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Will fiscal policy help move us towards a green economy?

The Green Growth Knowledge Platform recently held a conference in Venice that brought the importance of implementing properly designed green fiscal reforms to the attention of academics and policy-makers. The primary objective is environmental protection and climate change control, but also the setting of fairly uniform regulatory and taxation frameworks to avoid competitiveness concerns in those countries adopting more stringent environmental policies. Or to avoid excessive social problems in developing countries, because social impacts of green fiscal reforms are of often as important as the environmental ones.

Green tax reforms, designed to tax activities that result in environmental damage and excessive natural resource use, to redirect public and private investments from fossil fuel based activities to low carbon alternatives, to fuel green economy development, and to provide markets with the right signals for sustainable long-term investments, may indeed raise production costs in countries adopting them, thus reducing firms’ international competitiveness. Or may imply revenue reductions in important sectors of society.

The 3rd Annual Green Growth Knowledge Platform Conference held in Venice, Italy on the 29-30 January 2015 (you can find all papers presented at the conference here) gathered experts and policy-makers from several countries, particularly developing countries, as well as experts from international organizations, who shared knowledge and forged pathways towards better future implementation of green fiscal instruments.

The conference provided both theoretical analyses and best practices of concrete implementations of fiscal instruments designed to control climate change, natural resource excessive exploitation and local pollution. It also provided a useful exchange of views and suggestions between two communities (scientists and economists on the one hand, policy leaders on the other) that hardly interact. Let us summarize some of the main findings.

A variety of instruments, often country specific

Often the full range of fiscal reforms remains unexplored. As suggested by Franks et. al, this is partly due to governments’ preference for a taxation approach, which enables the scarcity rents to be reinvested in infrastructure. Revenue recycling of environmental taxes also facilitates a reduction in distortionary taxes and can be used to support green R&D.

However, despite the benefits of green taxes, other approaches can often facilitate green economic growth. Governments need to capitalize on the full range of fiscal policy options. For example, some governments have implemented feed-in tariffs to kickstart investments in renewable energy from sources such as solar, geothermal and wind. This is achieved by guaranteeing a tariff for a set period of time (up to 20 years in some cases) and thenphasing out this support over time as the share of renewable energy increases and becomes competitive with conventional fuels. This initial support is essential for redirecting capital flows from carbon based energy because, as Vona and Verdolini show, long-term investments have already been placed in existing fossil fuel infrastructure, which implies that changes in energy production will be slow and nearly impossible to achieve without a trigger.

In addition to feed-in tariff options, governments are also developing targeted financial programs that support the purchase of energy efficient appliances. These schemes, while important, require understanding and working with behavioral norms. For instance, Nadia Ameli shows that the application of these programs to households is more effective if the residents are landlords or are from high-income backgrounds.

These more innovative schemes are not confined to the more financially-secure developed countries. Indeed, the Tunisian government used US$24 million of public funds to promote the use of solar water heaters. In Mauritius, one of the pioneers of traditional fiscal reform through environmental taxation, we see the development of a number of green fiscal measures, including an excise duty on petroleum products and a charge on energy inefficient products. These policies have been able to elicit changes in both consumption and production behavior. As a positive side effect, the revenue generated as a result of these fiscal policies is equivalent to 2.6% of the country’s 2013 GDP.  This capital can be used to further support green economic growth.

The adoption of green fiscal instruments is not limited to the energy sector. Another crucial area is water. Here fiscal measures can play a critical role in ensuring sustainable water supplies through incentivizing water efficiency, stimulating investment in water supply infrastructure, ensuring affordability of water services and countering the unchecked pollution and abstraction of water sources. In fact, the use of taxing (along with tariffs and transfers) can ensure that the cost of the environmental externalities associated with water use is internalized and that water is therefore appropriately priced. On this note,encouraging news comes from Philippines where a wastewater effluent fee was introduced in Manila in 1997. This fee aimed to counter the extreme degradation of the Laguna de Bay watershed that was being used as a dumping ground by nearby industries. As a consequence of the fee, industries changed their production processes to reduce the volume of effluent that was discharged into the watershed.


3rd Annual Green Growth Knowledge Platform Conference held in Venice, Italy on the 29-30 January 2015

Removing subsidies

There is a growing realization that the transition to a green economy will not be achieved if countries continue to hide the true cost of current consumption patternsby subsidizing fossil fuels. This withdrawal of support has freed up capital that can now be spent in more efficient and beneficial ways. Often these savings can be redirected to fund social development, such as improved health, education and living standards. In Kenya, for instance, as Alice Kaudia convincingly explained, the government improved the country’s electricity network through the funds made available by removing fossil fuel subsidies.

Divesting from fossil fuel sources, particularly in cities and transport-intensive areas, not only encourages movement towards a green economy, but has direct positive impacts on health. This, in turn, means that governments will have to spend less on national health care. So even more public savings can be made. Shifting from these fossil fuel investments is especially important in developing countries. This is because, even though climate finance mechanisms are attempting to make development and climate mitigation compatible, fossil fuel subsidies are so vast that the climate finance given is almost insignificant.

As well as removing environmentally damaging subsidies, government can also encourage renewable energy subsidies in terms of technology innovation, adoption and manufacturing incentives. Though the enacting of these subsidies must be carefully designed because they are starting to be touted for their ability to distort international trade. At the conference, Carolyn Fisher analysed how the EU and US have both tabled complaints against China’s subsidization of solar photovoltaic production on the grounds that this support constitutes illegal aid to the companies.

Moreover, while there is some enthusiasm around the subsidization of clean energy, this may not in fact be the solution people are seeking. This is because some subsidies, especially upstream subsidies, tend to pick technology winners. This prevents the take-up of clean energy technology in the most cost-effective and efficient manner since picking the renewable energy options you want to subsidize withholds the funding other renewable energies that could, with the technological development, deliver energy in a cost-effective way.

Barriers to redirecting investments

The fact that developing green fiscal policies not only weans us off our fossil fuel dependency, but also can ensure savings and social benefits leaves you wondering why these measures have not been enacted with greater enthusiasm. Four main barriers have been highlighted at the conference. First, policymakers feel that they are damaging their economic competitiveness if they enact environmentally related policies when other countries do not do it. Second, green fiscal instruments would perhaps be more readily accepted were they to be introduced as part of a broader fiscal reform. Third, it’s often hard to effectively communicate the economic, social and environmental benefits that these reforms would bring.

A final important drawback is that, as with any reform, there will be winners and losers. One of the roles of government is to guarantee support for the affected groups. This is achievable. Indonesia, for instance, subsidized health care, rice production, village infrastructure and provided scholarships to economically-vulnerable groups to prevent against the worse impacts of inflation due to fossil fuel subsidy reform. As Renner et al. discussed in Venice, in Indonesia, and other places facing similar reforms, such protection schemes are essential since fossil fuel energy subsidies incur higher public spending than health, education and social protection combined, suggesting that the removal of subsidies will catalyze political and economic upset.

Green fiscal reforms need to be carefully designed and implemented in line with strong and sustainable governance to ensure that the reforms are effective and able to be maintained. Their design, especially of tax measures, needs to focus on activities that are inelastic in order to reduce welfare loss. Equally, this must be achieved while minimizing the aggregate deadweight loss for any given revenue or government expenditure.

3rd Annual Green Growth Knowledge Platform Conference held in Venice, Italy on the 29-30 January 2015

The way forward

Green fiscal policy clearly has a strong role to play in the transition towards a green economy. Even the limitations it presents are not insurmountable. Governments need, however, to start thinking more creatively, moving beyond using just environmental taxation, in particular in developing countries. See, for instance, Chaturvedi et al. on how India is developing alternative fiscal strategies, including deregulating petrol prices, introducing a coal cess and subsidizing the establishing of common effluent treatment plants.

Even so, more than moving into using a range of environmental fiscal reform methods, we need to stop seeing such reforms in solely an environment sector capacity. The transport sector, for instance, has much to offer in environmental improvements without necessarily terming them as such.

Further, we can explore ways of making such reforms more appealing to the people they will affect. Other approaches need to be used in combination with fiscal reform, such as communication and engagement with the parties concerned as well as improved monitoring. Sirini Withana suggested the use of complementary policies to increase the effectiveness of such reforms. Potential complementary policies might include behavioral change approaches that can incentivize the adoption of energy-efficient and low-carbon energy options.

A session moderated by Elke Weber emphasized the importance of combining behavioral, social and technological changes to stimulate the acceptance of the policy reforms that will lead us towards a low carbon future.

Before all these developments, we must overcome the notion that these decisions will come at a political and economic cost. If anything, this conference has shown that we can no longer use economic disadvantages as a reason for inaction. Solutions are being sought to address this concern and we need to listen to them to effectively start on the path to global green growth.

Credit: International Center for Climate Governance

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