The EU’s ambitious Paris Agreement climate targets will not be met with the current fiscal policies in place, a new study – proposing a new ‘green pact’ – has calculated.
Experts from the European economics think tank, Bruegel, conclude that total green investments must be increased by 2% of GDP annually, and one-third of that, about 0.6% of GDP, should be funded by state budgets – which they state is “a major challenge at a time when budgets are consolidated”.
Publishing in the peer-reviewed journal Climate Policy, they propose a European pact should be introduced – involving better regulatory policies and a higher price on emissions, as well as public green investments and public support for private green investments.
The EU has set a target of reducing greenhouse gases by 55% by 2030 compared to 1990, and eliminating them by 2050, but lead author Professor Zsolt Darvas explains that the target is currently an unrealistic ambition.
“Our calculations show that, even when exploiting the slowest possible fiscal consolidation pace allowed by EU fiscal rules, a steady fiscal consolidation effort will be necessary. The main challenge will be how to consolidate deficits while increasing green investment. Evidence suggests that in the current fiscal framework, this will not be achieved,” states Professor Darvas, a senior fellow at Bruegel.
“Public investments tend to be cut in fiscal consolidation episodes by vote-maximising politicians. Fiscal consolidation will be necessary after large public spending programmes during the COVID-19 pandemic and Russia’s invasion of Ukraine. But to meet the EU’s ambitious climate objectives, green investments need to be increased significantly.
“Therefore, creative thinking about how to do things differently is needed – such as increasing climate investments, while consolidating budgets.”
Following the scrutinizing of the National Energy and Climate Plans (NECP) of EU countries for overall climate-related investments (including tax incentives and subsidies) over 2021–2030, the expert team set a proposal including a ‘green golden rule’ that would allow green investment to be funded by deficits without counting them in any fiscal rules (deficit rules, expenditure rules, and the associated increase in debt in debt rules).
Excluding green investments from all types of fiscal rules would provide incentives to undertake them, because they would be excluded from the fiscal consolidation requirements.
Their proposal also limits, as much as possible, additional taxing for residents.
“Politicians must find other expenditures to cut, or increase taxation, to increase green investment. With the green golden rule, such expenditure cuts or tax increases are not necessary to increase green investment,” explains co-author, economist Guntram Wolff, the former director of European economics think tank Bruegel, who is now the Director and CEO of the German Council on Foreign Relations and is also based at the Free University Brussels.
“Appropriate regulation, taxation and elimination of subsidies should be part of the policy mix, but each of these instruments has limitations. For example, a significant increase in gas and electricity prices related to the Ukrainian war should be welcomed from the perspective of green transition, as it creates strong incentives for the private sector to move away from fossil fuel consumption. However, governments throughout the EU have rushed to dampen the impact of higher energy prices. There are political limitations to energy price increases.
“We propose that the Council of EU ministers defines a list of top green spending priorities which would not count as deficit and debt in the fiscal rules.”
Additional recommendations to policymakers within this suggested fiscal pact include:
- Clearly defining what constitutes emission-reducing climate investments and monitoring compliance.
- Eliminating fossil fuel subsidies.
- Incentivising private climate investments through appropriate taxation and regulation.
- A requirement that fiscally weak countries should not immediately benefit from the green golden rule, but rely on NextGenerationEU (NGEU) for their green investment up to 2026 and not ignore risks to public debt sustainability.
“Our proposed Green Fiscal Pact is the most promising option to address the tension between the conflicting needs of fiscal consolidation and increased green investments,” concludes Professor Darvas, who is also based at the Institute of Economics at the Corvinus University of Budapest.
“The ongoing review of the EU economic governance framework offers a good opportunity to discuss and decide on the Green Fiscal Pact. The European Commission recently proposed a new framework for EU fiscal rules, which includes useful elements, like the focus on country-specific medium-term debt targets as an anchor and an expenditure rule as the operational target, as we also make a case for these in our article.
“But, crucially, the proposal falls short of ensuring a proper framework for climate investment, even though the expressions of ‘green transition’ and ‘public investment’ appear multiple times in the proposal.
“We fear that if the Commission’s proposal is adopted without our proposed green golden rule, the EU will not meet its ambitious Paris climate targets.”