Fiscal Policy to Address Energy’s Environmental Impacts

Countries should reflect health, environmental costs of fuel use in energy prices

Setting appropriate charges on energy use could allow other taxes to be cut

Reforms can be initiated by finance ministers, need not await global action

Energy prices in many countries are wrong because they are set at levels that do not reflect environmental damage, notably climate change, air pollution, and various side effects of motor vehicle use, such as traffic accidents and congestion. Whether on energy or any other product, prices should provide consumers with an accurate assessment of the actual costs associated with the product.

A number of countries rely too much on general income, payroll, and consumption taxes for their fiscal objectives, and too little from taxes on energy use, according to the IMF report.

The case for a tax shift

The report stresses that energy tax reform need not be about raising new revenues. Rather, reform could focus on restructuring the tax system away from taxes that are likely to be most harmful for efficiency and growth, such as income taxes, and towards carefully designed taxes on energy—smarter taxes rather than higher taxes. According to the report, getting energy prices right involves extending motor fuel taxes, which are already well established and easily administered in many countries, to other fossil fuel products, such as coal and natural gas, or their emissions, and aligning the rates of these taxes with environmental damage.

“Fuel tax reforms can yield substantial health, environmental, and fiscal benefits,” said Vitor Gaspar, head of the IMF’s Fiscal Affairs Department. “According to our estimates, moving from existing to efficient fuel prices, at a global level, would reduce pollution-related deaths from fossil fuel combustion by 63 percent, mostly from reduced coal deaths, reduce energy-related carbon emissions by 23 percent, and raise revenues equal to 2.6 percent of GDP.” (See chart.)

Fiscal instruments, such as environmental charges on fuel use, have a powerful incentive effect on economic behavior. These instruments:

• are the most effective at exploiting opportunities (shifting to cleaner fuels, using more fuel-efficient vehicles, conserving on use of air conditioners, and so on) for reducing the harmful health and environmental side effects associated with energy use—so long as they are directly targeted at the right base (e.g., emissions rather than electricity consumption);

• achieve...