It Takes Two to Tango: The Role of Ministries of Finance in Designing Pricing and Non-Pricing Climate Actions

| 4 November 2024
Fiscal, Policy Briefs | Tags: Carbon Pricing, Energy, Fossil Fuel Subsidies, Renewables

 

Although carbon pricing is a key policy for fostering a low-carbon economy, it remains absent or incomplete in many sectors and countries. Non-pricing actions are often more popular, but their effectiveness can be uneven. Instead of relying on stand-alone policies, governments have recently begun to design packages that combine complementary pricing and non-pricing actions. Research suggests that these packages can be highly effective, though poorly designed ones may have adverse consequences. The following policy brief examines the recent emergence of climate policy packages and their impact on climate, social, financial, and fiscal outcomes. It also recommends steps that Ministries of Finance can take to better understand how to design coherent climate policy packages and facilitate the sharing of best practices across countries.

  • Carbon pricing has long been considered as a key policy tool to advance climate action. Putting a price on carbon emissions sends a strong signal that encourages saving energy and shifting to clean energy. Also, it generates government revenue that can be used to support the low-carbon economy. However, carbon pricing remains absent or incomplete in many sectors and countries. Worsening the situation, many fossil fuel subsidies remain, sending conflicting signals about policy consistency. This frequently reflects concern about the negative social effects of carbon pricing. Policymakers are also worried about issues of carbon leakage and waterbed effects.
  • Non-pricing measures are moving up policy agendas. Policymakers therefore increasingly focus on non-pricing interventions to unleash the low-carbon economy. This includes regulations such as bans, limits, standards, and fiscal measures such as green subsidies and tax expenditures. However, like for carbon pricing, these policies may have unwelcome effects on income distribution. Furthermore, their impact on emissions is often reduced by the rebound effect.
  • Instead of stand-alone policies, governments increasingly seek to design packages of complementary pricing and non-pricing policies. Recent climate initiatives combine carbon pricing with non-pricing actions to formulate coherent packages with limited side effects. Examples include the EU’s Fit-for-55 package, the UK’s Net Zero Strategy, the US Inflation Reduction Act, and China’s decarbonization plans. Some policy packages have proved to be effective, with relatively few adverse side effects. However, other packages are poorly designed and thus come with an unwarranted burden. As the government agency typically in charge of economic prosperity, Ministries of Finance need to ensure that climate policy packages are appropriately designed.
  • A better understanding of climate action packages is essential. More research is urgently needed on the appropriate design of coherent packages mixing pricing and non-pricing actions. This requires more data, especially on non-pricing actions. Progress is being made with the compilation of cross-country information on climate policies, though with significant gaps in developing countries. Progress is also made with analytical tools that can simulate the impact of complex policy packages.
  • Researchers take advantage of micro data to evaluate the impact of climate actions. Micro data such as tax statements, regulatory filings, energy bills and administrative records contain a wealth of data that can be used to evaluate whether policy packages are effective in unlocking a low-carbon economy. Ministries of Finance should play a key role in opening access to such data and in supporting the development of research using micro data on climate actions.

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