Towards a sustainable recovery? Carbon pricing policy changes during COVID-19

 Carbon pricing can support the COVID-19 recovery and the Paris Agreement

COVID-19 significantly impacted societies and economies globally. Governments responded with a range of social and economic measures to cushion these impacts as part of their COVID-19 recovery plans. Some of these efforts have direct or indirect consequences on countries’ future GHG emissions and, thereby, on the cost and likelihood of countries achieving short and long-term climate goals (OECD, 2021[1]). In the meantime, the latest report from the Intergovernmental Panel on Climate Change (IPCC) state that unless a deep cut in GHG emissions occurs within the following decades, limiting global warming to well below 2°C or 1.5°C, as stated in the Paris Agreement, would be unattainable (IPCC, 2021[2]).

Pricing GHG emissions, reducing or removing government support to fossil fuels and the aviation industry are effective policy means to increase the price of emissions and thus push investment and consumer choices towards low-carbon options. Furthermore, the revenue from carbon pricing or the public expenditure saved from removing fossil fuel support can be used to support vulnerable population groups, finance recovery measures or help reduce COVID-19-related debt.

Carbon price levels and coverage of emissions had been too low before the COVID-19 pandemic to attain the reduction levels needed to align with the Paris Agreement. Reaching the Paris Agreement would require a carbon price in the range of EUR 43-86 per tonne of CO2 (t/CO2) by 2030 (High-Level Commission on Carbon Prices, 2017[3]). Yet, in 2018, only 45% of energy-related CO2 emissions in 44 OECD and G20 countries faced a carbon price, leaving a lot of room for improvement (OECD, 2021[4]).

This policy brief investigates the developments of carbon pricing policy changes (i.e. carbon taxes, Emissions Trading Schemes (ETS), fuel excise taxes, aviation taxes, and fossil fuel support (FFS)) that occurred in the first 20 months of the COVID-19 pandemic (January 2020 – August 2021) in the 47 OECD and G20 countries. The policy brief is based on the OECD working paper developed for the Carbon Market Platform2 (CMP): Carbon pricing and COVID-19: Policy changes, challenges and design options in OECD and G20 countries (OECD, forthcoming). The CMP paper and this policy brief cover the number of policy changes. They do not assess the GHG coverage or the aggregate GHG impact of carbon pricing policies or existing policies that did not undergo any policy changes.

 Carbon pricing policy changes during the first 20 months of COVID-19

A total of 99 cases of carbon pricing policy changes took place in 37 of the 47 OECD and G20 countries between January 2020 and August 2021 (Figure 1). 56% of these policy changes would increase GHG emissions and were thus “climate-negative”. Most (78%) of these climate-negative policy changes were temporary, relatively small in scope and mainly stemmed from COVID-19 responses in the aviation and fossil fuel sectors. These sectors were deeply impacted as the global containment measures significantly reduced the demand for both. To avoid bankruptcies in the aviation sector (OECD, 2020[5]); spiralling debt in countries dependent on oil exports (OECD, 2020[6]); and impact on vulnerable households, policies supporting the industries and consumers were put in place during COVID-19 (IISD, 2020[7]).

44% of the carbon pricing policy changes were expected to reduce GHG emissions and were thus “climate-positive”. These mainly originated from policy changes in ETS, carbon and fuel excise taxes. Virtually all climate-positive changes were permanent and often planned before COVID-19 yet implemented during the first 20 months of it. In addition, these policy changes were broader in emissions coverage, such as the launch of the Chinese ETS, covering 40% of domestic GHG emissions, equivalent to more than 7% of global GHG emissions.3 As opposed to climate-negative changes, climate-positive changes are larger in emissions coverage and, thus, likely to outweigh the climate impact of the climate-negative changes.

 

Figure 1. Carbon pricing changes in the first 20 months of COVID-19 in OECD and G20 countries

Note: Dark/light green: Permanent/temporary policy change with an expected climate-positive effect; Dark/light red: Permanent/temporary policy change with an expected negative climate effect; White: no change; Number: the number of policy changes; *:Proposed but not yet implemented policy changes.

Source: OECD (forthcoming).

The pandemic did not derail the implementation of the planned and permanent policy changes in ETS, carbon and fuel excise taxes. Some countries (e.g. Canada, Indonesia, Israel) also announced possible implementation or strengthening of carbon pricing schemes. For example, Canada announced an increase of its federal minimum carbon price from CAD 40/tCO2 in 2021 to CAD 170/tCO2 in 2030. However, only a few countries (e.g. Denmark) explicitly integrated carbon pricing in their recovery plans (Box 1).

Policy changes varied across countries. Out of the 47 OECD and G20 countries concerned, 12 countries had carried out exclusively climate-negative policy changes, while 11 carried out exclusively climate-positive changes. In 14 countries, governments sent mixed carbon pricing signals, strengthening the signal for some instruments but weakening it for others. No changes were observed in 10 countries.

 Factors potentially influencing carbon pricing policy changes

Several potential factors could influence the direction of countries’ climate policy changes. These factors include countries’ green fiscal recovery spending and GDP per capita, as well as whether countries have committed to net-zero GHG emissions. All OECD and G20 countries where carbon pricing changes were all or mainly positive have committed to net-zero (Figure 2). In contrast, 30% of G20 and OECD countries with solely or mostly climate-negative carbon pricing changes have yet to commit to a net-zero target.

In more than a third (36%) of the countries, fiscal spending was aligned with their overall climate category. In other words, countries that carried out solely or mostly climate-negative policy changes also had a low share of green fiscal spending, whereas the opposite was true for those with climate-positive policy changes. However, for 15% (n=7) of countries, fiscal spending and carbon pricing policies were not well aligned. For instance, South Africa had only climate-positive carbon pricing policy changes, yet, it had a low green spending percentage (Energy Policy Tracker, 2021[12]). Finally, no correlation was found between the direction of policy changes and GDP per capita, indicating that wealthier countries did not perform better than poorer countries (or vice versa) regarding carbon pricing policy changes.

 

Figure 2. Countries net-zero commitments and their overall climate category of policy changes

Note: The left (right) pie chart displays the net-zero commitments of the countries with solely or primarily climate-positive (climate-negative) carbon pricing policy measures during the COVID-19 pandemic. As per the status of net-zero pledges on the 25th November 2021.

Source: Authors and (ECIU, 2021[13]).

 Overcoming barriers to carbon pricing

The implementation or strengthening of carbon pricing is associated with several challenges that have been amplified due to the economic and social consequences of COVID-19. However, multiple options are available for countries to mitigate these challenges. For example, an implementation of or increase in carbon prices can be announced in advance to shape firms’ long-term investments and provide sufficient adjustment time (Martin and Van Reenen, 2020[14]). Revenues from carbon pricing can be redistributed to protect vulnerable population groups or can reduce distortionary taxes on firms and labour to help increase economic growth (Maestre-Andrés, Drews and van den Bergh, 2019[15]). However, each revenue recycling option has its advantages and disadvantages (Table 1).

 Future policy recommendations

COVID-19 did not derail the planned implementation or strengthening of carbon pricing. Climate-positive policy changes are likely to outweigh the effect on GHG emissions of climate-negative ones. Despite of this, more needs to be done. Carbon price levels and coverage are still too low and the pace of change too slow to be compatible with the goals of the Paris Agreement (OECD, 2021[16]). Revenue recycling and embedding carbon pricing in a holistic policy package (e.g. support for low-carbon alternatives and infrastructure investments) can help increase carbon pricing’s effectiveness and acceptability.