How sustainable climate policy and sound public finances go hand in hand

The publication in the journal of the highly respected German Economic Association (Verein für Socialpolitik), founded in 1873, is primarily conceptual in nature, but it touches on a hotly debated and highly politicised topic: how can the state, in the interests of future generations, avoid inefficiently high levels of debt while investing enough in long-lasting public goods? “Our concept makes sustainable, future-proof policies go hand in hand with sound public finances,” says PIK Director Ottmar Edenhofer, one of the authors. “It minimises the risk of funds being misused in the name of noble goals. And although it has been worked out in detail for climate policy, it can be transferred to other policy areas as well.”

The starting point is the scientifically well-documented short-term orientation of governments. This is why, according to the research team, politicians take on excessive debt despite the subsequent burden of interest and repayment. This is also why, in the event of a fundamental ban on debt – as has been the case in Germany for many years – they direct excessive amounts of money towards current expenditure, rather than investments where only a fraction of the benefits accrue in the short term.

Releasing the debt brake is justifiable

The lack of political stamina is particularly problematic when it comes to investing in the avoidance of carbon emissions. This is because the centuries-long presence of this most important greenhouse gas in the atmosphere has the effect of a depreciation rate of close to zero: hardly any of the benefits of CO₂ avoidance measures (avoided climate change, avoided climate damage) will be felt before the next election, so to speak. The study shows that too little money flows into climate protection when there is a debt ban. It explores this situation using a mathematical “model of a short-term oriented government”.

However, a “welfare-optimised” result – both in terms of economically efficient climate protection and intergenerational justice – is achieved if the debt ban is replaced by the green-golden debt rule in the calculation model. This would allow the government to borrow for climate protection measures strictly linked to the amount of CO₂ emissions avoided as a result, or alternatively to the carbon price level.

“The key innovation of our proposal is that it focuses on the benefits rather than the costs of investment,” explains Matthias Kalkuhl, head of the PIK research department “Climate Economics and Policy - MCC Berlin” and also one of the authors. Since 1969, the German government was considering investment costs to be an increase in assets and hence – following a “golden rule of fiscal policy” – a justification for new debt. This was constrained by the debt brake in 2011, but exceptions were introduced in March 2025, including 100 billion euros for climate protection. “Our study provides guidance in this situation,” says Kalkuhl. “And it shows that the high sum is indeed justifiable.”

The EU should also revise its deficit control

In fact, the research team illustrates the effect of the green-golden rule by incorporating further assumptions into its model. It derives the emission reductions from the targets set out in the Federal Climate Protection Act. It quantifies the climate damage for the EU at a price level of 200 euros per tonne of CO₂ emitted. And it estimates the relevant response patterns – expressed in elasticities – such as how private individuals respond to price changes for fuel or heating oil. Under these assumptions, which are described as cautious, a total borrowing of 161 billion euros for climate protection would be justifiable for the period 2020 to 2030 in Germany. If the targets are not fully met, the allowed debt will automatically be lower.

The study also recommends revising existing deficit controls at the EU level. This is advantageous not least in view of the second EU emissions trading scheme for the building and transport sectors, which is due to start in 2027, for which further price developments are currently under political debate. Applying the green-golden debt rule means that high carbon prices – and thus ambitious climate protection – are doubly advantageous for governments: not only do they receive higher revenues to socially balance the impact of domestic carbon pricing, but they also have more leeway to borrow.