Fiscal & Environmental Policies : Green –Tax Reform for Chile

Specific episodes of major air pollution and consequential health emergencies caused by uncontrolled air contamination predominantly coming from industry and transportation (dust, particulates, NOx and SOx) in the valley of Santiago during the next Winter will certainly reopen a historic public debate with respect to the corrective measures in order to advance in sound national environmental policies .

As a matter of fact, air pollution is only a tip of a main historical problem that includes a critical smog problem in the main capital caused by the use of fossil fuels and climatic circumstances such as: the lack of wind, the scarcity of rains and high temperatures with an impact in 6 million inhabitants in Santiago; also, to some extent, it is becoming a raising problem in other major cities in Chile . Likewise, several reports show other increasing environmental problems within the context of: light contamination, acoustic contamination, water pollution in rivers, lakes and sea, agriculture and livestock impacts , salmon crops and massive mining contamination.

The aforementioned environmental consequences stem from a well-known market failure in the field of environmental protection. Indeed, the main negative externality is that businesses do not internalize pollution in their costs of production and apply insufficient measures to protect the environment. In the case of Chile, this stems as a direct result of a continued economic growth for the last 20 years, combined with a feeble institutional and legal architecture entailing low environmental thresholds, low environmental penalties and scarce enforcement of the environmental obligations under existent regulations. As a result, it is clear that Chilean environmental institutions and environmental protection system needs to be enhanced to ensure an adequate balance between the main principles currently debated and implemented in most developed countries, such as:

a) Ensuring environmental protection and sustainable development;

b) The legal enforcement of the polluter pays principle, according to which negative environmental externalities can be tackled by ensuring that the polluter pays for its pollution, which implies full internalization of environmental costs by the polluter and adequate compensation for direct and indirect environmental damages;

c) The alleviation of relevant environmental costs that could affect the competitive functioning of the economy by using programmed based instruments and market based instruments to enhance environmentally sound business productivity.

The need to redesign the environmental protection system implies determining an adequate legal framework that grants regulatory and control powers to a single institution (i.e.Ministry of Environment) in order to restructure end enforce control measures that mitigate the pressure put on the environment, according to the economic growth needs, so that it does not threaten resources for future generations.

From an economic point of view, the relocation of industries and production to Chile, due to its good economic performance and political stability, have benefited from fact that low environmental thresholds have been equivalent to granting these activities a production subsidy, equal to the health and cleanup cost borne by society. The laxity of environmental rules allowed firms to start up and continue operations, avoiding environmental costs and operating with an implicit financial subsidy from the Chilean State. Nonetheless, due to the interest of Chile in order to incorporate to the OECD a comprehensive Green Tax Reform seems to be a necessary idea to discuss.

All OECD member countries apply several environmentally related taxes, plus environmentally related fees and charges which raise revenues in the order of 2-2.5% of GDP, although, apart from oil and fuel taxes, revenue-raising is not the prime motivation for other taxes applied.



In spite of international experience it should be desirable to discuss a more harmonic convergence between fiscal policies and environmental policies through the intelligent design of a Fiscal- Environmental Policy Mix, including a set of programmed and market instruments combined to achieve specific targets in protection of the environment ,without jeopardizing the dynamism of the economy.

This Policy mix could make use ofthe following fiscal and environmental policy instruments:

a) enhancement of regulations providing ex-ante authorization and ex-post control of environmental impacts caused by harmful activities;

b) redesign of economic instruments such as tradable permits, CO2 tradable emissions and public concessions;

c) redesign of fiscal instruments as effective environmental taxes;

Evidently, the idea of a policy mix including environmental objectives in the design of fiscal policy instruments should seek an adequate balance with the potential outcomes. The following is a "map of ideas" with respect to debatable initial topics to be included in a green-tax reform:

1. Businesses activities directed to Research, Development and Innovation in Science and Technology related to Environment should be enhanced through fiscal subsidies and tax incentives targeted to Eco-innovation.

2. A public, transparent procedure to grant direct subsidies targeted to Eco-innovation projects should be established, with appropriate assessment of the market failure, input additionality and environmental impact.

3. A catalog of preexistent environmental related taxes and charges should be conducted and enhanced. Other environmental taxes should be considered including, like in the EU benchmark, those whose specific taxable base has a clear negative effect on the environment or which seeks to tax certain activities, goods or services so that the environmental costs may be included in their price and/or so that producers and consumers are oriented towards activities which better respect the environment.

4. Eventual cost increase in strategic sectors due to environmental taxes, higher environmental thresholds or exposure to severe environmental fines and penalties should be compensated with the design of fiscal incentives of a tax nature, containing environmental exemptions, allowances and credits for the use of environmental friendly technologies.

5. Other mechanisms should be implemented to avoid cost increase that could adversely affect international competitivity, such as exemption, refunds, rate reductions and tax ceilings.

6. Price increase in products or services subject to environmental taxation could be mitigated with general reduction in other taxes such as VAT or reducing Personal Income Taxation, specially benefiting low-income sectors or consumers.

7. Increases in fiscal budget caused by environmental taxation should be used to create a special fund for ECO-Innovation Projects in strategic sectors like energy, transportation, health and biodegradable products.

Concluding, compared to OECD countries, increasing levels of contamination will definitively produce deleterious effects in human health, degrading ecosystems, depredating natural resources and cause negative externalities in the environment in Chile if nothing intelligent is done in the near future.