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  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

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1

The authors gratefully acknowledge contributions from Martin Čihák, Inci Ötker-Robe, Yi Xiong, and Jinfan Zang. They also thank Chengyu Huang, Vera Kehayova, and Lamin Njie for research assistance, and Jocelyn Dizon-Razo and Claudia Salgado for help in preparing the paper.

2

The paper builds on an evolving body of analytical work at the IMF, see for example, IMF (2008a, 2008b, 2011a, 2011b), Parry, de Mooij, and Keen (2012), Parry and others (2014). See www.imf.org/environment

3

This impact is measured as a percent deviation from potential output, implying that potential global GDP would be about 2 percent lower due to the climate impact.

4

Illustrative calculations in Weitzman (2011), for example, suggest atmospheric accumulations by 2100 in the absence of mitigation would eventually increase global temperatures by more than 6°C with 22 percent probability and more than 10°C with 5 percent probability.

5

According to most models, northern Europe will mainly benefit from positive impacts on crop productivity and tourism, while other regions are expected to experience adverse effects on labor productivity and agriculture, increased energy demand, and greater flooding.

6

According to Verisk Maplecroft (2015), under a 2°C scenario, the share of land affected by unusual extreme heat at the end of the century is projected to be 30 percent in the MENA region, 30–40 percent in LAC, and 45 percent in SSA, compared, for example to 10–15 percent of land in Europe and Central Asia. Under a 4°C scenario, these shares would more than double.

7

For example, in a 2°C world (for the 2040s), sea levels are forecast to rise by about 30–70cm in SSA (with higher levels toward the south) and 20–65cm in MENA, and substantially more in a 4°C setting (for the 2080s).

8

Even in a 2°C scenario (for the 2040s), water runoff declines by a projected 30–50 percent in SSA, 10–30 percent in LAC and perhaps (due to declining snow melt) more than 50 percent in the Euphrates and Tigris basin in MENA (see Schlosser and others 2014, Kochhar and others 2015).

9

Thirty-three small states (defined as countries with populations below 1.5 million) are members of the IMF, of which 20 are small developing states, 12 are middle-income, and 8 are low-income (based on the World Bank per capita income groups).

10

See Raddatz (2007) and Loayza and others (2009) on climatic disasters; Reilly and Schimmelpfennig (1999) and Fomby and others (2013) on severe droughts; Acevedo (2014) on impacts for the Caribbean; and Cabezon and others (2015) on the Pacific Islands.

11

See Garcia Verdu and others (2015). However, these findings may not be directly applicable to estimating long-term economic impacts of climate change as they do not account for adaptation, macroeconomic adjustments, or intensified impacts of climate change relative to small weather changes (for example, Dell, Jones, and Olken 2014).

12

A recent study by Burke, Hsiang, and Miguel (2015) suggests that the unmitigated impact of climate change on world GDP per capita could be significantly larger—roughly 5–10 times—than current estimates (that is, 20 percent lower by 2100). The estimates include quite wide uncertainty bands, and project significant negative effects for many economies, both advanced and developing.

13

Under these systems, covered sources are required to hold allowances for each ton of emissions; the government caps the quantity of allowances and market trading establishes the emissions price.

14

See the extensive modelling results for the United States summarized in Krupnick and others (2010), Figure 10.2, where a wide range of commonly used regulatory policies for the power sector, transport sector, and buildings by themselves have effectiveness of only about 1–25 percent of that from a broad-based carbon pricing policy.

15

Controlling emissions, with variable prices, can be appropriate when there are thresholds in emissions levels beyond which environmental damages rise rapidly (for example, Weitzman 1974). However, this is not applicable to global warming where one year’s emissions in one country adds very little to the global atmospheric stock of emissions, which has accumulated over decades and centuries.

17

Domestic environmental problems are in principle more efficiently addressed through other policies including local air pollution taxes and peak-period pricing of congested roads. However, it will likely take a long time for these more efficient policies to be implemented comprehensively. In the meantime, it is appropriate to account for underpriced domestic environmental co-benefits when evaluating (nearer term) climate policies.

18

See, for example, Calder (2015) on the practicalities of carbon tax administration. There are some complications (for example, payments would be needed for industrial sources with carbon capture and storage technologies) but these should be manageable.

19

In both the United States or European Union, more than 10,000 entities need to be monitored in downstream systems, compared with about 1,500–3,000 entities in upstream systems (for example, Calder 2015), though even the former is modest compared, for example, with the number of firms and households paying income taxes.

20

See Calder (2015). According to US EPA (2014), a ton of methane and a ton of nitrous oxide are equivalent to 21 and 310 tons, respectively, of CO2 in global warming equivalents over a century.

21

Offset credits allow firms covered under a pricing regime to reduce their tax or permit obligations by funding emission reduction projects in sectors or countries outside of the pricing regime.

22

See Mendelsohn, Sedjo, and Sohngen (2012) for further discussion of the practicalities of pricing forest carbon.

23

For example Fell, MacKenzie, and Pizer (2012) estimate that expected price volatility under an ETS for the United States would increase costs by around 15–20 percent compared with a policy where prices rise annually at the rate of interest.

24

For example, IEA (2014) has these models for large countries and regions. A rough rule of thumb for the United States from its Department of Energy’s National Energy Modelling System is that cutting emissions by 10 percent requires prices in the order of $30 per ton (Krupnick and others 2010). This suggests, speaking very loosely, the INDCs in Table 1 might require emissions prices above $50 per ton.

25

Though with range $20–$170 under different damage scenarios and discount rates (see, for example, Weitzman 2011, Stern 2007, and Nordhaus 2013 for different perspectives on this). To the extent that “last resort” technologies (such as solar radiation management or direct removal of CO2 from the atmosphere) become feasible, there might be less need to fully reflect catastrophic risks in carbon prices (Aldy and others 2010).

26

Nordhaus (2013) p. 228.

27

Expectations of future CO2 pricing could perversely hasten incentives for exploiting fossil fuel reserves in the near term (for example, Sinn 2012) underscoring the urgency of establishing pricing mechanisms.

28

Carbon pricing itself causes economic costs by inducing households and firms to consume less energy than they otherwise would and to pay more for cleaner (but more costly) energy. In addition, higher energy costs tend to contract overall economic activity, leading to a slight reduction in aggregate employment and investment. This produces significant additional economic costs by exacerbating distortions in factor markets created by taxes on labor and capital income. However, these harmful effects on the broader economy can be ameliorated by using carbon pricing revenues to cut taxes on labor and capital. See for example Bovenberg and Goulder (1996), Parry and Bento (2000).

29

Early literature (for example, Bovenberg and Goulder 1996) suggested that swapping a carbon tax for a tax that distorts only labor markets has a positive economic cost (leaving aside environmental benefits). However, in reality labor income taxes cause a much broader range of distortions (for example, they also promote informal markets, excessive compensation in the form of untaxed fringe benefits, and excessive spending on tax-favored goods like housing). Accounting for the full range of distortions, the economic efficiency benefits from cutting broader taxes are larger, and the overall costs of carbon tax shifts smaller, than previously thought, and perhaps even negative over some range (for example, Parry and Bento 2000, Bento, Jacobsen, and Liu 2012).

30

See for example, Jorgenson and others (2013). Even prior to revenue use, Williams and Wichman (2015) suggest that carbon taxes are unlikely to reduce U.S. growth by more than 0.03 percent. For a broad discussion on the compatibility of growth and carbon mitigation see the Global Commission on the Economy and Climate (2014) report New Climate Economy.

31

See, for example, Arezki and Obstfeld (2015).

32

For example, firms may do too little R&D if it is difficult for them to capture spillover benefits to other firms from new technologies. And firms may be reluctant to pioneer use of a new technology because of economies of scale or if their learning about how to efficiently use the technology benefits rivals that may adopt the technology later on. These obstacles may be especially severe for long-lived, clean-energy technologies with high upfront costs, especially given uncertainty over future governments’ commitments to emissions pricing or infrastructure investment (for example, grid extensions to renewable generation sites). It is sometimes suggested that the private sector also undervalues energy efficiency, though the evidence on this is mixed (for example, Allcott and Wozny 2013, Helfand and Wolverton 2011).

34

For example, the U.S. Department of Energy has provided prizes for rooftop solar photovoltaic, energy-efficient lighting, and software to promote energy savings for utility consumers (Newell 2015). Incentives for demonstration projects (seeking to prove the viability of major new technologies at a commercial scale) are more contentious as they can absorb a large share of R&D budgets.

35

Subsidies for renewables deployment totaled $121 billion worldwide in 2013 (IEA 2014), although nearly 70 percent of renewable electricity subsidies were provided by just five countries: Germany ($22 billion), United States ($15 billion), Italy ($14 billion), Spain ($8 billion), and China ($7 billion). Often these subsidies take the form of feed-in-tariffs, which provide guaranteed prices for renewables—in contrast, fixed subsidies per unit of renewable generation are more flexible as they allow prices to vary with changing economic conditions (Löschel and Schenker 2014). Subsidies for fossil fuel energy (including undercharging for climate and other environmental costs) are much larger and estimated at $5.3 trillion in 2015 or 6.5 percent of global GDP (Coady et al. 2015).

36

Although the poor tend to allocate a greater share of their consumption to electricity than wealthier households, this is less true for transportation and heating fuels, as well as other consumer products whose prices increase indirectly as a result of higher energy costs.

37

About 10 percent for the United States (for example, Dinan 2015).

38

One caveat is that higher electricity prices from charging for polluting generation fuels may encourage household burning of (unpriced) biomass, with higher environmental costs. A possible interim response is to use feebates that can promote use of cleaner generation fuels but with limited effects on electricity prices.

39

Leakage results from migration of firms away from countries with mitigation policies to countries without these policies, as well as increasing fuel use in those countries as mitigation elsewhere puts downward pressure on international fuel prices.

40

For the United States, industries with energy expenditures in excess of 5 percent of the value of their output account for less than 2 percent of GDP (Fischer and others 2015). However, the carbon intensity of industries in developing economies tends to be about 2–3 times as high on average (Böhringer, Carbone, and Rutherford 2013, Figure 2).

43

Coverage will roughly double, however, when China introduces pricing on industrial sources in 2017.

44

One exception was the—now defunct—ETS in Australia (introduced in 2012 but repealed in 2014). The majority of allowances were auctioned, raising revenues of approximately 1 percent of GDP, about half of which were used for progressive personal income tax reductions.

45

For example, British Columbia has no reliance on coal.

46

See for example Weitzman (2014).

47

Statement by Héla Cheikhrouhou, Executive Director of the GCF, Financing for Development Conference, Addis Ababa, July 2015.

48

The International Civil Aviation Organization (ICAO) Assembly agreed in October 2013 to implement, by 2020, a market-based mechanism to stabilize industry CO2 emissions, but envisaged that any revenues would be retained by the industry.

49

For example, diversion of water systems to counteract drier climates, and efforts to stem climate-induced population migration may have spillover effects on neighboring countries.

50

Bosello,, Carrano, and De Cian (2010) estimate that about 88 percent of adaptation measures in OECD countries are preventative, compared with 43 percent in non-OECD countries.

51

See for example Jones, Keen, and Strand (2013); Osberghaus and others (2010). National governments are beginning to promote local adaptation initiatives through sub-national grants (for example, the U.S. Environmental Protection Agency’s Local Climate and Energy Program, Bhutan’s LoCAL program). See World Bank (2014).

52

Estimates in Figure 10 exclude, for example, adaptation costs related to ecosystem services, energy, manufacturing, retailing, and tourism. Adaptation costs for advanced economies are more modest, for example, equivalent to about $17 billion in Europe according to Osberghaus and Reif (2010).

53

The highest costs for East Asia and the Pacific are in infrastructure and coastal zones; for SSA, water supply and food protection and agriculture; and for LAC, water supply and flood protection and costal zones (Margulis and Narain, 2010).

54

For example, investments in hydroelectric plants may be worthwhile across a variety of wet and dry scenarios (Margulis and Narain, 2010).

55

SEEA System of Environmental Accounting provides a statistical framework for the classification and reporting of environmental activities, expenditures, and other transactions. Nepal’s 2013/14 budget statement indicated that 10 percent of total government expenditures were climate related. The analysis allowed government to improve the allocation of resources. Tagging climate expenditure in Morocco helped to reveal considerable differences among sectors in accounting for climate-related spending and lack of appropriate performance indicators for climate change programs. See World Bank (2014).

56

For further discussion see UNEP (2014).

57

The stranding of assets can also be a concern to countries richly endowed in fossil fuels.

58

This requires, for example, assessing emissions from a company’s electricity use, from direct fuel combustion, and from other sources (such as the transportation of inputs and finished products, and upstream emissions associated with extraction of raw materials it uses).

59

There are some 400 different initiatives underway, underscoring the lack of consensus on standards for effective disclosure.

60

Over the last two decades, several countries—for example, Caribbean and Pacific islands, Ethiopia, and Mexico—have used catastrophe bonds.

61

It recently recommended establishment of an industry-led task force to develop consistent climate-related disclosures. Adequate disclosure is a prerequisite for the private and public sectors to understand and measure the potential effects of climate change on the financial sector. The proposal envisages that (1) firms regularly disclose information on the size of their carbon footprint and strategies to manage their transition to a lower-carbon business model, (2) higher-quality corporate information be available to help financial institutions better assess firms’ climate risk management and transition plans, and (3) financial institutions be encouraged to disclose their carbon footprints and the management of their exposures to climate risks, including by running suitable stress tests.

62

See also IMF (2015b).

63

See www.imf.org/environment for details on recent events.

After Paris: Fiscal, Macroeconomic and Financial Implications of Global Climate Change
Author: Mrs. Mai Farid, Mr. Michael Keen, Mr. Michael G. Papaioannou, Ian W.H. Parry, Ms. Catherine A Pattillo, and Anna Ter-Martirosyan