Rodrigo Pizarro, ex-head of the Division of Environmental Economics of the Ministry of Environment of Chile, explains Chile´s environmental fiscal reform strategy, which  could represent a way forward for many developing and middle-income countries in their efforts to promote the 2030 Agenda for Sustainable Development.

Dr. Rodrigo Pizarro is an economist from the London School of Economics and holds a PhD from Stanford University with over 20 years’ experience working on environmental issues. Currently he is a professor at the at the University of Santiago of Chile (USACH). He was the former Head of the Environmental Economics Division of the Ministry of the Environment of Chile (2014-2018), where he was responsible for developing the Chilean Sustainable Consumption and Production Program, developing the Chilean System of Environmental Accounts and designing and implementing the first Environmental Tax in Chile, among other major initiatives.

Chile is a small middle-income country that in recent years has experienced significant economic growth achieving one of the highest per capita income levels in the region. Economic growth has had a direct impact on people’s lives, notably reducing the population living in conditions of poverty, from 38%, in 1990, to only 11.7% today. However, economic growth has brought on severe environmental problems related both to the potential impacts of climate change and local atmospheric pollution. Therefore, Chile implemented a series of environmental policy reforms including (i) the creation of an environmental ministry, (ii) the adoption of reforms in the energy sector, (iii) the establishment of protected areas and (iv) has taken very seriously its commitments to the Paris Agreement, even agreeing to host the COP 25 this December.

Although Chile does not contribute significantly to global greenhouse gas (GHG) emissions, it is highly vulnerable. According to the UNFCCC, Chile meets seven of the nine criteria associated with climate change vulnerability. With respect to air pollution, it is estimated there are 3,700 premature deaths per year, – over a third of deaths from respiratory diseases – because of the high concentration levels of particulate matter, associated principally with wood burning for heat, emissions from transport exhausts and industry. Moreover, the growth in car ownership not only generates considerable pollution but is seriously affecting the quality of life in the cities. For example, in 2018 sales of new cars rose by over 25% from the previous year.

Tax Reform

To help address these challenges, and contribute to climate mitigation efforts, the Government of President Bachelet (2014-2018) designed a two-pronged approach to implementing environmental taxes that targeted both local and global pollution simultaneously. In a General Tax Reform Bill (Law Nº 20.780) passed in September 2014, two pollution taxes were introduced (implemented in 2017), affecting stationary sources with boilers or turbines on both local and global containments. A third tax was also introduced on the first sale of cars (implemented in 2015), based on their expected emissions.

Taxes on stationary sources

The tax on stationary sources targets facilities across different economic sectors such as food-processing, refining and the electricity sector. The rate was set at US$ 5/ton of CO2 emissions. The tax is significant because it is the only one in the region explicitly based on emissions, not fuels. Although taxes based on the carbon content of fuels can achieve an equivalent result and lead to an accurate estimation of emissions, the advantage of using emissions as the tax base is that it facilitates the developed of an institutional infrastructure to support systems for monitoring reporting and verification (MRV) at the facility level. Developing more accurate reporting systems will be essential for international reporting, to expand carbon pricing policies across jurisdictions and sectors, and, above all, develop more sophisticated policy instruments, such as offsets, compensations schemes, or transnational emissions trading.

In the case of the local pollution tax, (i.e. particulate matter (PM) nitrogen oxide (NOx) and Sulphur dioxide (SO2)) the tax was set at a variable rate based on a formula that tries to capture the environmental damage associated with emissions in different areas. Although tax revenues cannot be earmarked and go to the national budget, the tax rate varies by municipality based on an estimated social cost coefficient defined in the law, the population and the carrying capacity of the municipality where the facility is located. For example, in the case of PM, the tax rate for an emitted ton can vary anywhere from US$60 thousand to US$ 500 per ton, depending where the facility is located. Thus, the tax rate not only captures the estimated marginal damage of a ton of emission in a specific locality, but signals to companies the most environmentally efficient geographic location in which to be based.

Taxes on stationary sources: Results

Although further research is needed to evaluate the full impact of the reform, the taxes have proved to be extremely effective. In the case of the tax on stationary sources, ninety-four facilities were liable, in 2017, raising US$191 million in revenue for both local and global contaminants. In 2018 revenues fell slightly to US$188 million, around 0,3% of total tax revenues, but nearly 8% of revenues from taxes on fuels.

The CO2 tax covers approximately 40% of the country’s carbon emissions, and although CO2 emissions have not fallen during the period, electric generation plants publicly declared that they would no longer develop new coal based electric generation plants and signed an agreement with the Ministry of Energy to gradually retire existing coal plants. Although there is no deadline to retire coal plants, there is an ongoing, voluntary, negotiation between the government and energy companies; making it quite clear that even a relatively small tax will act as a signaling device for future taxes, thus generating a soft incentive for companies to adjust their long-term investment plans.

In the case of local contaminants, there is evidence that facilities have introduced abatement equipment that has considerably reduced their emissions with a significant environmental impact. Preliminary estimates suggest that, in the period 2017-2018, emissions of particulate matter from the regulated industries have fallen by 7%.

Taxes on mobile sources

The tax on the first sale of automobiles has the objective of making combustion cars more expensive, with the purpose of limiting car sales and generating an incentive for individuals to buy cleaner cars. The tax rate is still low and is also based on a formula where the tax rate changes according to the expected NOx emissions. Revenues, in 2017, reached US$ 107 million, covering around 77% of the new cars that were sold in the country. Only 13% of the new cars sold were diesel run, but since the tax is based on potential NOx emissions, the tax revenue from the sale of diesel cars represented over 40% of the total revenue collected. As the tax rate increases, this could turn out to be a significant incentive to promote cleaner transport.

Lessons from Chile

These taxes can and should be refined. The taxes can be broadened and/or raised. In the case of the carbon tax, an offsetting scheme can be designed to allow for more compliance, flexibility and efficiency. However, what is relevant is that Chile has shown a way forward for developing countries to face their most significant environmental problems -local and global pollution- in a consistent and coherent manner with market-based economic instruments.

While market instruments are by no means the only instrument to support environmental sustainability, they are relevant as a mechanism to send price signals to public and private agents to internalize the external costs of global warming and local pollution. Furthermore, they can raise considerable revenue, thus generating income for other development objectives, or reducing taxes on labor income.

Environmental taxes are here to stay as a central policy instrument for green growth. An integral approach of environmental taxes and effective expenditure on environmental objectives is known as environmental fiscal reform, an effort to redirect the tax burden from ‘goods’, such as income, to ‘bads’, such as environmental externalities, may be an essential policy to move forward with the 2030 Agenda for Sustainable Development