# **1. Introduction**

Climate change poses a significant threat to development across South Asia. Appropriate adaptation and mitigation policies will be essential to embracing more green and inclusive growth in the future. However, investing in resilient infrastructure, which is key to climate change adaptation, as well as shifting to a low-carbon growth trajectory, will require considerable financing. Policy makers, thus, face difficult trade-offs amid limited resources: raising fiscal revenues is already a perennial challenge in South Asia as evidenced by its low average share of tax revenue in GDP (around 13 percent pre-COVID19). Moreover, the region’s per capita contribution to global greenhouse gas (GHG) emissions is very low: in 2021, a South Asian individual emitted 27 percent the amount of GHGs emitted by a non-South Asian, on average. This may explain why Paris Agreement pledges to reduce GHG emissions in South Asia tend to be unambitious and often dependent on external support.

This paper focuses on climate mitigation policies, specifically carbon taxes, and shows that the impact of implementing such policies in South Asia can be overwhelmingly positive for its development. Carbon taxes are associated with additional (and predictable) fiscal revenues, which can be deployed to achieve development and adaptation targets while reducing the burden of decarbonization costs. Building on recent research and data (IMF, 2019a; Parry, Black, and Vernon, 2021), this paper provides evidence that carbon taxes, particularly if combined with a phaseout of fossil fuel subsidies, could benefit South Asia regardless of what other economies or regions do.

The Climate Policy Assessment Tool (CPAT) is applied to estimate the effects of implementing a set of energy price reform measures centered around a carbon tax relative to a business-as-usual (BAU) scenario that assumes lack of new (or tightening of existing) climate mitigation policies. The results indicate that the gradual introduction of a carbon tax of US$25 per ton of carbon dioxide equivalent (/ton CO2e) provides monetized welfare co-benefits (reduced mortality/morbidity from local air pollution, as well as reduced accidents, congestion, road damage and output losses due to global warming), net of efficiency costs, equivalent to 1.4 percent of GDP in 2030. Moreover, government revenues-to-GDP would rise by almost 1.3 percentage points in 2030. We also consider three approaches (or ‘modes’) under which these additional revenues are redistributed ('recycled’) to help ensure a more equal income distribution and boost growth. The estimated distributional outcomes (post-‘revenue recycling’) in 2030 are progressive, with the Gini coefficient falling by between 1 and 5 percent depending on the economy and revenue recycling mode. Some economic sectors suffer more than others, but the overall effect on input costs is small (a GDP-weighted average input cost increase of around 2 percent), mostly because the sectors that see the highest cost increases represent a very small share of economy-wide output in the region. Real GDP growth effects are small but positive in 2030.

In addition, we consider a ‘comprehensive energy price reform’ (CEPR) package that includes both the US$25/ton CO2e as well as the gradual phaseout of all existing fossil fuel subsidies, price controls and exemptions by 2030. Such a reform would lead to net monetized welfare co-benefits equivalent to 1.4 percent of GDP, government revenue gains of 2 percent of GDP, slightly higher, positive real GDP growth effects, and even more equalizing income distribution outcomes compared to just 2