The climate-fiscal timebomb

How climate change will impact public budgets

By Jaya Sood, Sebastian Mang, Dominic Caddick, Maike Schmidt

09 March 2026

By 2050, the average public debt of EU member states could be 58 percentage points (pps) higher than official forecasts unless climate risks are addressed. In 2070, that could rise to 197 pps. New modelling by the New Economics Foundation (NEF) finds that fiscal stability depends on early and coordinated climate action. Despite growing evidence of the severe economic impacts of climate change, the EU’s economic framework still treats short-term public debt as the central threat to stability, while overlooking the deeper vulnerabilities that will drive debt in the decades ahead. Integrating climate damages, adaptation, and mitigation costs into debt paths shows debt ratios that rise steeply under inaction but are materially lower under credible climate investment and supportive policy settings. Meeting these challenges requires a fiscal framework that enables rather than constrains public investment.

At the same time, the EU faces a significant green investment gap. Institut Rousseau estimates that closing the mitigation investment gap will require around 1.6% of gross domestic product (GDP) in additional annual public investment to meet the 2040 and 2050 climate targets. The European Environment Agency (EEA) estimates that the investment need for adaptation in the EU27 and the UK combined will be around €40bn under a 1.5C scenario, rising to €80 – 120bn under 2C, and reaching €175 – 200bn under 3 – 4C (2015 prices).

This report extends the European Commission’s Debt Sustainability Analysis (DSA) to include climate impacts and transition dynamics — factors currently missing from official projections. Our model shows that because of weaker growth and productivity and reduced tax receipts, debt ratios rise once climate change impacts are incorporated, while investors demand higher borrowing costs to reflect mounting climate risk. The physical damage caused by climate change also requires billions in public funds to repair and rebuild infrastructure and support affected communities. Mitigation and adaptation investment reverses this dynamic. Green spending boosts productivity and cuts the costs of climate damage. Building cleaner energy systems, resilient infrastructure, and efficient housing not only protects public finances but also delivers wider benefits, from lower energy bills and better transport to healthier, more secure communities.

Increased green investment will require additional borrowing. Higher debt levels make fiscal rules harder to meet and increase the economic and political trade-offs required to stabilise public finances. Therefore, while higher debt levels shouldn’t necessarily be seen as opposed to the goal of debt sustainability, higher debt will continue to come with more economic and political trade-offs.

We have constructed five illustrative scenarios: climate agnostic, business as usual (BAU), early EU investment, delayed EU investment, and a scenario with early investment alongside global cooperation. We have also modelled two sub-scenarios under early EU investment, one where the EU adopts progressive tax policies and another where the European Central Bank (ECB) and fiscal institutions coordinate more effectively to achieve the transition.

Our stylised scenario modelling shows that early EU investment, particularly when combined with global cooperation, is more fiscally sustainable than late/no additional mitigation and adaptation investment. In that scenario, average debt increases by 4 pps above the Commission’s official projections in 2050 and decreases by 12 pps below official projections by 2070 – completely reversing the estimated effects of climate inaction on public finances.

Assuming early EU action, introducing progressive taxation (eg through a wealth tax) could raise around €213bn a year across the EU. Implementing such taxation could lower average debt to 17 pps above the Commission’s official projections in 2050 and 22 ppts by 2070.

Coordination between monetary and fiscal policy, combined with EU early action could cut borrowing costs and lower debt ratios significantly. This results in debt increases being 21 pps above the Commission’s official projections in 2050 and 15 pps above by 2070.

This report recommends a fundamental realignment of the EU’s economic governance to reflect the climate reality. First, the DSA must be reformed to incorporate a climate-adjusted baseline, realistic green multipliers, and sovereign risk premiums that capture the fiscal cost of delay. Second, the fiscal framework should move toward a preventive model, where independent fiscal referees replace rigid numeric rules with qualitative assessments of climate and resilience spending. To prevent regional fragmentation, the EU should establish a permanent Climate Resilience Facility for common borrowing and expand the Solidarity Fund. Finally, by phasing out fossil fuel subsidies and deploying a broader toolkit of progressive taxation and monetary-fiscal coordination, Europe can lower the cost of capital for green investments while ensuring the transition is financed fairly.

The conclusion is clear: climate stability is fiscal stability. Inaction drives debt onto explosive trajectories, while early, globally coordinated action means climate-related fiscal risk is averted. Europe’s fiscal rules and economic governance must now evolve to reflect this reality, integrating climate risk, supporting productive public investment, implementing fair taxation, and aligning monetary and fiscal policy to build lasting stability.

Country profiles

Our modelling includes data on 25 out of 27 EU member states. The country profiles below includes the fiscal and climate context for each country as well as the national results of our modelling.