Climate Change and Government Budgets: The OECD-EDISON Framework

Climate change is reshaping government balance sheets across the OECD. As economies transition away from fossil fuels, governments face a structural fiscal challenge: the revenue base that has funded public services for decades is eroding, while spending demands from climate adaptation, extreme weather, and transition support are rising. Yet in most countries, the fiscal implications of this shift remain poorly understood and inadequately quantified.

The OECD developed the EDISON (Environmental and Decarbonisation Impact Scenarios On National budgets) tool to address this gap. It provides a common analytical framework for projecting how climate change and decarbonisation will affect government revenues, expenditure, and long-term fiscal sustainability. This article explains the framework, its key findings, and why it matters for financial institutions assessing sovereign and macroeconomic climate risk.

Why Climate Change Is a Fiscal Sustainability Issue

The fiscal effects of climate change extend far beyond any single budget line item. They operate through multiple interconnected channels that compound over time. Governments face costs from supporting the energy transition through subsidies, building retrofits, and infrastructure investment. Simultaneously, traditional revenue sources — taxes on petrol, diesel, coal, and natural gas — decline as fossil fuel consumption falls. Extreme weather events damage infrastructure and require emergency spending. And if economies weaken due to chronic warming effects, the entire tax base shrinks.

A handful of OECD countries — notably the United Kingdom, Ireland, and the Netherlands — have begun assessing these impacts systematically. The UK’s Office for Budget Responsibility has published detailed fiscal risk assessments covering the climate transition. Ireland’s Fiscal Advisory Council produced pioneering work on what climate change means for Irish public finances. But for most OECD members, this analysis is still in its early stages.

How the OECD-EDISON Framework Works

The OECD-EDISON tool takes a structured, five-step approach to modelling fiscal impacts. Each step builds on the previous one, creating a comprehensive picture of how climate and policy choices interact with public finances.

You can explore this framework interactively using our free Decarbonisation Fiscal Impact Estimator, which models all six OECD scenarios across 38 countries with adjustable parameters for damage share, tax policy response, and transition spending.

The Six OECD Climate Scenarios

The OECD-EDISON framework offers six distinct scenarios that capture different warming pathways and damage assumptions. Understanding these scenarios is essential for anyone conducting climate risk analysis, whether at the sovereign, portfolio, or corporate level.

The business-as-usual scenarios (BAU1 and BAU2) assume no additional policy action beyond existing commitments. The median damage function draws on the meta-study by Howard and Sterner (2017), while the high-damage estimates use findings from Bilal and Känzig (2024), which found substantially larger economic impacts when focusing on global rather than local temperature changes. The energy transition scenarios (ET1–ET4) assume proactive policy action limiting warming to 1.6°C, with varying assumptions about transition speed and cost.

Key Findings: The Fiscal Trade-Off

The central insight from the OECD-EDISON analysis is that inaction is not cost-free. In the do-nothing scenario, governments face lower transition spending but higher costs across every other fiscal channel: greater weather damage, more severe GDP losses, rising health costs, and potential penalties for missing climate targets. The policy action scenario requires upfront spending on transition support but avoids or mitigates many of these downstream costs.

For the revenue side, the story is particularly striking. In both scenarios, fossil fuel tax revenues decline — the question is by how much and how quickly. In a transition scenario, the decline is faster but potentially manageable through active tax policy adaptation. In a business-as-usual scenario, the decline is slower but accompanied by weaker GDP growth, which erodes the broader tax base. The net fiscal outcome depends heavily on whether governments proactively replace lost revenues or allow the fiscal gap to widen.

This analysis has direct relevance for sustainability professionals and financial institutions. Sovereign fiscal health underpins the stability of the markets in which portfolio companies operate. Understanding these dynamics is increasingly relevant for climate scenario analysis under TCFD/ISSB and for stress testing under regulatory frameworks.

Extreme Weather: The Accelerating Cost

One of the most tangible fiscal channels is the direct cost of extreme weather events. The OECD-EDISON tool uses data from the EM-DAT database to estimate country-specific historical damage costs, then projects how these will evolve using risk multipliers from the IPCC Sixth Assessment Report.

The multipliers are sobering. Under a 3°C+ warming scenario, floods become four times more frequent, wildfires eight times more frequent, and extreme temperature events 25 times more likely compared to present-day baselines. Even under a 1.5°C pathway, most event types become 20–40% more frequent. The state is assumed to cover approximately 50% of total damage costs by default, though this proportion varies significantly by country and insurance market structure.

This data is embedded in our Decarbonisation Fiscal Impact Estimator, where you can adjust the state damage share and see how different warming levels affect projected fiscal costs for your country of interest.

Implications for Financial Institutions

For banks, insurers, and asset managers, the OECD-EDISON framework provides a structured way to think about climate-related fiscal risk at the macro level. This is relevant for sovereign credit analysis, where fiscal sustainability under climate scenarios directly affects bond valuations; for regulatory stress testing, as central banks and supervisors increasingly require climate scenario analysis; for ESG integration, where understanding the fiscal environment in which companies operate adds a systemic risk perspective to portfolio-level analysis; and for ESG data management, where climate scenario data needs to be captured, structured, and reported alongside company-level ESG metrics.

At Generation Impact Global, we build the data infrastructure that connects these macro-level risk signals to portfolio-level reporting workflows — helping financial institutions operationalise climate risk analysis within their CSRD/ESRS and SFDR compliance processes.