96412 Decarbonizing Development Decarbonizing Development: Getting Carbon Prices and Policies Right Stabilizing climate change entails bringing net emissions of carbon dioxide (CO2) to zero. CO2 stays in the atmosphere for hundreds, if not thousands, of years. As long as we emit more than we capture or offset through carbon sinks (such as forests), concentrations of CO2 in the atmosphere will keep rising, and the climate will keep warming. Countries can follow three principles in their efforts to create a planning ahead for a future with zero emissions, (b) getting carbon prices and policies right, and (c) ­ zero-carbon future: (a) ­ smoothing the transition and protecting the poor. This policy note is drawn from Decarbonizing Development: Three Steps to a Zero-Carbon Future (2015) by Marianne Fay, Stephane Hallegatte, Adrien Vogt-Schilb, Julie Rozenberg, Ulf Narloch, and Tom Kerr. Washington, DC: World Bank. Carbon pricing is simply good fiscal and economic policy. emissions reductions if overall emissions are already capped Carbon pricing—whether through an increasing tax on through a carbon market. In contrast, incentives offered by CO2 emissions or a carbon market with a decreasing cap on a carbon tax and a feed-in tariff simply add up. More gener- emissions—is an efficient way to raise revenue and can be ally, careful instrument choice and government coordina- easier to administer and harder to evade than other taxes. It tion can help ensure that policies interact positively with is appropriate for countries at all income levels, provided one another. their revenues are used to build support for poor and vul- nerable ­people who are affected by price changes, to reduce Getting Prices Right—Good Economic and ­ distortive taxes on labor and capital, and to invest in a Fiscal Policy ­ low-carbon, resilient future. Policies that get energy prices right can raise revenues in Total decarbonization will require a broad package of an economically and fiscally efficient way, making them climate policies. Multiple market and governance failures good fiscal policies in addition to providing environmen- come together to make climate change a c­ omplex problem benefits. That result is obvious with the elimination tal ­ to solve. The policy package must be both politically of harmful fossil-fuel subsidies, which reached about acceptable and robust enough to trigger the long-term $548 ­billion in 2013. It is also the case for carbon pricing. investments needed. Carbon pricing is an essential com- Countries can introduce a price on carbon in different ways ponent, but complementary measures can help make indi- and can start from different price levels, depending on the viduals and firms more responsive to prices, or can local political context and their economic characteristics, substitute for prices when carbon pricing is ineffective or including income, energy efficiency, and the importance of politically impossible. energy-­ intensive industries. Carbon pricing can offer a Policy packages should be designed carefully, as double dividend: it provides environmental benefits and it overlapping policies interact in complex ways. For instance, ­ raises revenue efficiently, making it possible to reduce more support for renewable power cannot lead to additional distortionary taxes, such as taxes on labor or capital. 1 Carbon sources are also concentrated, making ­ carbon Decarbonization Requires a Broader taxes difficult to evade. In the United States, for example, tax Package of Climate Policies collection covering 80 percent of emissions could be accom- Countries that have introduced a carbon price that is con- plished by monitoring fewer than 3,000 points, primarily sistent with their economic and political context can assess refineries, coal mines, and natural gas fields. In Sweden, whether that price will be sufficient to reach their decar- which has had a carbon tax since 1992, tax evasion is less bonization objectives, with regard to carbon content of than 1 percent for carbon—much less than for the value electricity, electrification and fuel shift, energy efficiency, added tax. In the United Kingdom, evasion of energy taxes and increased natural carbon sinks. In most cases, the car- is about 2 percent, much lower than the 17 percent for bon price will not be sufficient to get there, and additional income tax. A carbon tax offers substantial advantages for policies will be required. Those policies need to accomplish developing countries that struggle with tax evasion—and several objectives. the wedge it introduces between the formal and informal sectors. ■■ Ensure needed technologies are invented and deployed at scale. Green innovation suffers from a double mar- The competitiveness impacts of carbon prices are man- ket failure—environmental externalities and the same ageable. Available studies do not find any significant impact knowledge externality that plagues all innovation. of existing carbon prices on firm competitiveness, even in Support for green innovation in general is thus essen- heavy industries. Data from the U.K. production census governments may even need to target tial. In addition, ­ suggests that the introduction of the Climate Change Levy specific green technologies. For example, solar power (an energy tax) had a significant impact on energy inten- is still more expensive than wind energy in most loca- sity, but no detectable effects on economic performance or tions, but it has greater potential for addressing the plant exit. The reason is that abatement costs represent only clean-energy challenge. To ensure that green technolo- a small fraction of p ­ roduction costs for most industries, gies are deployed at scale, countries can use a number and factors such as the availability of capital and skilled of instruments, including the following: labor or proximity to markets are more important determi- – Performance standards, such as those commonly nants of competitiveness. Moreover, carbon revenues can used for cars or trucks in China, the European be used to improve competitiveness through investments in Union, India, Japan, North America, and the education and workers’ skills or infrastructure, or through Republic of Korea; and energy-efficient lighting reduction in capital and labor taxes. or building codes, such as energy-efficient win- Carbon pricing is gaining in use. About 40 national and dows, ventilation, or heating and cooling systems. more than 20 subnational jurisdictions, in both developed – Fiscal instruments, such as auto feebates, common and developing countries, have implemented or have sched- in Europe, which combine a surcharge, or fee, on uled implementation of carbon-pricing instruments. vehicles with low gas mileage with a rebate on more Carbon prices within those systems are diverse. Mexico’s energy-efficient ones; or a value-added-tax exemp- carbon tax is less than US$1 per ton of CO2, whereas tion for appliances or energy-efficient lighting, Sweden’s carbon tax is about US$168 per ton of CO2. In found in China, Ghana, and Tunisia. addition, over the past two years, more than 25 countries, – Mandates, such as renewable portfolio standards, including India, Indonesia, and Malaysia, have significantly that require electricity providers to include a min- reformed their fossil-fuel subsidies (map 1). imum share of clean energy in their output mix. 2 Map 1 More Countries Are Turning to Carbon Pricing NORWAY FINLAND ICELAND SWEDEN BRITISH MANITOBA COLUMBIA ALBERTA DENMARK LATVIA QUÉBEC IRELAND U.K. EUROPEAN WASHINGTON ONTARIO NEW BRUNSWICK UKRAINE KAZAKHSTAN OREGON FRANCE PRINCE EDWARD SWITZERLAND Beijing NOVA ISLAND KOREA, Saitama CALIFORNIA UNION SCOTIA PORTUGAL TURKEY CHINA Tianjin REP. Tokyo R.G.G.I. [Regional Greenhouse Gas Initiative] SLOVENIA HUBEI KyotoJAPAN (Connecticut, Delaware, Maine, Maryland, Chongqing Shanghai Massachussets, New Hampshire, New York, Rhode Island, Vermont) GUANGDONG Shenzhen MEXICO THAILAND BRAZIL Rio de Janeiro São Paulo SOUTH AFRICA ETS implemented or scheduled for implementation CHILE Carbon tax implemented or scheduled for implementation NEW ETS or carbon tax under consideration ZEALAND ETS and carbon tax implemented or scheduled ETS implemented or scheduled, carbon tax under consideration IBRD 41501 Carbon tax implemented or scheduled, ETS under consideration Source: World Bank (IBRD 41501, March 2015). Based on State and Trends of Carbon Pricing report 2014, developed by the World Bank and Ecofys, and updated in February 2015 for the purpose of this report. Such mandates have been used throughout difficult in the United States than in Europe, in part the world, notably in Chile, China, Germany, and because of the lack of public transportation in much of many U.S. states. the country. Infrastructure can also make a carbon price – Trade policies, such as cutting tariffs on green more effective by making demand more elastic to price goods—for example, solar panels, wind ­ turbines, changes. Similarly, some countries have struggled to and energy-efficient lightbulbs—as the mem- ensure that the needed electricity transmission system is ber countries of the Asia-Pacific Economic in place to handle increased shares of renewable energy. Cooperation recently agreed to do, to ensure ■■ Harness the financing needed for green infrastruc- that countries, firms, and households can access ture and technologies. Most developing countries the best technologies available worldwide at an struggle with infrastructure provision and techno- acceptable cost. logical development and deployment even without ■■ Ensure the availability of needed infrastructure. This is low-carbon objectives. This financing constraint critical for the effectiveness of low-carbon strategies and can extend to developing-country businesses, espe- the political acceptability of carbon pricing. For exam- cially small and medium-size ones. The challenge is ple, imposing significant fuel taxes has proved more to increase financing for investments in developing 3 Decarbonizing Development Figure 1 How to Assess the Obstacles to Low-Carbon Solutions Information Behavior Resource Incentive assessment access Policy design assessment assessment assessment Are incentives inappropriate? Are decision- Are behavior Are resources markers ill biases and access to informed? impairing resources too What policies should Because of Because of (e.g., people action? limited? market failures? (e.g., (e.g., lack of be implemented? government do not know (e.g., fossil fuel about existing preference for access to failures? subsidies, (e.g., poor law technologies) status-quo) credit) absence of enforcement) carbon pricing) Source: Adapted from World Bank (2013), World Development Report 2014: Risk and Opportunity—Managing Risk for Development. Washington, DC: World  Bank. countries and in long-term projects, notably infra- as green bonds, is helping ­ mainstream low-carbon invest- structure, and also to increase the share of these ments, connecting green project developers with possible investments that goes toward green projects. overcoming the behavioral bias toward con- investors, and ­ ventional investments. The green bond market is growing Closing the finance gap involves steps such as improving rapidly, with more than $36 billion in new issuances in 2014, the investment climate, developing local capital markets, and helping reallocate resources toward low-carbon projects. providing a pipeline of bankable projects. Closing the finance gap likely also requires changing regulations mandating Financial costs of low-carbon projects can be reduced risk assessment in the finance sector, so that stress tests use through cofinancing from governments or multilateral longer time horizons and include exposure of carbon-­intensive development banks. In particular, these actors can support projects to future carbon prices. ­ ­ p-front costs the transition by taking on part of the higher u or the higher technology and regulatory risks of low-­carbon Rebalancing both the actual and perceived risk-adjusted projects. Investments can also be redirected with bank return differential between brown and green projects is also ­ regulations that encourage ­ commercial banks to invest in necessary. The development of green financial ­products, such low-carbon projects. 4