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Fiscal Policy for a Sustainable Environment

Written by: International Monetary Fund

Article Overview: In both developed and developing countries, fiscal policy has an important role to play in assuring sustainable use of natural resources and safeguarding the environment. This applies to both the tax and spending sides of the government’s budget.

Fiscal Policy for a Sustainable Environment

In both developed and developing countries, fiscal policy has an important
role to play in assuring sustainable use of natural resources and safeguarding
the environment. This applies to both the tax and spending sides
of the government’s budget. On the former,
• Taxes can be used to ensure that prices reflect the full social costs of producing
goods and services. This type of pricing is most conducive for
growth over the long term. The prices charged for petroleum products,
for instance, need to reflect not only the cost of buying or selling them
on the world market but also the social costs of the airborne pollution
their usage can create and—in the absence of better-targeted instruments,
such as toll charges—the congestion associated with motor vehicle use.
• A well-designed tax and royalty system is key to ensuring that countries
receive a proper share of the rents earned by the exploitation of
their natural resources and to ensuring that those resources are not
overexploited. For many developing countries, rents from mineral deposits,
forestry, or fisheries can be an important source of revenue and
one that, with a well-designed tax regime, is compatible with socially
appropriate patterns of resource usage.
On the spending side,
• Some public expenditures, such as assistance to rural energy efficiency
and spending on forestry management agencies, directly
support more efficient resource use. Subsidies for, or relatively low
taxation of, kerosene may also be desirable, since in many developing
countries it is used as a household fuel, providing an alternative to
deforestation.
• Other kinds of spending, however, may inadvertently increase environmental
externalities by pursuing objectives that could be better
achieved by less damaging means. Subsidies for particular kinds of
energy use, for instance, are sometimes intended to serve primarily
distributional goals but generate adverse environmental effects that could be avoided. The underlying equity objective could still be met
by eliminating such subsidies and spending the resources saved on
basic health care or education. (Box 1 gives more examples of these
harmful subsidies.)
In many countries, there are significant opportunities for “win-win” fiscal
reforms that enhance the sustainability of both resource use and the
fiscal position. Prices of both intermediate inputs—such as energy or
chemical fertilizers—and outputs—such as agricultural commodities—
are still seriously distorted, even in many industrial countries, aggravating
environmental degradation (Table 4). These cases of combined policy and
market failures can be turned around to provide “win-win” opportunities
for fiscal reform. For example, eliminating subsidies on fossil fuels can
simultaneously strengthen macroeconomic balances, promote efficient
resource allocation, and improve the quality of the environment.32 Beyond the elimination of policy distortions, there may also be cases in which environmental
taxes—such as pollution or waste charges—are called for to
properly account for the negative effects of pollution. These have the side
benefit of increasing government revenue, enabling other and more harmful taxes to be reduced or beneficial public spending to be increased, although
such revenues, especially in developing countries, may be modest.
Many of the fiscal reforms needed to enhance sustainable resource use
and environmental protection would be good policy, even in the absence of
such special considerations. This is because many of the most damaging
provisions arise from distortions often introduced for nonenvironmental reasons,
so that the same policy objective can be achieved by other means that
do less damage. The desire to help farmers, for instance, has led some countries
to zero-rate fertilizers and pesticides under the VAT. As an alternative,
the VAT could be charged on these items at the standard rate; this would reduce
the prospect of fraudulent refund claims and generate additional revenue,
which could then help finance expenditures to benefit small farmers,
such as those to improve rural transportation networks. In such cases, environmental
considerations are usually only secondary in the policy debate,
with revenue and standard efficiency issues being more to the fore; nonetheless,
the potential environmental gains from such reforms can be significant.
Taking its lead from organizations with a particular expertise and mandate
in the environmental area (especially the World Bank) and focusing
particularly on problems with a macroeconomic dimension, the IMF has encouraged
countries to implement fiscal reforms that are consistent with
more sustainable resource use. In Uzbekistan, for example, the IMF has repeatedly
argued that the degradation of irrigation water and agricultural
land—owing to massive explicit and implicit subsidies—is unsustainable
and has severe economic costs. To remedy this, the IMF recommended increased
charges for irrigation and other communal services to cost-recovery
levels. The IMF has also advocated reforms in the pricing of energy—in
Azerbaijan, Belarus, Ecuador, Venezuela, and elsewhere—arguing that
prices should reflect the opportunity costs to the country. To help counter
the unsustainable depletion of water resources in Yemen, the IMF has encouraged
reforms to progressively eliminate the substantial subsidies on
diesel fuel and other petroleum products, since these encourage water
overuse by unduly reducing the costs of operating water pumps. The IMF
has typically not involved itself, however, in the design of pollution charges
and other taxes explicitly designed to correct environmental externalities,
leaving this to other organizations with the required expertise.
The forestry sector provides an example of how fiscal policy can be
used to capture resource rents while, at the same time, providing a number
of environmental benefits. Uncorrected market failures and governance problems are leading to the loss of large areas of forest in many
countries. These problems have also attracted attention in some IMFsupported
programs (Box 2). In many countries, the value of the rents
captured from concessions for forest resources has been too low, leading governments in need of revenue to accept excessive exploitation.33
Reforming the pricing of forest resources would help governments to capture
more resource rents and so strengthen fiscal balances. At the same
time, these reforms would encourage more efficient and environmentally
friendlier exploitation of forests.

Fiscal Dimensions of Sustainable Development
Prepared for
World Summit on Sustainable Development
Johannesburg, August 26–September 4, 2002

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  5.1 Fiscal space is critical for diversification: Economic Report on Africa 2007

Article Tags: airborne pollution, energy efficiency, energy use, environmental externalities, fiscal policy, forestry management, kerosene, kinds of energy, management agencies, mineral deposits, petroleum products, proper share, public expenditures, resource usage, resource use, rural energy, sustainable use, tax regime, toll charges, world market



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