In the road to COP30, this policy brief aims to analyze the main climate transition and physical risks for fiscal policy. The Paris Climate Change Agreement targets a temperature rise between 1.5o C and 2o C during this century. This requires the global economy to become carbon neutral between 2050 and 2070. This situation configurates some physical and climate transition risks.
These main risks consist of:
1. Climate change, including extreme climate events, has significant negative effects on economic activities, social welfare, and the environment that reduce fiscal revenues and increase public expenditure to attend these emergencies. Therefore, climate transition generates several fiscal risks such as the reduction of fiscal revenues due to the changes in the economic structure, production and consumption patterns, and the constitution of stranded assets, such as the capital in the oil and gas industry, that will reduce fiscal revenues and the increase of public expenditure due the climate emergencies and natural disasters.
2. Climate transition requires significant public investment in sustainable infrastructure. A Just Climate Transition requires governments to compensate some economic groups and promote a more egalitarian economy. This represents significant pressures for an increase in public expenditure.
3. Reducing fiscal revenues and increasing public expenditure can lead to fiscal macroeconomic balances that negatively impact the conditions of a Just Climate Transition.
However, there are also options and measures to administrate these physical and transition risks, such as:
1. Identify and elaborate a systematic risk administration of these physical and climate transition risks.
2. Green fiscal reform (including a carbon price) to generate additional revenue.
3. New financial instruments such as thematic bonds like debt for nature.
4. The elaboration of a new economic incentive matrix with consistent regulations that are in favor of sustainable development.
An efficient, feasible, and credible Just Climate Transition requires a solid fiscal policy that adequately addresses climate change risks consistent with the Paris Climate Change Agreement.
There is increasing interest from the academic and policy perspective in identifying and analyzing the main fiscal risks and considering some options and opportunities to tackle and properly administrate these risks. Therefore, the main objective of thIs Advocacy Note is the analysis of the main climate transition and physical risks for fiscal policy.
This Advocacy Note was produced by the South American Network on Applied Economics / Red Sur, with the aid of a grant from the International Development Research Centre (IDRC) of Canada, as part of the project: “Elevating and Connecting Research from Latin America and Africa to Inform the G20 and COP30: Public Debt, Care, and Climate Change”, between 2024 and 2025.