Meeting the increased ambition of the EU’s Green Deal, and Lithuania’s own National Climate Change Management Agenda, both of which target net-zero emissions by 2050, will require significant policy reform. The following report aims to contribute to the National Energy and Climate Plan’s (NECP) update by assessing reform options for enabling decarbonisation in Lithuania. It takes advantage of the OECD’s multidisciplinary expertise on tax policy, financial markets, social affairs, science, technology and innovation, and economic modelling to highlight a number of key policy insights. Specific analyses include: 1) a stocktake of existing and planned climate policies, including recommendations for reform options based on good practices from around the OECD; 2) a modelling exercise detailing the effect of climate policy pathways on emissions and macro‑economic indicators based on existing proposals to 2030 and a high-ambition carbon price trajectory to 2050; 3) an analysis of the effective carbon rates profile of key Lithuanian sectors; 4) an analysis of key financial needs for infrastructure development in the transition to net-zero emissions in Lithuania; 5) an analysis of the distributional impacts of carbon pricing in Lithuania; and 6) an assessment of innovation and technology diffusion needs and policy responses in Lithuania in meeting net-zero by 2050.

The stocktake of current and planned climate policies in Lithuania reveals that Lithuania already has a broad and comprehensive policy mix for all key economic sectors, including extensive economic incentives for decarbonising key economic activities, stringent regulations and complimentary measures such as in capacity building and education, as detailed in its current NECP. This is supplemented by a key policy proposal to increase excise duties and introduce a carbon price in 2025.

The modelling exercise reveals that current policies as detailed in the NDCs will not suffice to reach 2030 climate policy ambitions, with either the implementation of the proposed excise duty reforms and associated carbon price, or the introduction of an ETS 2 for the buildings and road transport sectors at the EU-wide level key to meeting 2030 emissions reduction targets. This highlights the importance of enhancing price signals in Lithuania. Beyond 2030 the modelling shows that a high carbon price trajectory reaching 400 EUR/t CO2 would further decrease emissions to a significant extent. However, such a high‑carbon price is not enough to meet net-zero emissions by 2050. Particularly, the transport and industry sectors exhibit hard-to-abate emissions even at high carbon prices. This highlights the importance of innovation and technology diffusion, also for the agriculture sector where non-CO2 GHG emissions remain high in the absence of pricing.

The innovation assessment highlights that Lithuania currently does not sufficiently target key technologies, relying instead on horizontal tax credits. More targeted support for innovation, but particularly also for technology adoption, would ensure hard-to-abate emissions in transport and industry are addressed. Furthermore, enhancing carbon sinks and reduction agriculture emissions is also key, particularly as historical trends show carbon sinks are currently decreasing in Lithuania.

A stocktake of the sectoral carbon pricing landscape in Lithuania shows that carbon price levels and instruments vary with sectors. While within Lithuania, they are highest in the road transport sector, they remain much below carbon prices observed for this sector in most other European countries. Moreover, a “diesel differential” remains, whereby diesel faces much a lower fuel excise tax rate than gasoline, which then translates into a lower carbon price signal and inefficiently encourages the use of diesel. The industry and electricity sectors face relatively high carbon prices, but the price signal in these sectors principally stems from the EU Emissions Trading Scheme (EU ETS), and the large share of free allocations observed in Lithuania combined with permit price volatility may result in uncertainty for investors and firms. The buildings (residential and commercial heating) sector faces the lowest rates and coverage, due to many fuel tax exemptions on households and businesses.

The Draft Law on Excise Duties proposed in Lithuania would increase coverage and rates of fuel excise taxes as well as introduce a carbon tax component with a pre-determined path to 2030. Overall, the full implementation of this law would bring coverage of CO2 emissions by a carbon price to close to 100% and considerably increase rates in certain sectors, particularly road transport and buildings. However, since the carbon tax component would not apply to installations subject to the EU ETS, it would not address the potential issues stemming from exclusive ETS coverage, in particular price volatility. As an alternative, a carbon levy with a pre-determined path complementing EU ETS prices, would provide better clarity to firms.

Considering financial needs for infrastructure development, the role of the public sector as both the provider of funds and enabler for low-carbon investments is central to meeting the country’s climate targets. The public sector has thus far relied heavily on distributing grants or subsidies to fund infrastructure investments, potentially undermining incentives for private sector involvement and even crowding it out. There is a substantial financing gap for low-carbon infrastructure that would need to be filled by private sector investment. For the power sector alone, investment needs for expanding renewable generation capacity reach EUR 6.5 billion. EU funds and co-financing from national resources will not be sufficient to meet investment demands for decarbonisation.

Enhancing the absorptive capacity and spending efficiency of EU funds should be prioritised. This can be achieved through the building capacity to clarify and help implement new regulation regarding sustainable activities. Spending efficiency of EU funds can be further improved through the use of repayable financial instruments as reflows can be channelled to other projects. Building robust project pipelines can contribute to a more effective absorption and spending of funds, in addition to helping to crowd-in private sector funds. Furthermore, subnational governments can play an important role in implementing infrastructure projects but currently face a number of challenges that affect their capacity to deliver infrastructure investment. Reaching critical size in capital markets to attract investors and create a larger pool of liquidity is essential for scaling up climate finance for the transition in a small country. Achieving an appropriate allocation of risks between public and private parties, and developing suitable financing channels, vehicles, and risk mitigation instruments will also help crowd-in private investment.

Considering the distributional impacts of carbon pricing, the analysis finds that, at levels currently being discussed in Lithuania, the impact of carbon prices on household living costs is significant, but much smaller than the effects of high levels of inflation seen across the OECD over recent months. The overall effects of carbon pricing are broadly similar across income groups, considering both direct and indirect effects. Overall losses for households sum to about 3.7% of income for most income groups. For the richest 10%, they are found to be lower, however, at 3.2%.

The revenues from carbon taxes are substantial, in the order of 1.3 % of GDP. Channelling them back to households therefore provides considerable room for cushioning losses and shaping the distributional profile as part of a broader policy package. Given the flat distributional impact of carbon pricing on households in Lithuania, the distributional effect of revenue recycling can be designed to target distributional outcomes as desired. For example, paying a lump-sum transfer to everybody, akin to a “basic income”, results in a large majority (60%) who would be better off than without the carbon tax.