Budgets in high water? Fiscal implications of flood adaptation in the United Kingdom

Climate change poses substantial fiscal challenges, driven by increasing damages and adaptation costs. While the benefits of timely, public adaptation are well established, the question of financing these measures remains underexplored. This paper addresses this gap for flood adaptation in the United Kingdom. Using a multi-sectoral CGE model, we analyse how different public financing mechanisms affect fiscal sustainability and economic welfare. Analysed financing mechanisms include (i) shifts in public expenditures maintaining budget neutrality, and (ii) deficit financing via domestic green bonds or (iii) via international bonds. We find that adaptation moderates economic losses and fiscal consequences from flooding, despite considerable upfront investment costs. However, the extent of positive effects depends on the financing mechanism and time horizon, as well as future lending conditions, represented by different interest rates. Domestic bond financing comes at the cost of reducing private investments, while budget-neutral financing requires cuts in public consumption. Debt financing allows for higher public consumption, but this effect is counteracted by interest payments on accumulating public debt in the long run. The results demonstrate that, while adaptation improves long-term welfare, fiscal outcomes depend on the chosen financing mechanism and time frame. More accurate expectations about future lending conditions can lead to better financing decisions.