Fiscal policy for net zero goals — have we got our principles right?
By: Padmasai Varanasi
Tags: Green Economy, Sustainable Development, Fiscal Policy, Net Zero Emission, Climate Change

Fiscal policy for net zero goals — have we got our principles right? Padmasai Varanasi Feb 20·3 min read

Over the past year we have seen a growing sense of urgency from governments across world to respond to rising global temperatures and climate change. Countries which account for over half of global GDP have pledged to climate targets and are charting policy plans and milestones to work towards achieving their goals.

These call for a transformation of our attitude towards our planet and the resources it has to offer. Old extractive ways and attitude must be upended to make way for a new more symbiotic approach towards harnessing natures gifts. Change is necessary across the board, from the way we produce, cleaning up our supply chains along the way to the way we consume followed by reuse/repair or recycling.

Fiscal policy can play a powerful role in driving change, disincentivising harmful activities, nudging businesses and consumers to make more sustainable choices and spurring greater innovation. UNCC has a very insightful and informative course on Green Fiscal Policy which I highly recommend to anyone interested in learning more about the motivation, principles, the instruments and strategies for implementing green fiscal policy initiatives.

An important learning from the course that I’d like to draw attention to in this post is the idea of an environmental tax shift. An environmental tax shift entails increasing taxes on things the society does not desire such as pollution and environment degradation and using the revenue raised to lower taxes on things valued by society such as good jobs, income and profits.

This reminded me of the concept of a Pigouvian tax, named after English economist Arthur Pigou. Pigou, an English Economist espoused taxing activities based on their social cost, also taking into account the externalities they generate. For example, a factory that pollutes the environment currently only takes into account its private costs, with no concern for the social costs i.e. the adverse impacts of its activities on society such as health risks and environmental degradation. This has to change, a polluter must pay as per Pigou.

Bringing together Pigouvian taxes and an environmental tax shift could see economies reap a double dividend, as higher revenues raised from taxing undesirable activities can be channelled to incentivise innovation, protect the vulnerable who might be affected by taxes (e.g. tax on kerosene can affect the poor) or lower taxes on other desirable activities.

Carbon taxes implemented in British Columbia, Denmark and Finland are an example of a tax on the public bad, with the revenue raised directed to lower taxes on labour, protect the vulnerable and fund pension contributions.

Source: OECD

But where do we stand as a world today when it comes to applying these ideas to our policies? Fossil fuel subsidies are still significant globally. OECD’s analysis of budgetary transfers, tax breaks and spending programmes linked to the production and use of coal, oil, gas and other petroleum products in 50 OECD, G20 and European Union (EU) Eastern Partnership (EaP) economies shows that total fossil fuel support rose by 5% year-on-year to USD 178 billion in 2019, ending a five-year downward trend as can be seen from the charts.

Clearly reform is needed, the world is faced with a rapidly shrinking carbon budget and fossil fuel subsidies which encourage its use worsen the situation.

Can the revenue raised from reforming fossil fuel subsidies be channelled to social protection programmes that support the poor and vulnerable? Certainly. Solutions emerge when the guiding principles are clear.

The simple principle — to tax ‘public bads’ and invest in ‘public goods’ should underpin our fiscal policies. Every existing policy can be re-examined with this lens as we strive to strengthen our response to the grave threat of climate change.

I hope to explore ‘what are public bads and public goods?’, ‘how do we determine their value?’, how do we design fiscal policy underpinned by social value?’ and many other questions in upcoming posts…