Carbon pricing: how best to use revenue?

At a Glance

Publication Date November 2015
Format pdf
Thematic Area Cross Cutting

Public policies to reduce greenhouse gas emissions could help improve the taxation system and reduce government debt, according to a report published on November 9, 2015 by the Grantham Research Institute on Climate Change and the Environment at London School of Economics and Political Science.

It is expected that €150 billion will be raised by the European Union through carbon pricing over the next decade. Dr Alex Bowen finds a strong case for these funds, equivalent to 0.1 per cent of GDP, being allocated to broader government spending.

Whilst Dr Bowen finds reason to invest more heavily in low-carbon infrastructure and energy efficiency projects, he warns that it would be a mistake to spend green revenues on only green policies.

The paper states that “strict earmarking, or ‘hypothecation’, of carbon pricing revenues is unlikely to be a good idea in the long run, given their uncertainty and time-varying spending needs.”

For instance, the amount of funding needed for low-carbon research and development is unlikely to match the exact amount of revenue collected through environmental taxes.

The paper adds that green revenues could “be used to help improve the tax-benefit system as a whole, to finance additional spending on other government objectives or to reduce outstanding public debt.”

The total receipt from environmental taxes is likely to increase over the coming decades and ‘could reach several percentage points of global income’. Some governments have already earmarked some of their green revenues, whilst channeling the remainder into the broader public spending pot.

Dr Bowen calls on governments to set priorities for spending these new and ‘considerable’ revenues. For instance, rich countries could use some of their revenue for climate finance, helping poorer countries adapt to the impacts of climate change.

The paper states: “Those advanced industrial nations that have pledged to contribute to climate finance for developing countries (the countries listed on Annex II to the UNFCCC) may wish to consider using carbon revenues to augment the public-sector contributions to the US$100 billion per year promised in the Copenhagen Accord.”

Dr Bowen also proposes that governments could use revenues from environmental taxes to deliver tax breaks for the households that are hit hardest by the cost of carbon pricing.

The paper concludes: “It is clear that governments will have a continuing need to assess and re-assess what best to do with new revenues… the potential revenues of carbon pricing do give societies many attractive options for pursuing a range of goals – environmental and otherwise – in addition to the environmental benefits of carbon pricing.”

The report on ‘Carbon pricing: how best to use the revenue?’ was produced as part of the Grantham Research Institute’s programme on ‘Growth and the economy’, sponsored by the Global Green Growth Institute.