The Baseline is Wrong: How EU Fiscal Rules Ignore Climate Change

Executive Summary

The EU’s fiscal rules now relies on debt sustainability analyses as its central steering tool. Since the 2024 reform, DSAs determine national expenditure ceilings on the basis of debt-to-GDP projections 14 to 17 years into the future. Yet the growth assumptions that anchor these baselines remain incomplete: they capture demographic and productivity trends but largely omit the economic effects of climate damages and the transition policies required to meet binding European emissions targets. This omission biases fiscal planning, underestimates risks, and leaves policymakers unprepared for the growth and fiscal consequences of the energy transition.

Current baselines underestimate the fiscal impact of both climate damages and transition costs. Research suggests that unchecked climate damages could reduce European output by 5–10% by 2050, while a transition strategy dominated by carbon pricing alone implies GDP losses of around 1–2% by the mid-2030s. Neither effect is reflected in current DSAs. This creates a structural inconsistency: Europe’s fiscal framework enforces strict targets while ignoring costs that are already legislated in climate law, risking higher debt ratios and more abrupt adjustments later on.

The macroeconomic effects of the transition depend on the policy mix. Evidence shows that carbon pricing on its own is both economically costly and politically difficult to sustain, particularly in a fragmented global environment. By contrast, a balanced approach that combines pricing with public investment in infrastructure, technology, and energy independence yields more favourable growth outcomes. Such investments address market failures, reduce reliance on volatile fossil imports, and mobilise private capital. DSAs that fail to reflect these differences risk discouraging strategies that are both fiscally and economically more efficient.

Indicative simulations confirm that results shift once climate is incorporated. Adjusting Italy’s DSA baseline with NGFS scenario data raises projected debt-to-GDP in 2028 from 146% to 148%, with most of the increase driven by climate damages. Yet alternative mixes that temper carbon prices and raise investment improve growth and stabilise debt ratios — provided higher multipliers for transition spending are acknowledged. Empirical studies suggest multipliers above 2.0 for targeted climate investment, compared with the Commission’s default assumption of 0.75, indicating that well-designed investment can partly or fully offset its own fiscal cost.

Reforming DSA methodology is essential for credible fiscal governance. Europe’s fiscal framework cannot remain blind to the economic impacts of the energy transition. Baseline projections must integrate legislated emissions constraints and climate damages, refine multiplier assumptions to capture the growth potential of investment, and align model inputs with actual revenue earmarking rules. Greater transparency and consistency across assumptions are also needed. Updating the DSA methodology along these lines would ensure that fiscal surveillance supports, rather than hinders, Europe’s dual objectives of debt sustainability and energy transition.

Policy recommendations

1. Reform DSA methodology to explicitly incorporate climate damages and the costs of mitigation policies.
2. Establish a climate-consistent baseline for fiscal planning, replacing today’s overly optimistic reference scenario.
3. Promote balanced policy mixes that combine carbon pricing with public investment to sustain growth and fiscal space.
4. Integrate climate targets into fiscal rules to ensure fiscal policy remains compatible with Europe’s decarbonization commitments.
5. Close modelling gaps by investing in research on climate–fiscal feedbacks and scenarios under fragmented global climate action.