This article has been published jointly with CEP.
The Argentine G20 presidency has three concrete priorities: jobs, infrastructure, and food security. Strikingly though, carbon pricing was not invited for Tango. Indeed, the absence of carbon pricing as well as green fiscal reform among the list of priorities within this year’s agenda jeopardizes the Group's goal of ensuring sustainable economic growth as both are crucial to reach these objectives simultaneously.
Green fiscal reforms that reduce subsidies for fossil fuels and introduce positive prices on emissions would not only contribute to climate change mitigation, but also could increase the economic efficiency of national tax systems and provide additional public revenues that could be employed to advance human development. However, most countries either have no carbon pricing, or they incorporate negative prices in the form of fossil fuel subsidies. This actively supports the use of fossil fuels, particularly for large oil producers.
Phasing out inefficient fossil fuel subsidies has been a long-standing issue in the G20 negotiations. While the G7 has suggested that all countries should phase out subsidies by 2025, the G20 has not yet agreed on a date. The resistance partly stems from the fear that it would be the poor who would suffer from the phasing out of subsidies. In Latin America, a recent Inter-American Development Bank study suggests that, with energy subsidies, it costs governments US$12 to transfer US$1 of income to households in the poorest quintile. Green fiscal reforms would hence not only help to maintain environmental integrity, but would also free substantial funds that could be employed in a pro-poor way to promote sustainable socio-economic development.
There are six key aspects are decisive for the successful introduction of such reforms.
First, policy makers will need to develop a clear understanding of conditions providing the opportunity for green fiscal reform, which will crucially depend on e.g. the state of the economy and national priorities such as energy security or economic diversification. Developments on the international level, such as progress in international climate negotiations or introduction of green policies in other countries, may boost domestic support for green fiscal reforms. Likewise, newly appointed heads of state may have the clout necessary to successfully foster such reforms, especially when there is sufficient backing by the general population. For instance, in Argentina fiscal pressures and the need to reduce fuel imports might provide an incentive for the reform of fossil fuel subsidies. Likewise, the Peru’s aspired OECD membership could create a favorable scenario for green fiscal reform, with environmental taxes being seen as an entry requirement.
Second, policy-makers can build on synergies between environmental policies and areas such as transport, industry, agriculture, finance, trade, or social inclusion. Potential co-benefits of green fiscal reforms include energy security (reduced reliance on fossil fuel imports), local environmental benefits, and the potential to diversify the economy. The multi-objective nature of energy and climate policies needs to be reflected in comprehensive strategies that ensure consistency of climate targets with other policies. Such strategies will need to include all relevant ministries and encourage coordination between national and subnational public entities. Green reforms should particularly consider important Latin American challenges such as informality, inequality, unemployment, air quality, or lack of national industries to provide capital inputs for renewable energy projects.
Third, green fiscal reforms will require a preparatory phase that lowers the costs of reform, thus reducing political resistance. For instance, fiscal incentives for alternative energy sources would create groups that would directly benefit from (and which can hence be expected to lend political support to) green policies. Green fiscal reforms can also be introduced after building administrative capacity to effectively enforce the policies. Such capacity could include staff to monitor fossil fuel sales and tax payment. In many countries, price increases for liquefied petroleum gas (LPG) and diesel are politically contentious as these fuels are important for low-income households, either directly, in the case of LPG, or indirectly through public or goods transportation.
On the other hand, gasoline prices are often less contentious in terms of aggravating poverty, as they are predominantly consumed by richer households. Suddenly raising prices for all fossil energy carriers to their desired level could cause substantial economic problems as firms and consumers require time to adjust. A salient example is the tax on the carbon content of fossil fuels introduced by Argentina in 2017. As it replaces existing fuel tax, it has no initial effect. Nonetheless, it can provide a basis for future price increases that will have real impact on final prices.
Fourth, understanding distributional consequences of green fiscal reform and the design of compensation schemes to prevent adverse outcomes for the poorest segments of society is crucial. Different schemes can protect low-income households from the impacts of higher energy prices. These include direct cash transfers, in-kind transfers (such as provision of health, education, social security, or public infrastructure, including public transportation), as well as targeted tax reductions (especially, indirect or regressive taxes and taxes on wages).
In addition, numerous countries use block-pricing schemes for electricity, which allow low-income households to consume a specified amount of electricity at a reduced rate. In principle, a small fraction of savings from subsidy removal is sufficient to compensate poor and vulnerable households. That is, poorer households benefit less than others from fossil fuel subsidies. For instance, in Ecuador the poorest 40% of the population only receive 20% of every dollar spent on subsidies for diesel and gasoline, whereas the other 80% accrue to the richest 60% of the population.
Fifth, transparency is key to ensuring policy credibility, i.e. the expectation that announced policies will in fact be introduced and maintained. To achieve this, environmental agencies need information about the social costs of negative externalities. Green fiscal reforms should include periodic evaluations of impact and effectiveness. It is critical to legitimacy to ensure that the associated revenues are well-employed. Importantly, stakeholder consultations need to guarantee that all relevant social groups are represented in the decision-making process and that appropriate measures are adopted to alleviate excessive adverse impacts on any single group. Fiscal reforms need to include consultation processes to guarantee that traditional rights of the indigenous peoples living in most Latin American countries are not violated.
Such consultations should not only occur prior to the introduction of a reform, but its impacts and the position of key stakeholder to the reform should be continuously monitored. This will enable adjustments to be made if goals are not met or measures need to be introduced to mitigate adverse effects that go beyond those that had initially been expected. For instance, in Brazil, the World Bank’s Partnership for Market Readiness has conducted workshops with stakeholders, e.g. from the industrial sector. These workshops revealed resistance to a carbon tax, whereas stakeholders expressed a more positive attitude towards an Emissions Trading Scheme.
Sixth, the international community could play a key role in supporting green fiscal reforms. The G20 could host processes that allow the exchange of experiences to better understand the relationship between policies, their effects, and their contexts. Such forums could also be platforms to perform peer-review of implemented policies as is already common practice for subsidy reform under the G20. Furthermore, international climate finance could not only be used for project finance, but could cover the macro-economic costs of green fiscal reforms.
An example of this are results-based payments for the introduction of a price on emissions (Steckel et al. 2017). International climate finance, particularly regional development banks, can play a very useful role in supporting the access of Latin American countries to international climate finance. The Inter-American Development Bank (IADB), the World Bank, the Green Climate Fund (GCF) and the Global Environment Facility (GEF) could be important institutions in the funding of green policies. The EU is also examining how to integrate sustainability considerations into its financial policy framework to generate finance for sustainable growth. It is likely this would also apply to strong green finance in the context of development cooperation.
In each country the conditions in regard to the synergies, the distributional consequences and the transparency of a Green Fiscal Reform are different, of course. Therefore, each country needs to make its own steps. But even if the specific steps may differ, it should still be the same dance: the Green Fiscal Reform Tango that Argentina should invite for.
Note: This article draws on the T20 policy brief “Green Fiscal Reform for a Just Energy Transition in Latin America” by Jakob, M., Soria, R., Trinidad, C., Edenhofer, O., Bak, C., Bouile, D., Buira, D., Carlino, H., Gutman, V., Hübner, C., Knopf, B., Lucena, A., Santos, L., Scott, A., Steckel, J.C., Tanaka, K., Vogt-Schilb, A., Yamada, K.