Fiscal Policies for Development and Climate Action Climate and Development for Policies Fiscal Pigato Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized INTERNATIONAL DEVELOPMENT IN FOCUS Miria A. Pigato, Editor Miria A.Pigato, ActionClimate and Development for Fiscal Policies INTERNATIONAL DEVELOPMENT IN FOCUS Fiscal Policies for Development and Climate Action Miria A. Pigato, Editor © 2019 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 22 21 20 19 Books in this series are published to communicate the results of Bank research, analysis, and operational experience with the least possible delay. The extent of language editing varies from book to book. This work is a product of the staff of The World Bank with external contributions. 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Contents Foreword vii Acknowledgments ix About the Editor and Contributors xi Executive Summary xv Abbreviations xxxiii CHAPTER 1: Benefits beyond Climate: Environmental Tax Reform 1 Dirk Heine and Simon Black Introduction 1 Why “climate action”? 2 Why “beyond climate”? 6 Why ETR? 8 How large is the environmental tax gap? 14 What is ETR’s effect on development and welfare? 21 What is ETR’s effect on equity, poverty, and competitiveness? 35 How suitable is ETR for developing countries? 39 How can developing countries best implement ETR? 40 Findings and policy recommendations 50 Notes 54 References 56 CHAPTER 2: Staying Competitive: Productivity Effects of Environmental Taxes 65 Antoine Coste, Massimiliano Cali, Nicola Cantore, and Dirk Heine Introduction 65 How can environmental taxes affect competitiveness, and what does the evidence tell us? 66 Estimating the impact of energy price increases on firms in developing countries 77 What policies can minimize adverse competitiveness impacts? 88 Conclusion 101 Notes 104 References 107 CHAPTER 3: Increasing Resilience: Fiscal Policy for Climate Adaptation 115 Lorenzo Forni, Michele Catalano, and Emilia Pezzolla Introduction 115 The macroeconomics of climate change 116 iii iv | FISCAL POLICIES FOR DEVELOPMENT AND Climate ACTION Leveraging fiscal policy to support climate change adaptation 117 An analytical framework that incorporates climate change in medium-term fiscal planning 118 Adapting to the gradual effects of climate change 120 Adapting to extreme events 123 Policy implications 128 Conclusion 129 Notes 129 References 130 CHAPTER 4: Managing the Fiscal Risks Associated with Natural Disasters 133 Philip Schuler, Luiz Edgard Oliveira, Gianluca Mele, and Matias Antonio Introduction 133 Fiscal risks from climate change 133 The fiscal sustainability model 138 Application to Jamaica 139 Application to the Dominican Republic 146 Conclusions and policy recommendations 150 Notes 151 References 152 Appendix A: Benefits beyond Climate: Environmental Tax Reform 155 Appendix B: Staying Competitive: Productivity Effects of Environmental Taxes 187 Appendix C: Increasing Resilience: Fiscal Policy for Climate Adaptation 197 Boxes 1.1 Externalities and Pigouvian taxation 11 1.2 Analytical tools for appraising and evaluating ETR 23 1.3 Factors determining the distributional effects of ETR 36 1.4 Environmental taxation’s interactions with other environmental policies 45 1.5 Managing shifts to untaxed informal fuel substitutes 48 1.6 Antedating of benefits: The 2010 Iranian strategy 49 2.1 Environmental health, resource efficiency, and productivity 72 3.1 Main characteristics of the model 119 A.1 VAT’s role as a withholding tax on the informal sector 160 A.2 FASTER principles for carbon pricing 171 A.3 The International Monetary Fund’s “rules of thumb” for energy price reform 173 Figures ES.1 Environmental tax reform can help raise welfare directly and indirectly xviii ES.2 Global environmental tax gaps on fossil fuels are large xix 1.1 Relation of temperature increases to emissions 3 1.2 Contributions to climate change 5 1.3 Overtaken: Annual greenhouse gas emissions in middle-income countries exceed those of high-income countries, 1970–2012 5 1.4 Human development varies by income level: SDGs 1–9 scores, 2017 7 1.5 Environmental tax revenues have declined as a proportion of GDP and total taxation in OECD countries, 1994–2014 9 1.6 Environmental tax reform has direct and indirect effects on welfare 9 B1.1.1 Theoretical complete economic allocation 11 Contents | v 1.7 Tax revenues among low- and middle-income countries lag advanced economies 13 1.8 Illustrative example of corrective tax on gasoline 15 1.9 Corrective taxes on gasoline by externality type, select countries, 2014 16 1.10 Global environmental tax gap 18 1.11 Explicit carbon prices around the world, 2018 20 1.12 ETR and development cobenefits: An example 22 1.13 Simulations of developed countries suggest that ETR can cut emissions while increasing employment, but effects on output are ambiguous 26 1.14 Air quality cobenefits tend to be larger in developing countries 30 1.15 Road death rates are higher in developing countries, 2013 32 1.16 Road deaths are strongly associated with gasoline prices, 2010 33 1.17 Channels that impact estimated welfare effects of ETR: Range of estimates from studies and possible effects for developing countries 34 1.18 Fuel taxes tend to be progressive in developing countries (select countries) 38 1.19 Stages of design for ETR 41 2.1 Channels of impact and mediating factors 67 2.2 Energy prices across countries, 2012 78 2.3 The nonlinear energy price–energy intensity relation across countries 87 2.4 Policy options to address competitiveness and leakage risks 89 3.1 The effects of early and late investment in climate change adaptation on capital depreciation, debt dynamics, and economic output 121 3.2 The effects of early and late investment in climate change adaptation on capital depreciation, debt dynamics, and economic output 122 3.3 The impact of extreme events on capital depreciation, debt dynamics, and economic output: Baseline scenario 124 3.4 Adaptation to extreme events: Deficit-financed early investment 125 3.5 Adaptation to extreme events: Ex ante debt reduction and reserve fund 125 3.6 Adaptation to extreme events: Donor grants 125 3.7 Adaptation to extreme events: Early adaptation spending combined with ex ante debt reduction 126 3.8 Adaptation to extreme events: Early adaptation spending combined with ex ante debt reduction and donor grants 126 4.1 Illustrative allocation