Climate Finance: Regulatory and Funding Strategies for Climate Change and Global Development

Chapter 34 Fiscal Considerations in Curbing Climate Change

Climate Finance 291 Chapter 34 Fiscal Considerations in Curbing Climate Change Lily Batchelder Professor, NYU School of Law Key Points • The choice between cap-and-trade and a carbon tax should mostly be made on political grounds, focusing on whether the targeted price change or emissions level is clearer, the likelihood of accurate distributional offsets, budgetary conventions, agency competence, and the salience of the cost imposed. • Climate regimes are highly regressive, disproportionately burdening the least well-off. Offsetting these distributional impacts is desirable purely from an efficiency perspective, and also because such regressivity undercuts one of the fundamental goals of curbing climate change. • Carbon taxes are likely to raise more revenue than cap-and-trade schemes to mitigate distributional effects because of the political tendency to allocate many permits for free. Free permits run the risk of benefiting the owners of politically savvy emitters, rather than those who are actually burdened. Funds from both schemes, however, may fail to reach those most affected, including the elderly, disabled, working poor, and unemployed. • Domestically, distributional offsets are more likely to be sufficiently large and well-targeted if structured as a universal contributory scheme, with all carbon revenues transparently used to fund direct rebates for all. Internationally, reasonable approaches include 292 Lily Batchelder gradual extension of permitting or tax regimes to less developed countries coupled with international carbon offsets, or excess permit allocations based on an objective measure of fiscal capacity. Introduction Climate change abounds with fiscal issues. At a macro level, the debate between a carbon tax, cap-and-trade system, and command-and-control regulation is about the extent to which the tax system is the best vehicle to address climate policy objectives. At a micro level, energy-related fiscal incentives and the tax treatment of carbon taxes, carbon permits, and climate markets can have important implications for a regime’s effectiveness . The question of how to address the distributional impacts of carbon mitigation, both domestically and internationally, is also a fiscal issue. This chapter provides a brief summary of the fiscal, administrative, and political considerations relevant in designing a climate mitigation regime. It then focuses on the importance of distributional offsets, and the challenges in implementing them. Other fiscal issues, including the nuts and bolts of taking carbon permits and carbon markets, are addressed by Kane (chap. 35) and Margalioth (chap. 36). Fiscal Issues in Climate Regulatory Choices While climate change policy can be, and is, implemented through a variety of mechanisms, including fiscal subsidies and command-and-control regulation, the current debate rightfully focuses on carbon taxes and capand -trade systems. Because the two can theoretically be structured to be economically equivalent, the decisive issues are political—how each will realistically be enacted and implemented. Keohane (chap. 5) outlines two critical considerations. Because the damages from climate change appear to rise sharply above some emissions level, cap-and-trade regimes can minimize externalities with fewer adjustment costs. Allowing permit banking can address permit price volatility under a cap-and-trade scheme. In addition, the fact that a carbon tax is denominated as a “tax” may generate more political opposition and thus limit its scale. Nevertheless, three additional fiscal issues, described below, Fiscal Considerations in Curbing Climate Change 293 are usually overlooked and highlight that there may be no one right answer . The best choice between carbon taxes and cap-and-trade will vary by country, and may be a hybrid of the two. Domestic Budgetary Conventions How a climate mitigation regime will be treated under a country’s budgetary conventions and procedures may be important when selecting a regime. The EU, for example, requires a unanimous vote for tax legislation , but only a majority vote for other bills. As a result, it has adopted a cap-and-trade regime, which policymakers were careful to ensure was not categorized as a tax. In other countries, however, enacting tax legislation is typically easier. For example, the US periodically requires fully paying for the cost of any legislation with revenue raisers. Costs and revenue raisers are calculated over a five- or ten-year budget window. These rules tend to make it easier to pass tax legislation because the tax committees control which revenue raisers are passed. They also artificially reduce the budgetary cost of legislation that raises revenue in the short term while deferring costs to the long term. Cap-and-trade regimes are more likely to grandfather existing emitters...