Correcting Climate Imbalance

With a new taskforce working towards developing global climate taxes, possibilities and challenges ahead are seemingly endless. 

As COP28 drew to a close in Dubai, many were buoyed by the official final text, which explicitly highlighted the importance of transitioning away from fossil fuels for the first time.  

Several new funding pledges were also made to boost existing levels of investment to ensure alignment with the 1.5°C by 2050 commitment. However, the climate finance gap still yawns wide. 

To address climate change issues properly, the developing world needs more than US$2.4 trillion a year by 2030. But, as demonstrated by the UN Environment Programme’s 2023 Adaptation Gap Report, climate adaptation-focused finance flows to emerging markets and developing economies (EMDEs) fell to just US$21 billion in 2021.  

On the global stage, there is growing consensus among governments and private sector representatives that innovation and financial reform are pivotal to support a just net zero transition. But reforming a system that has been in place since the late 19th century and changing the global mindset to unite against one existential threat is no easy feat.  

Crucially, the central question of who should pay what when it comes to dealing with the climate crisis still lingers. A popular answer to this is that the worst polluters should pick up the tab. 

“The decarbonisation of the global economy requires new sources of financing,” Frédéric Vonner, Sustainability and Sustainable Finance Leader at Big Four accountancy firm PwC Luxembourg, tells ESG Investor. “It is therefore only normal to ask players based in large, industrialised countries that pollute heavily, to chip in.” 

A new coalition of countries led by France and Kenya has expressed support for this view. Formally unveiled at COP28, the taskforce – which also includes Antigua and Barbuda, Barbados and Spain – is in favour of creating a series of global climate taxes to generate revenues that could support those most impacted by climate change. 

The taskforce will consider the feasibility of levies on shipping, aviation, financial transactions and fossil fuels, with plans to share progress at COP29 and produce a concrete proposal on how to enact those taxes the following year. 

In theory… 

On paper, the idea of introducing climate taxes for carbon-intensive industries to raise capital to support climate transition efforts sounds attractive. 

“The fact that this taskforce aims to generate more fairness and equity in the current tax system and puts the principle of ‘polluter pays’ at its core is important,” says Guillaume Compain, Climate Advocacy Officer at NGO Oxfam France. 

These tax revenues could also replace climate-related international aid, suggests Anna Crosby, Banking and Asset Finance Director at law firm Fieldfisher. “This would be especially welcome as politicians in the developed world come under pressure to curb foreign aid budgets as their own voters are squeezed by the rising cost of living,” she says. 

Analysis conducted by Oxfam and Action Aid showed that a tax of 50-90% on the windfall profits of 722 of the largest carbon-intensive companies globally could have generated up to US$941 billion at the height of the energy crisis. Recent estimates from the World Inequality Lab also showed that a progressive wealth tax on individuals with assets worth over US$100 million could generate US$295 billion annually. 

As well as raising sustainable revenues, climate taxes could encourage a wider adoption of clean technologies and sustainable practices, which in turn could accelerate transition efforts. 

From an institutional investor’s perspective, the implementation of climate taxes will make an investee company’s poor environmental performance more financially visible, Vonner explains. 

“Investors who look for both environmental and financial performance will thus be drawn towards companies that are not subjected to [a climate] tax,” he says. 

In practice…  

Despite these theoretical benefits, the implementation of a series of climate taxes on a global scale is far from being simple. An immediate challenge is that they would require buy-in from all the governments involved.  

“After all, tax is already a difficult animal to wrestle with, and it only becomes more complicated when combined with a highly politicised issue like climate change,” says Global Reporting Initiative (GRI) CEO Eelco van der Enden. 

Governments would also need to agree on many factors, such as the level of taxation of poorer versus wealthier countries, as well as how the taxes should be implemented and collected.  

“There should also be further clarification on whether firms or specific economic activities will be taxed,” says PwC’s Vonner.  

“If the former, how do we identify the polluting activities within a company’s revenues, and which definition of a polluting activity will be adopted?” 

Vonner also questions whether companies in carbon-intensive sectors would be taxed uniformly, regardless of whether they have drawn up or are acting on transition plans 

Compain, for his part, urges the taskforce to ensure that principles of equity and progressivity will be at the core of any future taxes, including for the distribution of the revenues they will bring.  

“A levy on maritime shipping’s GHG emissions, for example, must be properly designed to avoid adverse impacts on low-income countries’ trade and consumers,” he says. “The majority of the revenue should help developing countries cope with climate change through new and additional climate finance.” 

The idea of a new environmental tax is an important one, but it should be done right to prevent issues around legality and constitutionality and potential abuses, suggests Freshfields Bruckhaus Deringer Tax Partner Georg Roderburg.  

“We know that challenges may arise,” acknowledges Rachel Owens, Director of Climate Finance Programmes at the European Climate Foundation.  

“To tackle these, governments should work collectively to create mechanisms to mitigate the potential negative societal and economic impact of these taxes.” 

Tangled, multilateral web  

A broader question is how global climate taxes will interact with different regional approaches to the climate transition. 

“Whilst well-intentioned, this initiative is somewhat behind the curve and seems to ignore the fact that related initiatives are already deployed in many countries and are funding domestic budgets and public services,” says Paul Monaghan, CEO at the Fair Tax Foundation. 

“For example, how would a new levy on fossil fuels work when many countries already have carbon prices in place, and the EU has begun to roll out the Carbon Border Adjustment Mechanism (CBAM)?” 

The EU CBAM, which places a carbon levy on imports, is currently in a three-year transitional disclosure-only period, with EU importers expected to pay the levy from 1 January 2026.  

Other countries, including the UK and Australia, are also considering or are in the process of introducing their own CBAM to offset the impact of the EU’s mechanism. This begs the question of whether a multilateral carbon tax could be in our future.  

According to the World Bank, 40 countries and more than 20 cities, states and provinces worldwide are already using some form of carbon pricing mechanism. 

“I don’t see any insurmountable technical obstacles to a multilateral carbon tax. After all, the embedded carbon in economic flows already needs to be computed based on internationally agreed metrics for emissions trading schemes,” says Tim Sarson, UK Head of Tax Policy at KPMG. 

“However, the trouble with any multilateral – as opposed to global – solution is that it adds to the proliferation of different schemes around the world.”  

Such a prospect prompted the World Trade Organization to launch a carbon price taskforce last year, whose mission is to create a methodology that could be used globally and would ensure that EMDEs aren’t unfairly penalised.  

A prominent opponent to this strategy has been the US, which has been famously reluctant to impose a carbon tax. 

In 2022, President Joe Biden signed the Inflation Reduction Act into law, committing billions of dollars to tax incentives, grants and subsidies designed to encourage the industry to invest in upscaling domestic clean energy capacity and developing low-carbon technologies. 

A year on, US$278 billion in private clean energy investments had already been made and 170,000 jobs were created.  

Although both approaches have contributed to domestic decarbonisation efforts, they have not accounted for the negative impacts they may have had on other countries and regions. 

Any expansion of existing regional strategies requires a more equitable lens, says Franziska Mager, Senior Researcher and Advocate on Climate and Inequalities at the Tax Justice Network advocacy group. 

Research from the London School of Economics’ Grantham Research Institute on Climate Change and the Environment (GRI LSE) has shown that the EU CBAM will likely impact on African countries the most, as the EU accounts for 26% of fertiliser exports from the continent, as well as 16% of iron and steel, 12% of aluminium, and 12% of cement.  

“This is why we see a lot of potential in the global climate tax taskforce, as it is opening the floor for all countries to collaborate,” says Eleonore Soubeyran, Policy Analyst and Research Advisor at the GRI LSE.  

“It’s crucial that developing markets have a voice in ongoing discussions.” 

Time for change  

The Organisation for Economic Co-operation and Development (OECD) is already in the process of reforming the global tax system, with the backing of 130 countries.  

Pillar One of the OECD’s reform plan aims to ensure that the largest companies globally are paying their taxes in every jurisdiction they operate in, while Pillar Two – which came into effect this month – has introduced a 15% global minimum tax rate on the profits of large multinational companies.  

The new climate tax taskforce led by France and Kenya must now consider the work of the OECD, and whether its blueprint can be amended or extended to account for climate. 

“Leveraging existing frameworks and building upon the Pillar Two reforms can help streamline the implementation of a climate tax,” says Owens.  

She notes that the OECD is not the only forum where global climate tax projects should be discussed and implemented – the International Maritime Organization and the International Civil Aviation Organization should also facilitate the adoption of industry-specific taxes. 

Despite increasing momentum for tax reform, climate-related issues remain far more divisive.  

Ultimately, the willingness of governments, companies, and investors alike to embrace behavioural changes will be the key driver of progress towards net zero by 2050. 

“We already know that mitigating the worst effects of climate change will require a fundamental shift in our financial system,” says Owens.  

“We need to turn that political will into concrete steps and actions to generate much-needed sources of revenue. Now more than ever, we need the heaviest polluters to play a positive part in our collective transition to a net zero economy.”

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