Can Carbon Taxes Close Latin America and the Caribbean’s Climate Finance Gap?
As temperatures in Latin America and the Caribbean (LAC) heat up, economies in the region are cooling down. In August 2025, the United Nations Economic Commission for Latin America and the Caribbean (ECLAC) released a new edition of its Economic Survey of Latin America and the Caribbean 2025, finding that LAC faces a “prolonged period of low growth,” with gross domestic product (GDP) growth on track to average 2.2 percent in 2025 and 2.3 percent in 2026.
A new technical paper from the Task Force on Climate, Development and the International Financial Architecture, “Is Carbon Tax the Answer to Climate Change Investment Needs in Latin America and the Caribbean?”, reveals that intensifying climate shocks threaten to sink the region’s already tepid growth and weak productivity into deeper stagnation. Countering these effects, the authors argue, will require an extraordinary surge in both public and private investment—and an equally extraordinary effort to mobilize public and private financing. The authors specifically examine the role of carbon taxes in driving the necessary investment surge to combat economic losses from climate shocks.
Hotter Climate, Slower Growth
To illuminate the effects of climate change on economic growth, the authors employ two scenarios: a “moderate” scenario, where average temperatures across the region by 2.4 degrees Celsius by 2100 (2.4°C scenario). Their second scenario projects a more severe increase of 4.9°C by 2100 (4.9°C scenario). The authors estimate the economic fallout for six climate-vulnerable LAC countries: Dominican Republic, Guatemala, Honduras, Jamaica, Paraguay and Peru.
Using a growth model that links rising temperatures to total factor productivity (TFP)—the efficiency with which labor and capital combine—the authors find that warming temperature could cause TFP growth across the six countries to fall from the recent average of -0.2 percent during 2004-2023 to -0.6 percent under a 2.4°C global temperature increase and -0.8 percent under a 4.9°C scenario.
Meanwhile, by 2050, GDP growth could sink to 1 percent under the moderate scenario and 0.2 percent in the severe one—a sharp decline from current regional averages above 2 percent. Per-capita income could fall by 14 percent and 22 percent, respectively. And the damage, the study warns, is non-linear—each degree of warming inflicts exponentially larger losses. The cost of delayed action, therefore, rises every year.
Changing these trajectories demands breaking away from business as usual. According to the authors’ estimates, to close the GDP growth gap between the 4.9°C and 2.4°C scenarios, countries would need to increase investment by roughly 14 percent of GDP annually by 2050, lifting total investment to nearly double current rates. This echoes global estimates suggesting that closing Latin America’s twin development and climate gaps requires spending between 3 and 16 percent of GDP each year, well beyond both what governments can fund from current budgets and the private sector’s capacity to mobilize financing.
Carbon Taxes: Not the Silver Bullet
What options does LAC have to raise the investment needed to compensate for climate change-induced economic losses?
Fiscal fragility in the region predates the climate crisis. Years of weak growth, low tax burdens, tax evasion and the COVID-19 pandemic’s legacy have left public debt averaging 59 percent of GDP, up from 33 percent in 2008. Servicing that debt now consumes around 16 percent of tax revenues, and more than 30 percent in fiscally fragile economies. Many countries’ interest payments already exceed 185 percent of total public investment—an astonishing imbalance.
Behind these numbers lies a narrow tax base. The region’s average tax take, at 21.5 percent of GDP, lags far behind the Organization for Economic Co-operation and Development’s (OECD) 2022 average of 34 percent, while tax evasion drains another 6.7 percent and ill-targeted exemptions sap 3.8 percent more. This leaves precious little fiscal room for the green investments the region urgently needs.
Economists have long seen carbon taxes as a key instrument: they reduce emissions while generating revenue. Yet LAC’s experience has been underwhelming. Only five countries—Argentina, Chile, Colombia, Mexico and Uruguay—have them, and their fiscal yield is low: less than 0.05 percent of GDP. Carbon prices are too low—typically $3–7 per ton of CO₂, except Uruguay’s unusually high $167—and cover on average only 29 percent of total emissions.
Even under an ambitious regional carbon price of $50 per ton applied across the electricity, transport and manufacturing sectors, the authors estimate revenues would reach only 1.4 percent of GDP (Figure 1)—barely 12 percent of the investment needed to offset the climate change-induced productivity and growth losses. In short, carbon taxes are a useful tool, but far from sufficient.
Figure 1: Latin America and the Caribbean: Estimated Carbon Tax Revenues as Percentage of GDP with a Carbon Price of $50 per Ton of CO2e Emissions
Note: Carbon tax revenues in US dollar terms are estimated by applying the carbon price to emissions generated in the electricity, transport and manufacturing sectors in 2019. The carbon-tax-to-GDP ratio is then calculated using data on GDP in US dollars at current prices from the World Economic Outlook, October 2023 (IMF 2023).
A Green Fiscal Compact
While carbon taxes alone can’t fill LAC’s climate finance gap, a comprehensive response requires a “Green Fiscal Compact” built on three pillars.
The first pillar is domestic tax reform, a process involving broadening the tax base, closing loopholes and making systems more progressive. Consolidating personal income and wealth taxes—yielding barely 2 percent of GDP across LAC compared to 8 percent in OECD economies—offers clear potential.
The second pillar is reducing the cost of capital: international cooperation and development banks must expand concessional and blended finance to lower capital costs for climate projects. In 2023, multilateral climate lending to the region amounted to a paltry 0.2 percent of GDP.
The third pillar is debt relief, particularly for small Caribbean states where climate shocks and debt distress combine in a vicious cycle. While institutionalized debt restructuring mechanisms have been lackluster thus far, these states also stand to gain from debt-for-nature swaps, such as the agreement between The Nature Conservancy and the Government of Belize that reduced the country’s debt burden in exchange for marine conservation commitments.
Fiscal Survival in a Warming World
The message is stark. Without a sustained expansion of fiscal space, Latin America cannot finance the climate investment it needs. More taxes will be necessary—but smarter ones. So will more debt—but cheaper and longer-term. A carbon tax can help, but only as part of a wider fiscal re-engineering linking growth, debt sustainability and climate resilience.
For Latin America’s policymakers, the math is unforgiving: countries must invest to prevent climate catastrophe and revive growth and productivity while simultaneously struggling to keep budgets afloat. Ultimately, the climate crisis will be a test of fiscal architecture at least as much as planetary endurance.