renewable and energy efficiency policies. These policies might be extended, and harmonized, across states. A federal level approach however, which is the focus here, is more cost effective (i.e., it can equate incremental mitigation costs across sectors and regions unlike under multiple state policies), transparent (i.e., there is one uniform policy), and simplifies administration (with one implementing federal agency rather than multiple state agencies).

This paper describes a comprehensive package of federal and international fiscal measures—summarized in Table 1—that could play a key role in combination with other instruments in implementing the major goals of the Administration’s climate plan. The focus is on the rationale for these policies, their practical design, their emissions and other impacts, and strategies for enhancing their acceptability. The paper differs from other recent discussions of US climate mitigation policies11 by its focus on a broad range of fiscal instruments at the national, sectoral, and international level and its quantitative analysis comparing effects in the US with other large emitting countries. The three main sections of the paper focus on nationwide, sectoral, and international policies, respectively and the last section offers concluding remarks.12

Table 1.

Summary of Fiscal Mitigation Instruments to Help Implement US Climate Goals

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II. Nationwide Policies (for Energy)

The US Administration needs to develop intermediate emissions targets aligned to long-term carbon neutrality. For illustration, on a linear pathway to reduce US fossil fuel CO2 emissions from (projected) 2020 levels to zero in 2050 the target for 2030 would be 3.3 billion tons, about one-third below projected business-as-usual (BAU) emissions (i.e., emissions in the absence of new mitigation measures) in 2030—see Figure 4.13This target—termed here the linear target’—would be one of the more stringent intermediate targets among G20 countries (see the red dots in Figure 5) though other countries may submit more stringent pledges for COP 26 (more in line with long-term net zero pledges). Emissions projections discussed here, and the responsiveness of emissions to pricing, are based on an IMF spreadsheet tool described in Annex 1.

Figure 4.
Figure 4.

Emissions Trends and Targets

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: IEA, UNFCCC, staff calculations.
Figure 5.
Figure 5.

CO2 Reductions for Pledges/from Pricing

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: Updated from IMF (2019a).Note. Pledge is from Paris Agreement or subsequent pledge. Price is additional to any existing pricing.

Carbon pricing versus other approaches

The environmental, fiscal, economic, and administrative advantages of federal carbon pricing in the United States have been extensively discussed.14 Pricing:

  • Provides across-the-board incentives for firms and households to reduce energy and shift to cleaner fuels without favoring any specific energy matrix, other than discriminating by its carbon content (by reflecting the cost of carbon emissions in the prices of fuels, electricity, and goods);

  • Automatically minimizes mitigation costs (by equalizing the cost of the last ton reduced across fuels and sectors);

  • Redirects new investment to clean technologies (if there is a robust and rising price signal— indeed when businesses are making major investments, they may prefer the certainty of a robust price to regulations);

  • Mobilizes valuable revenues for the general government (which can be used, for example, to address distributional concerns, go toward deficit reduction, or finance other spending priorities or tax cuts);

  • Generates substantial domestic environmental benefits (e.g., reductions in local air pollution mortality); and

  • Is straightforward administratively (if it builds off institutional capacity for existing policies like fuel taxes).

Regulations (e.g., standards for emission rates and energy efficiency) and subsidies for clean technologies (e.g., for EVs, renewable plants) are a less efficient way to promote private sector responses than pricing and forgo fiscal opportunities—but may have greater traction. These approaches cannot promote some potential private sector responses (e.g., conserving on use of air conditioning and vehicles) and lack an automatic mechanism for equating incremental abatement costs across the responses they do promote. They may be more politically acceptable however as, unlike carbon pricing, they may avoid a large increase in energy prices—that is, they do not involve the pass through of carbon tax revenues (or allowance rents under an ETS) in higher electricity, gas, and road fuel prices. And the Executive branch has the legal authority to enact standards15—in contrast, carbon pricing could face a higher hurdle if it requires legislation, though it could have bipartisan support if it is revenue neutral and border-adjusted.16 The remainder of this section considers carbon pricing, and strategies to enhance its acceptability, while the following section considers complementary measures to the regulatory/subsidy approach envisioned in the Biden Plan that can exploit the price mechanism and are fiscally neutral.

Table 2.

Selected Carbon Pricing Schemes, 2020

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Source: WBG (2020) and staff calculations.

Carbon pricing—design, impacts, and acceptability

Carbon pricing—charges for the carbon content of fossil fuels or their emissions—can be implemented through a tax or ETS. Carbon charges can be applied midstream by integrating them into existing federal gasoline and diesel excises (collected by the Internal Revenue Service within the US Department of Treasury) and extended to coal, natural gas, and other petroleum products.17 A trajectory of progressively rising tax rates can be announced ahead of time and revenues would accrue to the general federal budget. A federal ETS, which would be administered by the Environmental Protection Agency (either a new program or an extension of the California ETS) is the main alternative. An ETS would be applied downstream at the point of fuel combustion for generators and large industry, but it could also be applied midstream to cover fuels for transportation and buildings.18 Price stability could be pr omo ted through a rising carbon price floor 19 and allowances could be auctioned to exploit fiscal opportunities.

A carbon price rising to $50 per ton in 2030 is estimated to deliver about two-thirds of the 2030 emissions reductions for the linear emissions target, and a $75 price 85 percent (Figure 5), though acceptable price levels will depend in part on prices elsewhere.20 The responsiveness of emissions to pricing in the United States is broadly comparable to that in most other countries (Figure 5)—price responsiveness is greater in, for example, China and South Africa due to their greater dependence on coal use. Carbon prices in current carbon tax and ETS schemes are mostly around $5–35 pert on (Table 2), though prices are expected to rise over time.

Table 3.

Energy Price Impacts of $50 per ton Carbon Price, Selected Countries 2030

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Source: Updated from IMF (2019a).Note: BAU prices are retail prices from Coady and others (2019), including preexisting energy taxes, and adjusted for projected changes in international reference prices. Coal and natural gas prices are based on regional reference prices while electricity and gasoline prices are from cross-country databases. Price increases are proportional to carbon emissions factors which are exogenous for coal, gas, and road fuels and endogenous for electricity. Producer prices are taken as fixed. GJ = gigajoule; kWh = kilowatt-hour.

A carbon tax in the United States would impact coal and natural gas prices the most, though electricity prices would also increase significantly (see Table 3). For example, a $50 carbon price would increase coal, natural gas, retail electricity and gasoline prices by 170, 103, 39 and 15 percent respectively above BAU levels in 2030. These percentage price increases would, on average, be smaller for the same carbon price in other G20 countries (especially for natural gas), though this generally reflects higher BAU prices in those countries.

Carbon prices of $50–75 per ton would raise revenues of 0.7–1.0 percent of GDP in 2030 which might be used to boost the economy. Leaving aside the environmental benefits, carbon pricing imposes two sources of distortion or efficiency cost o n the economy. First is the cost of the mitigation responses, which can be measured by foregone benefits to fuel users from cutting back on fossil fuel consumption, less reductions in the costs of producing fossil fuels. Second is the broader economic costs as higher energy prices (slightly) contract the economy-wide level of economic activity, which reduces work effort and investment—in turn, this exacerbates the distortions from taxes on personal income, payrolls, and corporate income that reduce labor supply and investment below their economically efficient levels. Using carbon pricing revenues to cut taxes on the income from labor and capital, or to fund productive (green or general) investments, provides offsetting benefits to the economy. In contrast, if revenues are used to fund lump-sum dividends to households there is no efficiency benefit (e.g., no improvement in work incentives) and the overall costs of carbon pricing can be much higher (Figure 6). In fact, a carbon tax and dividend can be costlier overall than a combination of feebates or regulations (see below) achieving the same economy-wid e emissions reduction—the broader economic costs are smaller under feebates/regulations as they have smaller impacts on energy prices.

Figure 6.
Figure 6.

Economic Efficiency Costs of Alternative

Mitigation Instruments for the United States ($50/Ton Carbon Tax), 2030

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: IMF (2019a).Note: Policies reduce economywideCO2 emissions 22 percent below BAU.

Carbon pricing in the United States imposes a modest burden on the average household—0.15 percent of consumption for a $50 carbon price in 2030 after revenue recycling—but potentially regressive effects need to be addressed. Prior to revenue use the average burden is much higher, around 1.2 percent of consumption. This burden comes directly through higher prices for electricity, natural gas, and road fuels (which, to varying degrees, are a disproportionately large share of the budget for low-income households), as well as indirectly through higher prices for consumer goods in general (for which budget shares are similar across household groups). Ideally carbon pricing revenues are used in a way that balances efficiency and equity— making this recycling transparent (e.g., through a general cut in payroll taxes) also helps to help build support for the reform. The burden of carbon pricing on households (before revenue use) would be a lot larger in China where production is far more carbon intensive (Figure 7).

Figure 7.
Figure 7.

Burden of $50 Carbon Price on Household Income Quintiles in 2030 Before Revenue Use, Selected Countries

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: Updated from IMF (2019a) after scaling household consumption to be consistent with national accounts.Note: “Indirect” is the increased price of general consumer goods from higher energy costs. Full pass-through of taxes to consumer prices is assumed. Burdens are measured against consumption as this is generally viewed as a better measure of household wellbeing than income.

Carbon pricing would moderately increase industrial production costs in the United States (Figure 8). Averaged across all industries, a $50 carbon price in 2030 would increase production costs by 1.5 percent, but much of this would be passed forward in higher consumer prices. Cost increases are, however, somewhat larger for the 20 percent of most vulnerable industries, on average 4 percent. Energy-intensive, trade-exposed (EITI) industries (e.g., aluminum, steel, cement, petrochemicals) are a key concern however, due to the adverse competitiveness impacts, and risks of emissions leakage,21 stemming from limits on their ability to pass forward higher production costs into higher product prices. Cost increases for the same carbon price are, however, larger for industries in China and India given their higher carbon intensity—about three times as large in the case of China. And cost increases for services in the United States are modest (typically 0.5 percent or less).

Figure 8.
Figure 8.

Burden of a $50/Ton Carbon Price on Industries in 2030 Before Pass Through, Selected Countries (Percent)

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: IMF (2019a).

A BCA is one possibility for addressing competitiveness concerns, and could encourage pricing in other countries, but delays while design details are finalized should not hold up progress on carbon pricing or other mitigation measures. A BCA would impose charges for the embodied carbon in imports and, if the primary motivation is to address competitiveness and leakage concerns, it should be limited to products competing with EITE industries. Such a BCA, with carbon charge of $50 per ton, would raise revenues of 0.1 percent of US GDP in 2030—with about half of the revenues from Chinese imports and about 10 percent each from Indian, Mexican and EU imports, and 40 percent and 33 percent respectively from metals and chemical products (Figure 9). However, some thorny design issues, including benchmarks for assessing embodied carbon in imports, whether to allow rebates for individual overseas exporters that are less carbon intensive than the industry average, how to adjust charges for carbon pricing or mitigation measures in trading partners, use of BCA revenues, and whether to rebate charges for embodied carbon in US exports. There is also some possibility of legal challenges at the World Trade Organization (WTO), or retaliation by trading partners.22 And the case for a BCA is less clear if the US eschews carbon pricing in favor of feebates and regulations, as the burden on EITE industries is smaller (see below). It also likely makes sense to delay a US BCA until lessons about design issues and legal risks can be learned from the EU, which is planning to announce its own BCA bill in June 2021 and implement it in 2023.23 In the meantime, an output-based rebating scheme, or a feebate (see below), are possibilities for addressing competitiveness concerns.24

Figure 9.
Figure 9.

Revenues Raised from $50 BCA on US EITE Imports, 2030

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: OECD (2020)

Carbon pricing in the United States would face political challenges, though a comprehensive strategy could improve its prospects. Past experiences with energy and carbon pricing reform across the globe suggests the strategy should include the following basic components:25

  • A balance between national level pricing and (less efficient but more acceptable) reinforcing sectoral instruments (see below) with progressive implementation;

  • Transparent, productive, and equitable use of carbon pricing revenues;

  • Assistance for vulnerable groups (low-income households, displaced workers, vulnerable regions, EITE industries);26

  • Supporting investment and technology policies to address broader market failures (see below) and enhance the effectiveness and credibility of the policy package; and

  • Extensive consultations with key stakeholders to garner their support and programs informing the public of the rationale for reform and how they benefit.

III. Sectoral Mitigation Instruments

Sectoral mitigation instruments have a critical role to reinforce carbon pricing or, if needed, substitute for it entirely, though insofar as possible they should rely on the price mechanism to contain costs on the economy. The greater the political acceptability constraints on carbon pricing, the greater the need for sectoral instruments. And even with aggressive carbon pricing, additional instruments may be needed to achieve sectoral targets, especially for sectors with low responsiveness of emissions to pricing (this will imply some divergence in implicit carbon prices across sectors). Broader market failures (e.g., associated with clean technology infrastructure, coordination failures, or knowledge spillovers in shifting to new technologies) may also warrant additional policies, though often these should be targeted at specific technologies.27 Where the objective of sectoral instruments is to mimic key behavioral responses that would be induced by pricing, ideally, they would be designed flexibly, allowing firms and households to choose responses that minimize costs for a given emissions reduction. This is one key attraction of the fiscal policies discussed below (the focus of the discussion as these instruments are more novel), though flexibility can (and has to some extent been) integrated into regulatory approaches through credit trading provisions. The discussion takes in turn road transportation, power, industry, buildings, fugitive emissions, forestry, and agriculture (other emissions sources are discussed in Annex 2).

Road Transportation (19 percent of GHGs)

Road transportation is especially difficult to decarbonize through carbon pricing (or higher gasoline and diesel excises) alone due to the relatively modest impact it has on retail fuel prices (Table 3) and political resistance to higher road fuel prices at the federal level. In fact, federal excises of 18.4 and 24.4 cents per gallon on gasoline and diesel respectively, have been frozen in nominal terms since 1993. 28 Instead, the centerpiece of federal efforts to progressively decarbonize the transport sector is the Corporate Average Fuel Economy (CAFE) program which sets standards for new light-duty vehicle sales fleets. These standards were to rise 5 percent a year from 2021 to reach (on average) a projected 46.7 miles per gallon (mpg) in model year 2026, but in 2019 the annual requirement was reduced to 1.5 percent implying projected fuel economy of 40.4 mpg in 2026.29 In addition, there is a federal gas guzzler tax of $7,700 applying to passenger vehicles with fuel economy below 12.5 mpg, a tax credit of $7,500 for EVs, and tax credits of between $4,500 and $7,500 for plugin EVs.

Generalizing the gas guzzler tax and EV tax credits with a more comprehensive feebate would strengthen incentives for progressively and cost-effectively decarbonizing the vehicle fleet, while avoiding a fiscal cost to the government. A feebate would provide a sliding scale of fees on vehicles with above average emission rates and a sliding scale of rebates for vehicles with below average emission rates. That is, each new vehicle would be subject to a fee given by:

CO2 price × {CO2/mile ─ CO2/mile of the new vehicle fleet} × {average lifetime vehicle mileage}

EPA-certified fuel economy by model type (currently used to administer the CAFE program) provides the data needed to assess the fees and rebates for each vehicle. The feebate:

  • Promotes the full range of behavioral responses for reducing emission rates, as there is always a continuous reward (lower taxes or higher subsidies) fr o m switching fr om any vehicle with a higher emission rate to one with a lower emission rate;30

  • Is cost effective as the reward is always proportional to the reduction in the emission rate—in contrast under the CAFE program, the reward for additional emissions reductions declines with higher emission vehicles given the focus on miles per gallon rather CO2 (or gallons) per mile; and

  • Maintains (approximate) revenue neutrality—by definition, fees offset rebates as the average emission rate in the formula is updated over time.

At present there are separate mpg standards for seven categories of cars and light trucks where standards are stricter for smaller size vehicles, so in principle a separate feebate (with the CO2/mile inferred from the mpg standard) could be applied to each category. This approach may be more acceptable to some manufacturers, but it would lower the rewards from increasing the sales shares for smaller size vehicles.

For illustration, a feebate with a price of $300 per ton CO2 would apply a subsidy of $7,500 for EVs and a tax of $1,800 for a vehicle with fuel economy of 30 mpg (or CO2 emission rate of 300 grams per mile).31 Other countries in Europe with elements of feebates generally impose much higher taxes on high emission vehicles than this illustrative feebate (Figure 10) though the sales shares for these vehicles in Europe is smaller than in the United States. Subsidies for EVs would decline over time as the average fleet emission rate declines, which is entirely appropriate as the cost differential between clean vehicles and their gasoline counterparts falls over time (e.g., with improvements in EV batteries). Gauging how fast the average emission rate falls in the future in response to a given feebate price is tricky given uncertainty about how the future penetration of EVs will be affected by changes in relative vehicle prices—the feebate price is, however, easily scaled up if needed to speed up the adjustment.

Figure 10.
Figure 10.

CO2-Based Components of Vehicle Taxes

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: ACEA (2018) and IMF staff calculations.Note. Assumes discounted lifetime driving of 62,000 miles.

Power Generation (29 percent of GHGs)

Power generation emissions are relatively more responsive to pricing than emissions in other sectors. This is principally because: (i) the sector uses coal and natural gas and carbon pricing has a more dramatic impact on the prices for these fuels than the prices of other fuels (Table 3); and (ii) there is a wider availability of low-carbon technologies (e.g., nuclear, fossil plants with CCUS, wind, solar, biomass and other renewables) than for other sectors. Federal policies for the sector currently include tax credits for renewable generation. Under the 2015 Clean Power Plan (CPP) states were responsible for developing strategies for meeting emissions targets, which amounted to projected nationwide reductions of 32 percent for the power sector by 2030 relative to 2005 levels—the CPP was repealed in 2017, however.

Even if the CPP were re-instated, incentives for de-carbonizing the power sector could be strengthened with a federal level feebate. Under this scheme, power generators would be subject to a fee given by:

CO2 price × {CO2/kWh—industry-wide average CO2/kWh} × electricity generation

The feebate cost-effectively, and in a revenue-neutral way, promotes the full range of responses for reducing emission rates per kWh— improving generation efficiency and shifting the mix of fuels from coal to gas and from these fuels to nuclear, fossil plants with CCUS, and renewables. Current tax credits, for example, promote only the last of these responses and lose revenue. If implemented in conjunction with a reinvigorated CPP, a federal level feebate would provide ongoing incentives to reduce emissions beyond state level targets, would promote cost-effectiveness in reductions across states, and would be a back-up in the event of legal or other challenges to the CPP. The feebate would not require new capacity for monitoring smokestack emissions beyond what is needed for implementing the CPP. And it avoids the politically challenging increase in electricity prices under carbon pricing, though it does not generate the same reduction in electricity demand.

For illustration, a feebate with a price of $50 per ton would currently apply a subsidy of 2.2 cents per kWh for zero-carbon generation plants and a fee of 2.8 cents per kWh for coal plants (Figure 11). Natural gas plants would receive a small initial subsidy (0.2 cents per kWh), though this would progressively decrease and become a fee (while subsidies for renewables would decline), as the industry average emission rate declines over time—alternatively the pivot point can initially be defined as the emission rate of a gas plant (in which case it would raise a small amount of revenue initially).

Figure 11.
Figure 11.

Illustrative Feebate for Power Sector

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source: IMF staff,

Industry (17 percent of GHGs)

Carbon pricing for industry may be constrained in practice, not least by concerns about competitive impacts. The burden of carbon pricing on industry consists of the costs of cutting emissions (e.g., from switching to cleaner but more expensive technologies) and the, typically much larger, tax or allowance purchase payments for remaining emissions (Annex 3). In other carbon pricing schemes, competitiveness concerns have been addressed through providing industries with free allowance allocations (e.g., in the EU) or charging firm emissions above a threshold level rather than all emissions (e.g., Canada, South Africa) though attention in the EU and United States is currently focused on possible BCAs.

Feebate schemes for industries could reinforce incentives for reducing emissions intensity but with a much smaller burden on the industries than from higher carbon pricing (Annex 3). Under a feebate firms would pay a fee

CO2 price × {CO2/production ─ industry-wide average CO2/production} × production

The focus should be on both direct emissions from fuel combustion and process emissions. The lower burden under a feebate may enhance their acceptability and reduce the pressure for a BCA. Annex 3 provides illustrative comparisons of the impacts of carbon pricing and feebates on production costs in the steel and cement industries.

Buildings (12 percent of GHGs)

Improvements in the energy efficiency of new and existing buildings, and appliances used in buildings, reduce both direct emissions and (through lowering electricity demand) indirect emissions.32 These improvements may however be hindered by possible market failures (e.g., liquidity constraints, cost-benefit mismatches between owners and renters, unawareness or uncertainty of energy savings from renovation) which would warrant some policy intervention, even if nationwide emissions were adequately priced.33 The federal government sets energy efficiency standards for a wide range of products (e.g., air conditioners, furnaces, light bulbs, refrigerators, light bulbs); provides tax credits for energy efficiency upgrades in residences and for energy efficient building; and improves consumer awareness of energy efficiency through labelling programs. Codes for the design, construction, alteration, and maintenance of buildings are implemented at the state level, in part to account for regional differences in climate.

Various feebate schemes could complement existing regulations to reduce emissions and address market failures by strengthening incentives for energy efficient and low carbon appliances and equipment. For example, sales of refrigerators, air conditioners, and other energy-consuming products could incur a fee given by:

CO2 price × CO2 per unit of energy × {energy consumption per unit ─ industry-wide energy consumption per unit} × number of units

For refrigerators, for example, the energy consumption rate would be kWh per cubic foot cooled (and the number of units would be cubic feet). A similar scheme applying taxes to gas- and oil-based heating systems, and a subsidy for electric heat pumps, could accelerate the transition to zero-carbon heating systems. Again, feebate schemes avoid a fiscal cost (unlike current tax incentives); the carbon prices in feebate programs across different product categories are easily harmonized to promote cost effectiveness (unlike regulatory approaches where there is no automatic mechanism for equating incremental mitigation costs across programs); and these schemes provide ongoing incentives to go beyond current standards.

Fugitive Emissions from Extractive Industries (5 percent of GHGs)

Natural gas, oil, and coal production accounted for 57, 25, and 18 percent of US fugitive emissions in 2018. About half the leaks from natural gas were from extraction—both venting, which releases methane, and flaring, which releases CO2—and the other half methane leaks from processing, transmission, storage, and distribution, while essentially all fugitive emissions from oil and coal are from extraction.34 Possibilities for mitigating fugitive emissions include: (i) reinjecting gas (for enhanced oil recovery) or storage (though the feasibility of this varies with the sedimentary rock); (ii) using methane for on-site or regional power generation; (iii) compressing the gas, or liquifying it, for sale; and (iv) improved maintenance of infrastructure for gas processing and distribution.35 Under a 2016 executive action, which has since been rescinded, new or modified oil and gas wells were required to report their emission rates but these facilities were not subject to emission rate standards and the requirements did not apply to existing wells or coal mines.

Pricing schemes for fugitive emissions would promote the full range of responses for reducing emission rates and are feasible using default emission rates with rebating for firms demonstrating lower emission rates. Emissions monitoring technologies 36 generally provide only discrete measurements at a limited number of sites, though technologies are improving—and CO2 emissions from flaring are measurable. Fuel suppliers might be taxed based on a default leakage rate with rebates to firms demonstrating lower leakage/venting rates than the default rate through mitigation and installing their own continuous emission monitoring systems. Fugitive emissions are released within the US borders, and therefore should be priced regardless of whether the fuel is for domestic or overseas markets. Pricing approaches are more flexible and cost-effective than regulatory approaches imposing the same standard on all firms, regardless of their mitigation opportunities .

For illustration, an emissions tax of $100 per ton on fugitive emissions would apply charges equivalent (prior to mitigation) of approximately $2 per barrel of oil, $0.4 per thousand cubic feet of natural gas, and $8 per ton of coal under default emission rates. These charges are equivalent to about 4, 11, and 20 percent of current supply prices.37 Studies suggest however, that this level of pricing would lower emission rates by around 60 percent.38


Ideally, federal forestry policies should cost-effectively promote, nationwide, the three channels for increasing forest carbon storage. These include: (i) afforestation; (ii) reducing deforestation; and (iii) enhanced management of tree farms (e.g., planting larger trees, longer rotations, fertilizing, tree thinning). Expanding forest coverage generates other environmental co-benefits beyond carbon storage such as biodiversity preservation and reduced risks of water loss, floods, soil erosion, and river siltation. Historically, the US forestry sector has on net absorbed 0.6–0.8 billion tons of CO2 a year and there is potential to scale up storage at the rate of about 0.2 billion tons a year by fully stocking forestland—forested land in the United States can sequester up to about 3 tons of CO2 per hectare a year during the growth cycle.39 Currently, however there are no federal policies that primarily target forest carbon sequestration.40

A national feebate program could cost-effectively promote all responses for increasing carbon storage without a fiscal cost to the government. The policy would apply fees to landowners at the agricultural/forestry boundary that reduce stored carbon relative to a baseline level and rebates to landowners that increase stored carbon. That is, the fee is given b y:

{CO2 rental price} × {carbon storage on their land in a baseline year ─ stored carbon in the current year}

The scheme would reward all three channels for enhancing carbon storage, either through reduced fees or increased subsidies (unlike an afforestation subsidy which just rewards one channel or a subsidy for additional storage which does penalize reductions in storage). Feebates can be designed—through appropriate scaling of the baseline over time 41—to be revenue-neutral in expected terms. Feebates should involve rental payments—on an annualized basis, a CO2 price times the interest rate 42—rather than large one-off payments for tree planting, given carbon storage may not be permanent (e.g., due to subsequent harvesting or loss through fires, pests, windstorms).43 For illustration, fully stocking a hectare that previously had no trees would increase the land value by about $2,000 under a $50 feebate (about 25 percent of current average agricultural real estate values).44 Fees and rebates could be administered based on the registry of landowners used for business tax collection. While still rudimentary, forest carbon inventories are estimated through a combination of satellite monitoring, aerial photography, and on-the-ground tree sampling. 45

Agriculture (9 percent of GHGs)

Agricultural GHGs can be reduced through several channels. Reducing livestock herds (particularly beef and dairy cattle) reduces methane releases from enteric fermentation (30 percent of US agricultural GHGs) and nitrous oxide emissions from manure (13 percent) while reducing crops for human and animal consumption (55 percent) reduces nitrous oxide emissions from soils, especially where there is intensive chemical fertilizer use.46 At the consumer level, shifting from meat and dairy products to plant-based and poultry diets would reinforce mitigation incentives. Currently, a voluntary approach is used to promote emissions reductions from US agriculture.47

Pricing could be based on proxy estimates of emissions but a compensation scheme for the farm sector may be needed to enhance acceptability and limit emissions leakage. Direct monitoring of farm level emissions is not currently practical, but emissions can be estimated indirectly using farm-level data (on livestock herds, feed, crop production, fertilizer use, and acreage) and default emissions factors.48 Emissions taxes would likely face strong political opposition and could cause significant emissions leakage as the tax burden reduced the international competitiveness of US farmers. A feebate approach is worth studying, perhaps based on GHG equivalent emission rates per hectare or nutritional value. 49 Another approach would be to combine an emissions fee with the revenues recycled to the agricultural sector in the form a rebate proportional to the value of farm output. This scheme would cost-effectively promote all behavioral responses for reducing the emissions intensity of farming and, from an administrative perspective, the fees and rebates could be integrated into collection procedures for business tax regimes for farmers. For illustration, an emissions fee of $50 per ton would amount to a charge of about 5 percent on average farm income. With revenue returned in subsidies proportional to value product, on net the scheme would provide modest subsidies for plant-based and poultry farming while taxing beef cattle at 9 percent of output value (Table 4). Demand responses at the household level might be promoted through taxes on meat and dairy products (from both domestic and overseas suppliers) though there may be some lessons to be learned by the mixed success of previous experiences with ‘sin’ taxes.50

Table 4.

Impact of Agricultural Emissions Fees, 2018

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Sources: FAOSTAT, IMF staff calculationsNote. Payments are calculated prior to behavioral responses. Rice cultivation, crop residues, and fertilizer data from 2017.

IV. Fiscal Policies for International Mitigation

International price floor

The 2015 Paris Agreement was a landmark achievement in international cooperation, but an additional international mechanism is urgently needed to stay on track with climate stabilization goals. The Paris Accord has clearly helped to galvanize the development of climate mitigation objectives at the country level and in some cases (e.g., the EU) strong policies to implement these objectives. Even if all parties achieved their emissions pledges however, this would be cutting global emissions about 10 percent below projected levels for 2030 (based on current policies) whereas emissions reductions of 28 percent and 55 percent would be consistent with a linear emissions pathway to 2oC and 1.5oC respectively.51 One difficulty with the agreement is that there are many signatories (195), negotiating over many targets (one per party), and targets are difficult to compare. Another difficulty is that countries acting unilaterally have limited incentives to scale up mitigation action due to concerns about competitiveness and free rider issues. A complementary arrangement is needed which should be effective, that is, it should contain a concrete plan to deliver the needed emissions reductions by 2030. And it must facilitate negotiation, that is, it should be limited to a few key countries and a small number of transparent parameters.

The US government could convene dialogue on an international carbon price floor (ICPF). It makes sense for China, EU, and the United States to be in discussion (given they collectively account for the huge bulk of global GHGs—see above), and perhaps the United Kingdom (as president of COP 26). A broader forum might include additional G20 countries, not least because some of them (e.g., Japan, Korea) have recently announced long-term carbon neutrality targets. Focusing the agreement on a carbon price floor would have several key attractions: (i) this is an efficient and easily understood parameter; (ii) a simultaneous increase in effective carbon prices would help to address competitiveness and free rider concerns; (iii) the arrangement could be designed equitably, with stricter requirements for higher income countries and/or transparent technological or other assistance for lower income countries; and (iv) the arrangement might be designed flexibly to accommodate different approaches (e.g., combinations of pricing, feebates, regulations) at the national level if they achieved equivalent emissions outcomes as would have been achieved by implementing the price floor.

An ICPF could be highly effective in scaling up global mitigation. For illustration, if the United States, China, and India were subject to price floors of $75, $50, and $25 per ton respectively in 2030 this would cut G20 emissions about 28 percent below baseline levels, which is just consistent with the 2oC target. Including all G20 countries would increase G20 emissions reductions, but only moderately, to about 30 percent. Emissions reductions under the $75/$50/$25 price floor would, broadly speaking, be evenly distributed—about 20 percent below baseline levels in the EU and India, about 28 percent in the US, and somewhat over 30 percent in China. 52

Table 5.

G20 CO2 Outcomes under Alternative ICPF Scenarios

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Source. IMF staff calculations.Note. aAssumes CO 2 reduced in proportion to total GHGs.

Higher/lower pr ice for advanced/emerging market economies.

Higher/middle/lower price for advanced/high income emerging market/low income emerging market economies.

Implementation issues would need to be fleshed out. For example, the focus could initially be on emissions from the power and industry sectors as: (i) these emissions are generally the most responsive to pricing and therefore play the key role in the early stages of clean energy transitions; (ii) most ETSs currently in place are limited to these sectors; and (iii) historically, fuels in these sectors were largely untaxed (or subject to minimal taxes in terms of CO2 equivalent taxes) making for a clean comparison to a baseline without carbon pricing. Over time, as the arrangement transitions to broader coverage of fossil fuel emissions, and measuring conventions are developed, the focus might transition to countries’ ‘effective’ carbon prices which take account of the possibility of incomplete coverage of formal carbon pricing schemes and changes in pre-existing energy taxes (which are typically large for transport fuels)—participants could agree to increase their effective carbon prices by a given absolute amount over time. 53

International transportation fuels

The US could also promote dialogue on schemes to promote development and deployment of zero-emission vessels (ZEVs) for the international maritime sector. The International Maritime Organization has pledged to reduce CO2 emissions (currently 2 percent of global CO2 emissions) by 50 percent below 2008 levels by 2050. Achieving this target will require development and deployment of ZEVs (e.g., using hydrogen fuels, or biofuels) given limits on technical and operational improvements to the efficiency of ships using oil-based fuels. A carbon levy with price needed to promote deployment of ZEVs as the shipping fleet gradually turns over—in the ballpark of $75 per ton (Figure12)—would raise considerably more revenue (tens of billions of dollars a year) than needed for research and investment to develop ZEVs and its high tax burden may face opposition at the IMO. An alternative is to use a feebate variant imposing a much smaller burden on the industry where ship operators are taxed on the difference between their CO2 emissions per ton-km of freight and a pivot point CO2 emission rate per ton-km, multiplied by their total ton-km—for a given feebate price, the pivot point can be chosen to meet a revenue target.54

Figure 12.
Figure 12.

Estimated Reductions in Maritime Emissions from $75 Carbon Price

Citation: IMF Working Papers 2021, 057; 10.5089/9781513571003.001.A001

Source. Parry and others (2020).Note. CO2 price rises progressively to $75 per ton by 2030. ZEVs are available (in the upper curve) by 2030 and replace conventional ships as the fleet turns over.

The US could also promote emissions pricing reform for international aviation. The International Civil Aviation Organization (ICAO) has pledged to stabilize emissions from the industry at current levels from 2026 onwards, through a scheme where operators can purchase international emissions offsets to cover any excess of their emissions above the benchmark. More ambitious emissions targets will ultimately be required however, for deep decarbonization of the sector, as well as a more robust price signal than provided by current offset markets.55 In the case of aviation, where fuel costs are a much larger share of transportation costs than for maritime, a carbon levy would reduce the demand for flying, in addition to promoting development and deployment of clean fuels—the former response would not be promoted under a feebate.

V. Conclusion

Using multiple, complementary mitigation instruments to reduce US GHGs is appropriate given uncertainties over the effects and feasibility of individual instruments—and novel fiscal policies have a potentially important role. Fiscal instruments can efficiently enhance the effectiveness and credibility of an overall package that also contains regulatory, infrastructure, and technology policies. And the acceptability of fiscal instruments can be increased by keeping them revenue neutral (in the case of feebates) or using revenues (in the case of carbon pricing) to fund the green transition or broader reductions in taxes on labor.

The United States also has a critical, and urgent role in promoting international coordination to scale up mitigation Large reductions in global GHGs over the next decade are needed to keep alive the possibility of meeting global temperature targets and this cannot be achieved without significant action in China and the United States. Coordinated action, as suggested here through a carbon price floor arrangement, would help facilitate the needed scaling up. Others would likely follow the lead of these three countries and knowing that the future of the planet depends on them should provide an imperative for joint ambition that is absent in the current framework of unilateral voluntary pledges.

Implementing the United States’ Domestic and International Climate Mitigation Goals: A Supportive Fiscal Policy Approach
Author: Ian Parry