The public finance tools that marry economy and environment

By on 16/10/2017
Solar panels like these in Hong Kong lie behind a Chinese success story (Image courtesy: Snowacinesy).

For years, China has been using subsidies and taxation to build its solar power equipment industries – and as a result, it dominates world markets. Now other countries are using fiscal tools to align economic growth with environmental sustainability. Gavin O’Toole reports

“As you invest in your economy to make it greener and more oriented towards sustainable development, you gain on your economic and social fronts as well,” says Dr Joy Kim, a senior economic affairs officer at the UN Environment Programme (UNEP).

Kim is challenging the idea that the goals of improving environmental sustainability and fostering economic growth must clash; policies such as the introduction of carbon taxes, she believes, can strengthen private investment, profits and job creation whilst reducing our impact on the environment. “It’s a myth that you will lose out if you have to invest in the environment,” she says. “Yes, it takes time and requires investment at the beginning, but you will actually harvest the benefits in the medium and longer term.”

UNEP is a co-founder of the Green Fiscal Policy Network (GFPN), along with the International Monetary Fund (IMF) and the German Development Agency (GIZ). And Kim says that both GFPN’s work on the ground with several countries, and broader green economy assessments, have shown that measures such as green taxes, reforms to energy subsidies, and the use of fiscal incentives to develop clean technology can give economies a boost whilst cutting pollution and the emission of greenhouse gases (GHGs).

A global debate

In the wake of the USA’s withdrawal from the 2016 Paris Climate Agreement, Kim is only too aware that the global debate around this issue is far from won. But there is growing evidence that green fiscal and subsidy policies can have a big impact on the development and costs of sustainable technologies: this week new figures from the UK’s Department for Business, Energy and Industrial Strategy revealed that the financial support required by onshore wind power providers has halved in just two years, after a programme of subsidies encouraged businesses to invest in R&D and scale up production.

The UK’s success here will ultimately bring down energy bills, whilst fostering a major new industry with export potential. Indeed, the supporters of green fiscal tools argue that they can help countries get into emerging markets early on, whilst improving productivity and future-proofing national economies. And where they succeed in improving sustainability, they reduce the risks and costs associated with environmental damage: whilst no-one can prove that this year’s devastating US and Caribbean hurricanes were caused by global warming, climate change scientists have long predicted a rise in the number of such extreme events.

The use of such policies has grown in recent years: Dr Kim says at least 90 countries have included fiscal measures designed to cut GHGs emissions or contribute to mitigation within the ‘Nationally Determined Contributions’ (NDCs) required under the Paris agreement. This month the Partnership for Action on Green Economy (PAGE), which brings together UN agencies to support the push for greener growth, will launch an e-course on green fiscal reform.

Green fiscal policies in action

Dr Joy Kim, a senior economic affairs officer at the UN Environment Programme (UNEP), which is a co-founder of the Green Fiscal Policy Network (GFPN) (Image courtesy: Joy Kim).

Environmental taxes are seen as an effective tool for addressing ‘externalities’ – the environmental damage caused by economic activity – by, for example, shifting power generation away from fossil fuels. By the end of 2016, about 100 countries – accounting for 58% of GHG emissions – were considering carbon taxation or had introduced it. The OECD says use of environmentally related taxes is growing, globally representing about 5.2% of all tax receipts.

The new sources of revenue generated by environmental taxes can be used either to soften the impact of the new regime, or to invest in social infrastructure such as education, healthcare and welfare.

Significant environmental tax reforms have been undertaken in Europe, and the German example is often cited as a success story. Revenues generated through environmental tax reforms in 1999 were transferred to the country’s public pension scheme to reduce labour costs. According to the German Environmental Agency, the reform helped create 250,000 jobs.

UNEP says fiscal reforms aimed at extractive sectors such as mining can generate new public revenues while reducing the damage this activity causes. And the GFPN believes sovereign wealth funds topped up with revenues from extractive sectors offer considerable promise. In Timor-Leste, for example, the Petroleum Fund – in which US$20.9bn (£16bn or €14.4bn) generated by hydrocarbons production has been deposited since 2005 – makes a major contribution to public finances.

Many countries employ tax breaks, reliefs or other fiscal tools to induce the private sector to invest in green technologies. China, for example, has used electricity tariffs and created a Renewable Energy Development Fund (REDF) to establish global leadership in solar power.

How to spend it?

A key issue facing countries is whether to earmark the revenues from environmental taxes solely for use in green sectors. Kim is not a fan of such ‘hypothecation’, noting that “in principle, earmarking is not advised – although in practice many countries are doing it. It is not wise to say that revenues from carbon taxation, for example, should all go towards clean technologies: if a country’s national priority is health because they have a health crisis, these resources should be mobilised to address that first.”

As well as introducing new measures to support sustainable technologies, countries can revisit the existing systems of taxation and subsidy built to support older, more environmentally damaging industries such as oil extraction and landfill waste disposal.
Countries continue to support fossil fuel production and consumption in many ways, at a cost of $60bn per year in the OECD area alone, but many are reforming subsidies despite the resistance and political risks.

Ghana illustrates the difficulties facing public finance managers, having tried several times to reform subsidies in the face of stiff opposition. Iran, a country with high fuel subsidies, began reforms in 2010 but has suffered setbacks as its government has battled inflation.

A new movement

International initiatives, networks and campaigns have sprung up to support green fiscal reforms – from the Carbon Pricing Leadership Coalition (CPLC) to the Climate Action Peer Exchange (CAPE).

Dr Kim says the GFPN is not attempting to transform public budgets into entirely green affairs, but finding ways to use fiscal policy to encourage sustainable development. “When you want to move towards a more circular and greener economy, and eventually towards the sustainable development goals (SDGs), it is critical to know how you are going to finance that – and a lot can be done with domestic public resources,” she says. “The double advantage of green fiscal policy is that it mobilises domestic resources, but also addresses environmental externalities at the same time.”

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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