On 6 June 2023 the OECD published a working paper with the title Decarbonisation and intergovernmental fiscal relations: Policy challenges and reform options by Luiz de Mello and Teresa Ter-Minassian. The study represents the latest in a series of OECD working papers on fiscal federalism.

The working paper looks at the intersection of decarbonisation and intergovernmental fiscal relations, examining the challenges that arise and the options for reform. The paper notes that there are growing concerns worldwide about climate change and damage to the environment, and subnational governments have a significant role in tackling these challenges.

Role of subnational governments

Subnational and national governments have shared responsibilities in covering matters related to environmental protection such as taxation, spending and climate change mitigation and adaptation. There is growing attention to the connections between environmental and climate objectives and the design of fiscal relations between national and subnational governments.

Subnational governments have an important role in these areas because the consequences of environmental problems vary within countries as well as between one country and another. There may therefore need to be different policy responses in different regions and municipalities within countries. The costs of the response to the environmental challenges, and the benefits they can bring, will also vary among regions and municipalities.

Intergovernmental co-operation

Effective intergovernmental co-operation is needed so that policy objectives and implementation strategies can be aligned. The authors set out decarbonisation requirements in the relevant sectors and they consider the issue of subnational government involvement in service delivery, investment, revenue generation and regulatory frameworks.

Policy options

The paper examines policy options that can strengthen the role of subnational governments in contributing to national decarbonisation goals.

The focus of the working paper is on the connection between the spending and revenue-raising activities of subnational governments and the reduction of CO2 emissions (decarbonisation). The paper outlines policy options for both subnational and national governments to strengthen the contributions made by subnational governments to the national goals in this area.

The authors set out the decarbonisation needs in a number of sectors, as estimated by the International Energy Agency, required to meet the international objective of carbon neutrality by mid-century. The paper examines the main reasons for locally-based decarbonisation efforts and the responsibilities of subnational governments in the relevant functions, including service delivery, investments, revenue mobilisation, and regulation. The main options for policy reform are outlined.

The paper looks at ways of bringing about the alignment of national and subnational agendas on reducing carbon emissions, examining why and how the national government should be involved in regional and municipal decarbonisation policies. Various possible actions to strengthen intergovernmental cooperation are highlighted.

National governments can support subnational decarbonisation efforts by reviewing the assignment of revenue sources (including green taxes) to subnational governments, and by helping to strengthen the capacity of subnational tax administrations. The national government can make special purpose grants and capital transfers targeted for decarbonisation. They can also facilitate the access of subnational governments to fiscally sustainable financing for green investments.

Subnational governments have responsibilities in a number of areas that must make important contributions to national decarbonisation agendas, such as electricity distribution, transport, commercial and residential buildings and land use. They can influence decarbonisation outcomes in these areas through their public consumption, subsidies and transfers, and through investments. Also of significance are their revenue policies, other price-based mechanisms such as emissions trading schemes, and the use of regulatory powers.