International cooperation on fossil fuel levies could raise billions for climate finance

Last year at COP29, governments agreed on a new climate finance goal of USD 300 billion per year by 2035, with an ambition to mobilise USD 1.3 trillion from public and private sources. However, there was no mechanism proposed to incentivise contributions. 

PIK’s analysis explores scenarios in which countries are driven by their own self-interest to cooperate on levies on fossil fuels, and then channel these funds to low and middle income governments for emissions reductions efforts that would displace fossil fuels. 

The authors find that if players like the European Union (EU) make the rate of levies conditional on which other countries participate in the coalition, this would generate sufficient incentives for other large importers like China to join. Cooperation also achieves additional benefits – in the case of the EU and China, cooperation would see the amount of climate finance raised by each quadruple relative to what they would achieve acting alone.

In the case of oil and gas, the analysis shows that if the revenues from the levies are earmarked to fund the energy transition in low and middle income countries, the resulting reduction in fossil fuels demand would decrease global fuel prices. This effect is sufficiently strong to offset the upward pressure on consumer fuel prices exerted by the levies themselves.

“Governments are facing tightening fiscal space and are grappling with the question of where the money for international climate finance will come from. Smaller coalitions of countries cooperating on different kinds of levies could go a long way to solve the problem, without extra cost to consumers,” commented PIK Director and lead author Ottmar Edenhofer.

Benefits for developing countries

Low and middle income countries would gain billions overall for implementing measures that achieve agreed emissions reductions, as well as avoiding damages from climate change impacts, and saving on lower fossil fuel prices. In one scenario where the EU and China worked together on levies for fossil fuels, developing countries are estimated to receive USD 66 billion per year to reduce their fossil fuel use, of which USD 33 billion would be net gains. Avoided damages from future climate impacts are estimated to be worth USD 78 billion, and savings on fossil fuel prices USD 19 billion per year.

In addition to the financial incentives, the funding from the levies is estimated to reduce emissions by more than a billion tonnes of CO2 per year, which is more than Germany’s current annual emissions. 

A model for funding global public goods

The initiation of a coalition of fossil fuel importers could build on momentum from the recent statement from the EU and China to enhance cooperation on climate change. For example, a coalition on pricing emissions from international aviation and maritime shipping could raise more than USD 200 billion per year and reduce emissions by roughly 1.5 billion tonnes CO2 per year – half of Europe’s emissions. 

There are already examples of ambitious groups of countries taking similar approaches. Recently, a coalition of countries including Antigua and Barbuda, Barbados, Benin, France, Kenya, Sierra Leone, Somalia and Spain, announced they would work together to tax private jets and premium class flights to raise money for climate action and sustainable development. Barbados, France and Kenya are chairing a Global Solidarity Levies Task Force to explore these kinds of levies.

“Our analysis strongly suggests that coalitions to raise funds for global public good provision would be a win-win. We show by pairing targeted spending of these levies on international climate finance, benefits can be shared by all,” said PIK’s Matthias Kalkuhl, another of the study’s authors.

The study is a contribution to the project "ODA in the Mutual Interest of Donors and Recipients", which is funded by the Gates Foundation and coordinated by the Kiel Institute for the World Economy.