Latin America sets the pace on environmental taxes

By on 20/06/2017
Mexico’s green taxes should help reduce pollution, helping to tackle Mexico City’s smog (Image courtesy: Fidel Gonzalez).

Several Latin American countries have introduced ambitious green tax reforms. Gavin O’Toole learns the lessons for others keen to push their economies towards environmental sustainability

The pioneering introduction of carbon taxes in Chile and Mexico has set an ambitious yardstick for Latin America, providing lessons for other developing countries as to how to fashion public finances into a weapon against global warming.

Chile’s carbon tax – which came into effect this year, and is due to be collected for the first time in 2018 – follows the launch by Mexico in 2014 of a tax on the sale and import of fossil fuels.

Both initiatives formed part of broader structural changes to taxation systems that are being emulated by other countries such as Colombia, which at the end of 2016 incorporated a carbon tax within an ambitious tax reform bill.

“Recent tax reforms in the region, especially those in Chile and Mexico, have been trailblazing in that they have included green taxes that were untried and untested in Latin America,” sas Michael Hanni, an Economics Affairs Officer at the Economic Commission for Latin America and the Caribbean (ECLAC). “A key lesson from the recent experience with green taxes in Latin America has been that their adoption has been eased by their inclusion in larger structural tax reforms.”

“It is likely that the adoption of these green taxes would have been more difficult on their own. For that reason, countries considering adopting these taxes would be well served to consider them within the framework of changes to the overall tax system.”

While the use of taxes to tackle environmental problems is well established in developed economies – European countries have been reconciling fiscal and green policies since the early 1990s – progress has been slower in the developing world as regions such as Latin America struggle to modernise ineffective tax systems.

However, governments have become increasingly aware of the advantages green taxes can offer public administration and financial management. Environmental taxes can be more effective than regulations; offer an economy broader efficiency gains by encouraging polluters to adopt new technology; and have the potential to yield revenues that can be used to reduce other taxes. The aim is to generate the “double dividend” of a cleaner environment and a more efficient tax system.

Although the revenue generated by these taxes varies among Latin American countries, some score well alongside their OECD counterparts, among which revenue from environmental taxes was on average 1.56% of GDP in 2014. In Brazil, Costa Rica, the Dominican Republic and Honduras, the environmental tax take exceeded 2% of GDP in 2014.

There are different categories of environmental taxes targeting energy consumption, motor vehicles, and other issues such as pesticide use; but climate change has increased the policy emphasis on reducing CO2 emissions. As a result, carbon pricing has become a multilateral priority and is now in use or planned in at least 40 countries. This allows polluters to decide whether to cut emissions by reducing their polluting activity, or to continue polluting and pay the price.

Countries wishing to tax the drivers of climate change can either issue emission permits or tradable emission rights, or tax the carbon in emissions and energy consumption. All these tools help to reduce emission levels and can coexist within one jurisdiction. Permits or tradable rights are effective at fostering supply and demand for emissions, and so indirectly establishing a market price for them. However, carbon taxes have advantages for developing regions because they are easier to introduce, offer polluters greater certainty about costs, adapt easily to changing fuel prices, and generate revenues that can be integrated effortlessly into established tax systems.

In Mexico, a tax on the sale and import of fossil fuels by carbon content was introduced as part of a major fiscal reform. Taxes were applied at different levels across a range of fossil fuels, although the carbon price that has been set is among the lowest in the world – equivalent to US$3.21 (UK£2.51, Euro €2.87) per ton of CO2 in 2014.

Chile’s carbon tax, also introduced as part of structural tax reforms, has a wider reach, applying to emissions produced by establishments whose boilers or turbines have a capacity of 50 thermal megawatts or more, and imposing a charge on unhealthy fine particulate emissions – a significant health hazard in the capital Santiago.

Both countries have faced a key question confronting policymakers about how these revenues are used: should they supplement the central government’s general budget, or supplant other taxes and so remain revenue neutral? Governments need to balance their ambition to cut emissions with the need to maintain public support for this form of taxation by protecting economic growth and ensuring fairness.

Carbon taxation has rarely been absolutely revenue neutral and proceeds have commonly been destined for general budgets, as happens in the UK. However, it is common for countries to use the proceeds to encourage low-carbon investments or to finance transfers to the households most affected by them. Green taxes can pose distributional questions because increasing levies on fossil-based energy for heating or transportation, for example, can affect low-income households disproportionately. In a region such as Latin America, where fiscal revenues are dependent on indirect taxation, authorities may consequently need to find ways of alleviating the overall tax burden on the poor.

In Mexico, legislation did not stipulate that the proceeds of the carbon tax – which ECLAC says has raised US$1 billion a year since 2014 – should be spent on environmental matters. However, the tax paves the way for the creation of a carbon market by 2018, in which manufacturers, producers and importers will be able to buy carbon bonds or certificates in lieu of the levy itself.

In Chile, when the government initially unveiled its carbon tax proposals it signalled that the proceeds – expected to total US$170 million in 2018 – would be destined for educational reform, a unique departure although one whose details have not been spelled out.

While in Chile and Mexico the assigned cost per ton of CO2 is considered to be low, there is little doubt that the reforms have created a ripple effect – seen as a factor in Colombia’s decision to introduce its own environmental taxes last year. The Brazilian states of São Paulo and Rio de Janeiro are now also exploring the introduction of sub-national carbon taxes.

Hanni says: “Carbon taxes are still in their infancy in Latin America, so it is difficult to judge them on being ambitious enough or not … Nevertheless, perhaps the most important element of the recently adopted carbon taxes in the region is that they have helped establish the institutional groundwork for more ambitious reforms in the future.”

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See also:

Brazil announces $64bn infrastructure project

Pensions reform aims to tackle Brazilian deficit

Regional administrations band together on climate change

About Gavin O’Toole

Gavin O’Toole is a freelance writer and editor in London. He has written for leading newspapers, magazines, wire services and business schools about financial markets, business and regulation around the world. He has a particular interest in international relations, and a specialism in Latin American affairs. He has conducted research on this region’s political economy and has also published a number of books about its politics and natural environment. His latest title, Environmental Security in Latin America, will be published by Routledge in September 2017.

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