Correcting Market Failures and Greening Public Finance: The Roles of Environmental Fiscal Instruments

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1 Correcting Market Failures and Greening Public Finance: The Roles of Environmental Fiscal Instruments Ma Zhong School of Environment and Natural Resources Renmin University of China May 14, 2007

2 Meaning of EFIs Environmental fiscal instruments (EFIs) cover the range of fiscal instruments designed to promote efficient and sustainable use of natural resources and cost-effective pollution control or abatement. The EFI toolbox includes three main components: : Environmental Fiscal Expenditures Environmental Taxation Environmental Pricing

3 Roles of EFIs Support governments in carrying out the functions of environment and natural resources protection Ensure adequate provision of public environmental services Create incentives for efficient resource use and pollution abatement Mobilise and allocate funds for environmental protection and natural resource management

4 Aims of EFIs in China Establish environmental fiscal system as a part of public finance framework Enhance the functions of governments to improve the effectiveness and efficiency of environmental policies Correct environmental market failures Promote the circular economy Encourage creation of markets for environmental protection Promote an environment-friendly society

5 Status of EFIs in China An Environmental Fiscal Expenditure Account has been established in 2006 Governmental funds accounts for more than 50% of environmental investments in 11 th FYP Revenues from the PLS in 2006 over 1 0 billion RMB The urban waste water discharge fees are widely levied Desulphurization electricity pricing (0.015 RMB per kwh) Reform of the natural resources tax Subsidies for renewable energies

6 Challenges Guarantee rapid and sustainable development in China Alleviate the pressures on the environment and natural resources Mainstream EFIs into public financial reform Overcome policy gaps and weaknesses

7 Gap between Eastern and western: GDP per capita Growing income gap between East, Middle and West ( )

8 West 6,086RMB Middle 7,841RMB East 15,337RMB

9 Key observations China s economic growth and the regional discrepancies are posing a threat to the environmental and development safety, and it s impossible to rely on the market alone to eliminate this threat. The trans-boundary effects and public-goods characters of environment require that central government should take the capacity for coordination of environmental protection and economic development on national level.

10 Absence of an institutional framework for EFIs Lack of comprehensive planning and ineffective allocation of fiscal expenditures on environmental protection Environmental goods and services underpriced Environmental considerations are not factored in to ongoing taxation reforms The financial capacity of central government for environmental protection is very weak

11 Policy and Institutional Obstacles Knee-jerk vs stable public finance Excessive delegation of environmental protection functions to the market Misplaced concerns that EFIs may dampen economic growth Institutional fragmentation and conflicts of interest between different government departments Optimize the collocation of environmental fiscal wealth

12 Opportunities for EFIs in China Consistency with ongoing public financial reforms Supports the shift to stable and neutral fiscal policy Rapid growth of government revenues: strong financial capacity to carry out bold reforms

13 Growth rates (%) for GDP and fiscal revenue ( ) GDP Growth Rate Fiscal Revenue Growth Rate

14 Recommendations on mainstreaming EFIs in to the Public Financial System Establish a policy framework for EFIs that sits firmly within the public financial system and involves relevant sectoral agencies Systematize environmental fiscal expenditures Gradual approach to environmental taxation reform Moving towards environmental pricing

15 (A) Establish a policy framework for EFIs 1. Clarify government functions with regard to EFIs 2. Establish coordination and evaluation mechanisms for EFIs 3. Enhance the capacity of environmental authorities to participate in economic and sectoral policy processes 4. Improve the capacity for supervision and management of environmental finance The EFIs should be oriented towards the long-term, be continuous and stable

16 (B) Support the establishment of the Environmental Fiscal Expenditure Account 1. Consolidate and reorganise all existing environmentally related expenditure items under a unified budget administration system 2. National social and economic development plans should clarify the total amount of environmental fiscal expenditure of central government, as well as its rates out of GDP and the total budget 3. Environmental financing under the EFEA should address environmental problems that have a clear national dimension, or where the environmental costs or benefits span several jurisdictions 4. Fiscal transfers to build environmental protection capacity in low-income or less developed areas that are environmentally significant should be prioritised

17 (C) A gradual greening of the taxation system Sequence: from adjustment of tax categories, tax items and tax rates, to introducing new taxes, to restructuring the taxation system Environmental impacts should form the basis of reforms of environment-relevant taxes Opportunities in fuel tax reform, in revisions to natural resource and product taxes, and vehicle consumption tax In the longer term, environmental considerations should be systematically built in to reform of environmentally-related taxes

18 Set up a water resources tax Set up water resources tax in the resources taxation reform Levy water resources tax according to the long-term marginal cost of water using and environmental cost The revenue of water resources tax should be managed by central and local finance: local finance should take the responsibilities of water resources protection, while the central finance should take the responsibilities of trans-jurisdiction water protection and trans-generation compensation Two-step Tariffs for urban water should be introduced

19 (D) Towards Environmental pricing Improve the decision-making mechanism of environmental pricing Central government should strengthen its supervision on environmental pricing Price differentials between regions should be monitored Independent experts to evaluate environmental pricing proposals The public hearings process should be improved to facilitate public participation in the pricing process In developmentally-delayed regions, central fiscal support may be needed to adjust pricing schemes