From Negative to Positive Carbon Pricing in Mexico

Abstract

Over the course of a decade, Mexico transitioned from a peak of 1.8% of GDP given as fuel subsidies in 2008 to generating positive fuel tax revenues equivalent to 1.6% of its GDP in 2018. This paper analyzes Mexico's carbon pricing experience: the mechanisms that made fossil fuel subsidies such a large burden on public finances, the strategies followed in its five-year phase-out, and the institutional changes that enabled crossing into positive carbon taxation, both explicit and implicit. We analyze the effect of three carbon pricing instruments: 1) the subsidy phase-out, 2) the explicit carbon taxation, and 3) the implicit carbon pricing in excise fuel taxation. We present scenarios to assess the contribution of each policy to Mexico's voluntary commitments under the Paris Agreement. The subsidy phase-out and carbon taxes phase-in significantly contributed to Mexico´s carbon emissions reductions. Importantly, we show that excise taxes applied to fossil fuels accrued the largest emissions reductions across all carbon pricing mechanisms due to their magnitude. We present evidence of decoupling between fuel (gasoline and diesel) consumption and economic growth. Our findings support the emerging view that carbon pricing through fiscal policy, in Mexico and elsewhere, shouldn't be restricted to explicit carbon pricing in the form of ETS or carbon taxes. Instead, it should be understood and calculated as the sum of excise taxes net of subsidies, carbon taxes and other forms of carbon pricing, subtracting any fiscal crediting or stimuli present.