Multilateralism key to solve diverging approaches to emissions reduction – only IMF can solve smaller countries’ capacity constraints

In analogy to income tax competition, uncoordinated attempts to discourage greenhouse gas emissions face national hurdles. Higher carbon pricing in one country, for instance, increases the costs for its domestic producers, posing competitiveness concerns and potentially motivating production and emissions to move to other countries (that is, carbon leakage). Even if some countries begin implementing domestic mitigation policies, others may wait to benefit from avoiding the costs of reducing emissions. This “free-riding” issue, together with competitiveness concerns, hampers global progress on emission reduction.

In contrast with the vital role of small countries in hosting global income and wealth, a handful of large economic regions account for the majority of global emissions. International coordination could therefore generate significant progress—at least initially—in a setting with fewer participants. For example, China, the European Union, India, and the United States together are responsible for 64 percent of global emissions (Parry, Black, and Roaf 2021).

Differences among countries’ incomes raise further challenges to coordination. Whereas high-tax advanced economies and developing countries face similar tax base erosion challenges, the latter countries tend to import capital, have far fewer multinational headquarters, and face harder capacity constraints in tax enforcement. An agreement must reconcile the interests of developing countries and advanced economies. Within each set, countries are different, for example, in the relative importance of specific sectors such as digital-heavy companies, natural resources, and financial firms.

The form of coordination can facilitate agreement. For example, regarding corporate income taxation, combining zero-sum reallocation of revenues with a revenue raiser facilitates agreement (as discussed in the “Corporate Income Tax Coordination” section). Coordination of mitigation policies among key large emitters could be effective in the immediate term and would constitute an important start (as discussed in the “Carbon-Pricing Coordination” section).