Carbon pricing and redistribution in low- and middle-income countries

Who would be most affected by carbon pricing in developing economies?

Climate change caused by greenhouse gas emissions is one of the biggest challenges facing society today. While developing nations account for only a fraction of these cumulative emissions, their share is increasing over time and is expected to continue doing so. Putting a price on these emissions is one of the favoured policy responses of economists, and also provides an opportunity to raise much-needed tax revenue in many contexts. However, there is limited existing empirical evidence on where such a price would fall hardest if implemented in developing countries. In this project, we simulate the introduction of a carbon price in a number of contexts in order to understand the distributional implications across households, businesses and industrial sectors, and to study where mitigating measures might be considered.

Impacts on households, businesses, industrial sectors, and trade policies

Who would be most affected by the introduction of a carbon price is crucial for policymakers to understand. While evidence from some high-income countries suggests carbon prices may be slightly regressive, different consumption patterns in poorer nations mean results may be very different. In addition, while a carbon price could raise revenue which in theory could be redistributed, the policy levers for redistribution tend to be more limited in developing countries.

We use various data sources concurrently to simulate the introduction of a carbon price in the form of a new tax on fossil fuels. Detailed consumption data in household surveys is used to study distributional effects across households and business surveys allow us to consider whether there are different implications according to firm size. Input-output tables provide a way of studying which sectors are most exposed to carbon prices; embedding these in tax-benefit microsimulation models allows us to estimate how this might feed through to consumer prices across the distribution, and these same models also provide a way of studying different compensation mechanisms. Finally, international trade data is used to study possible border adjustment policies.

A progressive source of potential revenue

Ongoing work suggests that carbon prices in developing economies would be strongly progressive, and with important revenue potential. Our results highlight that direct spending on fossil fuels and energy are important for this progressive pattern, but in addition the “indirect effect” through consumer prices across the economy is quantitatively large. Despite this, poor households would be hit by higher prices too. Thus, governments might consider compensation schemes using the additional revenue raised, and universal policies could fully compensate poor households with revenue to spare. Furthermore, we highlight the importance of considering border adjustment policies; not doing so would harm international competitiveness and lead to “carbon leakage”. Often though, much of the effect is concentrated in one or two key tradable sectors.

Our results provide an overview of key considerations for policymakers in developing countries that might be considering carbon prices to raise revenue and to meet climate obligations in the coming years. The analysis that we undertake in a selection of countries could in future be implemented in other contexts to provide country-specific evidence on the implications of a carbon price.