Background

Chile’s steady growth and macroeconomic, as well as political, stability have made it one of the best performing economies in Latin America and the Caribbean since 1985 (World Bank, 2011). Chile’s economy has experienced robust economic growth in the recent past, registering an average 4.35 per cent annual GDP expansion between 2011 and 2015. The first South American country to enter the Organisation for Economic Co-operation and Development (OECD) in 2010, Chile had a GDP of USD 258.1 billion in 2014 and a population of 17.95 million people in 2015. Chile’s rapid export-led growth has been driven by the country’s vast wealth of natural resources, including the world’s largest copper reserves, sizeable forestry and fisheries resources (USGS, 2014). Although the fall in commodity prices and China’s slowdown reduced output growth to 1.9 per cent in 2014 and 2.1 per cent in 2015, Chile’s sound macroeconomic framework and flexible exchange rate have helped maintain growth above the Latin American average (OECD, 2015).

Chile’s reliance on commodities – mainly mining, forestry and aquaculture – have put pressure on its natural resources, which is exacerbated by the effects of climate change. Chile is currently facing challenges related to air pollution, sustainable water management, land degradation and soil erosion (World Bank, 2011). Chile’s narrow and long territory, nestled between the Andes and the Pacific Ocean, covers a wide range of landscapes and biodiversity hotspots, such as glaciers and deserts, which are also threatened by climate change. For example, the country’s central region is expected to see less rain while receding glaciers in the country’s southern tip will diminish the amount of water available for aquaculture and agriculture (Searle & Rovira, 2008). These concerns, as well as a desire to gain access to international markets, namely the EU, through compliance with environmental regulations have prompted Chile to implement legislation that is in line with sustainable practices in recent years.

Fiscal Profile

Chile is often singled out among its Latin American counterparts for its ability to contain spending during commodity booms. Chile has followed a fiscal rule that has a cyclically-adjusted fiscal balance as its target (Frankel, 2010), despite the fact that copper accounts for a substantial amount of the Chilean government’s revenues (over 30 per cent in 2006) (Rodriguez et al., 2015). According to Frankel et al. (2011), this fiscal restraint has been possible due to Chile’s decision to grant forecasting responsibility to an independent Advisory Committee for GDP Trends. The Committee’s sound fiscal rule of structural surplus helped Chile achieve current account surpluses during much of the commodity boom, allowing the country to save more than 10 per cent of its GDP in two sovereign wealth funds (SWFs):  the Pension Reserve Fund (FRP) and an Economic and Social Stabilization Fund (FEES). The FRP complements payments on social protection and pension programs by backing state guarantees on basic social protection schemes. The FEES contributes to macroeconomic stability by financing possible budget deficits and making public debt payments so that the country’s fiscal position is not as strongly affected by fluctuations in tax and copper revenues (Chile, 2013). This fiscal restraint has been accompanied by pro-market policies that seek to boost competitiveness, institutional stability and international trade. While the fiscal outlook remains solid for Chile, the country has recorded current account deficits in recent years as a result of lower commodity prices and the 2010 earthquake (OECD, 2015).

Chile’s tax revenues are comparatively low in comparison to other OECD countries, with a 20.2 per cent tax-to-GDP ratio in 2013 (OECD, 2015). Taxation of personal income and natural resources has been historically low, a fact that has motivated the government to introduce a major tax reform in 2014 that is forecasted to increase GDP by 3 per cent (OECD, 2015). Chile’s spending on environmental protection is also significantly lower than other OECD countries. Chile’s central government agencies spent the equivalent of 0.1 per cent of GDP in environmental protection in 2012 (OECD, 2016). Most of the spending was concentrated on biodiversity and landscape protection, waste water treatment and environmental impact assessment and enforcement (Chile and ECLAC, 2015).

Policy and Legal Framework for a Green Economy

Pressure from international organizations and trade partners has spurred Chilean action on sustainable development policies. In 2009 Chile signed the OECD Declaration on Green Growth which encouraged domestic policy reform to advance sustainable policies and avoid practices that might thwart green growth, including fossil fuel subsidies (Woischnik, 2015). In 2013, a National Green Growth Strategy was adopted and outlined the country’s approach to policies to eradicate poverty and jumpstart economic growth while taking environmental considerations into account. The objectives of the Strategy are to implement environmental management instruments and develop a market for environmental goods and services to spur ecologically-friendly innovation and green employment. The Strategy is structured around five pillars: preventing environmental damage, attributing responsibility to polluters, and implementing reforms that are efficient, gradual and realistic (Chile, 2013). After joining the OECD, Chile also created a new Environment Ministry and the Council of Ministers for Sustainability which assesses the environmental impact of economic activities (OECD, 2011).

Chile’s remarkable economic growth has been accompanied by an increase in pollution as GHG emissions grew by 23 per cent from 2000 to 2010 in Chile (OECD, 2016). In 2010, the country voluntarily committed to implementing a Nationally Approved Mitigation Action (NAMAs) to reduce GHG emissions by 20 per cent by 2020 compared to 2007 levels (Chile, 2013). In 2015, Chile announced it would reduce its CO2 emissions per unit of GDP by 30 per cent relative to 2007 levels by 2020 (OECD, 2015). The country has also made ambitious commitments in other areas. Chile pledged to reach a 20 per cent target of renewable energy sources in its energy mix by 2020 (OECD, 2015). Despite the country’s heavy reliance on imported fossil fuels, Chile is expected to meet its renewable usage target by 2020 (OECD, 2015). The Chilean government has adopted a number of measures to reduce GHG emissions and increase renewable energy. For example, in 2008, the government approved a law that required companies to include at least 5 per cent of their electricity from non-conventional renewable energy sources by 2010 in a Renewable Portfolio Standard (RPS) scheme (Nasirov & Silva, 2014). The law stipulated that the percentage would increase by 0.5 per cent each year from 2015-2024 and a USD 28 fine would be levied on every MWh below the ceiling. In 2013, the Chilean government doubled its renewable energy target from 10 per cent by 2024 to 20 per cent by 2025. This move has created incentives to invest in renewables, however many projects have stalled due to limited access to financing and the high costs of initial investments (Nasirov & Silva, 2014). Nevertheless, there have been increasing expenditure in environment related research and development (R&D), which grew to 9 per cent of total R&D expenditure in 2012 – one of the highest amounts in Latin America (OECD, 2016).

Fiscal Measures for Green Economy

Chile has a history of utilizing tradable permits that take into account the environmental cost of certain economic activities. Chile pioneered the use of tradable permit mechanisms for water rights, particulate emissions in Santiago and for some fish species in the early 1990s (OECD, 2011). In September 2014, Chile became the first South American country to tax carbon and other pollutants as part of a sweeping tax reform. The annual tax will apply to particulate matter, nitrogen oxide (NOx) , Sulphur oxide (SOx) and carbon dioxide (CO2) emissions from thermal power plants with a capacity of over 50 MW beginning in 2018 (Chile, 2014). The carbon tax will be USD 5 per metric ton of CO2 equivalent, while the other air pollutants will be taxed at USD 0.1 per metric ton of pollutant multiplied by certain factors, including whether a high number of citizens are affected the emissions (Chile, 2014). The carbon tax does not apply to energy producers who use non-conventional renewable energy sources. Despite acknowledging the innovative nature of the tax, the OECD criticized the Chilean carbon tax for falling short of the actual social costs of carbon and being too low to spur long-term investment in low-carbon technologies (OECD, 2015). Revenues raised from the carbon and air pollution taxes will be channeled to the general budget (Lagos, 2016). Chile also supports international efforts on carbon pricing and is a member of the Carbon Pricing Leadership Coalition (CPLC, 2015). In addition to the tax on air pollutants, the tax reform included a one-time tax on new light and mid-size vehicles based on a formula that takes the car’s selling price and its NOx emissions into account (Chile, 2014).

Chile also provides a number of subsidies in other sectors, especially forestry, which represented 2.6 per cent of the country’s GDP in 2014 (Chile, 2015a). Since 1974, subsidies have been provided to tree planting to propel the growth of plantation forests. The subsidies increased from USD 150/hectare in the 1980s to USD 400/hectare in the early 2000s (OECD, 2005). The initial subsidies benefited large landowners for the most part and provided incentives that resulted in the replacement of 160,000 hectares of native forest by plantation forest between the 1970s and 1990s (OECD, 2005). The loss of native forests contributed to the rise of monocultures, loss of biodiversity and conflict with indigenous populations (Fraser, 2015). In 2008, Chile approved a new subsidy that is meant to recover native forests to ensure sustainable management of Chile’s forests. The subsidy is distributed through a public contest to projects that favor native forests, diversify forest cover and recover lost native forests (Chile, 2008).  The subsidy amount varies and applies to a number of different conservation activities. Fines from implementation, monitoring and enforcement of laws and regulations on the protection of soil and water resources; wildlife and flora; planting and harvesting of forest trees and shrub species and control of forest fires go towards the Chilean National Forest Corporation’s (CONAF) funds (FLA, n.a.).

In order to deal with increased water demand, Chile approved a water “patent” non-use fee in 2005 which has been applied to water rights holders with unused water rights since 2007 (Madden, 2010). The non-use fee is not applied to water flow below 10 liters per second in the country’s north and below 50 liters per second in the rest of the country (Madden, 2010). The annual fee functions on a system of escalating fees, which begin at one third of the total water right cost, and is meant to avoid speculation and discourage monopolization of water resources (Madden, 2010). The non-use fees raised CLP 31,275 million (USD 47 million) in 2015 with revenues divided between Regional National Development Funds (65 per cent), municipalities (10 per cent) and the central government’s coffers (25 per cent) (Revista Electricidad, 2016).  The OECD has recommended that Chile implement additional economic instruments, taxes, fees and tradable permits to address water quality problems, as well as charges for direct discharges into water bodies and agricultural inputs to waterways (OECD, 2011).

Years of overfishing have substantially reduced fish stocks in Chile, where fishing represented over six per cent of exports in 2014 (OEC, 2013). Though the government has introduced quotas for fishing certain types of fish, progress on replenishing fish stock has been slow. Chile, which boasts the world’s second largest production of farmed salmon, approved a National Fishing Law in 2013 that aims to reduce overfishing and ensure the sustainability of Chile’s fisheries sector (WWF, 2013). Chile is part of the World Wildlife Fund’s Southern Cone Alliance, which seeks to safeguard South America’s marine ecosystem from overfishing (WWF, 2013) and part of the informal “Friends of Fish” group, which includes the United States, Argentina, Iceland, New Zealand, Norway and Peru, which aims to end fish subsidies that contribute to overfishing (WTO, 2015).

In 2006, the country also introduced a specific tax on mining profits, however the taxation of mineral resources is relatively low in Chile compared to other OECD countries, and annual revenues from this tax amount to 0.45 per cent of GDP (OECD, 2016).

Environmental taxes amounted to 1.1 per cent of GDP in 2014, which is lower than the OECD average of 1.6 per cent of GDP (OECD, 2016). However, as a percentage of total tax revenues, environmental taxes stand at 5.6 per cent, which is higher than the OECD average of 5.1 per cent, which may reflect the fact that Chile’s tax obligations are lower than most OECD countries (OECD, 2016). In 2016, the OECD recommended that Chile apply higher taxes on diesel and petrol (OECD, 2016).

According to a recent assessment by the OECD (2016), although much progress has been made in Chile with new fiscal instruments, environmental rules and ministries put in place to move towards sustainable growth, careful implementation of these policies is required to ensure tangible changes on the ground.

Fossil Fuel Subsidy Reform

Chile is highly dependent on imported fossil fuels, which accounted for 69 per cent of the country’s energy mix in 2014 (Chile, 2015b). Biomass represented 24 per cent of energy use, while hydro power was at 6 per cent and non-conventional renewable energy (solar, wind and biogas) accounted for one per cent of the country’s energy mix in 2014 (Chile, 2015b).

As in Uruguay and Costa Rica, Chile utilizes a price stabilization mechanism for fuel, which smooths out fuel taxes (Carlino & Carlino, 2015). The country’s Fondo de Estabilización de Precios del Petróleo – FEPP was established in 1991 to minimize the impact of short-term price volatility on consumers and applied to petrol, domestic kerosene, diesel, liquefied gas, naphtha and petroleum fuel (Carlino & Carlino, 2015). Although the FEPP remained financially healthy during its first years, oil price hikes in the late 1990s led to an emergency injection of capital and reform (IMF, 2013). The total fiscal cost of the FEPP over 2000-2005 time period is estimated at 0.15 per cent of 2012 GDP, while the cost over 2006-2009 is estimated at 0.65 per cent of 2012 GDP (Vagliasindi, 2013). In 2005, Chile provided compensation to 5 million low-income households and those using less than 150 kWh per month, as well as another payment to low-income families in 2006 (IMF, 2013).

In 2011, FEPP was curtailed to apply only to domestic kerosene and a new system was introduced, the Sistema de Protección ante Variaciones de Precios Internacionales de  Combustibles – SIPCO, an adjustment mechanism that depends on excise taxes to smooth transmission of changes of international oil prices to consumers in Chile, but not large fuel consumers (IMF, 2013). It is estimated that the total cost of support to petroleum through FEPP in 2011 was CLP 2 million (in addition to CLP 6 million to natural gas in 2010) and CLP 82 million for SIPCO (OECD, 2013). In 2014, a new stabilization mechanism, the Mecanismo de Establización del Precio de los Combustibles  – MEPCO was established based on two prices: a reference price and a variable price to change duties on gasoline, diesel, liquefied natural gas, and compressed natural gas (Kojima, 2016). The MEPCO aims to transfer price hikes and drops to consumers over time. An analysis by the Latin American Center for Economic and Social Policy found that, between August 2014 and December 2015, the variable tax component for gasoline represented a net subsidy of USD 2 million and a net income of USD 25 million for diesel for a total net of USD 23 million in income for the two fuels (Alonso, 2015). MEPCO also established a fiscal expenditure maximum of USD 500 million on MEPCO (Kojima, 2016). Kojima (2016) contends that after years of stabilization funds, Chile has turned to a variable tax on fuel, which is a positive development on its path to reducing fossil fuel subsidies. According to the International Institute for Sustainable Development (IISD), Chile is a positive example of a country with strong transparency arrangements for fuel pricing, which can pave the way for the liberalization of the domestic fuels market (IISD, 2012). Chile also supports international efforts to encourage fossil fuel subsidy reform and is a member of the Friends of Fossil Fuel Subsidy Reform group (FFSR, n.a.). However, despite these developments, implied tax rates on transport fuels are among the lowest in the OECD (OECD, 2015).

References and additional reading

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Carlino, H. & M. Carlino. (2015). Subsidios a los combustibles fósiles en América Latina: enfrentando el reto de una estructura de incentivos perversos. Institut du développement durable et des relations internationales (IDDRI). Working paper.  November 2015. http://www.iddri.org/Publications/Collections/Idees-pour-le-debat/WP1515_ES.pdf

CPLC, Carbon Pricing Leadership Coalition. (2015). Carbon Pricing Leadership Coalition: Official Launch and Work Plan. November 2015. https://canada.citizensclimatelobby.org/wp-content/uploads/sites/8/2016/03/CPLC_Official_Launch_Report.pdf

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Chile, Ministerio de Hacienda. (2013). Directrices de Inversión del Fondo de Estabilización Económica y Social (FEES). 4 June 2013.

Chile, Biblioteca del Congreso Nacional de Chile. (2014). Reforma Tributaria, Ley No. 20780, Art. 8.  26 September 2014. http://www.leychile.cl/Navegar?idNorma=1067194&buscar=20780

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