Will the centralization of carbon pricing revenue in the European Union lead to laxer climate policy?

• Published date: 01 July 2024
• Author: Clemens Fuest,Volker Meier
• Date: 01 July 2024
• DOI: http://doi.org/10.1111/sjoe.12555

Scand. J. of Economics 126(3), 465–488, 2024

DOI: 10.1111/sjoe.12555

Will the centralization of carbon pricing

revenue in the European Union lead to

laxer climate policy?

Clemens Fuest†

ifo Institute for Economic Research, DE-81679, Munich, Germany

fuest@ifo.de

Volker Meier†

ifo Institute for Economic Research, DE-81679, Munich, Germany

meier@ifo.de

Abstract

We analyze the economic impact of using carbon pricing revenue to fund the European

Union (EU) budget. Such a reform would redistribute from countries with above-average

carbon-intensive production to less-carbon-intensive countries. Once the reform is implemented,

the low-carbon countries will prefer a lower carbon price (i.e., laxer climate policy at the EU

level) than before the reform, and vice versa. As a result, EU climate policy becomes less

ambitious and less disputed, where quantitative impacts presumably remain small. Weaker

incentives for national governments to enforce emission taxes after revenue centralization might

also contribute to higher emissions.

Keywords: Climate change; EU f‌inances; global externalities; political economy

JEL classif‌ication:H23; H27; H87; Q58

1. Introduction

There is an ongoing debate about reforming the f‌inancing of the European

Union (EU). This debate has been intensif‌ied by the introduction of the

NextGenerationEU fund, which is to support the economic recovery after the

COVID-19 crisis. The fund has been f‌inanced through debt, but the debt will

have to be repaid from 2028 and on. Therefore, the EU needs new revenue

sources. One proposal is to allocate the revenue from issuing carbon emission

certif‌icates to the EU. This revenue is currently collected and kept by the

member states. The arguments put forward for centralizing the revenue include

the fact that the EU emissions trading system (ETS) is an EU level policy

and that national carbon emissions give rise to externalities across borders

†Also aff‌iliated with LMU Munich.

c

2023 The Authors. The Scandinavian Journal of Economics published by John Wiley & Sons Ltd on behalf of F¨

oreningen

f¨

or utgivande av the SJE.

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution

and reproduction in any medium, provided the original work is properly cited.

466 Centralization of carbon pricing revenue in the EU

(Fuest and Pisany-Ferry, 2020). In the ETS, the EU def‌ines an emissions cap,

where each polluter participating in the system needs to acquire an amount

of allowances according to its annual emissions. Making these allowances

tradeable induces cost eff‌iciency, as f‌irms with low avoidance costs can sell

their certif‌icates at the going market price.

How much revenue would be collected? The value of these emission

certif‌icates in the EU is projected to be around 30 billion EUR per year over

the period 2021–2050, where a maximum scenario expects even 50 billion

per year (Fuest and Pisany-Ferry, 2020). If this revenue source is used, room

would be created to reduce gross national income (GNI) contributions so as to

balance the budget. Given the size of the 2021 EU budget of almost 170 billion

EUR, such a restructuring of EU f‌inances can be considered as substantial.

Centralizing the ETS revenue is particulary interesting among the proposals

to endow the EU with its own resources as other options, such as digital taxes,

are strongly opposed by the US, while the plastic tax is far less prominent in

terms of expected revenue.

Apart from the impact on the revenue structure of the EU budget, this reform

would have considerable redistributive effects across countries. Moreover, it

would change incentives for member states regarding the climate policy they

support at the EU level. In this paper, we use a highly stylized model of

climate policy in an economic union in the spirit of Oates and Schwab (1988)

and Sinn (2003). We investigate how cross-country redistribution and climate

policy incentives for member states change as a result of the reform. Our

key results are as follows. Giving the revenue from carbon emissions

certif‌icates to the EU and reducing GNI contributions accordingly would

redistribute from countries with above-average carbon-intensive production

to less-carbon-intensive countries. This suggests that the reform will go ahead

if low-carbon countries dominate decision-making in the EU. Once the reform

is implemented, the low-carbon countries will prefer a lower carbon price (i.e.,

a laxer climate policy at the EU level) than before the reform. This is because

they now benef‌it more from higher emissions, through the contributions to

the EU budget generated by these emissions. For high-carbon countries, the

opposite is true; they will prefer tighter climate policies than before the reform.

This implies that the differences in preferred climate policies between these

two groups of countries diminish. As a result, EU climate policy becomes less

ambitious and less disputed. The quantitative impact is likely to remain small

according to our simulation exercise, indicating that low-carbon countries will

increase their most preferred emissions cap by less than 1 percent. However,

because CO2emissions accumulate in the atmosphere, even small changes in

climate policy can have a sizable effect in the long term.

In an extension of our model, consumption generates carbon emissions

that are not covered by the emission certif‌icate regulation. The impact of

centralizing the revenue on overall EU-wide emissions then depends on the

c

2023 The Authors. The Scandinavian Journal of Economics published by John Wiley & Sons Ltd on behalf of F¨

oreningen

f¨

or utgivande av the SJE.