Chapter

Chapter 7. Fiscal Instruments for Climate Finance

Author(s):
Ruud Mooij, Michael Keen, and Ian Parry
Published Date:
September 2012
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Author(s)
Ruud de Mooij and Michael Keen 

Key Messages for Policymakers

  • Developed economies have pledged to generate, from 2020, US$100 billion per year to help finance climate mitigation and adaptation in developing economies. This chapter discusses the potential role of fiscal instruments in raising this “climate finance.”
  • Mobilizing public funds for climate finance does not in principle require earmarking revenue from any particular tax for this purpose, nor does it require using some “innovative” tax. It will also not ensure that funds raised are in addition to other development assistance, or that the finance is found in the most efficient way.
  • “Traditional” taxes—such as the value-added tax or personal income tax—could be used to raise additional finance (or expenditure cuts), with much scope for base-broadening in many developed economies, but this would not easily be cast as a common surcharge.
  • Most attention has, nonetheless, focused on identifying novel sources of finance linked explicitly to climate finance.
  • Prominent among such new sources is the possibility of using some of the revenue raised by comprehensive carbon pricing—which also has a key role to play in catalyzing the private part of climate finance. As a source of earmarked finance, this has the appeal of a particular salience to climate issues. But it is the mitigation benefits of carbon pricing that remain its primary rationale and make it likely to be a particularly efficient source of additional revenue.
  • Another promising way to generate revenue, while mitigating emissions, is by removing remaining fossil fuel subsidies in developed economies.
  • Charges on fuels used by international aviation and maritime activities are a particularly attractive possible source of finance, given the current absence of any charges or limits on these emissions and the borderless nature of the activities. Finding ways to ensure that such charges do not in themselves adversely affect developing economies, which may be important to obtain sufficiently broad participation to make these changes workable, is feasible.

At the UN Climate Summits of Copenhagen in 2009 and Cancun in 2010, developed countries agreed on a collective commitment to provide resources for climate adaptation and mitigation in developing economies. The sums committed approach US$30 billion for the period 2010–12 (“Fast Start Finance”) and rise to US$100 billion per year by 2020.1 In Cancun, governments also decided to establish the Green Climate Fund to support climate mitigation and adaptation projects in developing economies.2

These agreements do not specify, however, where the money is to come from. Addressing this, the UN Secretary General’s High Level Advisory Group on Climate Change Financing (AGF) reported in November 2010 on potential sources of revenue for climate finance beyond 2020. The AGF concluded that meeting the goal is challenging but feasible, and that funding will need to come from a wide variety of sources—public and private, bilateral and multilateral—and using a range of instruments. Drawing on and extending that analysis, in October 2011, the World Bank, in collaboration with the IMF and other organizations, reported further on this issue in response to a request from the G-20 Finance Ministers.3

Still, it remains an open question as to how governments are to realize their collective commitment. One broad outstanding question is the intended balance between public and private finance. While this will be largely a political decision, it seems clear that their commitments will require governments in developed countries to mobilize at least some new public funds. It is this aspect of climate finance that this chapter addresses: How might the public funds necessary to make a substantial contribution to governments’ share of the $100 billion commitment be raised? This $100 billion amounts to about 0.25 percent of their joint GDP, so if public resources were to constitute, say, 40 percent of this, the sum required would be approximately 0.1 percent of GDP. While this may not seem huge, it is about half of all current overseas development assistance. And the current severe strains on public finances in many developed economies amplify the evident difficulty of raising such amounts. In the hope of cutting through this difficulty, the reports of the AGF and to the G-20 pay particular attention to “innovative sources of finance”; that is, new tax instruments that could be employed to generate the necessary resources.

In reviewing the continuing debate on raising public funds for climate finance, this chapter relies heavily on background work for the October 2011 report to the G-20 mentioned earlier. It first considers the rationale for climate finance and then discusses the role of fiscal policy in this context. The next two sections discuss traditional domestic revenue sources and some “innovative” sources. Finally, we consider more closely one such possible source that emerges: charges on the use of international aviation and maritime fuels.

Why Climate Finance?

Transfers from developed to developing countries can promote both fairness and efficiency in addressing the collective challenges of climate change.

On ethical grounds, such transfers are particularly salient in the context of climate change. The past emissions that have led to high concentrations of greenhouse gases (GHGs) in the atmosphere have come predominantly from developed economies. Climate finance can be seen as a compensation for the (current and prospective) damages that developed economies have consequently caused in developing economies—which face large needs for costly adaptation in limiting the harm from climate change (perhaps in the order of US$90 billion a year by mid-century according to the World Bank) and will face great remaining residual damages.

Such transfers can also help facilitate the international cooperation that is vital to obtain efficient outcomes. Mitigation policies will be less effective if some countries do not participate in emissions reduction. For example, if carbon were to be priced by only a subset of countries, then emission reductions there would, to some extent, be offset by increased emissions by nonparticipants, whether as a consequence of relocation of emission-intensive activities or in response to a reduction in the world prices of fossil fuels induced by participants’ carbon pricing (Sinn, 2012). Emissions reduction in developing and emerging economies—most notably in China and India—is particularly important because a large part of future emissions growth is expected to occur in these countries, and, moreover, many low-cost mitigation options arise in these countries: Failure to exploit these would be a source of significant inefficiency, making the realization of emission reduction much more costly than it need be.

But developing economies, of course, are concerned that shouldering the costs of mitigation and adaptation will hinder their economic growth. By separating who finances climate action from where it occurs, flows of climate finance from developed to developing economies can play a key role in encouraging developing economies to participate in global action. They can, that is, play the pivotal role in reconciling economic efficiency with equity.

The Role of Fiscal Instruments

Fiscal instruments can play two broad roles in mobilizing climate finance: (1) catalyzing private climate finance and (2) raising public funds for transfer to developing economies.

Catalyzing Private Finance

The dominant scale and scope of global private capital markets and the growing fiscal challenges in many developed economies suggest that the financial flows required for a successful climate stabilization effort must, in the long term, be largely private in composition. With properly structured incentives, private initiatives will play an essential role in seeking out and implementing the least-cost options for climate mitigation and adaptation. And the most powerful way to create these incentives, in relation to mitigation activities, is by establishing strong and credible carbon pricing in developed economies—coupled either with similar pricing elsewhere (as, technically, would be preferred) or with international offset provisions that allow covered firms in developed economies to exploit abatement opportunities in developing economies instead of paying carbon taxes or purchasing emissions allowances. This would provide appropriate price signals to leverage the necessary private finance for investment in mitigation and low-carbon investments, including, not least, in developing economies.

Public Finance

By transferring public funds from developed to developing economies, public climate finance raises issues similar to those associated with development aid more generally: (1) How can one ensure that resources are indeed additional to other funds provided and (2) how should the burden be shared across developed economies?

“Additionality” refers to the extent to which new resources add to the existing level of resources flowing from developed to developing economies—in the form of development aid—instead of replacing any of them. Making additionality operational is politically and analytically very difficult, however. One reason is that adaptation needs are often broadly similar to wider developmental ones: Developing more resilient crops, or strengthening social support systems, delivers adaptation benefits, but would have beneficial developmental effects even in the absence of climate change. Difficulties also arise in defining a reference against which “greater” can be determined: Other forms of assistance might not fall, for instance, but simply increase less rapidly than they otherwise would have. Importantly, while a focus on the “innovativeness” as an indicator of additionality is perhaps natural, novelty of a revenue source simply does not resolve this fundamental difficulty.

In mobilizing funds, governments could agree on burden sharing among themselves, whatever revenue source(s) they adopt. A country’s contribution could, for instance, be based on its GNP or GDP, reflecting the principle of “capacity to pay,” or on population size, reflecting equal rights to the atmosphere. Alternatively—or in combination with other factors—contributions could be based on current or past emissions of GHGs, reflecting “responsibility to pay.” With agreement on some such formula, public revenue mobilization could simply come from whatever is each country’s most preferred domestic revenue source, separating the provision of some amount of climate finance from the issue of how that revenue is to be raised. By leaving it open to countries how best to raise whatever revenue is asked of them, this might indeed be the most efficient way in which to generate climate finance.

The alternative approach is to agree on the common deployment of some particular tax instrument(s) and earmark the revenue from them, partly or wholly, to climate finance.4 For instance, a surcharge could be imposed on the value-added tax (VAT) or on personal and corporate tax rates, with the revenue earmarked for climate finance, or part of the revenue from a coordinated carbon tax might be earmarked. Under this approach, burden sharing is determined implicitly—absent further adjustment—by the distribution of the corresponding tax base(s) across countries. Where tax bases differ widely across countries, however—as they commonly do—the idea of a common surcharge becomes much less simple than it may sound. Moreover, rate increases through surcharges might not be the most efficient way to raise additional funds in many countries, as base-broadening measures might be more desirable.

Earmarking of this kind is generally resisted by public finance analysts, the classic objections being that it introduces undesirable inflexibility of spending if it constrains spending patterns or is meaningless (and misleading) if it does not. These objections may, however, have less force in the climate finance context to the extent that there is a clear monetary target to be met. And earmarking may have some appeal in overcoming resistance to new charges, although whether explicitly allocating revenues to the benefit of other countries will be conducive to public support is not obvious. It is, in any case, this earmarking approach that has so far dominated policy debate in this area, and in the rest of this chapter, we focus on possible instruments.

“Traditional” Revenue Sources

What “traditional” revenue sources—meaning ones based on existing tax instruments—would be most appropriate as means for developed economies to generate additional contributions for climate finance? Identifying the best national revenue source requires applying the standard criteria in judging taxes of equity, efficiency, and ease of implementation. All taxes come along with costs of administration and compliance, all affect the income distribution, and distort behavior (in investment, employment, or consumption choices, for instance). While there is general agreement on these principles, there is little consensus on how the tax design best balances between them. Empirical work has, however, led to some broad views on desirable directions of tax reform in advanced economies, which we briefly summarize below. For a much fuller treatment, with some country detail and sense of the revenue potential from measures along these lines, see IMF (2010a).

Value-Added Tax

The VAT has proved to be a relatively efficient source of revenue and is widely believed to generate less costly distortions than many other taxes. Almost all developed economies—except Saudi Arabia and the United States—have a VAT and, on average, it raises for them revenue of over 5 percent of GDP. In many countries, however, exemptions and excessive rate differentiation reduce the effectiveness of the VAT. By changing relative prices of products and services, these measures distort patterns of consumption (and, in some cases, production, too), while achieving few equity gains that could not be better achieved by using the more directly targeted instruments (such as social benefits and earned income tax credits) that are available in advanced economies. Moreover, they also increase costs of administration and compliance. Hence, there is generally substantial scope for further improving the revenue performance of the VAT by reducing exemptions and eliminating reduced rates, combined, if needed, by measures to address any adverse distributional effects. In a number of countries, there is also a sizable “compliance gap”—that is, a loss of revenue due to noncompliance of various kinds, suggesting that improved enforcement would generate substantial revenue gains while also improving the fairness of the tax system. In countries with very low rates, such as Japan, a higher VAT rate could add to revenue. In countries without a VAT, its introduction is a leading option for substantially enhancing revenues.

Corporate Income Tax

The corporate income tax (CIT) is not a likely candidate as a source of additional revenue. International tax competition over the past decades has intensified and has led to significant reductions in statutory CIT rates. Many countries have, at the same time, broadened their tax bases by adjusting tax depreciation rules and restricting deductions (of, for instance, interest expenses). There remains scope for such base-broadening in some countries—by, for example, having leaner tax depreciation allowances or scrapping specific investment allowances—but the potential revenue gains are fairly modest. International coordination could perhaps strengthen the revenue potential of the CIT, but this remains contentious in principle (sensitive issues of tax sovereignty arise, and some see tax competition as a good way to discipline governments in their revenue raising) and quite remote in practice.

Personal Income Tax

The personal income tax (PIT) is generally considered key to achieving equity objectives (because the average rate of tax can be designed to rise with income levels) and might have some potential for higher revenue in a number of developed economies, although this is not likely through rate increases. High effective marginal rates of PIT can have damaging incentive effects on both real activity and compliance. For instance, while incentive effects on labor supply of primary workers are generally found to be modest, tax effects on the participation decisions of secondary workers (mainly married females) can be substantial. Moreover, high tax rates for low-wage earners tend to create large labor market distortions by driving unskilled workers out of the formal labor market. There is also significant evidence that higher rates of PIT encourage tax avoidance and evasion, particularly for high-income individuals. These considerations do not necessarily point to applying low PIT rates across the board, such as envisioned (except perhaps on the lowest incomes) under many “flat tax” proposals, but rather to a progressive structure, combining rates that rise with income and targeted tax credits that address particular incentive or fairness concerns. But in the absence, for instance, of substantially enhanced international cooperation in the taxation of high wealth individuals, whose physical and financial mobility across countries makes it hard for any country to tax them in isolation, scope for raising top marginal tax rates is limited. Where some countries do have scope for raising additional revenue from the PIT, this is done by base-broadening and simplification, such as reducing allowances and exemptions. In the United States, for example, the fiscal cost of tax expenditures under the income tax—a prominent example being mortgage tax relief of a kind that the United Kingdom, for example, has successfully phased out—has been put at over 7.5 percent of GDP5 (although by no means do all of these tax expenditures not serve a useful purpose).

Property Tax

Recurrent property taxes are a promising source of increased revenue for a number of countries. Efficiency and fairness arguments strongly favor their increased use in many developed economies: They appear to have only limited effects on growth and to be borne mainly by the wealthy. At present, their revenues amount to about 3 percent of GDP in Canada, the United Kingdom, and the United States, but well below 1 percent in other developed economies. This suggests significant untapped potential, but realizing this requires overcoming practical obstacles such as administrative complexities and the unpopularity of these taxes, no doubt partly reflecting their transparency. Nonetheless, property taxation has clear potential for significant and relatively efficient revenue enhancement in several countries.

Summary

There is then scope for raising additional revenue from a variety of traditional sources. But the best way to do this varies across countries and often takes the form of base-broadening rather than simple rate increases. Given too the wide variation in bases, a common add-on to some bases—a surcharge on PIT at the same rate in all countries, for instance—is unlikely to yield a pattern of revenue tailored to broader views on burden sharing or to exploit the most promising options for domestic tax reform.6 If (as seems implicit in much of the debate) the aim is not only to present to the public with an explicit link between climate finance and some tax instrument feeding it but also to use an instrument that looks the same across developed economies, earmarking additional revenues raised from traditional instruments may not be the best approach.

Innovative Sources of Finance

There are many possible revenue sources that can be called “innovative.” Atkinson (2003), for instance, discusses a variety of novel sources of development funding, including global lotteries, the creation of new special drawing rights, charges on remittances, and premium bonds. We restrict ourselves here to three other sources, of varying degrees of novelty: carbon pricing, the removal of fossil fuel subsidies, and financial sector taxes.

Carbon Pricing

Comprehensive carbon pricing policies, such as a carbon tax or emission trading with full auctioning of allowances, are widely viewed as a promising option for climate finance. Chapters 1, 2, and 8 discuss these policies and their optimal design in detail. These chapters, however, view carbon pricing policies primarily as an instrument for efficient climate mitigation and the raising of revenue for general fiscal purposes. Carbon pricing is indeed more effective at reducing emissions than regulatory instruments, providing incentives for clean technology development and promoting international carbon markets. Moreover, carbon pricing is vital for catalyzing private climate finance, as we have discussed.

In the context of climate finance, however, carbon pricing is also motivated specifically as a source of the public revenue needed. A carbon price of US$25 per tonne of carbon dioxide (CO2) in developed economies, for instance, could raise about US$250 billion in 2020. There is, of course, no logical necessity to earmark funds from carbon pricing for climate finance: The revenues could instead flow into national budgets. It is obvious, but easy to forget, that revenues from carbon pricing can only be spent once. One common concern with carbon pricing, for instance, is the impact on low-income families and/or on the competitiveness of certain industries; prominent among the options for addressing this are lowering other taxes or increasing social benefits to compensate certain groups—but such compensation reduces the net revenue from carbon pricing. Another concern is with the economic distortions caused by the wider tax system. To minimize these, it is generally advantageous to use the revenues from carbon pricing to cut other taxes that distort incentives for work or investment (see Chapter 2), which would again reduce the net revenue that could potentially be used for climate finance. Still, even allocating 10 percent of the sum above for climate finance would meet a quarter of the $100 billion funding commitment.

Removing Fossil Fuel Subsidies

Many countries have subsidies on the production or consumption of fossil fuels. As a revenue source for climate finance, scaling back fossil fuel subsidies in developed economies has attracted particular attention. A recent Organization for Economic Cooperation and Development (OECD) study estimates that fossil fuel subsidies in developed economies amounted to about US$40–$60 billion per year in 2005–10. These subsidies—over half of which were for petroleum, and a little under a quarter of which were for coal and natural gas each (in 2010)—include direct transfers of funds, selective tax reductions or exemptions, and other market interventions that affect cost or prices. At the Pittsburg Summit in 2009, the leaders of the G-20 countries committed to phase out over the medium term their fossil fuel subsidies.

There is thus significant revenue (and environmental improvements) to be found in scaling back these subsidies. As with the traditional instruments, however, making a link between this and the provision of climate finance that is both meaningful and transparent—if that is felt to be important—would not be easy.

Financial Sector Taxes

New taxes on the financial sector have been proposed as a way to raise money for climate finance. “Bank taxes”—typically levied on some subset of banks’ liabilities or assets—have been introduced by several countries since the 2008 financial crisis. Their revenue yield, however, is relatively low and seems unlikely to increase substantially (meaning that a large portion of revenues would need to be earmarked to provide a significant contribution to climate finance). In Europe for example, 14 countries have introduced bank levies of some kind, with a revenue yield typically between 0.1 and 0.2 percent of GDP. Other options are discussed in broader public debates. Most prominent are a broad-based financial transactions tax (FTT)—levied on the value of a wide range of financial transactions—and a financial activities tax (FAT)—levied on the sum of the wages and profits of financial institutions. Both were considered and compared extensively in the IMF’s 2010 report to the G-20 on financial sector taxation. Broadly speaking, the FTT has acquired greater political momentum (notably with a formal proposal by the European Commission, with an estimated revenue of 0.5 percent of GDP), while the FAT has acquired greater support from tax policy specialists. For instance, expert opinion tends to be that an FTT would increase the cost of capital and so could have a significant adverse impact on long-term economic growth and that its real burden would likely fall on final consumers rather than on actors in the financial sector. FTTs are also particularly vulnerable to avoidance and evasion. The FAT, on the other hand, is in large part simply intended to help correct distortions caused by the exemption of financial services under the VAT. Both the FTT and the FAT, nonetheless, are technically feasible—with the appropriate degree of international cooperation—and both could raise significant revenues. As a revenue source, however, they are not necessarily global: Revenue could instead flow into national budgets, and burden sharing for climate finance could be based on other factors as well.

International Transportation

Without the more comprehensive carbon pricing along lines discussed above, pricing the emissions from international aviation and maritime fuels—either through carbon taxation or emissions trading schemes with allowance auctions—has been proposed as an innovative source of climate finance. These two sectors account for about 1.5 and 2–3 percent, respectively, of global CO2 emissions, and some projections have their combined share rising to 10–15 percent by 2050, if unchecked. But these emissions are excluded from explicit charges and are not included in the Kyoto Protocol—reflecting precisely that the very nature of these activities makes it unclear which country should charge or regulate the fuel they use. And that, in turn, makes it natural to think of imposing charges on them and turning the revenue so raised to some collective use.

The Case for Charging Emissions in These Sectors

International aviation and maritime activities are currently taxed relatively lightly from an environmental perspective: Unlike domestic transportation fuels, they are subject to no excise taxes that can reflect environmental damages in fuel prices. Moreover, these sectors receive favorable treatment from the broader fiscal system. For instance, shipping income generally receives favorable tax treatment, being subject to relatively low “tonnage” taxes rather than normal corporate taxation. And international passenger flights are, unlike the generality of consumption items, almost invariably exempt from VAT.

Pricing emissions is widely viewed as the most economically efficient and environmentally effective instrument for tackling climate challenges in these sectors. Under the auspices of the International Maritime Organization (IMO) and the International Civil Aviation Organization (ICAO), both sectors are taking important steps to improve both the fuel economy of new planes and vessels and the efficiency of routes and speeds. In the maritime industry, an agreement was reached in July 2011 within the IMO on the first mandatory GHG reduction regimen for an international industry. However, higher fuel prices resulting from pricing instruments would be still more effective. Beyond reinforcing these efforts, they would, for example, reduce the demand for transportation (relative to trend) and promote retirement of older, more polluting vehicles.

The principles of efficient pricing design are the same in these as in other sectors. For emissions taxation, this means minimizing exemptions and targeting environmental charges on fuels rather than imperfect proxies, such as passenger tickets or arrivals and departures. For emissions trading, it means auctioning allowances to provide a valuable source of public revenue, incorporating provisions to limit price volatility, and developing institutions to facilitate trading markets.

A globally implemented carbon charge of US$25 per tonne of CO2 on fuel used could raise about $12 billion from international aviation and about $25 billion from international maritime transport annually in 2020. Revenues would be higher if, in addition to addressing environmental considerations, charges were also set to address other aspects of undertaxation noted above. A $25 tax is expected to reduce CO2 emissions from each sector by roughly 5 percent, mainly by reducing fuel demand. Compensating developing economies for the economic harm they might suffer from such charges—ensuring, in a phrase widely used in this context, that they bear “no net incidence”—is widely recognized as critical to their acceptability, and how this might be done is discussed below. Such compensation seems unlikely to require more than, say, 40 percent of global revenues, which would leave about $22 billion or more for climate finance or other uses.

Failure to price emissions from one of these sectors should not preclude pricing efforts for the other. Though commonly discussed in combination, the two sectors are not only different in important and fiscally relevant respects (e.g., ships mainly carry freight, while airlines primarily serve passengers), they also compete directly only to a limited degree. Nonetheless, simultaneous application to both is clearly preferable and could enable a common charging regimen (enhancing efficiency) along with, perhaps, a single compensation scheme for developing economies.

International Cooperation

Extensive cooperation would be needed in designing and implementing international transportation fuel charges—especially for maritime transport—to avoid revenue erosion and competitive distortions. Underlying the current tax-exempt status of international transportation fuels are fears that unilateral taxation would variously harm local tourism and commerce, undermine the competitiveness of national carriers, raise import prices and/or reduce the demand for exports. Fuelling might take place in countries without similar policy measures, so that even the revenue gain might be compromised. To overcome these fears, some degree of international coordination is likely to be needed.

In the case of international aviation, even an agreement with substantially less than universal coverage—for example, one that exempted some vulnerable developing countries—could still have a significant effect on global emissions and revenue potential, given the relatively limited possibilities for carriers to simply refuel wherever taxes are lowest. For maritime bunker fuels, globally comprehensive pricing is more critical: Large vessels can much more easily avoid a charge by taking up fuel in any countries where such charges do not apply.

Incidence and Compensation

The importance of ensuring “no net incidence” of these charges for developing economies has been stressed by many. Achieving this requires careful consideration of what precisely is the “real” incidence of these charges—that is, of who it is that suffers a consequent loss of real income. This can be quite different from who bears legal responsibility for the payment of the charge; in these sectors, these two groups may very well even be resident in different countries. It is the real incidence that matters for potential compensation, and this is sensitive to views on demand-and-supply responses; in the present context, it will also vary across countries according to their shares of trade by sea and air, the importance of tourism, and so on.

The first step in determining the incidence of these charges is assessing their impact on fuel prices. Jet and maritime fuel prices might not rise by the full amount of any new charge on their use, as some portion of the real burden is likely to be passed back to refiners and/or producers of oil products. If, however, it is fairly easy for refiners to shift production from jet and maritime fuels to other petroleum products (as may be plausible, given possibilities for reconfiguring refineries over the longer term), then the amount refiners have to absorb will be relatively small.

Even with full pass-through to fuel prices, however, the impact on final prices of aviation services and landed import prices of goods carried by ship—and on the profitability of the aviation and maritime operators—is unlikely to be large. A charge of US$25 per tonne of CO2 might raise average air ticket prices by about 2 to 4 percent (and then, of course, the total cost of a tourist package by a still smaller proportion) and the price of most seaborne imports by about 0.2 to 0.3 percent. The fairly modest scale of these effects means that the real burden on both the ultimate users and the providers of international aviation and shipping services is likely to be small—and the latter, in any case, reflects a scaling back of unusually favorable fuel tax treatment for these industries rather than the introduction of unfavorable treatment.

Nonetheless, there may be a need to provide adequate assurance of no net incidence on developing countries by providing explicit compensation. Significant challenges arise in designing such a scheme because of the jurisdictional disconnect between the points at which a charge is levied and the resulting economic impacts—especially for maritime transport. Practicable compensation schemes require some verifiable proxy for the economic impact as a key for compensation. Fuel take-up may provide a good initial basis in aviation, and simple measures of trade values may have a role in relation to maritime.

Fully rebating aviation fuel charges for developing economies (or giving them free allowance allocations) would be a promising way to protect them from the adverse effects of fuel charges. Indeed, this could more than compensate them: that is, they might be made better off by participating in such an international regime (even prior to receiving any climate finance). This is because much of the real incidence of charges paid on jet fuel disbursed in developing economies (especially tourist destinations, the impact on which has emerged as a particular concern) would likely be borne by passengers from other (wealthier) countries.

In contrast, there can be less confidence that rebating charges on maritime fuel taken up in developing economies would adequately compensate most of them. Unlike airlines, shipping companies cannot be expected to normally tank up when they reach their destination. Some countries—hub ports like Singapore—disperse a disproportionately large amount of maritime fuel relative to their imports, while the converse applies in importing countries that supply little or no bunker fuel, including landlocked countries. Revenues from charges on international maritime fuels could instead be passed to or retained in developing economies in proportions that reflect their share in global trade. Although this is relatively straightforward to administer, further analysis is needed to validate whether this approach would provide adequate compensation, for example, for countries that import goods with relatively low value per tonnage.

Implementation

Implementing globally coordinated charges on international aviation and/or maritime fuels would raise significant governance issues. New frameworks would be needed to determine how and when charges (or emissions levels) are set and changed, to provide appropriate verification of tax paid or permits held, to govern the use of funds raised, and to monitor and implement any compensation arrangements. While the European Union experience on tax coordination indicates that agreements can be reached, it also shows the sensitivity of the sovereignty issues at stake in tax setting and collection. One possibility is to limit the need for a separate decision process by linking an emissions charge on international transportation to the average carbon price of the largest economy-wide emission reduction scheme. There may be some role for the ICAO and IMO, with their technical expertise in these sectors, in implementing these charges.

The familiarity of operators and national authorities with fuel excises suggests that implementation costs would be lower with a tax-based approach than with an emissions trading scheme. Collecting fuel taxes is a staple of almost all tax administrations and very familiar to business; implementing trading schemes is not. Ideally, taxes would be levied to minimize the number of points to control—which usually means upstream in the production process. If taxation at the refinery level is not possible, the tax could be collected where fuel is disbursed from depots at airports and ports or directly from aircraft and ship operators.

Policies might be administered nationally, through international coordination, or in some combination of the two—with the appropriate institutions for monitoring and verification depending on the approach taken. For example, national governments might be responsible for implementing fuel charges or trading schemes on companies distributing fuel to airlines or ships. An alternative for the maritime sector might be to collect the charge without the intervention of national authorities along lines similar to the present International Oil Pollution Compensation funds administered by the IMO.

For international aviation, legal issues loom large in considering possible charges: The current fuel tax exemptions are built into multilateral agreements within the ICAO framework and bilateral air service agreements, which operate on a basis of reciprocity. Amending the Chicago Convention and associated resolutions would remove these obstacles, although the EU experience on intra-union charging seems to suggest the possibility of overcoming them without doing so. An alternative approach would be to use an emissions trading system or scheme (ETS) in this sector, and indeed, the EU is including international aviation in the EU ETS beginning January 1, 2012. This, however, is proving contentious and is currently the subject of litigation. No such legal difficulties appear to apply, however, in relation to international maritime fuels.

Conclusion

Climate-related transfers to developing economies can serve the objectives of both fairness and, by helping to realize low-cost mitigation opportunities there, efficiency. Developed economies could mobilize the additional public revenues needed by a range of measures, including through traditional domestic tax instruments, although differences in the bases of these taxes mean that a common surcharge is not likely to be acceptable or appropriate. “Innovative” financial instruments are not necessary to mobilize climate finance; but, nonetheless, the search for such instruments has been central to the debate.

Among these, its salience to climate issues has led to suggestions that some of the revenue from comprehensive carbon pricing in developed economies (which, given appropriate offset and other institutional structures, can also stimulate private financial flows to developing economies) be allocated to this end. This, of course, would detract from the appeal that such pricing may have in addressing deep fiscal challenges in many of these countries. Charges on fossil fuels used in international maritime and aviation industries, for which a strong environmental case can be made, have some advantage in the climate finance context—especially perhaps the former—with regard to the difficulty of allocating the base to particular countries and the need for widespread cooperation if they are to be effective. Measures can likely be found to protect developing economies from the adverse effects of such charges (which, in most cases, seem likely to be modest), but significant legal issues remain in establishing effective fuel charges for international aviation.

References and Suggested Readings

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    World Bank, International Monetary Fund, Organisation for Economic Cooperation and Development, African Development Bank, Asian Development Bank, European Bank for Reconstruction and Development, European Investment Bank, and Inter-American Development Bank, 2011, “Mobilizing Climate Finance,” Paper prepared at the request of G-20 Finance Ministers, October6. Available at http://climatechange.worldbank.org/content/mobilizing-climate-finance.

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1

The countries committed to providing fast start finance are the 27 EU member states, Australia, Canada, Iceland, Japan, Liechtenstein, New Zealand, Norway, Switzerland, and the United States.

2

The purpose of the Green Climate Fund (GCF) is to distribute the funds for climate finance, not to raise them; so the GCF is not equivalent to the more general concept of climate finance. At the Durban conference in 2011, it was agreed that the GCF would be an autonomous body within the United Nations, with the World Bank being an interim trustee of the funds over the next 3 years.

3

The G-20 comprises Argentina, Australia, Brazil, Canada, China, the European Union, France, Germany, India, Indonesia, Japan, Italy, Mexico, the Republic of Korea, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, and the United States.

4

Another possibility, of course, is that developed economies could reduce other expenditures to free up funds for climate finance.

6

Countries could, of course, simply impose such a charge as a signal that a contribution to climate finance is being made, but ultimately contribute some different amount—but this would hardly be transparent.

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