Policy instruments as levers of change for climate action

The role of finance and capital

Financing and capital have a key role to play in addressing climate change. The type of financing available determines the level and direction of economic growth, which subsequently influences climate change. Whether it improves or worsens the climate crisis, hinges on the policy environment.

Policy lies at the heart of a tripartite relationship between climate change, economic growth, and financing (Figure 1). It informs and directs financing decisions and defines the scope of economic activities. A good policy environment creates a harmonious relationship between climate change, economic growth, and financing. A poor policy environment drives the climate crisis. Unless this tripartite relationship is realigned, it will be difficult to mitigate against the climate crisis.

Figure 1: Climate change triangle (author’s demonstration)

Policy instruments as levers of change

Two broad strands of policies which could help address climate change, if adopted, are regulatory and fiscal policies. Regulatory policies are legal systems used to determine environmental standards and laws to tackle climate change. The United Nations Committee of Experts on International Cooperation term these “command-and-control” instruments. Regulatory policies are punitive, often reactive mechanisms, do not offer incentives for voluntarily compliance and require substantial investment into resources and systems to monitor and ensure compliance.

Fiscal policies use taxes, subsidies, and central government spending to influence climate change. These are broader market-based instruments which focus on reducing emissions using financing decisions. Unlike regulatory policies, fiscal policies serve as a sledgehammer, offering incentives for voluntary compliance and punishing offenders through high taxes.

A carbon tax is a key fiscal policy tool for reducing carbon emissions. The IMF has touted a carbon tax as a catalyst for reducing emissions and estimates that full implementation of a carbon tax could reduce the majority of emissions by 2030.

Local economies and carbon intensive sectors such as international air space, and the marine world are considering introducing carbon taxes. Despite the deterrent nature of carbon taxes and the potential to raise revenue for local and international governments, many policymakers remain hesitant to implement carbon taxes. While advocates of a carbon tax are concerned with how it will deter polluters and cut emissions, governments and international policymakers are concerned with the impact of additional taxes on heavily stressed economies.

Currently, over 100 countries have pledged to introduce carbon taxes as part of their commitment to the 2015 Paris Agreement with only half moving beyond the pledge to implement the measure. Many have shied away from the global carbon tax average rate, currently $2 per ton. The 2015 Paris Agreement recommendation stands at $50 and $25 per ton for developed and developing countries, respectively.

Image: Growth graph 

Fiscal policies have featured in almost every framework of the Conference of the Parties (COP) since its inception, as efficient tools to mitigate climate change. A key milestone during COP26, the Glasgow Climate Pact, aims to “phasedown unabated coal power and phase-out inefficient fossil fuel subsidies”. Attaining this Pact depends on the global fiscal environment. Many policies are poorly executed and widen climate injustices. In principle, cutting subsidies and raising taxes on coal could lead to a reduction in coal production and lower emissions, but it is imperative that equity and justice are embedded in the design and implementation of policies.

While carbon taxes have the potential to deter or punish polluters, countries which have the means to pay high taxes can avoid the tax burden. This sends the wrong message to polluters and undermines the intention of the tax. Another feature of carbon taxes are they depend on the elasticity of demand. Depending on the commodity, the entirety of the tax burden could be transferred to the consumer, yet another way for an organisation to deflect responsibility for inducing emissions. Like taxes in general, a carbon tax increases the cost of doing business and could deter local and foreign investors.

Solutions

The flip side of taxes is subsidies, tax cuts, and incentives to reduce emissions.

Carbon subsidies create a fairer playing ground for organisations as it encourages voluntary compliance and investment of proceeds from tax cuts into climate enhancing activities. While carbon subsidies and tax cuts reduce government revenue and can affect the provision of social goods in the short term, governments are better placed to make a long-term commitment to reducing climate change than organisations. Meanwhile, subsidies and tax cuts can improve an organisations productivity which is good for the general economy.

Offering carbon subsidies and tax cuts reduces a governments’ fiscal space and may serve to widen the existing fiscal deficit in many countries. Expanding fiscal space is a matter of policy with developing countries filling fiscal deficit with debt. Using debt to restore fiscal imbalance offers an additional opportunity for developed countries and international communities to influence local climate policies. Debt relief and aid can be tied to climate related policy compliance, especially for developing countries. History has shown that countries that benefitted from debt cancellation eventually returned to previous debt levels. Debt relief targeted towards climate and clean energy aid could alter the trajectory of developing countries.

Today, the impacts of climate change can be seen in every country with degrees of impact varying from region to region with the least emitters the most affected. Two decades ago, various economists advocated for financial aid for developing countries to propel them towards achieving the millennium development goals (MDGs). Without debt cancellation, many developing countries would not have made significant strides towards attaining the MDGs. It is in the same spirit that a significant debt relief and climate-focused grants could help scale investment for economically driven climate action in developing countries. It is only right that the Global North, which has benefited largely from polluting the climate, exercise responsibility for the devastating impacts of climate change on the Global South through debt relief conditioned on stringent environmental practices.