Rising global government debts could become unsustainable for many countries in the coming decades due to high expenditure on the climate transition. To raise more tax money – and to tackle the climate problem – governments must hurry to tax CO2emissions. The International Monetary Fund (IMF) made this call during its annual meeting in the Moroccan city of Marrakesh.
The case for CO pricing2emissions are in the first chapter of the Fiscal Monitorthe semi-annual IMF report on government budgets. This prominent place illustrates the extent to which the IMF – traditionally a monetary and macroeconomically oriented organization – feels compelled to focus on the climate problem. Both climate warming itself (damage caused by extreme weather) and its approach (the transition) threaten to cost governments heavily. As a result, the IMF itself, as a savior in debt crises, is also in danger of having to take more action.
Government debts have in any case reached a higher level after the Covid pandemic. And they are rising faster than the IMF expected before ‘corona’. Global government debts skyrocketed during the pandemic (2020-2021), from over 84 to almost 100 percent of global GDP. They then fell back to just under 92 percent of GDP in 2022. This was due to the economic recovery, but also due to inflation, which erodes the value of debt.
This year, global public debt has rebounded to above 93 percent of GDP. In five years, the IMF expects, they will be close to 100 percent again. The lavish governments of the US and China, the two largest economies in the world, are mainly responsible for this, but debts will also increase in many European countries and emerging countries such as India. These are becoming less affordable due to the weak economic prospects for the world, which the IMF reported separately on Tuesday.
In the meantime, interest costs on debt are rising: central banks have increased interest rates to combat inflation. More than half of the world’s poorest countries are at risk of defaulting on their debt, according to the IMF.
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Cyclone Freddy
The climate problem is putting many countries in further trouble. The warming itself is primarily felt by poor countries. Finance Minister Sosten Gwengwe of Malawi, which is financially supported by the IMF, said in Marrakesh that ‘normal’ rain hardly occurs in his country anymore. “Every day of rain has a name these days – the name of a cyclone,” he said. Cyclone ‘Freddy’, earlier this year, not only cost a thousand lives in his country, but also 600 million dollars in damage to infrastructure. “That is a huge amount for a small economy like ours. We do not have the buffers in the budget to absorb this.”
The fight against global warming will also be costly, the IMF warns in the Fiscal Monitor. This applies to both poor and rich countries. The IMF states that governments must “urgently” do something about global warming to prevent “potentially catastrophic consequences”.
Governments that use this CO2₂ emissions mainly through public expenditure – i.e. with green subsidies or investments – will see their debts rise quickly, the Fund states. That is why it is so important to use another tool in the climate fight: CO2-taxes.
CO2-tax ‘efficient’
By taxing emissions, as a government you kill two birds with one stone: you not only reduce emissions, because companies have an incentive to pollute less, but you also bring extra money into your own public purse, says the IMF. This way, as a government, you can keep the national debt within limits. The Dutch IMF economist Ruud de Mooij, who co-wrote the Fiscal Monitor, mentioned CO2-pricing in the run-up to the meeting is ‘economically the best option’.
At the same time, the IMF states, many countries must also phase out fossil subsidies, which would also benefit their budget position. According to the Fund, a “policy mix” is ideal: CO2-taxes that are high enough, green subsidies and regulation.
De Mooij and colleagues created two scenarios, based on the purpose of net zero (on balance no greenhouse gas emissions) in 2050. If an imaginary ‘developed economy’, such as a Western country or Japan, tries to achieve this goal without significant CO2₂ tax, this country’s national debt could increase by 45 to 50 percentage points. Many government debts will “likely become unsustainable” in practice, the Fund said.
If this same imaginary country chooses CO2₂ emissions, the national debt will be ‘only’ 10 to 15 percent higher in 2050. The CO2₂ price will have to increase considerably. In EU emissions trading, a form of CO2₂ tax, the price of a ton of CO2 at about 80 euros. That price must rise to above 200 euros in 2050, says the IMF.
For a ‘large emerging economy’ – think of China or India – the effects are similar. However, debt threatens both with and without CO2₂ tax to be even higher than in developed countries.
Political feasibility
The problem with CO2taxes is that they are often unpopular. “Political feasibility” is an obstacle, the IMF admits. In the US, for example, politicians do not want it, despite this the call in 2019 of American Nobel Prize economists to raise CO at the national level2to introduce tax. Instead, the Biden administration is focusing on billions in subsidies for greening the industry. CO2Pricing only occurs in a few states, including California, which has an emissions trading system.
Worldwide, the number of countries and regions with some form of CO is increasing2pricing clearly. China has started regional emissions trading systems, although CO2-price there is still low: around 10 dollars per tonne. Brazil and Indonesia have also taken first steps.
The pressure on countries to tax emissions is increasing because the European Union has introduced a CO2introduces border tax. To protect our own companies, which have to pay for emissions, against unfair competition from countries without CO2tax, foreign producers of steel, among other things, will have to pay a levy from 2026. This has led to India now wanting to negotiate with the EU about CO pricing2.
It would help, says De Mooij, if the world’s largest economies put their heads together. The G20 countries, he said, produce 85 percent of global emissions; the US, China, the EU and India together account for 65 percent. “If they sit down at the table and set a minimum price for CO2 If we agree, it would mean a huge breakthrough.”