In this paper, we study the implications of climate change on fiscal sustainability and inequality. First, using rich panel data, we show that rising climate-related disaster risks increase government debt and harm fiscal sustainability. We also find that the adverse effect of disaster risks is larger for low-income households, exacerbating inequality. Second, we construct a New Keynesian Dynamic Stochastic General Equilibrium (NK-DSGE) model to examine the implications of the distributional effect of disaster risk. The model features two kinds of households and a fiscal authority. We show that disaster risk has recessionary effects and also causes inequality among households to widen. More specifically, the model indicates that “hand-to-mouth” agents suffer a drop in consumption that is three times larger than that of the Ricardian households. Importantly, we observe a significant rise in sovereign debt due to disaster risk, which poses a challenge to policymakers. Lastly, targeted transfers are recommended but progressive taxes entail a significant fiscal cost.