Europe warned on need to encourage green investment

The European Union (EU) has been told that its plans to deliver the Paris Agreement target is doomed to failure unless it enshrines green investment within its fiscal policies.

A new study, that proposes a new ‘green pact’, concluded the EU’s ambitious Paris Agreement climate targets will not be met with the current fiscal policies in place.

Experts from the European economic think tank, Bruegel, concluded that total green investments must be increased by 2% of GDP annually, and one-third of that, about 0.6% of GDP, should be funded by state budgets, which they say is “a major challenge at a time when budgets are consolidated”.

The think tank proposes a European pact should be introduced, involving better regulatory policies and a higher price on emissions, as well as public green investments and public support for private green investments.

The EU has set a target of reducing greenhouse gases by 55% by 2030 compared to 1990, and eliminating them by 2050, but lead author Professor Zsolt Darvas, a senior fellow at Bruegel, explained that the target is currently an unrealistic ambition.

“Our calculations show that, even when exploiting the slowest possible fiscal consolidation pace allowed by EU fiscal rules, a steady fiscal consolidation effort will be necessary,” he added. “The main challenge will be how to consolidate deficits while increasing green investment. Evidence suggests that in the current fiscal framework, this will not be achieved.

“Public investments tend to be cut in fiscal consolidation episodes by vote-maximising politicians. Fiscal consolidation will be necessary after large public spending programmes during the COVID-19 pandemic and Russia’s invasion of Ukraine. But to meet the EU’s ambitious climate objectives, green investments need to be increased significantly.

“Therefore, creative thinking about how to do things differently is needed – such as increasing climate investments, while consolidating budgets.”

Following the scrutinizing of the National Energy and Climate Plans (NECP) of EU countries for overall climate-related investments (including tax incentives and subsidies) over 2021–2030, the experts have created a proposal including a ‘green golden rule’ that would allow green investment to be funded by deficits without counting them in any fiscal rules (deficit rules, expenditure rules, and the associated increase in debt in debt rules).

Excluding green investments from all types of fiscal rules would provide incentives to undertake them, because they would be excluded from the fiscal consolidation requirements, the study added.

Their proposal also limits, as much as possible, additional taxing for residents.

“Politicians must find other expenditures to cut, or increase taxation, to increase green investment. With the green golden rule, such expenditure cuts or tax increases are not necessary to increase green investment,” explained co-author, economist Guntram Wolff, the former director of Bruegel, who is now the director and CEO of the German Council on Foreign Relations and is also based at the Free University Brussels.

“Appropriate regulation, taxation and elimination of subsidies should be part of the policy mix, but each of these instruments has limitations,” he continued. “For example, a significant increase in gas and electricity prices related to the Ukrainian war should be welcomed from the perspective of green transition, as it creates strong incentives for the private sector to move away from fossil fuel consumption. However, governments throughout the EU have rushed to dampen the impact of higher energy prices. There are political limitations to energy price increases.

“We propose that the Council of EU ministers defines a list of top green spending priorities which would not count as deficit and debt in the fiscal rules.”

Additional recommendations to policymakers within the suggested fiscal pact include:

  • Clearly defining what constitutes emission-reducing climate investments and monitoring compliance.
  • Eliminating fossil fuel subsidies.
  • Incentivising private climate investments through appropriate taxation and regulation.
  • A requirement that fiscally weak countries should not immediately benefit from the green golden rule but rely on NextGenerationEU (NGEU) for their green investment up to 2026 and not ignore risks to public debt sustainability.

“Our proposed Green Fiscal Pact is the most promising option to address the tension between the conflicting needs of fiscal consolidation and increased green investments,” concluded Darvas.