WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

We study the consequences of rising temperatures for public finances in a global panel of countries. Using local projections and temperature shocks constructed from grid-level temperature data, we estimate the dynamic effects of local and global temperature shocks on government revenue, expenditure, the fiscal balance, and debt. We find that global temperature shocks have substantial fiscal consequences: they persistently lower output, erode tax revenue, deteriorate the fiscal balance, and raise government debt, while local temperature shocks leave public finances largely unaffected. These fiscal costs are regressive, as lower-income countries suffer large output and tax-revenue losses and are forced to run larger deficits and take on more debt, whereas high-income countries absorb the shock and experience more limited fiscal consequences. We show that this gradient operates through two interacting channels: exposure and fiscal capacity. We find that while exposure to rising temperature accounts for most of the differences, fiscal capacity also plays a non-negligible role. Our results imply that the fiscal burden of climate change’s global externality falls disproportionately on the countries least responsible for generating it and least able to finance an effective response.