1

INTRODUCTION TO
green fiscal reform
Policy context, rationale and related concepts

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Course authors:
Giuliano Montanari, Maya Valcheva, Amrei Horstbrink (UNITAR); Philip Gass (IISD)

Contributors:
Jason Dion (IISD); Sirini Withana (UN Environment); Sarwat Chowdhury, Massimiliano Riva
(UNDP).

Creative Concept:
Arturo Rago

Graphic Design:
Pilar Lagos (UNITAR)

Photo credits
Unless stated otherwise, the photos used in the journal are under a CC license.
TABLE OF CONTENTS
Introduction 5

1 Major Challenges Calling for Green Fiscal Reform 6

OVERVIEW 6
FISCAL CHALLENGES 6
ENVIRONMENTAL CHALLENGES 9
SOCIAL CHALLENGES 12

2 Defining Green Fiscal Reform:

Rationale, Barriers and Benefits 14

OVERVIEW 14
WHAT IS GREEN FISCAL REFORM? 14
THE RATIONALE FOR GREEN FISCAL REFORM 16
POLICY AND INSTITUTIONAL BARRIERS TO GFR 17
BENEFITS FROM GREEN FISCAL REFORM 18

3 BALANCING FISCAL, ENVIRONMENTAL AND SOCIAL GOALS 24

OVERVIEW 24
KEY DIFFERENCES BETWEEN TRADITIONAL AND ENVIRONMENTAL TAXATION 24
SYNERGIES SERVING FISCAL, ENVIRONMENTAL AND SOCIAL GOALS 26

4 KEY LEARNING POINTS 28

references 31

ABBREVIATIONS 32
Introduction
G
reen Fiscal Reform (GFR) can This Module describes the general policy
help achieve multiple government context of green fiscal reform. Lesson 1
objectives simultaneously, including outlines current economic, environmental and
fiscal consolidation, environmental protection social challenges which call for green fiscal
and poverty reduction. Many of these reform, while Lesson 2 provides a definition
objectives lie at the core of the newly adopted and a rationale for green fiscal reform, and
Sustainable Development Goals (SDGs). 1 highlights the various benefits associated with
it. Lesson 3 signals potential trade-offs related
In recent years, this policy approach has to green fiscal reform.
grown in popularity, with policymakers from
various departments recognizing the role After completing the module, participants will
of fiscal restructuring along sustainability be able to:
lines for the transition towards a green and
inclusive economy. - Outline trends and developments that
give rise to widened interest in green fiscal
GFR entails a broad spectrum of fiscal reform issues
measures, such as taxes and charges, subsidies, - Define the rationale for fiscal
tradable permits and finance schemes. interventions aimed at greening the
Green fiscal instruments can help correct economy
market failure, e.g. by incorporating social - Discuss possible impacts of green fiscal
and environmental costs such as pollution, reform
GHG emissions, health threats, etc., into - Describe the nature of trade-offs between
the pricing of goods and services traded in fiscal, social and environmental goals
the market place. In such a way, green fiscal
instruments alter the incentives for market
actors (consumers, producers and investors),
and encourage their sustainable economic
behavior. An additional benefit from GFR
can be the improved state of public finances,
resulting in co-benefits for a number of other
policy objectives. video
THE IMPORTANCE OF FISCAL POLICY TO THE
Green fiscal reform is concerned with the GREEN ECONOMY TRANSITION
intersection of two policy areas, i.e. fiscal
policy and environmental policy, although it
also affects many other policy domains, such
as economic and infrastructural development,
climate change, social welfare, etc. GFR
is not a new concept, however, due to its
cross-cutting nature and frequent lack of
interministerial dialogue within countries, GFR
has not received consistent attention over time
from fiscal and environmental policymakers. WATCH THE VIDEO

1 While environmental drivers are important motivators, and poverty reduction/job creation
is an overarching goal of government in all of its actions, it is usually the possibility for fiscal
reorganization that makes GFR most attractive for policy makers.
1

MAJOR CHALLENGES CALLING

FOR GREEN FISCAL REFORM
Countries are facing a number of challenges on their path to sustainable
development.The interlinked nature of these challenges requires a policy
approach that takes fiscal, environmental and social risks into account.

OVERVIEW
The persistence of interconnected fiscal,
environmental and social challenges in recent
years calls for policies and instruments
that are equally cross-cutting in nature.
The interest in green fiscal reform as an
innovative policy approach is an expression
of this way of thinking (UNEP 2010).
Although not the only factor, weak design and
management of government expenditure and
revenue collection can cause or exacerbate
a number of fiscal, environmental and social
challenges. By contrast, a healthy flow of
public finance can work to alleviate or reverse
them. In Lesson 1 we examine a series of
pressing fiscal (1.2), environmental (1.3) and
social problems (1.4) that GFR can help
tackle.

FISCAL CHALLENGES
Some of the key fiscal challenges that
countries face relate to high levels of public
debt, the inefficiency of their tax systems,
and the use of public finance in areas that are
environmentally and/or socially harmful.
Today, high public debt levels limit the fiscal
space of many governments, in turn tying the
hands of policymakers to make substantive
public investments (Brumby and Verhoeven
2010). In developed countries, public debts
have reached a historic level (see Figure 1).2

2 By contrast, in most developing countries the ratio of debts to gross domestic product (GDP) is
lower, however the greater risks related to currency devaluation make it harder to service external
debts (Gooptu and Primo Braga 2010).
 7

With donor countries facing debt challenges,
international financing, on which many
developing countries rely for poverty
alleviation and infrastructural projects, is
becoming scarce.3 Rising financial constraints
motivate governments to seek effective
measures to restore macroeconomic
stability, mobilize durable revenue streams
and decrease dependency on foreign market
conditions.
informal sector not covered by the fiscal
system (ILO 2015). This reduces the revenue
that countries can raise and use.
A related challenge is that tax systems still
tend to focus on taxing elements deemed as
positives like income, while items deemed
as negative, such as pollution or excess
resource use remain untaxed, or may even be
subsidized.

Efficiency, effectiveness and equity are In the area of government expenditure,

key principles of taxation. However, those
principles are often difficult to uphold,
and many tax systems are in fact complex,
bureaucratic, and/or abundant in legal
loopholes. Inefficient taxation facilitates tax
evasion and corruption (WB 2005).
Developing countries face particular
challenges due to the prevalence of a large
inefficient subsidies in energy, agriculture
or fishery sectors (among others) can weigh
heavy on public finance and pose serious
threat to the environment and human health.
In 2014, global energy subsidies stood at 628
billion USD, out of which 79 percent were
directed towards carbon-based energy sources
(Figure 2).

Notes:

Historical debt levels,

GDP-weighted average.

* includes Australia,
Canada, France,
Germany, Italy, Japan,
Korea, Spain, United
Kingdom and United
States.

Source: IMF Historical

public debt database,
OECD Economic
Outlook 94 database,
and OECD staff
calculations.

Fig. 1: Gross public debt of advanced economies: 1880-2013 (OECD 2013a)

3
For illustration, development aid by OECD countries fell by 4% in real terms in 2012, following a
2% fall in 2011.
 8

Accounting for environmental damages
from burning fossil fuels, these subsidies are
especially large relative to GDP in emerging
and developing countries (13-18 percent)
(IMF 2015).
However, subsidies can also be used to
support environmental, social and economic
goals.
For example, in areas that promote nascent
sustainable industries and technologies, such
as renewable energy production.4
The fiscal challenges, outlined in this section,
provide an opportunity for green fiscal reform,
as governments are looking for new sources
of funds and ways to make their taxation
systems and public expenditure more efficient
(i.e. by reducing inefficient subsidies).

Coal
2 billion USD Renewables
135 billion USD
Natural Gas
107 billion USD

Electricity from
fossil fuel
Oil 117 billion USD
267 billion USD

Fig. 2: Global Energy Subsidies 2014, billion USD (IEA 2015)

REFLECTION POINT
Looking at your own country’s public finances, what are current fiscal weaknesses or threats
to macroeconomic stability? Are these threats linked to global market trends?

4
Good governance practices are essential in ensuring that new subsidies (e.g. for renewables) provide
added value and do not become future ‘harmful’ subsidies if economic, technological or social
circumstances change.
 9

ENVIRONMENTAL CHALLENGES
Current patterns of consumption and
production result in a range of interconnected
environmental problems including water
scarcity, land degradation, deforestation, loss
of biodiversity, climate change, and pollution.
While the nature and magnitude of specific
problem differ between countries and regions,
environmental degradation and depletion of
natural resources is a global problem.
A 2015 estimation of the Global Footprint
Network shows that the ecological footprint5
of humanity exceeds the Earth’s bio-capacity,
with humans using the equivalent of 1.6
planets (Figure 3).
In a longer term, the overuse of natural
resources poses significant threat to
energy, water and food security. This drives
policymakers to look for cost-efficient ways to
reduce the use of natural resources.
The problem of overuse goes hand-in-hand
with the issue of inefficiency. A report by
TEEB estimates that the unsustainable use of
natural resources in the primary production
and processing sectors is responsible for
“environmental externality” totaling $7.3
trillion USD annually (2010). These
environmental externalities are largely
unaccounted for and untaxed, even though
they cause damage to natural and human
capital.

“Today humanity uses

the equivalent of 1.6
planets to provide the
resources we use and
absorb our waste. This
means it now takes the
Earth one year and six
months to regenerate
what we use in a year.

Moderate UN
scenarios suggest that
if current population
and consumption
trends continue, by the
2030s, we will need the
equivalent of two Earths
to support us.”

Source: Global Footprint

Network

Fig. 3: Exceeding the Carrying Capacity of the Earth 6

5
A method for measuring the pressure on the biosphere arising from human consumption of natural resources.
6
Click here for more information about the Global Footprint Network.
 10

BOX 1:
WHAT ARE EXTERNALITIES?

Externalities are effects or consequences
of an economic activity carried out by one
agent which are borne or enjoyed by others
without compensation (UNEP 2009a). For
example, the intended product of burning
coal may be to generate electricity.
The externality is the resulting unpriced air
pollution that affects the general public. The
associated costs from health problems (e.g.
respiratory diseases) are not paid by the
electricity producer, but – in this case – by
individuals or the public health sector.

Environmental externalities largely undermines hard-gained benefits from economic growth.

As Figure 4 shows, the costs of environmental degradation as a percentage of GDP are
considerable in many developing countries, thus refuting the validity of the “Grow first,
cleanup later” approach to development.

BOX 2:
ASSESSMENT OF ENVIRONMENTAL
COSTS IN INDIA

India has been enjoying rapid economic

expansion for multiple decades, thereby
lifting millions of people from poverty into
a growing middle class.

The downside of this development is

a rising level of environmental costs
associated with unsustainable economic
growth.

A World Bank report (2012b) estimates

the total cost of environmental
degradation in India at about 5.7 percent
of GDP in 2009, equivalent to 80 billion
USD annually.

Of this total, air pollution (both out- and

indoor) accounts for over half of the costs.
Other major contributors are croplands
degradation, decreased water sanitation
and hygiene and forest degradation. Fig. 4:
Cost of environmental degradation as
per cent of GDP (WB 2012a: 12)
(Source: World Bank, 2012b)
 11

REFLECTION POINT
Is the ‘Grow first, clean up later’ approach inevitable for development? What is the attitude in
your country?

Finding a way to live within Earth’s bio-capacity, account for environmental externalities,
and curb environmental degradation and climate change, obliges policymakers to look for
innovative fiscal instruments, in addition to traditional regulatory and economic policy
approaches.
 12

SOCIAL CHALLENGES
Social development and the state of the
environment are closely interlinked. Low-
income households are generally more
vulnerable to environmental degradation than
higher income segments, as they depend to
a larger degree on natural resources, (e.g.
forests, soils, water, coastlines, etc.) for their
livelihood.7
Figure 5 exemplifies this relationship. The
linkage between policies for social inclusion
and policies for environmental protection is
increasingly being recognized by policymakers.
Targeted cash transfers or tax exemptions
for the poorest, can be used to complement
measures aiming environmental protection.
The challenge of poverty alleviation is also
in close relation to the one of inequality,
i.e. the way income is distributed across
the population. In global terms income
distribution has become more unequal in both
developed and developing countries in the last
twenty years.
Between 1990 and 2012, inequality in
disposable income has increased for two thirds
of the world population (UNDESA 2013) and
let to a concentration of more than 50% of
the world’s wealth in the hands of the richest
1%.8

0 10% 20% 30%

Middle East and Drinking water

Northern Africa and sanitary
facilities
Southern Asia
Air pollution
(town)
Sub-Saharan Air pollution
Africa (indoors)
Exposure to lead
Eastern Asia
Climate

Latin America

North America

Western Europe

World

Fig. 5: Environmental risk factors for different regions (UNEP 2009a)

7 The reports from the World Bank (2005) and OECD (2005) discuss the role of green fiscal reform in particular
with a view on how it can support poverty reduction.
8 Click here for more info.
9 This issue will be picked up again in lesson 2 of this module, as well as in Module 3.
 13

Fiscal instruments can be designed in a way
that ensures that taxation and subsidies do not
benefit predominantly the rich, but reflect the
need to redistribute income.9
In a long-term, the best way to increase
social inclusion and reduce poverty is via
job creation. However, many policymakers
are concerned that commitment to
environmental protection and the green
economy may negatively affect jobs,
competitiveness, and ultimately deter
economic growth (UNIDO 2011).
Fiscal and market incentives can drive
innovation, thus support the development of
new green sectors and the restructuring of
the labor market (ILO 2011).

4 The Gini coefficient measures the distribution of income within a society. When the value is 0,
income distribution is perfectly equal. At value 1, one individual enjoys all income.

5 For an in-depth discussion about how fiscal policy can address inequality, consider IMF (2015b).
2

DEFINING GREEN FISCAL REFORM:

RATIONALE, BARRIERS AND
benefits
“Getting the prices right” lies at the heart of green fiscal reform.The choices
we make as consumers and producers are shaped by economic incentives.
Price signals, however, are often imperfect.

Overview
Now that we have explored the challenges Lesson 2 is structured in three parts, providing
that GFR can help address, let’s look into a definition (2.2) and a rationale for GFR
what it means. (2.3), as well as highlighting the benefits it can
result in (2.4).

WHAT IS GREEN FISCAL REFORM?

GFR refers to a range of taxation and
pricing instruments that can raise revenue
while advancing environmental goals
(WB 2005; OECD 2005).10 Thus GFR
works at the interface of fiscal policy and
environmental policy.
their supply. Employed for environmental
purposes, fiscal instruments can cost-
efficiently influence price signals and market
incentives and steer consumers, producers
and investors towards more sustainable
options (see Table 1).

In general, fiscal instruments aim at By definition, GFR is neither neutral nor

influencing markets. Instruments that
generate budget revenue (e.g. taxes) increase
prices of targeted goods in the market, thus
sending a signal to avoid/reduce activity or
product. Instruments that spend public funds
(e.g. subsidies) decrease the prices of goods
and services, thus lowering the costs for
certain products/services and encouraging
positive or negative with regard to revenue
flows. The budget implications will depend
on the specific design of the reform, which
in turn results from political priorities. At
its core however, GFR aims at achieving an
outcome that is socially, environmentally, and
financially sustainable.

10 In this course, GFR is synonymous with Environmental Fiscal Reform (EFR). In much of the literature on the
topic, the terms are used interchangeably unless otherwise stated.
 15

rEVENUE-GENERATING rEVENUE-SPENDING rEVENUE-NEUTRAL

INSTRUMENTS INSTRUMENTS INSTRUMENTS

Cap-and-Trade
Taxes Subsidies (free permits) 12

Charges Feed-in Tariffs Revenue-neutral

instruments

Fees Loans (below market rate)

Removal of subsidies Cash transfers,

compensation schemes

Cap-and-Trade Tax exemptions

(auctioned permits)11

Grants

Public procurement

Table 1: List of fiscal instruments for green fiscal reform

FROM REGULATORY TOOLS TO ECONOMIC INCENTIVES

In traditional terms, environmental policy has
often been a matter of static prescriptions.
The instruments used have been mostly
regulatory in nature and include, for example,
bans, prohibitions or technical standards
requiring a particular production method
or technology (UNEP 2011). Because they
leave little room for adaptation, regulatory
instruments are also known as command-and-
control tools.
Fiscal instruments, by contrast, are incentive-
based. This means that consumers and
producers can choose among goods and
services based on their financial capacity.
Command-and-control tools can be costly
and difficult to implement (e.g. costs for
monitoring). Furthermore, they provide
little incentive for market agents to innovate
and reap economic benefits from altering
their behavior (WB 2005; OECD 2005).
Thus, policymakers increasingly recognize
the need to complement them with a wider
range of instruments, e.g. fiscal instruments,
information tools and voluntary approaches,
within a dedicated policy mix (Withana 2015).
By combining different instruments, policy
makers can address complex environmental
challenges and ensure that the desired
outcome is achieved at the lowest possible
cost.
The notion of using fiscal policies for
environmental protection is not new. Since
the 1970s12 a number of countries have been
implementing environmental taxation and
subsidy reform with various scope and degree
of success.

11 Depending on the policy design, cap-and-trade can be revenue-positive or neutral. The distinction is made when
governments choose to sell, usually via auctioning, or give away permits (say, for carbon emissions) for free. Notably,
enforcing and monitoring such an instrument will generate administrative costs
12 France and Netherlands first introduced economic instruments to control water pollution (Schlegelmilch and Joas 2015).
 16

The rationale for Green Fiscal Reform

The costs of a product often do not reflect
the full environmental and social costs related
to its production, distribution, utilization and
disposal13. Imperfect price signals enable
market participants to engage in economic
activities that can be environmentally or
socially harmful (IMF 2012).
The rationale for a green fiscal reform is to
correct the market flaws and “get the prices
right” (UNEP 2010), i.e. internalize the costs
of externalities into the pricing of goods and
services, so that market participants can make
a choice that is both environmentally and
economically sustainable.

This occurrence is referred to as “market
failure”: a situation in which markets are not
able to entirely reflect the environmental and/
or social functions in a given price of a good or
service. When the cost of an environmentally
and/or socially harmful behavior is not fully
covered, or partially borne by others parties
without compensation, the result is an
externality.
If the market pricing correctly reflects the
smaller environmental and social footprints of
products, green products – such as renewable
energy or organic agriculture, would emerge
as competitive or even cheaper than
conventional ones. Such benefits are often
not accounted for, leading decision-makers to
perceive them as more expensive compared to
traditional options.

13 The life-cycle of all products have 5 phases: extraction of

materials, production of product, distribution and packaging, use,
end-of-life/disposal. During each phase resources products require
input from, or release outputs in, the environment
 17

REFLECTION POINT
Going through the things you regularly buy at the supermarket: Are there any products whose
pricing in your opinion do not fully reflect the costs of labor and resource input/outputs
throughout the life-cycle of the product?

POLICY AND INSTITUTIONAL BARRIERS TO GFR

GFR is mainly concerned with correcting
market failure. However, its successful
implementation, also depends on the
institutional and policy conditions within a
country. Often governments are unable or
unwilling to act in view of market failures,
which is referred to as a “policy failure”.
In some cases, governments can even
contribute to market failures by providing
perverse incentives, i.e. economic incentives
to engage in an environmentally harmful
behavior.
For example, fisheries subsidies are often
introduced to support national industries in a
heavily competitive market, but have steadily
contributed to falling profits in the sector
worldwide due to the depletion of fish stocks
caused by overfishing (UNEP 2008).
Furthermore, fiscal instruments rely on the
institutional capacities within a country,
i.e. the functioning of the administrative,
legal and monitoring systems. When such
enforcement systems are not in place, the
performance of the instruments is likely to
suffer. For instance, dumping fees at landfill
sites are commonly applied to raise revenue
and discourage solid waste generation. If
enforcement is not effective, however, it may
result in illegal dumping as consumers and
producers look for ways to avoid fees.

The photo illustrates

how markets can
produce very different
outcomes depending on
policy. In the past, Haiti
promoted deforestation
for crop plantation
without accounting for
longer-term economic
impacts such as
widespread soil erosion.

The Dominican Republic,

by contrast, chose a
policy less dependent on
soil or forestry inputs for
economic development.
The result is strikingly
encapsulated by
the photo. 14

14 Click here to see more country profiles and latest data on forestry compiled by Global Forestry Watch.
 18
BENEFITS FROM GREEN FISCAL REFORM
Tackling these failures via a dedicated fiscal
reform can bring significant benefits to
various segments of society and help achieve
multiple objectives. A successful reform
may translate into greater fiscal space and
administrative capacity for government, a
FISCAL BENEFITS
In the first place, GFR can substantially
improve the health of public finances by
reorganizing the revenue generation and
spending activities of governments (Green
Fiscal Commission 2009). Such reorganizing
may entail increasing public revenue through
new environmental taxes and higher taxation
efficiency on the one hand, or cutting
undesirable spending by eliminating subsidies
that harm the environment or vulnerable
groups, on the other.
BOX 3:
CHINA’S POLLUTION LEVY SYSTEM
(PLS)
China features one of the most extensive
policies for taxing industrial pollutants.
The PLS covers about 200 substances
relating to air emissions, water discharges,
solid and radioactive waste. The system is
generally considered to play an important
role in containing pollution in China in
a period of rapid industrialization while
generating significant revenue
Source: GIZ 2013.
15 If an extraction tax is applied primarily for revenue purposes, the resulting practice can be a “sell-out” of natural
resources. For example, taxation on logging timber may encourage governments to issue additional logging
concessions in order to maximize revenue from this activity.
16 When designing and implementing harmful subsidies reform, it is important to consider measures to lower potential
social costs.
cleaner and more preserved environment for
citizens, higher innovation rates for businesses
that yield competitive advantages over time,
as well as job creation and poverty reduction.
This section reviews the fiscal, environmental
and socio-economic benefits from GFR.
By means of green fiscal reform, governments
can expand their tax bases to cover new
industries, activities or products. For instance,
environmental taxes can be designed to
recover costs associated with various industrial
pollutants (Box 3). Or they can be applied to
natural resource extraction. The objective of
raising new revenues and the one of pricing
externalities can in some cases go hand in
hand. However, in other cases it is important
to ensure that the revenue potential does
not become prime motive as this could put
increasing pressure on the resource base (WB
2005). 15
On the expenditure side, removing misguided
subsidies can free up significant resources for
green public investment. Putting subsidies
under close scrutiny may reveal that the total
costs to society outweigh the total benefits.
Most energy consumption subsidies benefit
the rich and middle-income population,
particularly in emerging and developing
countries. Removing them can produce two
benefits at the same time, i.e. create fiscal
space for government on the one hand and
reduce unwanted economic distortion (in this
case, the disproportionate subsidy distribution)
on the other16 (IMF 2013).
 19
FIG. 6: Fiscal gain from eliminating energy subsidies as percent of GDP (IMF 2015)
In emerging economies, the revenue potential
from energy subsidy reform equals two times
the revenue from corporate income tax or the
public health spending. (see Figure 6).
The newly gained fiscal space allows
governments to redirect spending in various
ways (WB 2005). Revenues may flow into
the general budget where they can reduce
public debt. They may also be earmarked
for specific purposes, e.g. improving energy
efficiency in the industry sector, or research
and development of new sustainable
technologies. Alternatively, revenues can
be recycled (that is, partially flow back) to
compensate vulnerable groups or support the
reduction of other taxes, e.g. on labour (see
Box 4).
BOX 4:
ENERGY SUBSIDY REFORM IN IRAN
In the past, Iran featured the highest level
of energy subsidies in the entire world.
The economy has been one of the most
energy-intensive for many years due to oil
products being traded below market value.
In response to sustainability concerns about
both public finances and the environment,
the government embarked on a gradual
phase-out of energy subsidies within a
five-year period (2010-2015). As a result,
between 2011-2012 the government saved
41.6 billion USD which it could use to
partially compensate the most vulnerable
groups and business sectors.
Source: GIZ 2013.
 20

REFLECTION POINT
Given the key role of energy in the economy, are there energy subsidies in place in your country?
If yes, who benefits the most from them? Do the subsidies reflect a greening of the economy or
do they privilege fossil resources?

It is important to bear in mind, furthermore,

that generated revenue coming from
environmental taxation can be useful to cover
some or all of the costs of administrating
the same tax. Especially in developing
countries (see Box 5), where environmental
protection agencies are often underfunded,
the potential to cover the costs of monitoring
and enforcement with environmental tax
revenue can be considerable.
In sum, fiscal opportunities are considerable
for both developed and developing countries.
In developed countries with well-developed
fiscal system, gains can be achieved largely
through smart restructuring of taxation and
public expenditure. In developing countries,
where large part of the economy is informal
and therefore remains untaxed, tapping into
new tax sources can carry significant benefits
(OECD 2005).
BOX 5:
COVERING MANAGEMENT
COSTS IN UGANDA
The Sustainable Fisheries User Levy
enabled the Ugandan government to
reverse environmental degradation
in the fisheries sector by using
the generated revenue to improve
management practices, control and
surveillance. The administrative costs
are easily covered by the levy (GIZ
2013).

Source: GIZ, 2013

 21
ENVIRONMENTAL BENEFITS
Decades of experience in pricing reform
suggest that fiscal instruments can help
deter environmental degradation by
correcting market failures. Applying full-
cost accounting and taxing externalities
forces market participants to adjust their
economic activities in a way that minimizes
their tax burden. In the same way, removing
environmentally harmful subsidies eliminates
perverse incentives to exploit or consume
natural resources beyond sustainable rates
(Schlegelmilch and Joas 2015).
BOX 6:
EUROPEAN UNION EMISSIONS TRADING SYSTEM (EU ETS)
The EU ETS is a large-scale application
of the polluter-pays-principle by putting
a price on carbon and the environmental
damage it causes. It covers more than
11.000 power stations and industrial
plants as well as airlines in 31 countries,
representing around 45% of total EU
ECONOMIC BENEFITS
Unlike the static command-and-control
approach, taxes allow for a flexible reaction
to price signals by consumers and producers.
Once a tax is implemented, market actors
seek creative ways to reduce their tax-
related costs as much as possible, thus
incentivizing innovation (OECD 2011)
(Box 7). 18
17 The IISD study (2013), for example, presents comprehensive evidence on the effectiveness of economic incentives in the
energy sector
18 This innovation effect is also known as Porter hypothesis, named after the economist Micheal E. Porter.
Green fiscal policy essentially puts into
practice the polluter-pays-principle, i.e.
through fiscal instruments polluters assume
responsibility for environmental damages
and costs incurred to their activities. (see
Box 6). Thus, GFR provides market actors
with economic incentives to shift to cleaner,
resource-efficient products and services.17
GHG emissions. Given an overall limit (cap)
on emissions, members of the system are
required to buy so-called allowances for
emitting carbon. As allowances become
scarce, their price increases, thus shifting the
cost of pollution unto members. A market for
carbon emerges (European Union 2013).
Innovation spreads quickly and typically
increases efficiency in the economy.
Therefore, the environmental damage is
avoided at the lowest cost (OECD 2011).
Shift taxation from “goods” like labour and
income tax to “bads” like carbon emissions
or natural resource extraction creates an
 22
incentive for businesses to employ more
workers and opens opportunities for new
green sectors to develop (Schlegelmilch and
Joas 2015).
Thus, GFR can help the restructuring of
the labour market from sectors that have
negative environmental externalities towards
sustainable, green industries, e.g. moving from
coal to renewable energy.
SOCIAL BENEFITS
GFR can result in significant benefits for
the poor (OECD 2005). As GFR seeks to
improve environmental quality and resource
conservation, the vulnerability of poor groups
and their livelihoods would be reduced.
GFR can also contribute to poverty reduction.
Pro-poor measures can be direct, e.g. through
cash transfers or tax breaks for low-income
households, as well as indirect, e.g. via
additional investment in education, health
care or basic infrastructure.
Adjustment of tax rates for different income
groups is another way to further social
equality.
By applying a progressive tax rate on income
(i.e. one that increases with the taxable
income) wealth can be redistributed from
affluent to low-income people. Thus, GFR can
help make the fiscal system more equitable
overall.
As we have seen in this section, fiscal
instruments are quite versatile and can yield
a series of cross-cutting benefits. Against
this background, we will see that GFR also
contributes to the achievement of the new
2030 Sustainable Development Agenda
(GFR’s linkages to the 2030 Sustainable
Development Agenda will be discussed in
more detail in Module 5).
BOX 7:
CONTINUOUS DECREASE IN FOSSIL
FUEL USE IN SWEDEN
Sweden adopted several taxes on
carbon emissions and industrial sources
of pollution in the early 1990s. Today,
the country is among the lowest per
capita emitters of CO2 in the EU
thanks to a steady decrease of fossil
fuel use primarily in transportation
and heating. Taxation encouraged
consumers and producers to make
changes to both lifestyle and business
models in favor of less carbon-
dependent behavior.
(GIZ 2013)
BOX 8:
SHIFTING TAXATION IN GERMANY
In 1999 Germany started to shift
taxes from labor towards polluting
and energy-intensive sectors with a
goal to reduce carbon emissions and
save energy as well as create jobs. The
reform entailed an incremental tax
rise on mineral oil fuels, natural and
liquid gas. The transfer of tax revenue
to the public pension scheme allowed
for a reduction in labor costs due
to companies paying fewer pension
contributions. By 2003, the reform
created 250.000 new jobs and helped
environmental products and services
increase their market share.
(Knigge/Gorlach 2005)
 23

REFLECTION POINT
Can think of other benefits from GFR, e.g. in term of public finances, the political process,
personal well-being, etc.?

BOX 9:
HOW GREEN FISCAL REFORM CAN SUPPORT AGENDA 2030
Many of today’s development issues are jobs creation (SDG 8) or strengthening means
pricing issues at the bottom line. The of implementation (SDG17) can be supported
linkage of the Sustainable Development as well.
Goals and green fiscal reform is very
obvious in the case of, for example,
promoting sustainable water (SDG 6),
energy (SDG 7) or ecosystems services
(SDG 15), among others.

GFR can provide effective economic

instruments for regulating the use of
natural resources, encouraging sustainable
consumption and production patterns or
green infrastructural development. Inter
alia, non-environmental issues like decent
3

balancing fiscal,
environmental and social goals
Fiscal, environmental and social policy may stand in conflict at times due
to their divergent objectives. Implementing green fiscal reform requires
managing conflicting interests, priorities and trade-offs. But synergies
between fiscal and environmental objectives exist as well.

Overview
Policymakers are often faced with the difficult
task of balancing divergent policy goals. This
lesson illustrates some of the challenges of
using fiscal instruments for environmental
protection and social inclusion. Section 3.1
discusses why trade-offs can emerge between
fiscal and environmental goals, while section
3.2 highlights potential synergies between
them. This lesson is largely based on the paper
by Schlegelmilch and Joas, 2015.

A fundamental goal of fiscal policy is to raise
stable levels of revenue without necessarily
influencing the behavior of market actors.
For example, the taxation on postal services
does not aim to deter people from using
the postal system; value-added taxes on
retail services exists regardless of levels of
consumption.
On the other hand, environmental tax policy
deliberately aims to change or end certain
behavior through price signals. For example,
charges on pollution aim to discourage
the continuation of polluting activities.
Eventually, the achievement of the set
goal will gradually erode the tax base, for
example as market actors switch to cleaner
and more efficient production methods (WB
2005). 20

20 Certain taxation instrument that have a social function, also have the potential to erode gradually the tax base on
which they are set. For example, progressive taxation may diminish the incentive of a person/company to innovate
as rewards (relative income) shrink with success.
 25
The main point of environmental taxation
is thus not to provide a study revenue
stream (unlike conventional taxation), but
instead to alter the way economic actors
interact between each other and with the
environment.
As we have seen, fiscal goals may run
contrary to social and environmental
objectives. The more policymakers focus on
achieving one set of taxation goals, the more
likely are they to compromise another.
In the design fiscal instruments, one set of
policy objectives often outweighs the others.
BOX 10:
TWO EXAMPLES OF POSSIBLE ENVIRONMENTAL FISCAL POLICY DESIGNS
If the goal of the policy intervention
is to internalize externalities, fiscal
and environmental goals can be
complementary. If polluters’ charges
are set at a level which accounts for all
social and environmental costs caused
by pollution, then both fiscal and
environmental objectives can be met.
Polluters might decide to shift to a
different production method, which does
not generate pollution, in which case
the tax base and related revenue would
diminish. However, if the tax is at a level
that makes the shift too costly to polluters,
the taxation will continue to produce
steady revenue.
Taxes on plastic bags, for example, typically
aim at shifting entirely to non-plastic
alternatives.
The design of fiscal policies is an amalgam of
many factors, among which country specific
socio-economic consideration and factors
related to the political economy play an
important role.
Box 10 gives an example of two possible
scenarios for environmental fiscal policy
design, which look differently based on their
lead objective.
If the goal is to stop or phase out
a particular behavior, fiscal and
environmental goals would stand in
conflict with each other. The planned
disappearance of a behavior by means
of taxation implies that fiscal revenue
will eventually phase out as well with the
erosion of the concerned tax base.
For example, if all consumers switch to
energy-saving LED light bulbs, taxation
on incandescent light bulbs will no longer
generate revenue.
(Schlegelmilch and Joas 2015).
 26

Synergies serving fiscal, environmental and social goals

In some cases, fiscal and environmental
goals strengthen each other, creating useful
synergies. Consider the examples of tax
exemptions for heavy-polluting industries or
environmentally harmful subsidies, which are
of neither fiscal nor environmental benefit.
Removing these privileges would yield
benefits to both public finance (by freeing
up public funds) and the environment (by
correcting flawed economic incentives).
In other cases, putting an environmental tax
on certain products can help internalize social
and environmental costs, while providing
a steady and significant revenue flow to
governments.
Fuel taxes in OECD countries, for instance,
serve both these purposes. While their goal is
to reduce fuel usage, they are usually set with
a long timeframe and the tax rate can climb as
usage dissipates. Thus, the tax provides steady
revenue over time which can be deployed
for social purposes, while inducing change of
consumer behavior (OECD 2013).
taxation, in order to reduce the tensions and
maximize the synergies between fiscal and
environmental objectives:
“In principle, environmental
taxes should be evaluated based
on their environmental impact,
irrespective of revenue potential.
Accordingly, the primary purpose
of such – the correct pricing of
environmentally harmful activities
– must form the starting point
of any discussion of their use.
Nevertheless, the future revenue
potential of environmental taxes
must also be considered closely
in the context of a green tax
shift.”
(Ministry of Finance, Norway 2014)

The Norwegian commission on green

taxes proposes a general guideline on how
to approach the design of environmental
27
 28

key
learning points
1
Green fiscal reform (GFR) entails a broad spectrum of fiscal measures (taxes, fees, charges,
subsidies, etc.) that can be applied to achieve environmental, as well as economic and social
goals.

2
By correcting flaws in the functioning of the market, i.e. internalizing environmental and social
costs in the prices of goods and services, GFR changes the economic incentives of market
actors and influences their behavior.

3
Tackling externalities with fiscal instruments can yield significant economic, social, and
environmental benefits.

4
Attempts at achieving fiscal, environmental and social goals at the same time can lead to difficult
trade-offs. Policymakers need to carefully balance environmental and fiscal goal when designing
fiscal policies.
 30

REFERENCES
Brumby, J./ Verhoeven, M. (2010) Public Expenditure after the Global Financial Crisis, in: The Day After
Tomorrow, A Handbook on the Future Economic Policy in the Developing World, World Bank,
Washington, DC.

EU (2013) The EU Emissions Trading System (EU ETS), Factsheet, Brussels.

GIZ (2013) Environmental Fiscal Reform, Case Studies. Eschborn.

Gooptu, S./Primo Braga, C. A. (2010) Debt Management and the Financial Crisis, in: The Day After
Tomorrow, A Handbook on the Future Economic Policy in the Developing World, World Bank,
Washington, DC.

Green Fiscal Commission (2009) The Case for Green Fiscal Reform of the UK Green Fiscal Commission,
London.

IEA . 2015. World Energy Outlook 2015. Paris

IISD (2013) Green Revenues for Green Energy: Environmental Fiscal Reform for renewable energy technology
deployment in China, Winnipeg.

ILO (2011) Skills for Green Jobs, A Global View, Geneva.

ILO (2015) World Employment and Social Outlook, The changing nature of jobs, Geneva.

IMF (2012) Externalities: Prices Do Not Capture All Costs, Washington, DC.

IMF (2013) Energy Subsidy Reform: Lessons and Implications, Washington, DC.

IMF (2014) Taxing Principles, Washington, DC.

IMF (2015) Working Paper, How Large Are Global Energy Subsidies? Washington, DC.

Knigge, M./Gorlach, B. (2005) Effects of Germany’s Ecological Tax Reform on the Environment,
Employment and Technological Innovation, Ecologic, Berlin.

Ministry of Norway (2014) Mandate for a new green tax commission. Oslo.

OECD (2005) Environmental Fiscal Reform for Poverty Reduction, Paris

OECD (2011) Taxation, Innovation and the Environment: A Policy Brief, Paris.

OECD (2013) Taxing Energy Use, A Graphical Analysis, Paris.

TEEB (2010) The Economics of Ecosystems and Biodiversity: Mainstreaming the Economics of
Nature, Geneva.
 31

UNDESA (2013) Inequality Matters, Report of the World Social Situation 2013, New York.

UNEP (2008) Fisheries Subsidies: A Critical Issue for Trade and Sustainable Development at the
WTO, Geneva.

UNEP (2009a) Vulnerability of people and the environment – challenges and opportunities, Nairobi.

UNEP (2009b) Training Resource Manual, The Use of Economic Instruments for Environmental and
Natural Resource Management, Geneva/Nairobi.

UNEP (2010) Driving a Green Economy Through Public Finance and Fiscal Policy Reform, Geneva.

UNEP (2011) Towards a Green Economy: Pathways to Sustainable Development and Poverty
Eradication, Nairobi.

UNIDO (2011) UNIDO Green Industry, Policies for supporting Green Industry, Vienna.

WB (2005) Environmental Fiscal Reform, What Should Be Done and How To Achieve It,
Washington, DC.

WB (2012a) Inclusive Green Growth, The Pathway to Sustainable Development, Washington, DC.

WB (2012b) India, Diagnostic Assessment of Selected Environmental Challenges, An Analysis of

Physical and Monetary Losses of Environmental Health and Natural Resources, Washington,
DC.

Withana, S., (2015) Overcoming Obstacles to Green Fiscal Reform, GGKP Research Committee
on Fiscal Instruments, Working Paper 02/2015, UNEP 2015
 32

Abbreviations

co2 Carbon Dioxide

ETS Environmental Tax Shift
EU ETS European Union Emissions Trading System
EU European Union
GDP Gross Domestic Product
GFR Green Fiscal Reform
GHG Greenhouse Gas
GIZ Deutsche Gesellschaft für International Zusammenarbeit
IEA International Energy Agency
IISD International Institute for Sustainable Development
ILO International Labour Organization
IMF International Monetary Fund
LED Light-emitting Diode
OECD Organisation for Economic Co-operation and Development
PLS Pollution Levy System
SDG Sustainable Development Goal
TEEB The Economics of Ecosystems and Biodiversity
UNDESA United Nations Department of Economic and Social Affairs
UNEP United Nations Environment Programme
UNFCCC United Nations Framework Convention on Climate Change
UNIDO United Nations Industrial Development Organization
USD United States Dollar
WB World Bank