Carbon pricing is increasingly recognized as an important source of government revenue. If used wisely, carbon revenues can support further climate mitigation, industry competitiveness, and pursuit of further economic and development objectives. This report lays out a framework that can assist governments in using carbon revenues to pursue these objectives, drawing insights from a range of practical experiences.
Carbon revenues have grown in recent years. As of April 2019, there were 57 carbon prices either in place or scheduled for implementation. These initiatives cover around 11 gigatons of carbon dioxide equivalent (GtCO2 e), representing around 20 percent of global emissions per year, an increase from 13 percent of global emissions in 2016. As a result, the estimated revenues generated from carbon pricing have increased from US$ 22 billion in 2016 to US$ 44 billion in 2018.
Carbon revenues are expected to increase further in 2019 and the years following, and this growth has the potential to unlock fiscal opportunities, particularly in developing countries. These opportunities stem from both the possible expansion to new jurisdictions and increases in price. Most carbon prices are currently well below the US$ 40–80/tCO2 e 2020 level recommended by the Carbon Pricing Leadership Coalition’s High-Level Commission on Carbon Prices. A recent International Monetary Fund (IMF) policy paper suggests that a US$ 70/tCO2 carbon price would raise revenues equivalent to around 1–3 percent of gross domestic product (GDP) by 2030 in most countries considered, and around 2–4 percent of GDP in major developing countries, including China, India, and South Africa.
Carbon pricing operates as part of a broader fiscal landscape that requires consideration of complex relationships and trade-offs. Government objectives in the fiscal context often include consideration of efficiency, equity, and long-run growth. Policy makers face trade-offs between objectives when choosing how to spend tax revenue. The circumstances are no different when exploring the different options for carbon revenue use. In addition, when balancing these trade-offs, policy makers must account for public opinion, as a lack of public acceptance for a policy can undermine its effectiveness and threaten its existence over time.
Many forms of revenue use will require only limited new governance arrangements as they take advantage of existing structures for revenue allocation. Many countries have existing tax and social security systems for example that can be used for revenue allocation, reducing the need for additional structures. In cases where revenue allocation structures are not in place—and there are many participants involved—there may be a case for a new cross-ministerial committee or an independent board to govern new programs. In addition, governments may need to prepare for practical challenges that can be associated with carbon revenue use, such as the potential for revenue volatility. Further, they should develop structures to ensure accountability, including processes for stakeholder engagement and for monitoring, reporting, and evaluation procedures.
Carbon revenues can either be allocated to general government revenue or be tied to specific purposes, through legal earmarking or hypothecation. Tying carbon revenues to a particular use provides greater visibility of the link between carbon pricing and public services, and greater certainty around funding. Nevertheless, there are benefits to directing revenues into the general fiscal pool, as this allows greater flexibility to alter revenue uses as circumstances and priorities change. Regardless of whether revenues are tied to a specific purpose, it is ultimately the specific use of revenues that is most important for outcomes.
Data for revenue uses are often incomplete, and categories can be inconsistent. Nonetheless, in 2017/18, World Bank estimates that the majority of global revenues (excluding foregone revenues) have been allocated to environmental projects (42 percent). Other revenue allocations include assigning revenues to the general budget (38 percent), development-related topics (12 percent), cuts to other taxes (6 percent), and direct transfers for households and businesses (3 percent).
Jurisdictions’ experience to date shows the wide range of spending options for carbon revenue. This report focuses on six main options:
- Tax reform, to target higher economic growth alongside lower pollution;
- Climate mitigation, by encouraging investment in low-carbon technologies;
- Pursuit of other development objectives, such as in education and health;
- Prevention of carbon leakage, to achieve carbon pricing’s environmental and economic objectives;
- Assistance for individuals, households, or businesses affected by carbon costs, through transfers or programs;
- Debt reduction, to lessen the debt burden on future generations.
This report assesses the use of carbon revenues to prevent carbon leakage and reduce national debt. The use of free allowances under emissions trading systems (ETS) or carbon tax exemptions is a common form of compensation to address carbon leakage. To be specific:
- Carbon revenues can finance tax reforms to support increased economic growth.
- Carbon revenues can finance additional policies or programs aimed at reducing emissions.
- Carbon revenues provide an important source of funds for developing countries seeking to finance development objectives.
- Carbon revenues can be used to address the potentially negative impacts of carbon pricing on competitiveness for domestic industry, reducing the risk of carbon leakage.
- Carbon revenues can be used to help individuals, households, or businesses deal with the impacts of carbon pricing through direct transfers or other policies and programs.
- Carbon revenues can pay down the existing stock of debt, if not used for tax reforms or increased spending.
- In practice, countries do not need to choose only one option for revenue use but can implement a package of spending initiatives.