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European Department

EU Climate Mitigation Policy

Jiaqian Chen, Maksym Chepeliev, Daniel Garcia-Macia, Dora Iakova, James Roaf, Anna Shabunina, Dominique van der Mensbrugghe, and Philippe Wingender


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Copyright ©2020 International Monetary Fund

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Names: Chen, Jiaqian. | Chepeliev, Maksym. | Garcia-Macia, Daniel. | Iakova, Dora. | Roaf, James. | Shabunina, Anna. | Van der Mensbrugghe, Dominique. | Wingender, Philippe. | International Monetary Fund. European Department, issuing body. | International Monetary Fund, publisher.

Title: EU climate mitigation policy / Jiaqian Chen, Maksym Chepeliev, Daniel Garcia-Macia, Dora Iakova, James Roaf, Anna Shabunina, Dominique van der Mensbrugghe, and Philippe Wingender.

Other titles: European Union climate mitigation policy. | International Monetary Fund. European Department (Series).

Description: Washington, DC : International Monetary Fund, 2020. | Departmental paper series. | At head of title: European Department. | Includes bibliographical references.

Identifiers: ISBN 9781513552569 (paper)

Subjects: LCSH: Climate change mitigation—European Union countries. | Environmental economics—European Union countries.

Classification: LCC TD171.75.C44 2020

The Departmental Paper Series presents research by IMF staff on issues of broad regional or cross-country interest. The views expressed in this paper are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

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  • Acknowledgments

  • Executive Summary

  • 1. Introduction

  • 2. The EU Objectives and Policy Framework

    • Overview of EU Policy Framework

  • 3. Toward an Enhanced Policy Mix

    • Introducing EU-Wide Carbon Pricing

    • Using Revenues to Enhance Economic Efficiency and Political Acceptability

    • Ensuring Equal Burden Sharing Across Member States

    • Managing the Sectoral Transition

    • Mitigating the Distributional Impact Across Households

    • Ensuring Equal Burden Sharing Across Member States

    • Carbon Leakage and Global Coordination

    • Supporting Investment and Promoting a Green Recovery

  • 4. Conclusions

  • Annex 1. Model Specification and Results

  • References

  • Boxes

    • Box 1. German Emission Trading System

    • Box 2. The Domestic Environmental Co-Benefits from Carbon Mitigation

    • Box 3. Reinforcing Carbon Pricing with Feebates

    • Box 4. The Rationale for an International Carbon Price Floor

  • Tables

    • Table 1. EU Climate Policy Framework

    • Table 2. Selected Carbon Pricing Schemes, 2019

    • Table 3. European Commission Action Plan on Financing Sustainable Growth, 2018

    • Table 4. EU: Impact on Income of Emission Reduction Policies, 2030

    • Table 5. EU: Impact on Macroeconomic Aggregates of Revenue Recycling Options, 2030

    • Table 6. EU: Carbon Leakage Under Different Policies, 2030

    • Annex Table 1. Simulation Scenarios

    • Annex Table 2. EU: Simulation Results, 2030

  • Figures

    • Figure 1. Impact of Climate Change on European Regions

    • Figure 2. Difference in CO2 Emissions from Consumption and Production

    • Figure 3. EU27+UK: Total GHG Emissions’ 2019 Projections and Targets

    • Figure 4. World: Total CO2 Emissions

    • Figure 5. Total GHG Emissions by Sector

    • Figure 6. Share of Free Allocation vs. Auction

    • Figure 7. EU ETS Carbon Price

    • Figure 8. EU27+UK: GDP per Capita versus GHG Emissions Reduction Targets

    • Figure 9. Change in Unemployment Rate, 2030

    • Figure 10. Change in Aggregate Income, 2030

    • Figure 11. Change in Employment in Most Affected Sectors, 2030

    • Figure 12. Projected Job Losses in the Coal Mining Sector by 2030

    • Figure 13. €100 Carbon Price Burden by Category, France

    • Figure 14. €100 Carbon Price Burden by Category, Germany

    • Annex Figure 1


The authors are grateful to Enrica Detragiache for very useful comments. We are indebted to Nicolas Arregui, Vizhdan Boranova, Christian Ebeke, Jan Frie, Andreas (Andy) Jobst, Morgan Maneely, Florian Misch, Louise Rabier, Sebastian Weber, and especially Ian Parry for helpful discussions and contributions. Ian Parry contributed to several of the boxes in the paper. We are grateful to participants in seminars and meetings at the IMF, the World Bank, and the European Commission for useful comments. In addition, Vizhdan Boranova and Morgan Maneely provided superb research assistance, and Rachelle Vega provided excellent production assistance. Houda Berrada of the IMF Communications Department helped navigate the editorial process.

Executive Summary

In the absence of urgent action, global warming could have devastating and irreversible effects on the environment and on the health and living standards of people. The recovery from the current economic crisis provides an opportunity to build consensus on actions to support the transition to a more sustainable economy, including strengthening carbon pricing, prioritizing investment in green infrastructure and innovation, reducing subsidies and tax exemptions for emissions-intensive activities, and promoting green finance.

The European Union remains a global leader in climate change mitigation. The European Green Deal provides a roadmap to transforming the EU into a climate-neutral economy by 2050. Furthermore, the European Commission (EC) is currently conducting a review of climate policy instruments and an assessment of the economic impact of raising the emission reduction target to at least 50 percent by 2030 compared to 1990 levels.

This paper aims to contribute to the debate on the choice of policies to reach the more ambitious 2030 emission reduction goals currently under consideration. It provides an analysis of the macroeconomic and distributional impact of different options to scale up the mitigation effort, and proposes enhancements to the existing EU policies. A key finding is that a well-designed package, consisting of more extensive carbon pricing across EU countries and sectors, combined with cuts in distortionary taxes and targeted green investment support, would allow the EU to reach the emission goals with practically no effects on aggregate income. From a risk-reward perspective, the benefits of reducing the risk of extreme life-threatening climate events and the health benefits from lower air pollution clearly outweigh the costs of mitigation policies. To enhance the social and political acceptance of climate policies, part of the revenue from carbon pricing should be used to compensate the most vulnerable households and to support the transition of workers to greener jobs. In the absence of an international agreement among major emitters, to avoid an increase in emissions outside the EU from higher carbon prices in the EU (“carbon leakage”), a carbon border adjustment mechanism could complement the package although various operational, legal, and political aspects would need to be considered before its introduction.

More robust carbon pricing should be at the core of the new EU climate package as it is the most powerful and efficient tool to cut emissions. Carbon pricing induces consumers and firms to internalize the social cost of their emissions, and steers investment to low-carbon technologies. Moreover, it can generate much needed fiscal revenue. Setting a uniform carbon price across the EU would focus efforts on the lowest-cost mitigation opportunities and help avoid carbon leakage between member states. In practice, carbon pricing in the EU could be strengthened by expanding the emission trading system (ETS) to other economic sectors. Alternatively, national-level carbon pricing could be imposed for sectors outside the ETS. While an ETS system provides certainty in emission reduction, the implied carbon price can be volatile. Introducing a carbon price floor in the ETS would provide a predictable price signal for investors, while discontinuing the use of free allowances would allow a more efficient use of public resources. Moreover, subsidies and tax exemptions to fossil fuels in the EU should be discontinued.

With progressively stricter emission reduction goals, the equilibrium carbon price would likely rise from its relatively low current levels, leading to higher energy prices. In fact, some EU countries already have—or are planning to raise—carbon prices well above the ETS price. If increasing carbon prices beyond a certain point proves to be politically difficult, policymakers could consider complementary tools such as feebates, subsidies, or regulations. These instruments reduce the explicit carbon price necessary to achieve climate goals but tend to be less economically efficient as they operate through only a subset of mitigation channels and do not generate fiscal revenue.

The transition to a low-emission world will have multiple benefits but is also likely to have short-term distributional consequences that would need to be addressed in a comprehensive policy package. Fiscal transfers can support the transition in lower-income member states most exposed to higher carbon prices. Within each country, governments should facilitate the transition of workers to growing industries through retraining programs, targeted job-search support, and regional development assistance. The impact of higher energy prices on low-income households could be mitigated through the social support system. Clear communication of the support schemes would help gain broad public support for more robust mitigation policies.

Establishing a carbon price floor across all major emitting countries is necessary to tackle global emissions. Without concomitant global action, carbon leakage to non-EU countries could undermine the EU’s effort to curb global warming. The EU currently grants free emission permits to certain firms with the aim to reduce leakage. A more efficient alternative proposed in the Green Deal is a border carbon adjustment (BCA) mechanism to equalize the cost of carbon emissions for domestically produced and imported goods.

The large investments needed to ensure long-term environmental sustain-ability would also provide an impetus for the recovery from the current COVID-19 crisis. A predictable gradual path to a higher carbon price will already spur investment in green technologies and infrastructure, while generating much needed revenue. However, even under optimal carbon pricing, targeted public support for green investment is needed to address market failures beyond emission externalities. For instance, public investment is warranted to improve infrastructure including public transportation networks and electricity grids, research and development (R&D) support is needed to boost research in low-emission technologies, and the development of a robust green taxonomy would foster green financing. The EU recovery packages, which already have a strong green focus, should integrate these priorities.

EU Climate Mitigation Policy
Author: Mr. Jiaqian Chen, Maksym Chepeliev, Mr. Daniel Garcia-Macia, Ms. Dora M Iakova, Mr. James Roaf, Ms. Anna Shabunina, Dominique van der Mensbrugghe, and Mr. Philippe Wingender