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Integrating climate policy and fiscal policy: national policies under international systems competition

Subject Area Economic Policy, Applied Economics
Term from 2017 to 2021
Project identifier Deutsche Forschungsgemeinschaft (DFG) - Project number 326144982
 
Final Report Year 2022

Final Report Abstract

Fiscal policy is an essential tool for governments to provide services and public goods, and to steer a nation‟s economy. But the policy space is constrained, especially when interactions with other countries' policies or budget rules are taken into consideration. This can affect the feasibility and optimal design of environmental and climate policy because of their role in fiscal competition and their budgetary implications. Previous analyses of fiscal competition and debt policies have rarely considered environmental or climate policies. Likewise, the optimal design of environmental and climate policies has largely ignored fiscal competition and public debt. This project takes an integrated approach to jointly consider fiscal and climate policy and address questions which have only been analyzed separately before. Our investigation of the interactions between climate policy and fiscal competition addressed both horizontal tax competition among countries with asymmetric endowments in fossil resources, and vertical tax competition in a multilevel governance system like the EU and its member states. We showed that among countries with asymmetric resource endowments differentiated motives for the taxation of (carbon) resources arise: resource poor countries tax fossil fuels to appropriate part of the resource rent, whereas resource rich countries have an incentive to attract capital to match the resource abundance and thus subsidize fossil fuel use. For multilevel governance, we found that the scope for Pareto improving federal policies sensitively depends on revenue recycling rules. A numerical application of the model to the case of the EU identifies revenue recycling per capita as potentially regressive in contrast to recycling based on past emissions, making the latter more likely to be agreed to by all member states. We also consider political economy aspects and the role of interest groups. While resource rich states have an incentive to veto federal environmental policy, a Pareto improvement can be attained via a targeted redistribution of emission tax revenues to various interest groups. Finally, focusing on national climate policy, we show how optimal energy taxation should account for horizontal equity considerations, i.e., differentiated energy dependency within income groups. If household-specific transfers are not possible, a clean energy subsidy can increase welfare. In the second part of this project, we analyze the relation between climate policy and public debt. We show that climate policy provides a normative reason to deviate from the balanced budget principle. When emissions accumulate as a stock pollutant, it is no longer optimal to levy constant emission tax rates over time, so issuing public debt may become welfareincrease. Additionally, we consider the political economy effects of reelection uncertainty on deficit spending and polluting activities. Strategic interactions due to voting – which are usually distortive and decrease efficiency in models only considering fiscal effects – create an incentive to abate emissions and improve environmental quality if we also include environmental considerations. Again, stock pollution is the driving factor which challenges the results of previous models and may render reelection uncertainty and the associated strategic incentives welfare-increasing. Finally, we examine the role of emission taxation, public abatement and debt in the optimal regulation of imperfectly competitive markets. If a monopolistic firm produces a polluting good, social welfare can be improved by lowering the emission tax and recycling its revenues for public abatement spending. Public debt should be employed to fund public investments in durable abatement technologies.

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