MARKET –BASED ENVIRONMENTAL POLICY IN LATIN AMERICA : THEORY AND REALITY

A Thesis

Presented to the Faculty

Of

The Fletcher School of Law and Diplomacy

By

Jean José Acquatella Corrales

In partial fulfillment of the requirements for the

Degree of Doctor of Philosophy

December 2009

Dissertation Committee

Prof. William Moomaw, Chair

Prof. Katrina Burgess

Prof. Ann Helwege

Jean José Acquatella Corrales

Oficial de Asuntos Económicos CEPAL, Naciones Unidas Unidad de Energía y Recursos Naturales División Recursos Naturales e Infraestructura DRNI Casilla 179-D, Santiago, Chile Tel: +562 210 2153 Jean.Acquatella@cepal.org Fax: + 562 208 0484

EDUCATION

THE FLETCHER SCHOOL. Tufts University Ph.D. candidate International Environment and Natural Resource Policy Doctoral fields: international environmental policy, development economics, environmental economics. Dissertation: “Market based environmental policy in Latin America: theory vs. implementation outcomes”. M.A.L.D Master of Arts. Fletcher School 1996 Thesis: "Triggering the implementation of pollution management policies: case study Mexico". Urban and Environmental Policy Department. Tufts University Medford, MA M.A . Master in Urban and Environmental Policy. 1996

UNIVERSIDAD METROPOLITANA ( U.M ) Caracas, Venezuela E.E Electrical Engineer. cum laude 1988 STANFORD UNIVERSITY Palo Alto, CA Engineering and English 1982

EXPERIENCE U.N ECLAC 1999–2010 United Nations Economic Commission for Latin America and the Caribbean Santiago, Chile Economic Affairs Officer Energy and Natural Resources Unit 2006 - 2010 Natural Resources and Infrastructure Division � Regional energy policy analysis and project development in the areas of energy efficiency, renewable

energy, biofuel sector development, and climate change energy policy responses. Sustainable Development Division 1999-2005 � Regional environmental policy analysis and project development in the areas of fiscal-environmental

policy coordination, public finance and economic instruments for environment and natural resource sectors.

� Coordinator ECLAC/IMF/OECD annual Workshop on Fiscal Policy and Environment 2002-2004 � Executive Coordinator ECLAC/UNDP project Application of Economic Instruments for Environmental

Management in Latin America and the Caribbean � Academic Director ECLAC/ASDI/World Bank Institute capacity building program and annual course

on “Market Based Instruments and Financing Sources for Sustainable Development”. � Member Int’l Working Group on Economic Instruments, UNEP Economics and Trade Unit Geneva,

2000-2002 � Coordinator ECLAC/World Bank National Climate Change Strategy Studies (NSS) Regional

Workshop (2001) HIID Harvard Institute for International Development Cambridge, MA Teaching Fellow, Environmental Economics & Policy Analysis Workshop 1998 IAE International Academy of the Environment Geneva, Switzerland Research Fellow, Climate Change and the Global Economy Research Program 1998 UNITAR United Nations Institute for Training and Research Geneva, Switzerland Special Fellow (1996-97) and Consultant (1994-95)

PUBLICATIONS Acquatella Jean and Hugo Altomonte. “Policies for energy access in Latin America and the Caribbean”. Regional contribution to Knowledge Module 23 Energy Access Policies. IIASA / UNIDO Global Energy Assessment (GEA), Vienna, Austria forthcoming 2010. Acquatella, Jean. Energía y Cambio Climático: oportunidades para una política integrada en América Latina y el Caribe. CEPAL / GTZ, LC/W 218. Santiago, Chile 2008. Acquatella, Jean y Alicia Bárcena eds. Política Fiscal y Medio Ambiente: bases para una agenda común. Libro de la CEPAL No. 85, Santiago, Chile 2005. Acquatella, Jean. “ Integración de Políticas Fiscal y Ambiental: análisis y desafíos pendientes”. Introducción y Capítulo 1 en Acquatella y Bárcena eds. Política Fiscal y Medio Ambiente: bases para una agenda común. Libro de la CEPAL No. 85, Santiago, Chile 2005. Lerda, Juan Carlos, Jean Acquatella, José Gomez. “Integración, coherencia y coordinación de Políticas Públicas Sectoriales: reflexiones para el caso de las políticas fiscal y ambiental”. CEPAL, Serie Medio Ambiente y Desarrollo No. 76, noviembre 2003. Acquatella, Jean. “Fundamentos Económicos de los Mecanismos de Flexibilidad para la reducción internacional de emisiones en el marco de la Convención de Cambio Climático (UNFCCC)”, CEPAL, Serie Medio Ambiente y Desarrollo No. 38, julio 2001. Acquatella, Jean. “Aplicación de Instrumentos Económicos en la Gestión Ambiental de América Latina y el Caribe: Desafíos y Factores Condicionantes”. CEPAL/PNUD, Serie Medio Ambiente y Desarrollo No. 31, enero 2001.

Acquatella, Jean. “Financing Carbon Offset Projects: Implications for the design of the Clean Development Mechanism”. International Academy of the Environment (IAE) working paper. Geneva 1998.

Acquatella, Jean ed. “Globalización y Sostenibilidad Ambiental”, capítulo 9 en Globalización y Desarrollo.

CEPAL, Libro institucional para el IXXX Período de Sesiones de la CEPAL, Brasilia 2002. Acquatella, Jean ed. “Consolidar los Espacios del Desarrollo Sostenible”, capítulo 13 en Equidad,

desarrollo y ciudadanía. CEPAL, Libro institucional para el XXVIII Período de Sesiones de la CEPAL, México 2000.

AcLorenzo Eguren. Analysis of the present situation and future prospects of the Clean Development

Mechanism (CDM) in FEALAC member countries. CEPAL – Ministry of Foreign Affairs (MOFA) Government of Japan. May 2006.

Report commissioned by the Government of Japan for the occasion of the Forum of East Asia and Latin American Countries (FEALAC) meeting in Tokyo, 2006.

ADDITIONAL INFORMATION - Bilingual in English and Spanish, basic French. - Nationality: Venezuelan and U.K., one daughter. - International professional experience in most Latin American countries, Europe and USA. - Outdoor sports enthusiast and organizer of nature and cultural expeditions.

ABSTRACT

The dissertation assesses the implementation of “market-based” environmental policy instruments in Latin

America and the Caribbean. National surveys were undertaken in 13 countries to assess implementation

outcomes and instrument choice, 81 instruments in 13 countries were documented in our dataset. Each

record is a mini case-study of the implementation history for one “market-based” instrument (MBI). The

analysis determined the extent of MBIs implementation in practice, the instrument choices made, and the

outcomes obtained by environmental authorities attempting to incorporate MBIs into the regulatory mix.

We find that in a third of all cases documented (25 in 81 or 32%) implementation was either not completed,

or derailed, due to a variety of factors. Furthermore, among 56 cases where implementation took place, 12

instruments ( 21%) were found to be no longer operating or not enforced in practice; and a further 9 (16%)

were operating only partially.

Plausible independent variables associated with these outcomes were identified across cases.

Approximately half of all cases (38 in 81, 47%) indicated poor cooperation by fiscal authorities as a major

barrier to successful implementation outcomes. A third of all cases (26 in 81, 32%) indicated transaction

costs implicit in coordinating MBI operation across bureaucratic boundaries (fiscal–environmental

authorities), and between levels of government, as another barrier behind poor outcomes. Case data

suggests that structural features of the political/institutional context in which environmental authorities

operate condition implementation outcomes. A typology of key interactions identified point to the fiscal-

environmental policy interface, and the public finance–infrastructure policy interface, as key areas where

policy coordination is required for successful implementation.

Integrating MBIs into existing fiscal and sectoral policy structures (agriculture, energy, transport, water) is

often difficult, and sometimes impossible under political/institutional constrains. Political leadership and

governance innovation is required to overcome existing policy biases, and ensure coherent incentives biz-a-

biz high inertia fiscal and public finance bureaucracies. These Latin American findings are a sobering

reminder that there are no easy and quick policy solutions. While increased use of MBIs remains an

important element, any integrated policy response that hopes to tackle the complex environmental

challenges facing this region (and emerging global ones like climate change) will have to emphasize a

much broader set of public interventions.

Dedication

A Angelique (21 Agosto 1994) y mis padres Profesores Harry Acquatella M.D y Greta Corrales de

Acquatella M.D por su amor, y apoyo durante toda esta aventura que empezó en 1993.

To Professor Bill Moomaw in gratitude for his leadership, constant motivation, and encouragement

throughout all these years.

Acknowledgment

En reconocimiento y agradecimiento al Profesor Juan Carlos Lerda, por su amistad y estimulo intelectual

(de las discusiones compartidas surgieron muchos de los conceptos que explora este trabajo); y a mi jefe,

Profesor Hugo Altomonte, por su generoso apoyo para terminar este trabajo, y su amistad y liderazgo que

han sido muy importantes para hacer de mi trabajo en CEPAL una experiencia grata y con sentido.

A big thank you to Professors Ann Helwege, Ann Rappaport, Katrina Burgess and the Tufts UEP and

Fletcher community for their generosity and intellectual stimulus.

In gratitude to the Albert Schweitzer Foundation, and the Tufts – Albert Schweitzer Environmental grant

which supported the origin of this research project; and to the United Nations Economic Commission for

Latin America and the Caribbean (U.N ECLAC) which enabled its conclusion.

Contents

Chapter 1. INTRODUCTION .................................................................................................................................... 1 1.1 Market-based instruments in environmental policy................................................................................. 5 1.2 Motivation of Research............................................................................................................................ 9 1.3 Statement of research objectives............................................................................................................ 14 1.4 Research questions................................................................................................................................. 15 1.5 Overview of dissertation contents and main results............................................................................... 15 CHAPTER 2. LITERATURE REVIEW ................................................................................................................ 18 2.1 Taxonomy of “market-based” instruments in environmental policy .............................................. 18

Environmental taxes .............................................................................................................................. 20 Charges..................................................................................................................................................20 Tradable permit systems........................................................................................................................ 21 Deposit-reimbursement schemes........................................................................................................... 23 Fines for non-compliance with standards.............................................................................................. 23 Environmental performance bonds........................................................................................................ 23 Financial compensation for environmental damages on the basis of legal responsibility ..................... 24 Subsidies for activities related to environmental protection.................................................................. 24 Environmental disclosure and other demand-side information instruments.......................................... 25

2.2 Normative theory ................................................................................................................................. 27

The theory of externalities and normative environmental policy .......................................................... 27 Property rights and the Coasian approach to the internalization of externalities................................... 29 Incomplete information: measuring cost and benefits in the presence of externalities. ........................ 29 Tax interaction effects vs. the “double dividend” ................................................................................. 30 Changes in energy subsidies and other taxes in under fiscal-neutrality. ............................................... 31 Cost-efficiency in normative environmental policy .............................................................................. 32 Instrument design issues under uncertainty: prices vs. quantities ......................................................... 33 Distributive properties........................................................................................................................... 33

2.3 Policy literature on the application of “market-based” instruments .............................................. 35

Environmentally related taxation in OECD countries........................................................................... 35 The political economy of environmentally related taxation. ................................................................. 37 Political economy in implementation of economic instruments in Latin America................................ 39

Public finance: budgetary deficiencies, earmarking of environmental revenue, fiscal competition and perverse incentives. ............................................................................................................................... 41

CHAPTER 3 METHODS and DATA .................................................................................................................. 44 3.1 Methodology overview.......................................................................................................................... 44 3.2 National surveys and research scope ..................................................................................................... 46 3.3 Types of environmental policy instruments surveyed ........................................................................... 51 3.4 Data description and dependent variable: instrument implementation outcomes .................................. 54 3.5 Coding of implementation outcomes..................................................................................................... 60 3.6 Process tracing and identification of independent variables .................................................................. 61 3.7 Coding of independent variables associated with observed implementation outcomes......................... 64 3.8 Development of working hypothesis ..................................................................................................... 67 3.9 Framing the analysis of instrument case data ........................................................................................ 68 3.10 Illustrative case studies. ......................................................................................................................... 69

CHAPTER 4. ANALYSIS ........................................................................................................................ 75 4.1 Analysis of the extent of implementation............................................................................ 75

Instruments not – implemented: A closer look at the 25 cases that did not reach the implementation stage (30% of data set). ............................................................................ 79

Main patterns preventing instrument implementation........................................................ 85

Instruments implemented but retired/not enforced/partially operating: A closer look at these 12 cases ( 21% of those implemented). ..........................................89

Main patterns associated with retired / not-enforced / partial operation outcomes. ........... 94

Summary findings on the extent of implementation...................................................101 4.2 Analysis of Instrument Choice........................................................................................... 104

Instrument choice: types of “market-based” environmental instruments implemented ... 104 Positive incentive instruments: Environmental subsidies, tax credits, fiscal transfers and other incentives. ............................................................................................................... 105

Environmental taxes and charges linked to pollution externalities. ................................. 109 User charges for water and municipal service provision.................................................. 113 Other instruments in the data set: tradable permits, deposit-refund, certification............ 118 Instrument choice: summary of findings.......................................................................... 119

4.3 Identifying variables associated observed implementation outcomes. ........................... 123

4.4 Main analytical conclusions from chapter........................................................................ 125 4.5 APPENDIX Ch. 4: Comparing the extent of implementation found with previous studies . 135 CHAPTER 5 CASE STUDY: Colombia’s water pollution charge...................................................136 5.1 Background........................................................................................................................... 136 5.2 Water pollution in Colombia ................................................................................................ 137 5.3 Colombia’s decentralized institutional framework for environmental management ............ 139 5.4 Water pollution control......................................................................................................... 140 5.5 Law 99 economic instruments .............................................................................................. 142 5.6 Design of the Pollution Charge instrument “ Tasa Retributiva” ........................................... 142 5.7 Implementation of the Pollution Charge instrument............................................................. 145

Description of the implementation process during the first three years 1997-2000......... 145 Early successes and environmental effectiveness ........................................................... 148 Problems of implementation at the national level. ........................................................... 154

5.8 Differing assessments ........................................................................................................... 156 5.9 Concluding comments on the “Tasa Retributiva” case study ............................................... 159 5.10 Appendix Ch. 5: Fiscal and environmental decentralization: CAR revenue sources.......... 161 CHAPTER 6 DISCUSSION of FINDINGS and CONCLUSION ..................................................... 165 CONCLUSION…………………………………………………………...……………………………....176 BIBLIOGRAPHY …………………………………………………………………………………...…...178

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Chapter 1. INTRODUCTION The primary goal of this dissertation is to assess the extent of implementation of “market-based”

environmental policy instruments in Latin America and the Caribbean. National surveys were undertaken in

thirteen countries to assess the implementation of this type of instruments applied towards environmental

objectives in the region. A total of 81 cases from 13 countries were documented. The first part of the

dissertation is focused on the analysis and findings of this survey data to determine the extent of application

of these policy instruments in the region, the instrument choices made, and the outcomes from their

implementation process in this n=81 data set. A secondary goal was to characterize the political and

institutional context in which “market-oriented” environmental policy instruments take place in Latin

America to better understand the nature of the constraints faced by environmental authorities trying to

incorporate this type of instruments into the regulatory mix. This involved the identification of plausible

independent variables or factors associated with the implementation outcomes observed in the data set. The

patterns identified are illustrated with examples from the cases documented for this dissertation and

findings are contrasted with relevant literature in the analysis and discussion chapters.

Findings indicate that, although there has been a considerable extent of incorporation of these instruments

into law or regulations and experimentation with their application (81 cases were documented in thirteen

countries), environmental authorities in Latin American and Caribbean countries have faced significant

difficulties in their attempts to incorporate “market-based” instruments into existing regulation. Contrary to

expectations that the introduction of “market-based” instruments in environmental policy could achieve

rapid improvements in policy outcomes, their actual implementation in Latin America seems to have been

mired in a variety of factors exogenous to environmental policy. The cases in this dissertation illustrate that,

rather than any intrinsic failing with “market-based” instrument design or lack of competence by

environmental authorities, the factors generally associated with poor outcomes point to interactions with

other pre-existing government policies, and poor cooperation by fiscal bureaucracies at various levels of

government as key factors conditioning the implementation outcomes observed. The implementation of

“market-based” environmental instruments interacts with, and across, a number of policy interfaces outside

the strict domain of environmental authorities. The cases in our data set indicate key policy interactions

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with: a) existing tax policy structures in environmentally sensitive sectors (i.e. agriculture, energy, natural

resources etc.); b) national infrastructure policies and their public finance, in particular for municipal

water/sanitation infrastructure; and c) the interaction between national environmental mandates and the

realities of fiscal decentralization and resource transfers between various levels of government (i.e. federal,

state/provinces, municipal ), among others. Neither private industry opposition to the introduction of

“market-based” environmental instruments, nor weak capacity of environmental authorities featured

prominently in the Latin American cases. These findings are contrary to the emphasis given in the literature

from OECD and developing countries to opposition by industry interest groups, and weak capacity of

environmental authorities respectively, as the major factors determining poor outcomes from new

environmental regulatory initiatives.

The difficulty of introducing “market-based” instruments into the policy mix is illustrated by the fact that in

approximately half of the eighty one cases examined in Latin America and the Caribbean, the obstacles

faced resulted in failure or derailment of the implementation process. The barriers were such that in these

cases, instrument implementation either could not be initiated, or was initiated but the instrument was later

retired and found no longer being applied in practice at the time of the national surveys undertaken. Among

the cases where implementation was achieved and instruments were found in application, over one third

reported obtaining only partial results relative to their intended design goals.

Our thesis is that the observed outcomes from the implementation of “market-based” instruments that have

taken place in Latin American countries since the 1990s, have been conditioned to a great extent by

structural features of the political and institutional context in which environmental authorities operate in

these countries. Most cases where instruments in law or regulation were never implemented point to

particular features of the interaction between traditional fiscal bureaucracies, and recently formed

environmental authorities within the same government, as a major stumbling block in enabling the

incorporation of “market-based” environmental instruments into the existing regulatory mix.

3

Lack of cooperation by fiscal authorities was cited in most cases where the introduction of environmental

charges, fees and/or taxes (i.e. pollution charges, water effluent charges, water use charges etc.) required

accommodation of invoicing and payment collection mechanisms, as well as revenue administration and

allocation channels. In a number of countries fiscal authorities outright opposed any proposal from

environmental authorities involving the introduction of selective environmental taxation or charges. In the

two countries that attempted to introduce “market-based” environmental instruments at the national level

(water pollution charge in Colombia, and payment for environmental services in Costa Rica) environmental

authorities found more resistance in recouping charges from public entities (municipal sewerage authorities

in Colombia, and the public electric utility in Costa Rica) than from private industry and individual users.

The barriers faced by environmental authorities vs. uncooperative fiscal bureaucracies, and other public

entities within the same government in these Latin American cases, illustrate a different dynamic than the

traditional government vs. industry opposition to the introduction of environmental charges highlighted in

the literature.

This thesis is compared with alternative hypotheses advanced in the literature assessing the performance of

“market-based” environmental policy in Latin America, in particular to explain poor implementation

outcomes1. One hypothesis which has been emphasized in this literature attributes poor environmental

policy outcomes to weak technical, financial, and enforcement capacities of environmental authorities in

the region, noting the large asymmetries between mandates and the public resources allocated. A common

theme found in the empirical literature that has looked at developing countries’ experience with the use of

economic instruments in environmental policy, points to the lack of capacity and institutional weakness of

environmental authorities2.

This literature ascribes the poor results in experiences with economic instruments to the weak institutional

capacity of environmental agencies, frequently mentioning lack of technical capacities, weak monitoring

1 Richard Huber, Ronaldo Seroa da Motta, Jack Ruitenbeek. “Market Based Instruments for Environmental Policy Making in Latin America and the Caribbean: lessons from eleven countries”, World Bank Discussion Paper 381. World Bank. Washington DC 1998. 2 An alternative statement of this “weak institutional capacity” hypothesis is that environmental policy is not a priority in a region faced with unmet challenges in poverty reduction and the reversal of a highly skewed distribution of income, and hence insufficient resources are allocated to environmental mandates

4

and enforcement practices, insufficient budgets and trained staff. The data collected for this dissertation

indicate that this diagnosis might be “too narrow” in pointing only to the institutional weakness of

environmental authorities to explain poor environmental policy outcomes. It implies that if only

environmental authorities were allocated more financial and technical resources to increase their

institutional capacity and political bargaining power then we would see a reversal of the disappointing

policy outcomes observed.

Approximately half of all cases in our data set point to the nature of the interaction between traditional

fiscal bureaucracies and more recently established environmental authorities, as a major stumbling block in

the implementation of “market-based” environmental instruments. Lack of cooperation by fiscal authorities

was cited in most cases where the introduction of environmental charges, fees and/or taxes (i.e. pollution

charges, water effluent charges, water use charges etc.) required accommodation of invoicing and payment

collection mechanisms, as well as revenue administration and allocation channels. In a number of countries

fiscal authorities outright opposed any proposal from environmental authorities involving the introduction

of selective environmental taxation or charges. In the two countries that attempted to introduce “market-

based” environmental instruments at the national level (water pollution charge in Colombia, and payment

for environmental services in Costa Rica) environmental authorities found more resistance in recouping

charges from public entities (municipal sewerage authorities in Colombia, and the public electric utility in

Costa Rica) than from private industry and individual users.

The barriers faced by environmental authorities vs. uncooperative fiscal bureaucracies, and other public

entities within the same government in these Latin American cases, illustrate a different dynamic than the

traditional government vs. industry opposition to the introduction of environmental charges highlighted in

the literature. The detailed case studies in this dissertation show that Latin American environmental

authorities have been highly creative in working within existing constraints in the State apparatus, and the

high administrative coordination and information requirements involved in operating any system of

environmental policy instruments.

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1.1 Market-based instruments in environmental policy The literature has noted the divergence between normative theory prescriptions for greater use of economic

instruments in environmental policy and actual policy practice in the U.S., the European Union and other

OECD countries. That observation has also motivated the growth of a fertile literature in the political

economy of environmental policy3, both in the U.S and Europe, rooted in several theoretical traditions that

attempt to explain social choices of regulation. These include rational choice, public choice (median voter

models), regulatory capture4, interest group competition for political influence5, among others.

More recently and particularly in the U.S, that literature has addressed the political interaction between

government and interest groups to explain environmental regulation and instrument choices, such as the

setting of standards, bureaucratic and industry preferences for direct regulation over taxation, state-level

regulatory choices in the U.S Federal context (i.e. environmental federalism) etc. The empirical literature in

the U.S and Europe has found evidence supporting the notion in these models that political interactions are

often an important determinant of environmental regulatory and policy instrument choices. Oates and

Portney6 point out the diverging paths this trend has taken in both side of the Atlantic, with Europe (in

particular Scandinavian countries, Germany, The Netherlands and Britain) turning first to environmental

taxes, and the U.S towards tradable emissions allowance systems for the control of SO2; arguing that the

reasons are not clear but might be related to the extreme aversion to new forms of taxation in the U.S. The

literature exploring topics of political economy of environmental regulation and instrument choice in the

context of developing countries is relatively scarce. In our opinion this approach is of more practical

interest and policy relevance to developing countries, than the theoretical debate on the direct regulation vs.

“market-based” instruments dichotomy that occupied wide attention during the 1990s.

3 For a comprehensive survey of this literature see reference by Wallace E. Oates and Paul R. Portney “The Political Economy of Environmental Policy”, in Handbook of Environmental Economics. Volume 1, eds. Karl Goran Maler, Jeffrey Vincent (Elsevier, 2003). 4 George J. Stigler, “The Theory of Economic Regulation,” Bell Journal of Economics and Management Science, vol. 2 (1971). 5 Gary Becker, “A Theory of Competition among Pressure Groups for Political Influence.” Quarterly Journal of Economics no 98 (1983). 6 Wallace E. Oates and Paul R. Portney “The Political Economy of Environmental Policy”, in Handbook of Environmental Economics. Volume 1, eds. Karl Goran Maler, Jeffrey Vincent (Elsevier, 2003).

6

For the purpose of this dissertation we use the broad definitions of economic and/or “market-based”

instruments as categorized by Theodore Panayotou and Robert Stavins respectively, both authors have

systematized in their publications the broad repertoire of these instruments as used in environmental policy.

According to Stavins: “Market-based environmental policy instruments are regulations that encourage

behavior through market signals rather than through explicit directives regarding the specific level of

pollution control or methods that the regulated agents must comply with”.7

Earlier Panayotou defined economic instruments for environmental policy even more broadly: “Any

instrument that aims to induce a change in behavior of economic agents by internalizing environmental or

depletion cost through a change in the incentive structure that these agents face (rather than mandating a

standard or a technology) qualifies as an economic instrument”.8

For our purposes the terms “market-based” instruments, and “economic” instruments are equivalent and are

used interchangeably in the text. Pollution charges and tradable permits are the stereotypical examples of

market-based instruments. When properly designed and implemented they create economic incentives at

the margin that encourage firms and/or individuals to undertake pollution control efforts in their own

interest, and that in the aggregate also contribute to meet social environmental policy goals at reduced

collective costs. The above authors’ categorizations include pollution taxes/charges, tradable permits and

cap-and-trade systems, effluent charges, deposit-refund systems, user charges, insurance premium taxes,

sales taxes, administrative charges, and tax differentiation systems which includes credit, tax cuts and

subsidies for environmentally desirable behavior. Robert Stavins’ categorization of “market-based”

instruments also includes market creation (establishment of water rights markets, and restructuring of

electric power markets with environmental impacts), information programs (labeling/certification,

environmental performance reporting/disclosure), liability rules, and reduction of government subsidies for

activities with adverse environmental impacts. The first section of the literature review in Chapter 2,

7 Robert Stavins. “Market-Based Environmental Policies”, in: Public Policies for Environmental Protection, P. Portney and R. Stavins, eds., Resources for the Future, Washington D.C (2000). 8 Theodore Panayotou. Instruments of Change: motivating and financing sustainable development, UNEP, (UK: Earthscan publications, 1998).

7

explains these instruments in detail, as well as their applications in environmental policy. Table 3.1 in the

methodology Chapter 3, provides a detailed taxonomy of the instruments included in the scope of the

national surveys undertaken for this dissertation.

The theoretical promise of “market-based” instruments is based on the fact that regulatory flexibility across

heterogeneous agents is required for cost-efficient achievement of social environmental goals. In general

environmental regulation proceeds in practice by authorities first establishing a certain policy goal (such as

for example achieving a certain ambient air quality standard, or reducing annual pollutant emissions by a

specific amount etc.), and then appropriate instruments must be designed and applied in practice to attain

the established policy goals at reasonable costs to society. Herein lies the attractiveness of greater reliance

on “market-based” environmental policy for its cost minimizing properties. In theory the flexibility

introduced by “market-based” instruments should enable the attainment of the established environmental

goal at the least possible aggregate cost, by allocating the overall burden across agents in the most efficient

manner. It is perhaps these cost-efficient properties, rather than theoretical welfare maximization through

internalization of externalities, that make “market-based” environmental policy relevant.

Providing increased flexibility is particularly important when aggregate environmental goals must be

attained through collective efforts by highly heterogeneous economic agents and sectors, each confronting

widely different marginal cost structures for pollution abatement. This is the case for example of CO2

emissions reduction in the context of climate change mitigation. Achieving an aggregate national goal of

reducing “X” amount of CO2 emissions at the least possible cost, requires that those agents facing lower

costs per ton of CO2 emissions reduction undertake more abatement, than other agents facing higher per

unit costs. In this context, a cap and trade system could be used to establish the aggregate CO2 emissions

cap and enable economic agents to buy and sell their CO2 emission allowances depending on whether their

own marginal CO2 abatement costs are below or above the market price for emission allowances. Firms

with lower CO2 abatement costs have an incentive to reduce emissions as much as possible and sell their

excess allowances for profit. The demand in this market for CO2 emission allowances is provided by firms

8

facing the opposite marginal cost situation, where it is cheaper to purchase CO2 emission allowances to

comply with the regulation than undertaking costly emission reductions.

The same flexibility can also be introduced by imposing a CO2 tax per unit ton of emissions. In this case

firms opt between undertaking in-house emission reductions, or paying the tax for their emissions, based on

their individual cost structures for pollution abatement. In both instruments the incentives for aggregate

cost minimization are the same. The only difference being that the emissions tax rate, or “price” per unit of

emissions, is imposed by the regulator; whereas in the cap and trade instrument the emission allowance

“price” is determined by the market and the regulator imposes only the cap, or overall “quantity” of

emissions allowed in a given period. Note that if the regulated community consists of homogeneous agents

facing identical cost structures for CO2 abatement (i.e. identical technology and processes), the rationale of

providing flexibility for aggregate cost-minimization through cap and trade, or emissions tax instruments,

disappears. If all regulated agents face identical cost structures, the flexibility afforded by these economic

or “market-based” environmental instruments is inconsequential, and the same result can be achieved

through direct regulation mandating all agents to abate the same “x” quantity of emissions across the board.

Pollution control is not the only environmental policy application of these types of instruments, they are

also applied to rationalize the use of natural resources and environmental services (water use charges,

environmental taxes on energy, forestry, mining etc.), or to create positive incentives for the conservation

and/or enlargement of forests and other stocks of natural capital providing spillovers in the form of

ecosystem services. Stavins’ categorization fails to include subsidies for investments or other activities with

positive environmental spillovers, however, we do not subscribe to that view. In Latin America and the

Caribbean countries reforestation subsidies have been used effectively and have a long standing tradition,

more recently many countries have also incorporated various forms of subsidization schemes for pollution

control and cleaner production investments into their policy packages. More widely, several countries such

as Germany and Spain have used feed-in tariffs successfully to begin incorporating renewable power

generation (i.e. wind, solar etc.) into national electric power markets. Chile has recently begun

experimenting with this instrument. On the other hand, agricultural and energy subsidies typically induce

9

negative environmental spillovers, and their modification must be considered within any comprehensive

initiative seeking to improve national policy coherence with declared environmental goals.

1.2 Motivation of Research Latin America offers an interesting opportunity for the empirical research of the application of

environmental policy instruments, as well as the policy dynamics driving instrument choice, instrument

implementation, and their final policy outcomes. The region is characterized by natural resource and

environmental endowments of global significance which continue to suffer well documented environmental

degradation that imposes high social costs on society at both the global, national and local levels9. During

the last two decades valuation studies of the social costs of environmental degradation have been

undertaken in several countries in the region (most notably on the public health costs of air and water

pollution)10. These studies have demonstrated that the social costs of environmental degradation are not

negligible and may increase under a business as usual scenario. Moreover the region’s comparative

advantage and its insertion in world trade is concentrated in agricultural, mining and oil exports, all of

which are natural resource based and highly environmentally sensitive industries. Given these regional

characteristics, it seems clear that Latin American countries’ policies to ensure sustainable development

and exploitation of their natural and energy resources are key to their long term economic performance and

development prospects.

During the 1990s Latin America underwent a decade of liberal economic policy reforms undertaken in

many countries to recover from the 1980s debt crisis with various degrees of success. The standard reform

package advocated by Washington-based institutions at the time, such as the International Monetary Fund,

World Bank, and U.S. Treasury Department, was codified by Williamson (1990) in ten major points and

termed the “Washington Consensus”11. Alongside fiscal discipline, open trade and capital account

9 United Nations Environment Program. “The State of the Environment. Latin America and the Caribbean”, in Global Environment Outlook 2000. (Nairobi: UNEP, 2000). 10 Larsen, Bjorn. “Cost of Environmental Damage: a socio-economic and environmental health risk assessment.” Prepared for Ministry of Environment, Housing and Land Development. ( Republic of Colombia: MAVDT, July 2004). 11 Williamson, John, ed., Latin American adjustment: how much has happened? (Washington, DC: Institute for International Economics, 1990). 29. Williamson, John, “What Should the World Bank Think about the Washington Consensus?” The World Bank Research Observer, 15(2), (World Bank, August 2000), 251-64. World Bank, Economic Growth in the 1990s: Learning from a Decade of Reform, Washington, DC, World Bank, 2005.

10

integration into world markets, increased deregulation and market competition, the dictum of “getting

prices right” pervaded new policy directions in both macroeconomic and sector level policies (i.e.

agriculture, energy etc.). At the sector level “Washington Consensus” reforms emphasized the removal of

existing price distortions, revision or dismantling of subsidies, simplification of tax structures, and the

general revision of public expenditure policy to reduce deficit spending and increase fiscal receipts.

The reform process also included substantial changes in the regulatory frameworks governing strategic

sectors like energy, electric power, water, mining and transport. Existing public monopolies and

infrastructure tasks were opened to increased competition and private investment. These changes included

dismantling of previous incentive structures driven by past regulatory choices and moving towards

“market-oriented” regulatory regimes designed to attract private investments into these sectors, as the

State’s role decreased. To what degree the revision of price distortions undertaken during the 1990s reform

period contributed to dismantle perverse incentives and to reduce market and policy failures behind

environmental degradation remains an open question.

The early ‘90s were also marked by the Earth Summit in Rio (UNCED 1992). The heavily publicized and

participatory multilateral process leading up to the United Nations Conference on Environment and

Development in Rio succeeded in engaging governments and civil society in a boom of environmental

policymaking inspired by the principles of Agenda 21. Following this, a majority of Latin American and

Caribbean countries enacted General Environmental Laws or Acts in the 1990s which included mandates to

internalize the social costs of environmental externalities in the price system through a variety of policy

instruments. These general environmental laws were modeled along the conceptual principles of Agenda

21, including the “polluter-pays-principle” and the mandates to address both “market failures”

(environmental externalities in this case) and “policy failures” (perverse incentives in current policies) in

order to achieve national environmental goals. The ongoing legislative activity throughout the nineties, also

established or significantly strengthened, the institutional standing of environmental agencies charged with

executing the new legal mandates at the national and state/provincial levels, elevating them in many cases

to the ministerial level.

11

During most of the 1990s and beyond, several international agencies such as the World Bank and UNDP,

openly advocated for greater use of economic instruments and “market-based” environmental policy in

developing countries12 extolling their theoretical advantages over direct regulation. This advocacy called

attention to the increased flexibility afforded by “market-based” instruments in contrast to more rigid

command and control regulation. In theory this increased flexibility would enable economic agents (i.e.

firms, consumers, etc.) to find the most cost-effective means to comply with environmental policy goals. It

would also encourage innovation to find cheaper and more efficient production/consumption alternatives as

firms and consumers seek to reduce the costs imposed by having to pay pollution charges/taxes from

continuing business-as-usual practices. Applying the “getting prices right” dictum to further environmental

policy goals, in the sense of harnessing price-signals and economic incentives to promote changes in the

behavior of economic agents towards improved environmental performance, made intuitive sense.

Another aspect of “getting prices right” related to the removal of existing economic distortions inherited

from previous price controls, subsidies, import tariffs and quotas, discriminatory tax structures etc. Energy,

water and agricultural subsidies in many cases contribute perverse incentives that tend to exacerbate

environmental degradation. For example the reduction of subsidies on dirtier fuels and fuel/electricity

prices in general would tend to encourage greater efficiency in energy use and substitution towards cleaner

fuel alternatives. It makes environmental sense to adjust marginal tax structures so that the final consumer

price of dirtier fuels at the pump, does not enjoy a cost advantage over cleaner alternatives. The same

12 World Bank. Five Years After Rio: Innovations in Environmental Policy. (Washington DC: World Bank, 1996). World Bank. Greening Industry: New Roles for Communities, Markets, and Governments. (New York: Oxford University Press, 2000). Theodore Panayotou. “Economic Instruments for Environmental Management and Sustainable Development.” Paper prepared for the UN Environment Program, Environmental Economics Series Paper no. 16 (1994).

Rio Declaration on Environment and Development: Principle 16

'National authorities should endeavor to promote the internalization of environmental costs and the use of economic instruments, taking into account the approach that the polluter should, in principle, bear the cost of pollution, with due regard to the public interest and without distorting international trade and investment.'

Source: UN, UNCED 1993

12

applies for dirtier vs. cleaner13 power generation competing in electricity markets. The removal or

reduction of agrochemical subsidies and other agricultural policy incentives promoting continued

expansion of crop land use into forested areas, would also tend to have positive environmental effects. For

example in rationalizing fertilizer/pesticide use contributing to reduce surface water pollution from

agrichemical run off. Removal of subsidies and tax incentives for continuous expansion of crop land would

tend to encourage greater soil conservation efforts and reduced deforestation by readjusting incentives

towards agricultural intensification rather than crop land expansion.

Aside from these theoretical advantages for improving economic efficiency, the revenue collected from

greater use of ”market-based” environmental instruments could offer new sources of public revenue either

for general fiscal use or earmarked for public environmental investments, or partial self-financing of

national environmental management costs. It was also argued that increased reliance on “market-based”

instrument price-signals could save public resources by reducing the need for widespread compliance

monitoring and enforcement efforts, as required by widespread “command-and-control” environmental

regulations.

These are no doubt attractive features from the perspective of both fiscal and environmental authorities

facing chronic budget deficits. Although in hindsight the supposed administrative and enforcement cost

advantages of “market-based” environmental instruments over “command-and-control” regulation have

failed to materialize. In general the intensity of information, monitoring and enforcement resources

required for the effective operation of “market-based” environmental instruments has been shown to be as

demanding, if not more, than traditional “command-and-control” environmental regulation.

A key element of the “Washington Consensus” policy reform package had to do with ensuring fiscal

balances and expanding public revenue bases. In this context the theoretical argument for increased

taxation of “bads” such as environmental pollution seem to fit very well. International agencies’ advocacy

13 Dirtier vs. cleaner power refers here to electricity generation fueled by coal, fuel oil, diesel etc.(dirtier) vs. natural gas, hydro, other renewable energy sources such wind and solar, new clean coal technologies etc. which are relatively cleaner.

13

for introducing these types of instruments paralleled the overt “neo-liberal” bias in development policy

circles and the academic literature that characterized the nineties decade. It was only natural that the newly

emergent environmental policy-making were also permeated by this general optimism for market-based

policy advocacy, increased reliance on price-signals for resource allocation, scale-back of regulation, and a

reduced State role. The following developments through the 1990s lead one to expect that Latin American

countries would have moved to deploy “market-based” environmental policy instruments to internalize, at

least partially, the social costs of environmental degradation in the price system

Given that a decade has passed since these developments in Latin America, an empirical assessment of

policy outcomes constitutes a legitimate research goal. Clear legal mandates to do so have been in place

since the early 1990s, or earlier, in most countries; as evidenced by the incorporation of the “polluter-pays-

principle” in general environmental laws, and/or specific regulation mandating the application of economic

instruments by environmental authorities to internalize environmental costs.

a) Documentation of the social costs of environmental degradation and their economic impact has been

growing in the region during the same period and is widely available to political authorities.

b) During the 1990s most environmentally sensitive industry sectors (energy, agriculture, forestry,

mining, transport etc.) also underwent significant reforms in their regulatory framework oriented

towards deregulation, an increased role for private investment, greater international competition, and

alignment of domestic and international price signals.

The expectation to find evidence of actual application of policy instruments aligned with environmental

cost internalization14 is also well grounded in welfare economics, rational choice policy-making, and the

theory of environmental externalities. From a theoretical perspective polities of rational individuals

14 Environmental cost internalization through Pigouvian taxes, and/or optimum pollution charges, in the strict sense demanded by welfare economics theory, involves the economic valuation of environmental externalities. The informational requirements for the economic valuation of environmental externalities are enormous and presents severe analytical complications. In practice environmental charges on previously un-priced pollutant streams achieve partial cost internalization which can be adjusted through iterative adjustment process of charge levels as information is revealed.

14

incurring negative spillovers from private production and consumption decisions, would mobilize to correct

these market failures through the various institutionalized means at their disposal.15

1.3 Statement of research objectives This dissertation attempts to:

1) Assess the extent of implementation of “market-based” environmental policy instruments in Latin

America since 1990;

2) Identify plausible independent variables or factors associated with the observed instrument

implementation outcomes (dependent variable); and

3) Discuss Latin American findings in contrast with relevant literature on the application of “market-

based” environmental policy in general to derive possible policy implications.

15 For a survey of literature on the economic valuation of environmental externalities, and its application to cost/benefit analysis in public policy decision-making please refer to: Maureen Cropper and Wallace Oates. “Environmental Economics: A Survey”. Journal of Economic Literature, Vol. XXX (June 1992), pp. 675-740.

15

1.4 Research questions The following research questions were prepared as means to attain the above research objectives:

1) To what extent have “market-based” environmental policy instruments been implemented in Latin

America? What instrument choices have countries made to address environmental externalities16 in the

region? What implementation outcomes were obtained from attempts to introduce “market-based”

instruments into the environmental policy mix? (method: national surveys were undertaken on the

extent of implementation and outcomes).

2) What variables or factors can be identified with plausible explanatory power to account for the

observed implementation outcomes? What characterized the implementation process of “market-

based” environmental instruments? What barriers and political/institutional context did environmental

authorities face? (method: process tracing of instrument design and implementation processes for each

case).

3) Are the implementation outcomes and associated variables observed in Latin American and Caribbean

countries, any different from those reported in the literature on “market-based” environmental

instruments at the international level? This literature has tended to emphasize weak institutional

capacity and poor enforcement as major factors associated with poor environmental policy outcomes.

Are there any (method: case studies analysis and comparison with literature)

1.5 Overview of dissertation contents and main results The first part of the dissertation assesses the extent of implementation of “market-based” policy instruments

that has taken place in Latin America since the 1990s, the decade when a majority of countries in the region

embarked in widespread economic policy reforms. This task was accomplished through national surveys

that documented 81 cases of “market-based” instruments in thirteen countries17. The national surveys

16 Externalities are spillovers or side-effects of production/consumption activities that impact the welfare of third parties that are not part of the transaction, or society in general. These external costs/benefits imposed on third parties, or society in general, are not reflected in the price signals that drive individual market transactions and private production/consumption decisions. 17 These surveys and case studies were made possible by virtue of their being incorporated as part of two U.N ECLAC policy research and capacity building projects which the author developed and held main responsibility for during 2000-2004. Survey reports and case study data were prepared in each country by national consultants selected jointly between U.N ECLAC and the national environmental authority acting as counterpart for the purposes of the project. The writing of national survey reports and case studies was supervised by the author and edited for publication by U.N ECLAC as project outputs. Each case study was published separately under the national consultant name as a U.N ECLAC project publication, the detailed references are included in the bibliography.

16

focused on documenting the implementation process of all cases of “market-based” instruments (i.e. taxes,

charges, subsidies, tradable quotas, etc.) applied towards environmental policy goals in each country for

which information was available.

Chapter 2 surveys relevant literature for the dissertation research objectives. The literature review is

organized in three parts. The first part explains in detail the various types of policy instruments which

comprise the broad categorization of “market-based” environmental instruments. The second part covers

the normative theory relevant to “market-based” instrument design and instrument choice as applied in

environmental policy. The last part covers relevant literature on both OECD and developing countries’

experience with the application of “market-based” instruments, and international trends regarding their use

in environmental policy. This section also covers selected topics from the literature on the political

economy of “market-based” environmental regulation, fiscal-environmental federalism literature, and

policy instrument mixes in second best settings; which are relevant to understand the complex institutional

and political context in which Latin American environmental authorities attempt to implement “market-

based” instruments.

Chapter 3 covers the methodology and data acquisition procedures that resulted in the data set of 81

instrument cases, was well as the methods used in the analysis of this data set in light of the three research

objectives of the dissertation. The methods chapter also explains the procedures devised for coding both

dependent variables (instrument implementation outcomes) and plausible independent explanatory

variables in the data set. As well as how these coded variables were interpreted and analyzed, within and

across cases, to arrive at conclusions. The case selection rationale for further in-depth analysis in the last

part of the dissertation is also presented.

Chapter 4 is the core analytical chapter of the dissertation. The analysis of the n=81 data set is organized in

three sections. The first two sections focus on determining the extent of implementation of “market-based”

instruments in the region, and describing the outcomes and instrument choices observed in the data set

(research objective 1). The third section of the chapter focuses on the identification of plausible

17

independent variables or factors associated with the observed implementation outcomes (research objective

2). Contrary to 1990s expectations that the introduction of “market-based” instruments could achieve rapid

improvements in environmental policy outcomes, their actual implementation in Latin America seems to

have been hindered by a variety of factors exogenous to environmental authorities themselves. Nearly half

of the cases documented for this dissertation make reference to lack of cooperation by fiscal authorities and

between levels of government within the State structure (i.e. national, state, municipal) as playing an

important role in explaining poor implementation outcomes. The main findings and patterns identified in

the data set are summarized and interpreted.

Chapter 5 is a case study on the implementation of a national level water pollution charge in Colombia.

This case illustrates in detail the institutional and political context in which the implementation of “market-

based” environmental instruments operate in the region. This experience illustrates the complex

interactions with fiscal authorities, public finance, and municipal infrastructure constrains, that

environmental authorities confront in their attempts to introduce “market-based” instruments into the

existing regulatory structures.

Chapters 6 discusses findings and draws conclusions and general policy implications. Findings indicate that

environmental authorities operate in Latin American countries in complex political and institutional

contexts, where “market-based” instrument implementation outcomes depend on the orchestration of a

wide range of incentives across multiple bureaucracies and public agencies (horizontal coordination), and

between the national/state/and municipal levels of government (vertical coordination). The data shows that

Latin American countries have not shied away from experimenting with “market-based” environmental

instruments, but the implementation outcomes obtained have been conditioned by policy interactions

largely exogenous to environmental authorities. The main findings are compared with relevant literature

(research objective 3).

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CHAPTER 2. Literature Review

It should be a sobering fact to economists that their policy recommendations are so seldom adopted. Incentive policies, such as taxes and subsidies are the typical prescriptions of economists for the problem of environmental degradation. These policies are designed to bring private and social costs more in line with corresponding benefits via the price system. Economists are seldom makers of public policy; equally seldom do we find that the gainers compensate the losers. We find numerous alternatives proposed in an attempt to eliminate pollution and environmental deterioration. These politically motivated solutions are quite different from those suggested by the economist….. ….….The reason is quite straightforward. The efficiency criteria of the economist play little of no part in political decision making. Any lawmaker who did decide public policy by such criteria would not survive long in office.

Douglass C. North , “Political Economy and Environmental Policies” Environmental Law Journal 7, (1976-1977): 449-462,

The literature review has been organized in three sections centered around the following points: a) What are

“market-based” environmental instruments, and how are these instruments applied to support

environmental policy objectives?; b) What is the normative theory that informs their design and

application?; and c) What political economy implications have been identified in the literature on

environmental regulation and instrument choice in developing countries?. The first section describes in

more detail the various types of “market-based” instruments applied in environmental policy according to

their definition in OECD Environment Directorate publications. It is useful to review these definitions since

the OECD maintains the largest international cross-country databases on the use of environmentally related

policy instruments and these are categorized according to the organizations criteria. The second section

covers topics in normative theory related to the design of environmental taxes and charges. The third

sections covers relevant points from the political economy literature of environmental regulation, and

international organizations publications (i.e. OECD, World Bank, Inter-American Development Bank etc.)

regarding policy trends in the application of “market-based” instruments in OECD countries and in Latin

American and Caribbean region..

2.1 Taxonomy of “market-based” instruments in environmental policy

There is no standardized definition for “market-based” instruments. Earlier treatments of the role of

economic instruments in environmental policy emphasized the alignment of private costs with social costs

to reduce externalities. In theory, economic instruments can be used as a complement or substitute for other

environmental policy instruments, such as direct regulation through mandatory compliance with

19

environmental standards, fines for non-compliance, licensing of industrial operations based on specific

parameters of environmental performance, strict liability for environmental damages (i.e. tort law). In

practice, the use of economic instruments in environmental management has not reduced the need for

standards, controls, sanctions and other forms of direct governmental intervention. In industrialized

countries this type of instrument is being increasingly used to complement the traditional regulatory

framework. The rationale for their introduction is to introduce flexibility into the regulatory mix to enable

efficiency gains, provided that : (a) the regulated agents are able to minimize their individual cost of

complying with environmental standards or mandatory targets, and (b) that national environmental and

pollution reduction objectives have successfully been reoriented to encompass cost-efficiency criteria,

which requires flexible allocation of the burden of attaining environmental quality goals flexibly across

economic agents to minimize the overall cost to society.

The use of economic instruments in environmental management has had a slow but continuous evolution

since the early 1970s, when the most industrialized countries began to develop their environmental policies.

Since then the tendency has been towards increasing the variety of instruments used in environmental

policy. Whereas charges for the use of natural resources (user charges) were already common in the 1970s,

other types of environmental charges for the control of air, water, soil, solid waste and noise pollution have

seen increasing application since the early 1990s in several OECD18 member countries.19

Apart from charges and taxes for the use of natural resources, or per unit volume of pollution released into

the water or air, other types of have also appeared, such as deposit-reimbursement schemes to promote

emergence of recycling markets, environmental performance labeling and certification. Environmental

performance certification and labeling has been gaining importance in several European countries and the

U.S. International certification schemes on the sustainable production of tradable commodities such as

tropical timber, and agricultural exports, are also increasingly influencing consumer preferences and the

market access of environmentally sensitive commodities exported to OECD markets. As industrialized

18 OECD stands for Organization for Economic Cooperation and Development, which encompasses the more industrialized economies and a number of developing countries (European Union member countries, USA, Japan, Korea, Australia, New Zealand, Mexico, among others). 19 Jean Philippe Barde, The use of economic instruments for environmental protection in OECD countries, Organization for Economic Cooperation and Development (Paris: OECD, 1992).

20

countries adopt stricter environmental and energy/fuel efficiency standards, and international certification

and labeling schemes of environmentally sustainable production proliferate; they are also becoming key

drivers of environmental investments and cleaner technology adoption in the export sectors of developing

countries increasingly preoccupied with maintaining access to discriminating OECD markets.

The following sections provide a brief description of the different types of instruments used within the

context of environmental management following the definitions developed in the OECD Environment

Directorate publications.

2.1.1 Environmental taxes

The 1990s saw the increasing use of taxes linked to environmental parameters. This environmental tax

reform has proceeded along three complimentary lines: (a) the introduction of new taxes, generally applied

on products with harmful environmental externalities (e.g., pesticides, fertilizers, automotive vehicles,

hazardous waste, etc.); (b) the restructuring of certain existing taxes on relevant environmental sectors (e.g.,

transportation and power) to incorporate an environmental element, as occurred in the case of the so-called

carbon tax that is applied to different types of fossil fuels; and (c) the modification or elimination of

subsidies and tax exemptions on activities that are potentially damaging to the environment (e.g.,

agricultural subsidies, tax exemptions for the transportation sector, etc.). Some industrialized countries are

in the process of studying the feasibility of even more ambitious “green” fiscal reforms. These would

mainly entail displacing part of the fiscal charge that currently falls on capital and labor factors (for

example, through the reduction or elimination of taxes on profits, capital goods, labor contributions, etc.)

and compensating for the lost revenues through the introduction of new taxes on environmentally harmful

activities, while being careful not to raise the total tax burden of the productive sector.

2.1.2 Charges

Charges are defined as payment for the use of environmental resources, infrastructure and/or services.

Three main types of charges are used in environmental management: emissions charges, user charges and

impact charges. Each category can be further subdivided as follows.

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Emissions charges

Emissions charges are levied based on either the flows of pollutants or waste produced in the course of

certain activities and released into different media (e.g., air, waterways or land) or the amount of solid

waste. Examples include:

• emissions charges for atmospheric pollution;

• hazardous waste charges;

• other waste disposal charges; and

• charges on effluents discharged in waterways.

User charges

Examples of user charges include the following:

• sewage and water use charges;

• charges for the use of municipal waste collection and treatment services;

• charges for the use of electricity and/or power in critical areas; and

• charges for access to parks, beaches and protected areas.

Impact charges

Impact charges seek to internalize the external costs to the environment and/or scenery that are associated

with certain types of private investment, such as construction, tourism, industrial development, etc.

Examples:

• noise pollution charges for take-off and landing cycles (airplanes); and

• charges per square meter of construction or development in critical areas.

2.1.3 Tradable permit systems Tradable permit systems have mostly been applied in the United States, where they have been used

primarily to control atmospheric pollutants, particularly SO2 and, regionally, CO2 emissions.20 Such

systems establish an aggregate level of emissions allowed for each air quality control zone. The total

emissions cap is then distributed among the different sources either by auction or allocated in accordance

20 This type of system is also used to rationalize exploitation in designated fishing areas, whereby the fishermen receive tradable permits granting them the right to limited annual quotas. The aggregate total quota should not surpass the level of exploitation that the fishing grounds can sustain, which is determined by the schools’ annual capacity for regeneration.

22

with their volume of production or current volume of emissions. Because the total quota is set below the

current level of emissions, the permits acquire a positive value, and the different polluting agents can trade

them on the market. The different agents trade their permits with the objective of minimizing their

individual cost of reducing emissions at the same time that they comply with the goal imposed by the total

quota. If the marginal cost of reducing pollution is lower than the market price of the permits, the firm has

an incentive to reduce emissions and sell surplus permits. If, on the other hand, the marginal cost of

lowering pollution is greater than the price of the permits, the polluters will be forced to purchase additional

permits to continue operating at the same level of production.

2.1.4 Deposit-reimbursement schemes Deposit-reimbursement schemes have traditionally been used in relation to bottles for beverages. In recent

decades they have also been used for products such as car batteries, pesticide containers, household goods,

lubricants and other products that could represent eco-toxicological or public health risks if they were not

disposed of properly.

2.1.5 Fines for non-compliance with standards Provisions for levying fines on the basis of infringement of environmental standards are common in both

industrialized and developing countries. The application of fines rarely makes any real difference in the

budget estimates of regulated companies, however. In order to generate an effective economic incentive,

the amount of the fine should be significant or at least greater than the economic savings implied by

postponing the investments necessary to comply with the standard.

OECD member countries employ different systems of fines for noncompliance with environmental

standards. Some examples are shown in table 1, which outlines the different areas of application, methods

for calculating the fine, applied rates and the number of times the fine is imposed. There are basically two

methods for calculating the fine. One method consists in calculating the amount of environmental damage

caused by the regulated agent’s noncompliance with the standard. The second method is based on the

magnitude by which the legal limit of pollution has been exceeded.

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2.1.6 Environmental performance bonds Systems based on environmental performance bonds seek to shift the responsibility for controlling,

monitoring and enforcing compliance with standards onto the individual producers and consumers by

charging them in advance for potential damages21. If the productive activity or product is completed

without causing damages, then the regulatory body returns the amount deposited as a performance bond.

Environmental performance bonds can guarantee the following, for example: that companies which extract

resources and which are potential sources of pollution take appropriate measures to minimize the

environmental damage caused by their activities; that producers undertake a cost-effective restoration and

clean-up of any residual damages left by their economic activities; or that sufficient funds are available for

cleaning up waste and otherwise restoring environments damaged by an agent that has not complied with

regulations.

2.1.7 Financial compensation for environmental damages on the basis of legal

responsibility This instrument seeks to induce socially responsible behavior on the part of agents by establishing legal

responsibility for financial compensation of damages to the environment, natural resources, public health,

non compliance with environmental laws, regulations, and evasion of environmental taxes, rates and fees.

2.1.8 Subsidies for activities related to environmental protection This category includes direct subsidies, subsidized credit, tax relief and other incentives for activities with

positive environmental spillovers. Direct financial subsides and tax exemptions frequently target

reforestation or environmental restoration activities. Fiscal incentives, such as tax exemptions, fiscal credits

and provisions for accelerated depreciation of assets are linked to investments in pollution equipment and

the import of cleaner technologies. Tax incentives can be associated with the environmental performance of

firms over time, or they can be oriented toward the relocation of industries as part of a plan for industrial

decentralization. Market-based environmental strategies also call for a reduction of subsidies to degrading

activities. For example, fertilizer subsidies encourage their excessive use, which carries tremendous

21 Theodore Panayotou, Instruments of Change: motivating and financing sustainable development, UNEP (UK: Earthscan publications, 1998).

24

environmental consequences. The literature on economic instruments, particularly the OECD literature,

generally expresses considerable reservations when discussing subsidies, although they are wielded

enthusiastically in countries that are new to environmental regulation.

Fiscal incentives and instruments that offer subsidized credit and technical assistance to promote

environmental investment often target small and medium enterprise sectors (SMEs) in developing

countries. In these sectors, positive incentive instruments are required to mobilize investment in cleaner

production technologies, environmental infrastructure and remediation activities. SMEs respond better to

these incentives than to the imposition of environmental charges or taxes because they have limited

technical capacities to undertake the required environmental investments on their own. In many cases, such

as the construction of treatment plants, these investments require scale economies that can only be achieved

though collectively organizing sufficient numbers of SMEs in appropriate industrial parks. In these cases

environmental incentives must work in tandem with urban planning authorities and SME industry

associations.

2.1.9 Environmental disclosure and other demand-side information instruments. A few countries have implemented public information disclosure programs for regulated industrial

emissions. The Pollution Emissions and Transfer Registration (RETC), which is currently being implemented in

Mexico, is one of the first attempts to apply this type of instrument in the Latin American region. This instrument is

similar to the USA Toxic Release Inventory (TRI) which mandates the annual disclosure of emissions of listed

pollutants, based on the public right-to-know act and labor rights to information on employment related risks. These

public disclosure instruments along with official certifications of environmental performance create

incentives via social pressures, and consumer market image based on firms’ environmental performance. 22

Studies demonstrate that informal regulation of this type can be a significant factor explaining the

differences observed in firm level compliance.2324 The use of various eco-labeling and official certification

22 Sumita Dasgupta, Benoit Laplante, and Mamingi, N, “Capital Market Responses to Environmental Performance in Developing Countries,” Development Research Working Paper, no. 1909, (Washington DC: World Bank, 1997). 23 Shakeb Afsah, Benoit Laplante, David Wheeler. “Controlling Industrial Pollution: a new paradigm”. World Bank policy research working paper no. 1672. (Washington D.C World Bank, 1996). 24 World Bank, Greening Industry: New Roles for Communities, Markets, and Governments (New York: Oxford University Press, 2000) provides several examples of application of these type of instruments in developing countries.

25

schemes also generates incentives of this type. Their use has been extended considerably at the

international level during the last decades.

In Indonesia, the PROPER program provides an example of a simple and successful application of a demand-side

information instrument in a developing country context.. The Indonesian environmental agency (BAPEDAL) classifies

companies according to their environmental performance using data on compliance with standards for discharging

waste water. This official classification of firms environmental performance is published widely by the press and other

media, generating market reputation incentives for improving performance. The classification employs a scale of five

colors, from gold for leaders in pollution prevention who go beyond compliance standards, to black for firms causing

serious environmental damages. The classification has proved to be a simple, effective format for making information

on the environmental performance of companies available to the public, media and financial markets in Indonesia.

PROPER was initiated in June 1995, when BAPEDAL classified the performance of the 182 largest plants. That first

publication cited only the names of the five plants whose efforts exceeded the standard, thereby giving them public

recognition. Of the total number of plants, 65% were in situations of noncompliance; these were contacted privately

and given six months to improve their classification before information on their performance would be made public.

With the second edition of the publication, just fifteen months after the program was initiated, the incentives generated

by the program had reduced the number of plants in a situation of noncompliance from 65% to 47% of the total. 25

25 For more information on PROPER, see Shakeb Afsah, Allen Blackman, and Ratunanda, D. “How Do Public Disclosure Pollution Control Programs Work? Evidence from Indonesia”, Discussion Paper 00-44, (Washington, D.C Resources for the Future, 2000).

26

2.2 Normative theory

2.2.1 The theory of externalities and normative environmental policy

The theoretical literature on externalities contains the basic economic principles underlying the design of

normative environmental policy. The potential economic efficiency gains from the internalization of

externalities26 through taxation, was first proposed by Arthur Cecil Pigou in 1932, and more recently

formalized by William Baumol27. In the presence of externalities or spillovers from private economic

decisions, a gap is created between the external marginal social cost and the private marginal cost of

individual economic decisions. A Pigouvian tax of equal value to the externality closes this gap between

the external social cost and the private marginal cost, thereby internalizing spillovers into private economic

decisions. In the case of pollution externalities, the normative prescription is to impose a Pigouvian tax per

unit of pollution released into environmental media at the source of the externality. The level of such tax

would have to be equal to the external marginal social cost caused by each additional unit of pollution

released to obtain the economic efficient outcome. In welfare economics theory, the economically efficient

equilibrium is achieved when the marginal social cost and marginal social benefit from the last unit of

economic activity are equalized. These are simply the first order conditions required to maximize overall

welfare (measured as the sum total of producer and consumer surplus) in welfare economics theory.

According to microeconomic theory the application of a Pigouvian tax per unit of pollutant emissions, or

alternatively a cap-and-trade system for emission allowances, creates an incentive for economic agents to

undertake pollution reduction efforts up the level where their private unit cost to reduce a ton of pollution is

equal to the tax rate, or the price of a unit emissions allowance. Each firm reduces pollution in house up to

the amount when any additional reduction becomes more costly than paying the Pigouvian tax, or buying

an allowance, per unit of emissions. At that point is more cost efficient for firms to pay the emissions tax,

or allowance price, than to attempt to reduce further their emissions in house at increasing marginal costs.

26 External spillover effects from economic transactions that impact society in general or any third parties that are not part to the transaction. Environmental externalities tend to manifest as public health costs from pollution, productivity losses from degradation of natural capital (i.e. water, soil, forests, fisheries), congestion costs, among others . The external costs imposed on society or third parties, are not reflected in the market prices informing the private production/consumption decisions which cause these spillover effects. 27 Arthur C.Pigou The Economics of Welfare (Cambridge. 1920). William J. Baumol., “On Taxation and the Control of Externalities", American Economic Review 62 (3) (1972): 307–322.

27

Due to the high heterogeneity in production processes, factor use, and technologies across economic sectors

each firm faces its own specific cost structure to reduce its pollutant emissions. Supposing that a country

sets for itself an aggregate emission reduction goal (“X” tons of annual emission reduction at the national

level), the application of either of the above instruments would create incentives to allocate the aggregate

emission reduction effort at the least overall cost to society. Firms facing lower emission reduction costs

would undertake larger reductions rather than pay any emission taxes, or make a profit by selling part of

their unused emission allowances. Whereas firms facing higher costs would undertake less reductions and

opt to pay their emission tax, or buy the necessary allowances to cover their annual emissions.

In theory this process of individual firms: a) reducing their emissions in house and paying taxes for their

marginal remaining emissions, and/or b) trading emission allowances in a frictionless low transaction cost

world, continues until all firms face the same marginal cost per unit of pollution reduction (which in this

case should be equal to either the tax rate, or the going market price for a unit emission allowance).

Students will recognize this equalization of the marginal cost of emissions abatement across heterogeneous

firms, as the first order condition for aggregate cost minimization of attaining the “X” national emission

reduction goal. Therefore at least in theory, these are the instruments of choice to achieve national emission

reduction targets at the least possible aggregate cost, across the broad range of heterogeneous sectors that

comprise any modern industrial economy.

Since environmental regulators generally do not have information on the cost structures that individual

firms face to reduce their emissions, this theoretical cost minimization cannot be achieved through direct

regulation mandating all firms to comply with a uniform standard or across-the-board uniform emission

reductions (i.e. 10% emission reduction for all agents). Uniform standards or direct regulation fails to

exploit the heterogeneity of cost structures across economic agents to realize the potential “gains from

trade” of enabling flexible allocation of emission reduction burdens towards the more cost-efficient

emission reducers in society. The same logic underlies the economic rationale for the creation of the so-

called international carbon market. In order to achieve “X” amount of reduction of global emissions at the

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least possible aggregate cost, it pays for these reductions to be achieved wherever they are cheaper, since

the net effect on the atmosphere is independent of the country where the reductions take place, as long as

they are in effect net reductions relative to the baseline.

2.2.2 Property rights and the Coasian approach to the internalization of externalities

Ronald Coase proposed that under a theoretical setting of complete definition of property rights, and in the

absence of transactions costs and strategic behavior, externalities would be resolved without regulatory

intervention (i.e. such as Pigouvian taxation) through private bargains or court litigation. The property

rights approach to the solution of externalities emphasizes complete definition of rights, and an efficient

court system enabling low-cost Coasian bargaining between affected parties. This strand in the literature is

known as “free market environmentalism”, or the bargaining approach to the control of externalities28, as

opposed to the pigouvian tax approach. In theory both approaches are incompatible, since the introduction

of Pigouvian taxes in a Coasian setting would themselves be a new source of economic distortions, rather

than a welfare enhancing public intervention29. In a Coasian bargaining approach to externalities, the

solution is independent of the rights allocation. For example, in cases where the polluter holds the right to

pollute, the solution involves payments from the pollution victims to the polluter for reducing pollution

output. In cases where the right to a pollution-free environment is with the victims, the solution involves

the polluter making payments to compensate for his/her pollution spillovers.

There is a further distributive distinction between the two approaches. Whereas in the Coasian approach

compensation of the victims for the damages caused by polluters is necessary for an efficient outcome

when they hold the appropriate rights; in the Pigouvian approach no such compensation is required. The

theoretically efficient outcome is obtained whenever the aggregate net welfare gain is positive, without

regard to whether in effect the groups appropriating the benefits compensate the groups bearing the costs.

In the case of Pigouvian pollution taxation the benefits are social and the costs are shared between

consumers and polluters depending on tax pass through and tax interaction effects. 28 Robert Stavins, “Experience with Market-Based Environmental Policy Instruments,” Resources for the Future Discussion Paper 01-58 (Washington DC, 2001). 29 Maureen Cropper, and Wallace Oates, “Environmental Economics: A Survey,” Journal of Economic Literature no 30 (1992): 675-740.

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2.2.3 Incomplete information: measuring cost and benefits in the presence of

externalities.

To achieve this first best efficient equilibrium however, the tax level would have to be set equal to the

marginal social cost of pollution which is generally unknown, and moreover is probably not static for

pollutant flows that are constantly changing with variations in seasonal, climatic, economic, environmental

and technical parameters among others. The information requirements that attaining such an alignment

requires are generally insurmountable in practice. The economic valuation of environmental externalities is

analytically complex, information intensive, always controversial, and almost never available for the

specific policy issue and situation at hand. Environmental regulators not only lack this information on the

social cost of externalities, but also do not generally have access to the private marginal costs of pollution

abatement; moreover plant-level and individual costs are very heterogeneous across agents.

The economic valuation of environmental externalities presents enormous and often insurmountable

information requirements. In practice not only is the external marginal social cost of pollution generally

unknown, but regulators also do not have access to the private marginal abatement costs at the individual

plant level. In fact production managers often first become aware of their private marginal abatement cost

as a result of regulation30. Another practical complication is that taxation is often impossible to apply

directly at the source of the externality. It would require fitting emission meters in car tailpipes, or figuring

how to tax run-off into surface waters/aquifers from agrochemical use31, etc. Such targeting of externalities

is practicable only in the case of a manageable number of major fixed sources where emissions/effluents

can be measured and taxed directly As such, a system of Pigouvian environmental taxes to obtain a Pareto

efficient equilibrium, in the strict theoretical sense, is unattainable.

30 The application of a pollution tax/charge creates the necessary price-signal for the previously untaxed/charged effluent discharged at price zero to enter the balance sheets as a cost item thus creating the economic incentive for pollution reduction. 31 This would have required that the instrument in effect created incentives for economic agents to equalize their private marginal costs of pollution abatement and marginal benefits at the margin. Economic efficiency here refers to equating the marginal social cost of environmental degradation with the marginal social benefits from economic activity with environmental degradation spillovers.

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2.2.4 Tax interaction effects vs. the “double dividend”

When taxing the source of the externality is not feasible regulators must opt for a proximate tax base where

taxation is practicable and proportional to the externality. Generally production “inputs” (such as fuel,

fertilizer etc.), rather than pollution “outputs” (air emissions, water effluent discharges etc.) are used as “tax

handles”. However for this indirect taxation of externalities through inputs (i.e. fuel taxes) to create the

theoretical incentives mentioned, it would have to differentiate at the margin between fuels in proportion to

each fuel’s relative contribution to the total pollution load. This is the idea behind a carbon-tax based on the

carbon content of fossil fuels, as an indirect yet practical way to tax CO2 emissions. A carbon tax would

create incentives to substitute dirtier fuels for lower-carbon content fossil fuels, more natural gas and less

coal use in power plants for example. However most fuels are already heavily taxed for general revenue,

rather than for environmental externality purposes, meaning that environmental taxation would have to

come on top of the existing tax structure, and be able to modify it at the margin in order to instill the right

externality-internalizing incentives.

The environmental economics literature32 has pointed out that the imposition of environmental taxes on top

of existing tax distortions (tax interaction effect) might cause the dead-weight efficiency losses33 from

environmental taxation to be larger than expected. Even to the point of negating any net positive welfare

effect, or potential “double-dividend” from revenue-neutral environmental taxation. In theory such a

“double-dividend” could be captured when the revenues from externality-reducing environmental taxes

(first dividend) are used to enable tax cuts on labor/capital, thereby also reducing the dead-weight

efficiency loss (second dividend) incurred from these distorting taxes relative to the previous equilibrium

before the introduction of environmental taxation. In practice the overall welfare effect will depend on the

whether the welfare gains from reduced environmental externalities, plus the net tax-interaction effect

(positive or negative) turn out to be positive. Therefore the net welfare gain from pollution taxes will

depend on: a) the extent of externality reduction achieved through the imposition of the tax (unknown

32 Larry Goulder, Ian Parry et al.. “Revenue Raising vs. Other Approaches to Environmental Protection: The Critical Significance of Pre-Existing Tax Distortions,” RAND Journal of Economics no 28(4) (1997): 708-731. Larry Goulder. “Environmental Taxation and the Double Dividend: A Reader’s Guide.” International Tax and Public Finance vol 2 (2) (1995): 157-183. 33 “Dead weight efficiency loss” refers to the net welfare loss incurred from taxation (reduced producer and consumer surplus relative to the pre-tax equilibrium).

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beforehand and a function of the elasticity of the pollution tax base, among many other parameters34); and

b) the net tax-interaction effect (also unknown and a function of the pre-existing tax structure).

2.2.5 Changes in energy subsidies and other taxes in under fiscal-neutrality.

Simultaneous reductions in taxes can have complex effects, or for that matter subsidy reductions

accompanied by tax reductions in a fiscally neutral context. Anil Markandya gives the counterintuitive

example of a reduction in energy subsidies, which if accompanied by a reduction of labor taxes under a

fiscally neutral maneuver, could actually result in increased output and energy consumption, thereby

increasing, rather than lowering the pollution externality from energy consumption. If the ultimate

objective of a fiscally-neutral tax and/or subsidy reform, is the reduction of environmental externalities,

then the whole package needs to be analyzed with a general equilibrium model to get a grasp on the net

effect35. Of key normative importance are any political decisions regarding the recycling of pollution tax

revenues back to specific economic sectors or to tax payers in general, in revenue neutral green tax reforms.

The devolving of revenue back to the economy is the tax recycling effect. If policy makers decide to recycle

back to the economy the proceeds from pollution tax revenues, the net effect on emissions relative to the

pre-tax equilibrium will depend on general equilibrium effects; based on the specific sectors receiving the

recycled revenue transfers (revenue recycling effect), and the interaction between these and the sectors

bearing the new pollution tax ( tax interaction effect).

2.2.6 Cost-efficiency in normative environmental policy In practice normative environmental policy generally proceeds first by establishing an environmental

quality standard, or other environmental target to be achieved by the regulated community, and then

proceeds to develop the instrument mix to achieve the set target. Note that this is a completely different

situation from the first best efficient equilibrium discussed above. The theoretical prescription in this case is

34 The economic valuation of the net welfare gain the from achieving a certain amount of pollution externality reduction is extremely information intensive. 35 Anil Markandya, “Environmental implications of non-environmental policies,” in Handbook of Environmental Economics, Volume 3. eds. Karl G. Mahler and Jeffrey R. Vincent. (Elsevier, 2005): 1377-1379. Ian Parry, “A second best analysis of environmental subsidies,” International Tax and Public Finance 5, (2001): 157-174.

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to minimize the overall social cost of attaining the established environmental goal, through the use of

marginal incentive instruments.

When regulators design an environmental tax or charge per unit of pollution emitted that can be effectively

applied at the source of the externality (i.e. smokestack, end of pipe etc.), the incentive thus created drives

each individual polluter to equalize his/her own private marginal cost of abatement with the tax charged per

unit of pollution. At the aggregate level such a tax minimizes the overall social cost from the aggregate

pollution abatement effort. In effect the tax creates an incentive for all polluting sources to reduce pollution

until their marginal abatement cost equals the tax rate. And since the tax rate is the same for all polluters,

this achieves the first order condition necessary for aggregate cost minimization (all polluters abate until

they reach the same marginal cost). Note that what is achieved here is the minimization of the cost of

pollution reduction, not economic efficiency in the sense discussed previously.

2.2.7 Instrument design issues under uncertainty: prices vs. quantities In a 1974 article Martin Weitzman explored the asymmetries between price and quantity instruments, and

established the conditions under which the expected welfare gain from a unit tax on pollution is larger,

equal or lower than with a tradable permit/quota system36. The result is straight forward and depends on the

relative steepness of the marginal benefit and cost curves. For example in the case of threshold effects like

a toxic releases, or irreversible climate change, the environmental regulator should go for a quantity

instrument that establishes a cap in the safe zone. The reverse situation involves the opposite case of very

steep marginal abatement costs after a certain point, and relatively constant marginal benefits. In this case

the price instrument is better, since an overshoot of the standard by the regulator will force compliance

costs that are much larger than the benefits, with overall decreased welfare resulting from the regulatory

choice.

Marc Roberts and Michael Spence, and later also Martin Weitzman, established the important result that

under uncertainty a combination of both quantity and price instruments provide a larger expected welfare

36 Martin Weitzman, “Prices versus Quantities”, Review of Economic Studies 41(4) (1974):477-491.

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gain relative than reliance on either instrument alone37. For example in a cap and trade system is subject to

uncertainty on the equilibrium price that emissions allowances will command in the market once the cap is

applied and the initial distribution of allowances is allocated. By combining a cap and trade system with an

emissions tax, the maximum price per unit of emissions allowance that any firm would expect to pay is also

capped at the tax rate. The proceeds from such a tax can also be recycled to subsidize further emission

reduction efforts beyond those required by compliance with environmental regulation. The authors

mentioned show that under certain conditions such mix of instruments can provide larger welfare gains

than the use of individual instruments. This literature recognizes that optimum instrument choice also

depends on preexisting structural features; such as the particular shape of the relevant marginal benefit and

cost curves, and the specific demand/supply elasticities in markets targeted by the instrument.

2.2.8 Distributive properties In theory both a marginal pollution tax/charge and tradable permit or cap and trade system are equivalent.

The latter offers regulators the advantage of explicitly establishing the cap or aggregate emissions target,

whereas in the former the level of the tax that will accomplish the regulatory target is unknown beforehand.

On the other hand the marginal pollution/tax charge offers the possibility of generating revenue, a

possibility that is only available in the other case if the tradable permits are allocated by auction. In most

empirical applications to date the initial allocation of permits has been free of charge and proportional to

historical emission levels (grandfathering). These differences are relevant for the political acceptability of

these normative instruments. Where there is high aversion to the introduction of new taxation, tradable

permit systems with initial allocations distributed at relatively low cost might represent an advantage. On

the other hand the distributive impact of environmental taxation on specific sectors or jurisdictions can be

ameliorated through the recycling of revenues back to the taxed sector in the form of earmarked funds for

environmental investments and/or industrial re-conversion.

37 Marc J. Roberts and Michael Spence, “Effluent charges and licenses under uncertainty,” Journal of Public Economics 5 (1976) 193-208. Martin Weitzman, "Optimal Rewards for Economic Regulation," American. Economic Review 68(4) (Sept. 1978): 683-91

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Environmental taxes offer interesting redistributive possibilities, even when the absence of information

makes it impossible to determine the gap between social and private costs. For example in the case of

clearly negative externalities, some level of taxation enables the transfer of at least part of the external cost

of pollution from society back to the polluter. As long as the tax closely targets the source of externality it

should contribute to improve efficiency relative to the untaxed situation (with the caveat of tax interaction

effects out-weighting gains if preexisting distortions are large). Also from a redistributive standpoint the

revenue collected opens the possibility of compensating the social groups bearing the pollution costs. In

practice, such social equity goals are, seldom incorporated into the design of environmental policy. The

compensation for environmental damage generally takes the route of tort law and litigation in the judiciary

sphere.

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2.3 Policy literature on the application of “market-based” instruments

2.3.1 Environmentally related taxation in OECD countries.

A clear trend in OECD countries during the last two decades has been the gradual experimentation and

increasing use of a greater variety of instruments in environmental policy. The joint database operated by

the OECD and the European Environment Agency (EEA) 38, currently details about 375 environmentally

related taxes, and 250 environmentally related fees and charges, which raise revenues amounting to 2-2.5%

of GDP (OECD 2007). Revenues from environmentally related taxes in OECD member countries

represented 2.5% of GDP, or almost 7% of their total tax revenues during the 1990s..39 A number of these

are indeed environmental taxes/charges linked to measured or estimated emissions. Although the majority

are not, strictly speaking environmental instruments, but rather taxes/charges on tax bases such as energy

and transport with admittedly high environmental repercussions. The OECD has come up with the useful

definition of Environmentally Related Taxes (ERT) to refer to this group. It has also recognized that

increased use of environmental taxation on energy and transport raises both international and sectoral

“competitiveness” and distributional issues that must be addressed politically.

Another aspect of this evolution has been increasing discussion of the role of environmental policy as an

integral component of fiscal reform in European countries. In general this discussion is concerned with the

possibility of increased environmental taxation of externalities (i.e. pollution, inefficient energy use etc.) as

a new source of revenue enabling the reduction of taxes on labor and capital; the so called “double

dividend” debate. At a more practical level the discussion concerns the design of environmental taxation to

create marginal incentives for improved performance, while instituting schemes for revenue devolution to

the taxed sector to allay competitiveness concerns (i.e. steel, power generation etc.).

Many OECD member countries, are increasingly using taxes tied to environmental parameters in their

pollution control strategies. Aside from the energy and transportation tax bases, taxes on the disposal of

38 Environmentally Related Taxes and other instruments database (ERT) is available at www.oecd.org/env/policies/database 39 OECD, “Economic Instruments for Pollution Control and Natural Resources Management in OECD Countries: A Survey,” (Paris: OECD Development Centre, 1999): 5.

36

solid and liquid waste are also common. In the area of natural resource management, OECD member

countries frequently levy charges or taxes on water use as a mechanism for controlling the amount drawn;

in a few cases schemes have been implemented establishing transferable quotas on water use. The

instrument that has been used most frequently to control fishing resources involves transferable fishing

quotas, although some countries also use rates and taxes as instruments for managing this sector. In the

forestry sector, the use of charges and subsidies is very common in the management of logging and

reforestation activities in several countries. In the last two decades, the most industrialized countries have

clearly moved toward an increasing application of these types of instrument as an integral component of

their environmental management strategies.40

In theory, economic instruments can be used as a complement or substitute for other types of instruments

with the same goals, such as instruments of direct regulation through environmental standards or direct

agreements between environmental authorities and industry to improve environmental performance, to

reduce emissions, etc. In practice, the use of economic instruments in environmental management has not

reduced the need for standards, controls, sanctions and other forms of direct governmental intervention. In

industrialized countries this type of instrument has been used to complement the traditional regulatory

framework. The rationale for their introduction is to enable efficiency gains through the increased

flexibility provided: (a) the regulated agents can minimize the individual cost of complying with standards,

and (b) efforts to mitigate pollution have successfully been reoriented to encompass criteria based on

efficiency, thus reducing the total cost of meeting the environmental quality goals set in each case.

The use of economic instruments in environmental management has had a slow but continuous evolution

since the early 1970s, when the most industrialized countries began to develop their environmental policies.

Since then the tendency among member countries of the Organization for Economic Cooperation and

Development (OECD) has been towards increasing the variety of instruments used in environmental policy.

Whereas charges for the use of natural resources (user charges) were common in the 1970s, other types of

40 For a detailed review of the instruments currently in use in OECD member countries please refer to: OECD, “Economic Instruments for Pollution Control and Natural Resources Management in OECD Countries: A Survey,” (Paris: OECD Development Centre, 1999): 5.

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charges have become more common. OECD for example, documented over 60 charges in use in various

countries for the control of air, water, soil, solid waste and noise pollution during the early 1990s.41 Apart

from charges and taxes for the use of natural resources, or per unit volume of pollution released into the

water or air, other types of have also appeared, such as deposit-reimbursement schemes to promote

emergence of recycling markets, environmental performance labeling and certification. The latter have

been gaining an increased role as a differentiation strategy by firms intent on ensuring access of their

exports to the European market for example, where consumers are increasingly conscious about the

external lifecycle-costs of their product choices. The increasing discrimination against non-certified tropical

timber products in international trade is an example of this trend. Official certification and labeling schemes

of environmental and sustainability performance are becoming key instruments driving environmental

investments and cleaner technology adoption in the export sectors of developing countries increasingly

preoccupied with market access to discriminating OECD markets.

2.3.2 The political economy of environmentally related taxation.

The political economy of Environmentally Related Taxation (ERT) has been the subject of recent work by

OECD.42 Whereas general taxes do not discriminate against any specific sector, environmental taxes are

specifically targeted at externalities and the specific sectors or industrial activity causing them. This applies

in particular to energy-intensive commodities (i.e. steel, cement, aluminum etc.) and other energy-intensive

export oriented sectors subject to “environmentally untaxed” international competition. As such

environmental taxation generally evokes reactions for its potential negative impacts on the competitiveness

of taxed sectors. This is clearly evident in the fact that the OECD reports no less than 1,150 exemptions to

environmentally related taxes, and several hundred refund mechanisms and other tax provisions43.. The

other side to this debate on the “international competitiveness impacts of environmental regulation” is the

“race to the bottom argument”. The latter holds that countries, or states within a federation, will lower their

environmental standards as a means to gain competitive advantage over counterparts with more stringent

41 Jean Philippe Barde, The use of economic instruments for environmental protection in OECD countries, (Paris: OECD, 1992). 42 OECD. The Political Economy of Environmentally Related Taxes. OECD Environment Directorate. (Paris: OECD, 2007). 43 For a detailed database of environmentally related taxes in use by OECD member countries please refer to www.oecd.org/env/taxes . This database is maintained and updated regularly by OECD Environment Directorate.

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environmental regulation. The empirical literature testing this argument in the U.S. Federal context does

not find support for it, since States tend to have at least the same or more stringent standards; the same

result holds for Brazil. At the international level also there is also no conclusive evidence that there is a

race-to-the-bottom in environmental regulation. The level of environmental regulation is apparently a very

minor determinant in the international investment location decisions of transnational firms44.

There is a fundamental conflict between the economic rationale inherent in the normative theory of

environmental externality taxation (which specifically targets externality producing firms and economic

sectors) and the non-selective, equal-treatment principles in public finance theory and trade policy which

emphasize homogeneous flat tax and tariff structures across sectors.. In general environmental regulators

are newcomers to the public apparatus and are no match for the deeply entrenched public finance and trade

policy bureaucratic cultures they confront, both of which are highly resistant to innovation.

A key component of “Washington Consensus” policy reforms in many Latin American implied the

dismantling of previous non-uniform and highly selective tax and tariff structures. As well as their

substitution for increasingly flat and simplified structures to avoid distortions in resource allocation, and

promote greater competition and economic efficiency across sectors. Paradoxically the same technocrats

and public finance bureaucracies in charge of implementing the newly simplified tax/tariff rates, also

resisted proposals for the introduction of new environmental taxes and charges. These instruments were

also promoted on the grounds of increasing economic efficiency and making prices work for the

environment by the same international organizations advocating the wider policy reform process; but in the

eyes of Latin American fiscal bureaucracies they do not seem to have generated much enthusiasm as shown

in the cases in this dissertation. Public finance authorities also tend not to accommodate earmarking of

funds for specific public expenditures. In theory earmarking decreases the flexibility to allocate public

revenue to its highest social value uses (i.e. education, health etc.), and could induce inefficient public

spending when earmarked funds are allocated to less worthy projects simply because they are not fungible.

44 Wallace E. Oates and Paul Portney, “The Political Economy of Environmental Policy,” in Handbook of Environmental Economics. Volume 1. eds. Karl G Mahler and Jeffrey Vincent (Elsevier. 2003).

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The introduction of “market-based” instruments in environmental regulation opens up new fronts of

interaction between environmental and fiscal policies, where traditionally there had been virtually no need

to coordinate policy interfaces across these separate bureaucracies. These new challenges expose the weak

or inexistent coordination mechanisms between traditional fiscal and environmental bureaucracies facing

the task of implementing “market-based” environmental policy.

2.3.3 Political economy in implementation of economic instruments in Latin America.

The theoretical and empirical literature on the political economy of environmental regulation and policy

instrument choice in the U.S. and other OECD countries has traditionally emphasized “industry vs.

government” interactions, rather than “policy failure” within government, as explanatory factors. Examples

include the capture theory of regulatory agencies45, incumbent industries’ preference for direct regulation

over taxation as the former imposes barriers to the entry of new competitors46, among other political

economy dynamics specific to the interaction between interest groups and regulators in particular industry

sectors.

More recent literature on the political economy of environmental regulation and instrument choice in the

U.S. also focuses on “industry vs. government” and “constituencies vs. government” interactions47; rather

than on interactions between government actors within the State apparatus as seems to be the case in the

Latin American cases documented. The latter could be characterized as “government vs. government”

interactions. Some studies48 have drawn attention to the role of fiscal distortions and perverse incentives of

various origins, including agricultural policy incentives, as factors exacerbating environmental degradation

in the Latin American region. Others call attention to the large asymmetries between environmental

45 First posited by George Stigler in 1971 and developed later by Sam Peltzmann, please see bibliography. 46 First posited by James M. Buchanan and Gordon Tullock in 1975. 47 For models of the political economy of environmental regulation see references by Wallace E. Oates and Paul Portney (2001), Nathaniel Keohane and Robert Stavins (2002), and Robert Stavins (2005) in the bibliography. 48 UNEP “Human Dimensions of Environmental Change,” in Global Environment Outlook GEO 4, (Nairobi: United Nations Environment Program 2007): 372. UNEP The Use of Economic Instruments in Environmental Policy: Opportunities and Challenges. (Geneva: Division of Technology, Industry and Economics –UNEP, 2004).

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mandates and the public resources allocated49. An alternative statement of this is that environmental policy

is not a priority in a region faced with unmet challenges in poverty reduction and the reversal of a highly

skewed distribution of income. Shedding light on these intra-governmental dynamics is important to

provide a basis for comparison of Latin American results with existing literature.

Over the last decade, a growing body of literature has emerged, documenting the challenges that both

industrialized and developing countries face in the implementation of economic instruments for

environmental management. The experiences of industrialized countries demonstrate that in the application

of economic instruments involving charges, rates and taxes, the revenue objective has predominated over

the objective of creating incentives to improve environmental quality (ECLAC/UNEP/SEMARNAP, 1998;

Panayotou, 1998). Collecting funds has been the primary role of economic instruments used in

environmental policy in developing countries, as well.50 Other potential objectives, such as reducing

environmental impacts, improving environmental performance or increasing regulatory efficiency, have not

received the same emphasis. The literature on the barriers faced by environmental policy in developing

countries tends to emphasize the lack of institutional capacity of environmental authorities, in the sense that

they seldom command the necessary technical staff, environmental information systems, budgetary

resources, and political clout commeasured with their ambitious mandates. These conditions tend to

generate situations where environmental laws and regulations exist but they cannot be enforced credibly.

The following paragraphs summarize relevant observations from reports published by development banks

and other international organizations that have looked at potential challenges for a wider application of this

49 The case of Peru is an extreme example of this. In relation to the extent of Peruvian territory and the sheer magnitude of its natural resources, the 1990-2007 public budget allocated to the national environmental authority CONAM ( “Comisión Nacional de Medio Ambiente”) was minuscule. This is underscored by the fact that when CONAM was recently upgraded into Peru’s new Environment Ministry in 2007-2008 its budget was increased by two orders of magnitude, of course its mandate did not increase in the same proportion. Peru environmental authorities have to be commended for their achievements during this extended period of constrained resources relative to the former CONAM’s mandate. 50 In many cases, the necessary information for anticipating the degree of response by the regulated agents simply does not exist, and so the charges must be applied gradually in a process of trial and error until the desired objective is achieved. Furthermore, in order to attain political approval, the applied charges must often be set below the level at which targeted agents would be motivated to change their behavior significantly enough to improve the parameters of environmental quality. Experience indicates that in general the regulatory institutions find it more feasible to design an environmental charge, rate or tax that carries a specific revenue objective, than to address the technical demands of designing a system of charges that achieves a specific improvement in environmental quality.

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type of instruments in Latin America and the Caribbean. Perhaps the most comprehensive assessment to

date of the use of economic instruments in environmental policy in Latin America is the report published

by the World Bank in 1998. This report drew from three regional workshops on market based instruments

organized by the World Bank in 1995, 1997 and 1998, along with a series of country studies and related

papers sponsored by the same institution. This report emphasized the institutional capacity required for

effective application of these types of instruments, as seen in the concluding remarks51:

The most important lesson emerging from the study is that a more coherent approach to the use of economic instruments for environmental management is needed in the region. Any such approach, moreover, must clearly recognize and address issues of institutional fragility…. • While market-based instruments (MBIs) can improve environmental management, they normally

impose high administrative demands and do not represent a “quick fix” to the problems associated with more traditional command-and-control approaches.

• Despite substantial experimentation with MBIs, limited institutional capacity is pervasive and constrains their effective utilization in the region;

• Historically the primary motive for the use of MBIs has been revenue generation rather than improvements in environmental quality.

• Budgets for environmental management are limited, and in many cases resources are poorly targeted or do not effectively advance policy goals.

• Public awareness of the costs of environmental degradation and of the management tools available to address it remains low, and environmental regulations are frequently plagued by uncertainty that undermines their credibility.

• Even though genuine efforts have been made to adapt MBIs to local circumstances, the flow of information is still predominantly in a North-South direction, and intra-regional cooperation remains weak52.

In general the diagnosis found in studies sponsored by international organizations place emphasis on the

need for further institutional strengthening of national environmental authorities, improved monitoring and

enforcement of compliance, and the recommendation for increased capacity building and investment in

building the information systems required by national environmental management.

51 Richard Huber, Jack Ruitenbeek and Ronaldo Serôa da Motta, “Market Based Instruments for Environmental Policy Making in Latin America and the Caribbean”, World Bank Discussion Paper, No. 381, (Washington D.C 1998). 52 Ibid.

42

2.3.4 Public finance: budgetary deficiencies, earmarking of environmental revenue, fiscal

competition and perverse incentives.

Increased fiscal revenue collection will continue to be the central political objective in most developing

countries. The generation of additional revenue earmarked for specific environmental objectives is present

in several countries. The most successful programs seem to be those in which (a) the charges, rates and/or

taxes are linked to existing collection systems and (b) the resulting income is decentralized to local

authorities carrying out environmental investments. Earmarking funds received from environmental

charges, rates and taxes has also contributed to their political acceptance when used on local sanitation

infrastructure and other high visibility projects. In general earmarking is avoided in public finance.

Increasing the use of earmarked environmental revenues in the region presents important challenges with

regard to the collaboration between environmental and fiscal authorities53. In general Latin American

countries have little experience with this type of collaboration. The Inter-American Development Bank

(IADB) echoes this need in the closing recommendations found in its study on the legal and institutional

framework of environmental management of the Southern Cone countries54:

Stringent financing constraints at all levels of environmental management were encountered in this analysis. One of the options to mitigate these constraints is to link fund-raising or environmental protection to the income-generating capacity of the sector itself. To do so, specific legislation must be enacted to change the prevailing mechanism of allocating all fiscal receipts to the national budget without distinction of origin and the possibility of earmarking them for specific expenditures

IADB goes on to recommend the following specific actions:

Review all sources of funding for environmental management. Promote a participatory discussion with government agencies on current sources of funds for environmental management and possible improvements. Enact legislation earmarking receipts from environmental fees, fines, and other charges to environmental agencies55.

The same point is also remarked in the executive summary of a World Bank report mentioned earlier,

earmarking revenues is identified as one of the three most important areas that merit future attention:

53 Jean Acquatella, “Aplicación de instrumentos económicos en la gestión ambiental en América Latina y el Caribe: desafíos y factores condicionantes,” Serie Medio Ambiente y Desarrollo No 31. (Santiago: CEPAL. 2001). 54 IADB, Environmental Management in the Southern Cone. Final Report, Recommendation, No. 14, (Washington, D.C: Inter-American Development Bank, December 1996). 55 Ibid.

43

While the revenue collection task of MBIs [market-based instruments] has been highlighted, there still is a strong need to channel revenues to local authorities to assist in building institutional capacity56.

The above points underscore the key role that adequate public budgets for environmental management

functions plays in the determining environmental policy outcomes. Municipalities and central governments

public finance constrains often do not leave room for the large investment resources required by basic

water/sanitation, water treatment and waste disposal infrastructure. In the case of Latin America and the

Caribbean, public investment in basic water, sanitation and waste management infrastructure all play key

roles in environmental policy outcomes.

Latin American countries have traditionally used a broad array of tax incentives and fiscal provisions to

promote capital investments in certain types of industry (industrial policy), such as mining and other types

of capital intensive export oriented industries based on resource extraction as a way of securing foreign

currency revenues. These incentives include lowering tariffs on capital inputs, property taxes and corporate

income tax holidays, reduced taxes/royalties or special provisions. It is often the case that these types of

fiscal incentives are granted to highly environmentally sensitive industries, such as mining for example,

without incorporating fiscal provisions for recovering the costs of environmental pollution externalities

from construction/production, and rehabilitation of sites and environmental liabilities after closure. In many

cases fiscal competition to attract investment, either between countries or even between states/provinces

within the same Federal State, generate perverse incentives through lax environmental risk and liability

provisions that run precisely in the opposite direction to the internalization of social environmental costs,

particularly in the case of large strategic investment projects.

This chapter has reviewed a broad range of normative theory concepts, and topics in the policy literature on

environmental regulation and the use of economic instruments. This broad conceptual background is

referred to in the analysis and discussion of the data set of 81 cases of environmental instrument

implementation that constitutes the core of this dissertation research effort in the following chapters.

56 Richard Huber, Jack Ruitenbeek and Ronaldo Serôa da Motta, “Market Based Instruments for Environmental Policy Making in Latin America and the Caribbean”, World Bank Discussion Paper, No. 381, (Washington D.C 1998).

44

CHAPTER 3 METHODS and DATA 3.1 Methodology overview The present chapter covers the methodology used to attempt the three research objectives listed in the

introduction. The first research objective is to assess the extent of implementation of “market-based”

instruments in environmental policy in Latin America. National surveys were undertaken in thirteen

countries for this purpose. The data reported back from these surveys documented 81 cases of “market-

based” instruments from 13 Latin American and Caribbean countries. Survey results where assembled in a

data set where each record represents one case of a “market-based” instrument. Each case documents one

instrument either enacted as law or regulation in these countries, or officially submitted by the national

environmental authority for government approval. Each record in the data set documented the

implementation history of one environmental instrument and consists of a combination of descriptive,

qualitative and quantitative information, akin to a mini-case study of the instruments design and

implementation process. Implementation outcomes were coded for each case as explained in detail in the

following sections in this chapter. The implementation outcome coded for each case constitutes our

dependent variable.

The second research objective is to attempt to identify plausible independent variables or factors associated

with the observed instrument implementation outcomes in the dataset. For the purpose of identifying

plausible independent variables, process-tracing of the implementation record of each instrument was used.

The information collected in surveys went beyond simply determining the outcome of the implementation

process ( objective 1 ). It also included information on the origin of the instrument’s mandate, the political

actors and bureaucracies involved in its design and implementation process, the barriers faced during its

implementation, and how these various factors played out towards the outcomes observed.

Based on this information the implementation process was traced within each case to identify the main

independent variables or exogenous factors plausibly associated with the implementation outcomes

observed. Process tracing within each case resulted in the identification of a reduced set of independent

variables associated with barriers or exogenous factors which were also coded for each case in the data set.

45

These variables were coded and graphed across homogeneous units (i.e. instrument types, implementation

outcomes) in order to identify and highlight relevant patterns, or salient features across cases in the data set.

This descriptive analysis attempted to identify patterns or plausible relationships between the variables

identified and the instrument implementation outcomes observed in the data set.

A descriptive approach was selected to attempt to identify common patterns in the data set. The descriptive

analysis relied on graphing the implementation outcomes observed (objective 1) against endogenous

features such as instrument type (i.e. tax vs. tradable permit) and country of implementation; as well as

against those independent variables or exogenous factors identified across cases. Graphing the data across

these various dimensions enabled to highlight both common and/or contrasting patterns in the data set.

Such as for example examining whether the incidence of positive/negative implementation outcomes

differed across different types of “market-based” instruments, across countries, and across the coded

variables and exogenous factors identified as candidates with plausible explanatory power over the

outcomes observed.

A statistical approach was considered inappropriate for this data set given the very high heterogeneity in the

data. This high heterogeneity was due to the fact that the data set was assembled with instrument cases

coming from thirteen very different countries, ranging from small Caribbean island countries like Barbados

and Jamaica, to very large federal countries such as Brazil and Argentina. Likewise the surveys

documented a broad spectrum of “market-based” instruments encompassing very different types ranging

from environmental charges and taxes, to environmental labeling and certification schemes of as explained

in later sections of this chapter.

The descriptive analysis undertaken comparing whether implementation outcomes differed for different

categories of “market-based” instruments, such as for example positive incentive instruments (subsidies,

tax credits etc.) versus negative incentive instruments (taxes, charges etc.), as well as comparing outcomes

between these and other instrument types (certification, deposit-refund etc.). It also involved comparing

implementation outcomes across other key features in cases, such as the scale of implementation. For

46

example to examine if outcomes differed between cases in which the instrument implementation was

attempted at the national level, in contrast with those cases were implementation occurred in a more limited

sub-national jurisdiction, such as specific watershed, urban area, municipality or a particular state or

province rather than nationally.

Finally the third research objective is to gain a more detailed understanding of the political and institutional

context in which environmental authorities have attempted the implementation of “market-based”

environmental instruments in the Latin American region. As mentioned in the previous chapters the

literature on the application of “market-based” instruments in environmental policy in developing countries

have tended to emphasize “weak institutional capacity” as a catch-all diagnosis for poor environmental

policy outcomes. There is a need to open up this “weak institutional capacity” black box to gain a more

detailed understanding of the factors driving the instrument implementation outcomes observed. To attempt

to gain insight into this problem a combined approach was followed. Basically it consisted in leveraging the

n = 81 data set to illustrate generic patterns or syndromes57, on how the independent variables or exogenous

factors identified played out in conditioning implementation outcomes for sub-sets of cases sharing

common features and outcomes. This exercise was supplemented with the analysis of three case studies that

illustrate in more detail the workings of the generic patters of in Brazil, Colombia and Costa Rica. In

discussing these case studies, the emphasis is placed on comparing our findings with those that had been

previously reported in the literature on the implementation of “market-based” instruments in developing

countries.

3.2 National surveys and research scope The survey was designed to document all available experiences with “market-based” instruments that

national environmental authorities had attempted to implement in each country. Placing emphasis on

documenting each instrument’s design and implementation process for all cases where information was

available to do so. A detailed list of the survey questions and terms of reference is shown in Box 1 in the

57 Syndrome refers here to a cluster of endogenous and exogenous variables, features, interactions and outcomes that tend to manifest together as a whole, even if the specific functional relationships between the group of variables and factors characterizing this cluster remain unknown. Mapping the data set into distinct subsets of cases sharing a common cluster of variables/features/outcomes, that clearly follow similar patterns in terms of causal pathways to arrive at similar outcomes, is akin to identifying a reduced number of syndromes.

47

following pages. The survey placed emphasis in documenting the instrument’s design and implementation

process through its entire lifecycle58.

The specific range of “market-based” instruments surveyed is presented in detail in the following sections.

The empirical literature on implementation of economic instruments in environmental policy calls attention

to the fact that their introduction can be quite challenging for environmental agencies with have

traditionally relied exclusively on direct regulation (i.e. licenses, norms, technology standards, and other

command-and-control instruments etc.). Therefore the survey had to accommodate the possibility of

finding instances of partial and/or failed implementation and include the detailed documentation of the

implementation process in order to trace these outcomes. Accordingly the second and third sections of the

survey Terms of Reference were designed to collect information throughout all stages of the instrument’s

lifecycle.

Figure 3.1 bellow illustrates the different steps in the policy instrument’s lifecycle that were distinguished

for the purpose of collecting information in the national surveys. Note that the dissertation’s scope of

analysis is on the first stages of the policy instrument lifecycle. Our research is focused on the empirics of

what happens as environmental authorities attempt to implement a new “market-based” instrument

(mandated by law or regulation), and try to establish this new instrument into the existing regulatory mix

for the first time. The dissertation research is focused on the analysis of this critical early implementation

stage, in which a wholly new environmental policy instrument is being introduced into the existing policy

framework, and on top of existing institutional structures and practices. Therefore our outcome or

dependent variable, attempts to measure whether “market-based” instruments in law or regulation, were

actually implemented in practice. That is, whether environmental authorities were indeed able to establish a

new “market-based” instrument as a fully operative component into the prior regulatory mix. This

proximate outcome of the implementation process, whether or not a new instrument could be established

operationally and incorporated into the existing policy structure; must be clearly distinguished from its

58 The lifecycle of a policy instrument encompasses the sequential stages starting with its origin (i.e. legal foundations, policy mandate, stated goals etc.), design process (i.e. agencies/actors responsible for its technical design etc.), implementation process (i.e. extent of implementation, barriers faced, actors responsible for implementation and enforcement etc.), and final policy outcome.

48

ultimate outcome, or eventual impact or contribution towards policy goals from its lifetime operation. This

later outcome is the subject of ex-post policy evaluations, and is not part of our scope of analysis. Our focus

is on the proximate outcome from the early lifecycle of the implementation process as new “market-based”

environmental instruments are introduced.

Source: own elaboration to illustrate survey framework. The surveys were executed by local consultants supervised by the author, in coordination with national

environmental authorities in participating countries, as a required project activity within the framework of

the U.N ECLAC / UNDP Project “Application of economic instruments in environmental management in

Latin America and the Caribbean” 59. This research opportunity became available since the author held

primary responsibility for developing the concept for this research project, and for coordinating its

execution during 2000 -2002 in his capacity as Economics Affairs Officer at U.N ECLAC Environment and

Development Division, from Santiago, Chile. The project sponsors were ECLAC and UNDP, the GTZ the

German International Technical Cooperation Agency was the donor funding project activities which

consisted in the undertaking of country level surveys on experiences and lessons learned with the

application of economic instruments in environmental policy.

59 Detailed information on the project concept, activities and output publications (case studies) is provided in the project’s internet page at CEPAL official website: http://www.eclac.cl/dmaah/noticias/proyectos/1/7451/inicio.htm The official project title in Spanish was: “Aplicación de instrumentos económicos a la gestión ambiental en América Latina y el Caribe”. The project was motivated by the following policy-relevant questions: (1) What factors are present in the cases of successful application of economic instruments in the region? What strategies or circumstances determined their success? (2) What barriers do the countries of the region face against the effective implementation of economic instruments? (3) What implementation process or strategy can environmental authorities follow to overcome these barriers and to achieve an effective use of these instruments? (4) Which instruments are considered most feasible for application, given the institutional frameworks and capacities prevalent in the region?. UNDP is the United Nations Development Program, its network of national level offices and resident representatives provide the administrative platform for U.N activities at the country level. U.N ECLAC is the United Nations Economic Commission for Latin America and the Caribbean. It is one of five regional economic commissions in the United Nations system, the others are ECA (Africa), ECE (Europe), ESCAP (Asia Pacific) and ESCWA (West Asia). Regional Commissions provide intergovernmental frameworks for regional cooperation through the convening of ministerial conferences, policy dialogues and high level meetings to identify, document, and disseminate best practices and policy innovations; assist in building national capacity; and promote cooperation between individual countries and international organizations. Through their multi-disciplinary work programs, expertise and networks, have comparative advantages in particular in policy advocacy for mainstreaming emerging issues into policies and planning . The main clients of regional commissions are government officials at all levels, other stakeholders include academia, NGOs, the private sector, and civil society.

Figure 4.1 Extent of implementation not surveyed Not surveyed Not surveyed

Instrument mandate origin

•Executive

•Legislative

•State/municipal .

Design process Instrument goal Incentive to change behavior of economic agents? Raising revenue? Charging for services? (water & waste treatment) Subsidizing env. investment?

Implementation process Actors involved? Barriers faced? Administrative costs? Perverse incentives? Political and institutional interest

Implementation o utcome Instrument:

1. Implemented and found operating.

2. Implemented but no longer operating/enforced.

3. Never implemented.

49

The project budget provided for approximately 1-2 man-months of national level research work for

completing the survey terms of reference. National consultants were identified with the assistance of

national environmental authorities, and hired through the above project to undertake the survey in the

following countries: Argentina, Brazil, the Caribbean sub-region (Barbados and Jamaica), Chile, Colombia,

Dominican Republic, El Salvador, Guatemala, Mexico, Peru and Venezuela. These experts were selected

for their ability to work in conjunction with the national authorities directly responsible for the design and

implementation of environmental policy instruments within national environmental agencies and

organizations.

A national focal point in each country’s national environmental authority served as official counterpart

coordinating the undertaking of these national level surveys. The idea behind the project was to directly

involve environmental authority officials in a stock taking exercise assessing accumulated experience with

the application of these instruments. This provided the base for later engaging them in regional level

discussions, along with their peers from other participating countries, to extract lessons learned and

recommendations for improved outcomes. The survey Terms of Reference (shown in the following pages)

included questions aimed at documenting experiences and lessons learned by environmental authorities in

their efforts to implement “market-based” instruments.

Upon completion of the national surveys environmental officials that participated as project focal points,

along with the national consultants undertaking the surveys, met at U.N ECLAC in Santiago, Chile, for a

closing seminar to present national results, exchange perspectives and discuss findings. The national reports

from the first group of countries surveyed were published collectively in Spanish by U.N ECLAC as:

“Desafíos y propuestas para la implementación más efectiva de instrumentos económicos en la gestión

ambiental de América Latina y el Caribe” Estudios de caso: Brasil, Subregión Caribe, Chile, Colombia,

Guatemala, México, Venezuela, CEPAL LC/L.1690-P, May 200260. The national reports from country

surveys that followed were published by U.N ECLAC as individual reports. The reports for Argentina,

60 Please refer to the bibliography for complete details on the authors and consultants involved in each of the eight individual national reports compiled as separate chapter in this publication.

50

Costa Rica, Dominican Republic, and Peru were published separately61. The report from El Salvador was

not published and remained as mimeograph. A separate section in the bibliography lists all these national

case studies in detail, specifying the individual authors responsible for drafting each country report and the

specific U.N ECLAC publication where each country report was published.

61

CEPAL. Eduardo Beaumont. “El caso de Argentina. Desafíos y factores condicionantes para una aplicación más efectiva de instrumentos económicos en la gestión ambiental en América Latina y el Caribe”. CEPAL LC/L. 2074-P, (Febrero 2004). CEPAL. Jeffrey Orozco, K. Ruíz “Uso de instrumentos económicos para la gestión ambiental en Costa Rica”.CEPAL LC/L.1735-P,(Junio 2002). CEPAL. Luis F. Castro, Caicedo C., Jaramillo A. Morera L.“Aplicación del principio contaminador-pagador en América Latina: evaluación de la efectividad ambiental y eficiencia económica de la tasa por contaminación hídrica en el sector industrial colombiano”. CEPAL LC/L.11691-P, (Marzo 2002). CEPAL. Magdalena Lizardo, R. Guzmán. “Coordinación de las políticas fiscales y ambientales en la República Dominicana”. CEPAL LC/L. 2303-P,(Marzo 2005). CEPAL. Raúl Tolmos.“Desafíos y propuestas para la implementación más efectiva de instrumentos económicos en la gestión ambiental de América Latina y el Carib: el caso de Perú”.CEPAL LC/L. 2073-P, (Febrero 2004).

51

Box 3.1 Survey terms of reference The following questions were prepared to guide the survey of national experiences in the application of economic instruments for environmental management. It is expected that analysts consult official information, as well as interview the actors involved, including relevant authorities and national experts, in order to check facts and record the various actors’ perspectives on the extent of effective implementation of each policy instrument. 1. General questions

• Please identify the economic instruments that have been applied in the context of environmental policy in the country since 1990, or that are being planned for application in the short/medium term?

• Is there evidence of application of price-based instruments (i.e. taxes, charges, fees, subsidies, fiscal incentives etc.) specifically linked to the environmental externalities?

2. Questions regarding origin of policy mandate and instrument’s design process

For each type of instrument identified above please specify the following details: • Describe the origin of the policy mandate for application of this instrument: a) law, b) executive

decree, c) administrative process, d) other (please describe) • Regulatory entity(ies) or agency(ies) that designed the instrument, and consultations held. • Objective specified for the instrument: a) internalization of social costs of environment degrading

production/consumption activities and/or resource use; b) incentive creation to induce improvement in environmental quality parameters, c) revenue generation, d) cost recovery, e) other objective? (please describe)

• Criteria that guided the design of the instrument: a) economic, b)environmental, c) fiscal, d) administrative, d) other.

• Degree of participation of affected parties (pollutant sources) in the instrument design process. • Realization of pilots, or tests for the calibration/adaptation of the instrument to national circumstances. • Describe in general terms the sequence of steps that were followed, both political and technical, in the

design process and application of this instrument. 3. Questions regarding the instrument’s implementation process, enforcement and application in

practice. • Regulatory entity(ies) or agency(ies) charged with implementing and enforcing the instrument. • Barriers or challenges faced while implementing the instrument in practice? • Describe the most significant obstacles, and the actors presenting greater opposition? • To which factors do you attribute the presence of these barriers/challenges/opposition to policy

implementation?. • Were any strategies or actions taken to overcome the barriers and difficulties in the implementation,

application, and enforcement of the instrument? • Was effective application of the instrument achieved? Is there available data indicating the degree of

success (or failure) achieved? Please report this data in detail. • To which factors do national authorities/experts attribute the success (or failure) achieved in the

application of the instrument?. • Is there any available estimation of the cost incurred in the design and application of the instrument?.

Is there any estimation available of the benefits generated by the application of the instrument? 4. Open question. General observations regarding the overall policy implementation process

We would greatly appreciate if you could share your individual perspective and observations on the factors determining the policy implementation process of price-instruments used in environmental management in your country. Please feel free to use all the space required to highlight any additional aspect or details that you consider relevant. Source: CEPAL/PNUD Jean Acquatella. “Términos de Referencia para el relevamiento de información a nivel nacional”. translated from Spanish original (mimeo).

52

3.3 Types of environmental policy instruments surveyed Table 3.1 shows the typology of instruments included in the survey Terms of Reference. Market-based

instruments were classified in three types, namely: price-based, market creation or, and demand-side

information instruments for the purposes of the present research. These types are listed in the second, third

and fourth column of Table3.1. Demand-side information instruments refer to instruments that create

incentives through indirect channels, such as the public dissemination of information on the environmental

performance of firms. The public disclosure of official information or certification of firms’ environmental

performance, can impact their market reputation with consumers and, in some cases has been shown to

affect the stock market value of individual firms. These demand-side information instruments are finding

increasing use in several countries.

The second column of Table 3.1, price-based instruments, consists of per unit taxes, charges, fees for the

use of natural resources, for emissions of various types of pollutants to environmental media, and/or for any

other activity causing environmental externalities. These instruments can be designed either to create price

incentive effects to alter environmentally harmful behavior, or to generate revenue and/or recover costs.

Most applications are a combination of these two pure forms. The revenue generating potential of these

types of instruments constitutes an attractive property. In particular environmental authorities might see

their application as an opportunity for earmarking the revenues generated for environmental investments, or

to partly cover the costs of national environmental management.

Subsidies, tax credits, fiscal incentives, and special financial facilities for activities with positive

environmental externalities are the counterpart of charges and taxes which are applied in cases where

negative externalities exist. Fiscal and financial incentives are used to promote investments in cleaner

production technologies, environmental infrastructure, and imports of pollution control technologies.

Subsidies are often used for conservation and environmental remediation activities like reforestation. This

type of positive instruments finds important applications in the promotion of environmental investments in

small and medium enterprise sectors whose characteristics and cost structure respond better to these

incentives than to the imposition of charges.

53

The third and fourth column of Table 3.1, market-creation (tradable permits, cap and trade etc.) and

demand-side instruments (certification, eco-labeling etc.), are instrument categories that also operate

through market incentives. Tradable permits systems have found a number of applications internationally.

These instruments have been used in situations where there is a need to limit the total load of pollutant

emissions, or to cap the aggregate harvest as for example in a fishery. The final group of instruments, are

those grouped under demand-side information based interventions. This category, more than formal

instruments per se, consists of “informal regulation” schemes that generate incentives through the public

disclosure of information and transparency on the environmental performance of firms and their products.

These instruments operate through reputation incentives that affect a firms’ market image with consumers

relative to its competitors, and in some cases might even affect a firm’s stock market valuation in capital

markets62.

For the purposes of this dissertation price-instruments applied to transportation fuels, such as gasoline and

diesel taxes, were not included in the research scope. The rationale for excluding them is that these fuel

taxes are generally designed for collecting general public revenue, and not for environmental objectives. In

fact in many countries fuel taxes, along with value-added sales taxes (VAT), provide the largest public

revenue sources aside from personal and corporate income taxes. On the other hand instruments such as a

surcharge on leaded gasoline, applied on top of existing fuel taxation in Mexico’s Federal District for the

purpose of collecting funds for the upgrading of vapor capture equipment in gasoline pump stations, were

included since their design involved an environmental objective. A similar rationale was used for excluding

road congestion charges, recently implemented in Santiago, Chile. These charges are not considered by

Chilean environmental authorities (CONAMA) as part of their greater Santiago air pollution

decontamination plan. They have been implemented by the private urban highways concessionaries for the

purpose of rationing traffic by increasing tariffs per kilometer traveled in peak hours.

62 The paper by Dasgupta et al, included in the bibliography provides empirical evidence supporting these claims.

54

Table 3.1 Taxonomy of environmental policy instruments Direct regulation

Economic instruments Litigation

Regulations and sanctions

Price-based instruments Market creation quota-based & rights-based instruments (allocation of property rights)

Demand-side information-based instruments

Responsibility for damages, tort laws

• Taxes, charges, user fees, etc.

• Subsidies, fiscal incentives, etc.

• Preferential financing

• Performance bonds guarantees and insurance requirements

• Tradable quotas or permit systems.

• User rights

• Resource concessions, privatization.

• Labeling, product certification.

• Information disclosure and transparency laws.

Standards Direct regulation of type, quantity, and/or concentration of emissions or effluent discharges of pollutants allowed; technology and equipment performance standards; ambient air and water quality standards, pollutant emissions and effluent discharge norms; energy efficiency standards; fuel standards; car and truck fuel efficiency standards, etc Compliance is monitored, and sanctions are imposed for noncompliance (e.g., fines, closures and prison sentences).

Environmental taxes / charges Pollution is taxed or charged per unit emitted or discharged at the source of the externality (tail pipe) or through a proximate tax base (fuel taxes) . Rates depend on whether the goal is cost-recovery, or the creation of incentives to reduce environmental impacts and internalize pollution costs. Water use charges per volume consumed or discharged, user charges for natural resource use, taxes on forestry/mining, linked to negative spillovers etc Subsidies, fiscal incentives, preferential financing Positive incentives to promote investment in clean technologies, energy efficiency, cleaner production, forest protection, soil conservation, reforestation, and other activities with positive externalities. Deposit of performance bonds, financial guarantees, or insurance requirements internalize environmental risks into private project costs.

Cap and trade Maximum limit for aggregated annual emissions (cap) is officially established, and divided into individual tradable quotas or emission permits. Government sells or distributes the individual permits and monitors compliance with the system. Private users can freely trade the permits allocated at market prices, which fluctuate freely. Applications include: Tradable permits for air pollutant emissions by fixed sources (i.e. power stations) in cities and saturated regions (bubbles). Tradable fishing quotas that cap the annual catch tonnage to manage fisheries. User rights, Allocation of tradable water use rights or water quotas. A concession is the temporary granting of private rights to exploit a public resource (forests) under specific terms.

Public disclosure of environmental performance Certification and labeling requiring producers to reveal environmental information/risks on products destined for end use. Required reporting and public disclosure of toxic releases to environment (TRI). Official ranking and public disclosure of environmental performance of regulated industries out of compliance; and conversely of industries with strong compliance records. (PROPER program Indonesia) Voluntary performance-based certification (i.e. ISO 14000, zero discharge, pollution prevention technology, recycle-reuse policies etc.)

Strict legislation on environmental liability Law requires that polluters or resource users pay for damages that affect third parties. Affected parties receive compensation through judicial litigation.

Source: Author’s elaboration based on instruments taxonomies in the literature and the categories presented in Richard Huber, Jack Ruitenbeek and Ronaldo Serôa da Motta, “Market Based Instruments for Environmental Policy Making in Latin America and the Caribbean”, World Bank Discussion Paper, No. 381, (Washington D.C 1998).

55

3.4 Data description and dependent variable: instrument implementation outcomes The data reported back from the national surveys consisted of country reports answering the survey

questions in text format and documenting different types of information including: a) available primary

data; b) official records and documents, government public information, reports and publications; c)

information gathered through interviews with public officials, national experts and other actors involved in

the instrument design and implementation processes; d) secondary information from national studies,

policy evaluation, and impact assessment reports when available; as well as e) expert judgment regarding

factors driving instrument implementation and policy outcomes. As such each country report resembled a

mini descriptive national study providing rich contextual information on the implementation process of the

instruments found in application; and in some cases, on instruments that were planned and designed but

whose implementation was aborted for one reason or another. This information was assembled in an

aggregated n = 81 data set where each data point consisted of an instrument case. The survey data allowed

for distinguishing among the following five outcomes from the implementation process for each case

documented in the data set:

Table 3.2 Implementation outcomes Data set n = 81 cases Implementation outcomes coded

Instruments Implemented

55 cases

1. instrument had been implemented and was found in operation by the national survey

2. instrument had been implemented but was found to be not operating,

retired, or not being enforced at the time of the national survey. 3. instrument had been implemented but was found operating only

partially or in a limited fashion relative to its original goal

Instruments for which

implementation had not been initiated

26 cases

4. instrument had been enacted in law or regulation, but nevertheless its implementation had not been attempted

5. instrument had been designed by environmental authorities and

submitted as proposal to the government, but had failed to obtain the required political support to be pushed through the executive and/or legislatives processes required for its official enactment

Each instrument case was coded for one of the above five implementation outcomes as a dependent

variable. Instrument implementation outcomes in our dataset, are defined as outcomes of the process

whereby environmental authorities attempted to introduce a “market-based” instrument into the existing

policy framework and/or environmental regulatory mix. Including attempts to put in practice instruments

56

already enacted as law or regulation, and also initiatives where environmental authorities submitted

instrument proposals for executive or legislative approval with a view towards ultimately implementing

such instruments.

Our definition of instrument implementation outcome is different, and should not be confused with, notions

about an instrument’s environmental efficacy, or ultimate contribution towards the attainment of the

environmental policy goals which motivated its deployment63. These ultimate outcomes would only

manifest themselves in latter stages of an instrument’s lifecycle, ex-post implementation, after authorities

have succeeded in firmly incorporating the new instrument into the baseline policy mix. Our analysis is

circumscribed to earlier stages of instrument’s lifecycle when authorities attempt to establish and put into

practice for the first time an instrument that has been designed as blue-print in law or regulation.

The following Table 3.3 summarizes the 81 instruments in the data set listed by country, each row

represents one case documented in the national surveys undertaken in these thirteen countries. The

implementation outcome coded for each case is shown in the last columns at the right side of the table.

Aside from implementation outcomes, Table 3.3 also indicates the variables coded for the major

barriers/obstacles to implementation in each case, as identified through process-tracing and text analysis of

documented information for each case. By these we mean that the case documented information explicitly

mentions the variable as a major factor determining the observed implementation outcome. Some cases

were coded for several of these variables, when the case documentation explicitly indicates more than one

factor as relevant to determining the outcome observed from the instrument implementation process. The

main source for each case are the CEPAL (U.N ECLAC) publications listed in the bibliography. Each of

63 It is widely recognized that the ultimate environmental impact of a policy instrument is usually very difficult to disentangle from other factors in the overall policy mix. In most countries ex-post policy evaluations to estimate the ultimate impacts achieved from specific policy interventions are few and far between. However the terms of reference for the national surveys undertaken also called for identifying studies, ex-post assessments or any other objective indicator of attainment or overall environmental outcome that could be associated with instrument implementation when available. Examples of plausible indicators of ultimate environmental impact could include for example: documented changes in regulated agents’ behavior, changes in environmental quality parameters or in the volume/concentration of emissions, changes in the level of charges/fees for resource use, or revenues collected, etc. occurring after a particular instrument was introduced and unambiguously connected with its application.

57

these publications is a national study which integrates all the instrument cases found in one country through

national survey. The author(s) of each country report are listed with the title of each report indicates the

country.

Table 3.3 barrier/obstacle variables code: F= (fiscal authority has operational role in instrument implementation); F*=(fiscal authority opposition ex-ante implementation); E=(poor enforcement indicated in case); T=(case indicates interagency transaction costs, horizontally across public agencies/bureaucracies and vertically between government levels); T* =(case indicates interagency transaction costs and lack of coordination ex-ante implementation); W= (case explicitly indicates “weak capacity of environmental authorities” as a key factor in implementation outcome obtained); D = (case indicates that distributive considerations on instrument’s impact on low income groups, was key factor in implementation outcome observed)

58

Table 3.3 Market -based instruments identified in national s urveys ( n = 81) thirteen countries

NOT implemented

implemented

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Implementation outcome, Percentage (%) share in t otal n=81 15% 16% 68% 42% 16% 15% Number of cases in n=81 12 13 56 34 9 12

Argentina Subsidy, concessions rural renew electr. generation (PERMER, 2000) F 1 1 Fiscal incentive and feed in tariff wind & solar generation (ley 25019, 1998) F 1 1 Fiscal incentives/grant reforestation, forestry plantations (ley 25080, 2000) 1 1 9 instr. Evaluation and fiscalization charge on hazardous waste producers TEF (ley 24.051) earmarked E – F – T 1 1 5 implemtd. Certification sust. forestry exports. 1 1 Matching grant incentive SME clean production investment (Decreto 1411/98) 1999 F* 1 Minimum budgets in waterbasins env. quality mgmt (leyes 25.688) F* - T* 1 Minimum budgets for industrial hazardous waste and PCB operators registry (leyes 25.675 y 25.670) F* - T* 1 Environmental Compensation Fund (ley 25.675) 2002 F* - T* 1 Barbados Deposit-Refund mass consumption bottles 1 1 Import Fee on durable goods to pay eventual disposal F 1 1 8 instr. Tax credit for solar water heaters F 1 1 5 implemtd. Fiscal incentives imports of water-saving equipment in hotels F – T 1 1 Fiscal incentives for rain water collection systems F 1 1

User charges based on water consumption volume D – T 1 Differentiated solid waste collection fees (not implemented) 1

Jamaica User charges based on water consumption volume F 1 1 1 Brazil Fiscal compensation for oil production (Federal – State) 1991 F 1 1 Water use charge, decentralized watershed mgmt ( Paraiba do Sul, SP RJ Ms) T 1 1 7 instr. Water rights use charge (decreto 23.067/94) Ceará 1 1 6 implemtd. Tariff on industrial effluents (Sao Paulo). water utility 1 1 ICMS tax revenue sharing env criteria to municipalities (art. 158 Federal Constitution) state-level Paraná, Minas, Sao Paulo etc. F 1 1 1 retired Vehicle inspection fee for air pollution monitoring program (Rio de Janeiro) RJ state env. Authority F - T 1 1

Ondazul prize & public recognition for industrial env. performance 1 Colombia Water effluent charges in CAR jurisdictions (tasa retributiva) Law 99, 1993 F – T -W 1 1

4 instr. Tax credit for cleaner production (VAT, Income tax) 1995 F - T 1 1 All implemtd. Reforestation project lump subsidy (CIF Forestal) 1 1 Reforestation income tax credit (Art 157 y 253 codigo tributario) 1 1

59

Table 3.3 Market -based instruments identified in national surveys

( n = 81) thirteen countries NOT implemented implemented

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Implementation outcome, Percentage (%) share in t otal sample 15% 16% 68% 42% 16% 15% Number of cas es in n=81 12 13 56 34 9 12

Costa Rica Payment for env. services in watershed protection areas (PSA) Forest Law 7575, 1996 F - T 1 1

1 implemtd. Water effluent charge (Canon de Vertidos) proposal 2000, law passed 2005 F* - T* 1 Chile Reforestation subsidies (Decreto/01 1974) F 1 1

Compensation system for fixed source PM emissions in Santiago (decreto 4/92, 812/95) 1992,1995 1 1 12 instru. Cleaner production financial incentives (CORFO, FAT) F - T 1 1 Individual transferable fishing quotas (CIT 1991) 1 1 5 implemtd. Eco-labeling for ozone-safe and organic agricultural products. 1 1

Tradable air pollution permit system for Santiago metropolitan region (SPET) proposed law T* 1 Native forest Law taxes, fiscal incentives (proposed law) CONAMA-CODEF nat'l env. & forestry development authorities F* 1 Private protected area fiscal incentives (proposed law) CONAMA F* 1 Industrial liquid waste (RILES) (instrument design) CONAMA T* 1 Differentiated solid waste volume collection fees (feasibility study) CONAMA T* 1 Env. Taxation (feasibility study) CONAMA F* 1 Non-compliance economic disincentives, fines (feasibility study) CONAMA 1

Dominican Forestry fiscal incentives and finance (ley 290, 55) 1985-88 F 1 1 Republic Renewable energy fund, 2% revenue of fuel taxes (ley 112-20 F 1 1

4 instr. Mining env. compensation liability (ley minería 1971) 1 1 3 implemtd. Tax credit for cleaner production investments (2000) F 1

El Salvador Fiscal incentive nat. gas conversion of buses. (not implemented) 1 Guatemala Tradable water rights. "Paja de agua" 1950 (Discontinued /no longer operational) F - T 1 1

Certification organic export agriculture and ecotourism operations 1997 1 1 8 instr. Self-governed indigenous community forestry concessions in Petén (Res. Biosfera Maya RBM) 1990 1 1 All implemtd. Reforestation subsidy per hectare (PINFOR, decreto 101-96) 1996 1 1 Env.quality and clean production certification for exporters 1999 T 1 1 2 retired or Financial incentives through Natl env.fund (FOGUAMA, 1997) F 1 1 Not enforced Integrated municipal fees for water, sewage, solid waste.(recibo único, Quetzaltenango) 1989 1 1

EIA non-compliance fines (decreto 68-86) only 10% invest. Projects comply with EIA E – T - W 1 1

60

Table 3.3 Market -based instruments identified in national surveys

( n = 81) thirteen countries NOT implemented

implemented

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Implementation outcome, Percentage (%) share in t otal n=81 15% 16% 68% 42% 16% 15% Number of cases in n=81 12 13 56 34 9 12

Peru Forestry extraction fees and concessions auction E – F - W 1 1

Irrigation water extraction fees F - T 1 1 8 instr. Municipal water supply and wastewater treatment charges. (require State subsidies, over 95% do not cover costs) F - T 1 1 3 implemtd. Fishing licneses (MIPE) and transferable fishing quotas (Decreto 1999) not implemented F - T 1 User charge (compensatory) for natural resource exploitation ( Ley Orgánica Aprovechamiento Sust. Rec. Naturales) 1997 not implemented F* F - T 1 5 retired or Polluter pays principle in EIA (Codigo Ambiental 1990) articles eliminated by Ley Prom. Inversión Privada (1997) 1 Not enforced Transferable water use rights (Ley de Aguas) proposed not implemented 1

Tradable industrial emission permits (Reglamento Amb. Ind. Manufacturera MITINCI 1997) proposed not implemented 1 México Accelerated depreciation on pollution control equipment (laws LISR, LGEEPA 1996) ind.associations CANACINTRA consulted in design F 1 1

Zero tariff on pollution prevention/control technology (INE-SECOFI- SHCP 1997) ind.associations CANACINTRA consulted in design F 1 1 12 instr. Leaded Gasoline surcharge Mexico DF (INE, Banobras, GDF, Gob. E.México) revenue not devolved since 1997) F 1 1 11 implemtd. Insurance premium for hazardous waste transport (Art. 22 LGEEPA, SCT, CNSF,1994) T 1 1 Wastewater discharge charges,fines (Ley Federal de Aguas, SHCP-CNA criteria 1995) implemented 2000 not enforced F - T 1 1 5 retired or User rights for sport hunting in natural areas (Ley Federal de Derechos LFD, LGEEPA, INE Baja California Sur 1 1 Not enforced Deposit-refund system for car batteries (INE) 1 1

Deposit-refund system for car tires.(INE) in consultation w industrial chambers CONCAMIN T 1 1

Deposit-refund system for used motor oil (INE-SEMARNAP) proposed not implemented T* 1 Deposit-refund system for Ni-Cd batteries. not operational. T* 1 Subsidy for forestry plantations in degraded areas (PRODEPLAN 1997) 1 1 Subsidy for reforestation, forest management (PRODEFOR 1997) 1 1

Venezuela Deposit-refund for mass consumption bottles (Decree 2216, Art. 24 industrial recycling) Private initiative Owens-Illinois 1 1 6 instruments Corporate tax credit on pollution prevention, control investments (LIC 1986-91) discontinued F 1 1 4 implemtd. Deforestation tax (SEFORVEN 1970s) partly operational, no information on revenue allocation, no enforcement. F - W 1 1 Industrial solid waste collection fees. Concession of solid waste collection to private co. COTECNICA 1 1 2 retired or Leaded Gasoline tax earmarked for nat'l solid waste fund (MARNR, MSDS 1999) proposed not implemented F* - T* 1 Not enforced Water discharge tax Lake Valencia basin (MARNR 1990) not implemented F* - T* 1

61

Figure 3.2 bellow shows the number of cases coded for the above implementation outcomes in the thirteen

countries covered in the national surveys. As seen the number of cases documented in our data set varied

widely across countries64. In this figure implementation outcomes 4 and 5 above, have been aggregated into

a single group labeled “not - implemented” (shown as light yellow bar). The same applies to

implementation outcomes 1 and 3, which appear aggregated as a single group labeled “implemented”

(shown as blue bar). Outcome 2 appears by itself labeled as “retired/not operating (shown as dark red bar).

4

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Figure 3.2 Number of cases and implementation outco mes by country ( n = 81)

non-implemented implemented retired / not operating

64 Mexico accounted for 12 cases, with 2 instruments not implemented ( deposit-refund schemes for used motor oil, and Ni-Cd batteries), 3 retired/not operating (accelerated depreciation and zero tariff for pollution control equipment, leaded gasoline surcharge in Mexico D.F), and 2 instruments partly operating ( Industrial waste water discharge fees (not enforced), insurance premiums for hazardous waste transport, and car tired deposit refund system). Chile accounts for 10 instrument cases, with 5 implemented, and 5 official proposals that had not obtained enough political support to be enacted. Argentina accounts for 9 cases, of which 4 are officially sanctioned instruments not implemented. Peru accounts for 8 cases, with five officially sanctioned instruments not implemented. Brazil and Barbados account with 7 cases each, with only 1 case not implemented in Brazil, and 2 in Barbados. The other countries ranged from 1 case (water use charge) implemented with success in Jamaica, 1 not implemented proposal in El Salvador, 2 cases in Costa Rica, 4 in Colombia, 6 in Venezuela, 4 in the Dominican Republic and 8 in Guatemala.

62

3.5 Coding of implementation outcomes Implementation outcome was coded in a straightforward manner by distinguishing between instruments

that were implemented and applied in practice (coded as implementation=1); and instruments that had not

been implemented (coded as implementation = 0). Within the total of 81 cases of “market-based”

instruments reported in the national surveys from thirteen countries, 25 instruments (31% of data set) had

not been implemented for various reasons which are the subject of analysis in later chapters. These cases

were coded as (implementation = 0, or not implemented) in the data tables appended at the end of this

chapter. This group of 25 instrument cases not implemented included both instruments officially enacted as

law or regulation (13 cases), and instruments that had been designed but failed to obtain the required

executive and/or legislative backing for their final enactment (12 cases). These subsets were distinguished

by placing them in separate columns in the data tables appended at the end of this chapter.

Within the remaining group of 56 instruments implemented, 12 cases (22% of the 55 implemented) were

found to be no longer operating at the time of national surveys. These were instruments had operated for

some time but had been either retired, or were not being enforced, and therefore were no operating for

practical purposes. This situation occurred for example in cases where no charges were being invoiced, or

payments were not being collected by authorities in the case of charges/fees, or no payments were being

made in the case of subsidies/tax credits; or fines were not being enforced etc.; and also in cases where the

instrument was not operating according to its original design intent. For example in cases where

environmental revenue flows or mandatory transfers to environmental funds had been “captured” or

withheld by fiscal authorities in charge of administering/transferring earmarked funds, among others

situations impeding the flow of funds towards their originally mandated environmental end use. These 12

cases of retired or not enforced instruments were coded as (implementation = 0, not operating / not

enforced / retired) in the data tables, but were distinguished in a separate column from the previous 25

cases that were never went into practice.

The national surveys also documented cases were instruments were operating only partially, or in a limited

fashion relative to their original design goal. These were instruments which were being only intermittently

63

or inconsistently applied, or were being applied only in some geographical jurisdictions but not in others, or

which had experienced relative weak demand (in the case of incentives) relative to their original goals.

These cases were coded as (implementation = 1, partial / limited operation) in the data tables appended at

the end of this chapter.

The following Figure 3.3 illustrates the number of cases in the data set coded for each of the above

implementation outcomes. As shown approximately 30% of cases in the original n = 81 data set never

entered the implementation stage. And of the 56 instruments that did, approximately 22% had been retired

or were not being enforced, and a further 16% were found to be operating only in a partial or limited

fashion.

12

13

56

35

9

12

0 10 20 30 40 50 60

number of instruments for each outcome

proposal

official sanction

Operating

Partial operation

not operating/not enforced

NO

T im

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Figure 3.3 Number of cases by implementation outco me ( n = 81 inst ruments in 13 countries )

56 instruments implemented are disaggregated into the

three outcomes above

64

3.6 Process tracing and identification of independent variables The second research objective is to identify plausible variables associated with the observed

implementation outcomes. “Within-case” analysis through process-tracing in combination with “across-

cases” comparison methods65, were used to identify variables and plausible causal factors in the political

and institutional context underlying the observed implementation outcomes. The data set evidenced a

remarkably “low variance” regarding the following features:

� The high rate of “non-implementation” outcome documented for approximately one third of all cases

documented ( 25 cases of instrument mortality ex-ante implementation).

� Similar high rates observed for the ‘not operating/not enforced/retired’; and ‘partial operation’

outcomes ex-post implementation (12 and 9 cases respectively, or 37% in 56 instruments

implemented).

� These outcomes were observed across very different countries, and across the different instruments

types covered by national surveys. For example it occurred for taxes and charges, as well as for

subsidies and other positive incentive instruments with comparable frequency. Similar rates of

aborted/failed implementation attempts were also found across very different countries, such as

Argentina and Mexico on one hand, and Guatemala, El Salvador and Jamaica on the other.

This “low variance” of implementation outcomes suggests the possibility that exogenous or systemic

factors, independent of endogenous features such as the specific environmental instrument type being

implemented, might be playing role in the frequent derailment of the implementation process. Our second

research objective calls for identifying factors and/or variables plausibly associated with the outcomes

observed. Therefore the methods selected for case analysis must be appropriate to the situation of “low

variance” in the dependent variable. In methodological literature jargon this situation is termed “equi- 65 For the purpose of this research we refer to the analytical methods of process-tracing, congruence, and typological theorizing, as codified in Alexander L. George and A. Bennett. Case Studies and Theory Development in the Social Sciences (MIT Press, 2005): 151-205. A growing number of scholars support the application of these methods in research design for the construction of middle-range theory, or contingent generalizations, in political science, international relations and comparative politics literature. David Collier, “The Comparative Method: two decades of change”, in Ada Finifter, ed. Political Science: The State of the Discipline (Washington, D.C.: American Political Science Association, 1993): 8-11: 110-112. David D. Laitin, “Comparative Politics: the State of the Subdiscipline” in Helen V. Milner and Ira Katznelson, eds. Political Science: The State of the Discipline ( New York: Norton 2002).

65

finality” 66, sometimes called “multiple causality”, which is present in many social phenomena. The fact that

the same type of outcome (i.e. aborted or derailed implementation) can emerge in different cases through

alternative causal patterns; via a different set of independent variables, or even via the same set of variables

but acting through different causal paths, has major implications for the selection of appropriate case

analysis methodology. According to Alexander George and Andrew Bennett67:

Equifinality challenges and undermines the common assumption that similar outcomes in several cases must have a common cause that remains to be discovered. This assumption misdirects the attention of the investigator by leading him/her to believe that the task of empirical enquiry is to discover a single causal pattern for cases that have similar values on the dependent variable. Instead a major redefinition of the task of developing theory is required when a phenomenon is governed by equifinality. The task becomes that of discovering the different causal patterns that lead to similar outcomes. When a phenomenon is governed by equifinality the investigators’ task is to produce a differentiated empirically based theory that identifies the different causal patterns that produce similar outcomes.

The relevant methodological point for our purposes is that the task of identifying different causal patterns

leading to the same outcome, or reduced set of similar implementation outcomes (low variance in

dependent variable), requires the use of so called “within-case” methods such as process-tracing, to

supplement comparison methods alone. Therefore tracing each instrument’s implementation process

throughout its lifecycle within each case appears to be the appropriate first step to identify plausible

factors and independent variables leading to the observed outcome in each case. The second step in the case

analysis methodology would then involve comparing the plausible independent variables and causal

patterns thus identified, across cases in the dataset to check if they have explanatory value compared with

alternative explanations in the literature.

66 “Equifinality” is a term from general systems theory, also sometimes called “multiple causality”, which describes the condition when different instances of the phenomenon under investigation have alternative determinants. According to George and Bennett, John S. Mill referred to this problem as “plurality of causes”. 67 Alexander L. George and A. Bennett. Case Studies and Theory Development in the Social Sciences (MIT Press, 2005), 161.

66

3.7 Coding of independent variables associated with observed implementation outcomes. Our second research objective calls for identifying plausible independent variables or factors can be

identified with plausible explanatory power to account for the observed implementation outcomes? The

data reported back on each instrument’s design and implementation processes included information on the

roles that government and/or private actors had played throughout the instrument’s lifecycle, the barriers

faced, and in some cases even a preliminary identification of plausible factors associated with the

success/failure of implementation. The detailed documentation of the policy instruments’ lifecycle was

intended to serve the heuristic purpose of identifying plausible independent variables68 associated with

implementation outcomes (research objective 2). Process tracing within cases singled out a reduced set of

variables identified as the major barriers/obstacles associated with poor implementation outcomes. The

following Table 3.4 summarizes the variables or factors identified as major barriers and/or obstacles in the

implementation process, the coding criteria devised, and their respective relevance to implementation

outcomes as indicated by the number of cases which associate the variable with negative implementation

outcomes.

68 Alexander George and A. Bennett classify heuristic case studies as one of six different kinds of theory-building research objectives, building on the five types identified by Arend Lijphart, “Comparative Politics and the Comparative Method”, American Political Science Review, Vol. 65, No. 3 (September 1971); and Harry Eckstein , “Case Studies and Theory in Political Science”, in Fred Greenstein and Nelson Polsby, eds. Handbook of Political Science, Vol. 7 (Reading, Mass.: Addison-Wesley, 1975): 79-138.

67

Table 3.4 Variables identified as barriers/obstacles in the instrument implementation process

Variables coding criteria Relevance to outcomes

1 0 ?

1. Fiscal authority involvement in implementation process

Fiscal authority plays a major role in the instrument implementation process and in its routine operation.

Implementation process and instrument operation are fairly independent of Fiscal authorities.

Insufficient information to code unambiguously

Mentioned in 38 cases: 7 (18%) of which were not implemented; and 18 (47 %) reported partial or retired/not operating outcomes.

2. Inter-agency transaction costs

(coordination and administrative costs across bureaucracies

and levels of government)

Case mentions inter-agency coordination problems ( either horizontally across bureaucracies, or vertically between levels of government) resulting in delays or otherwise poor instrument operation jeopardizing the implementation process.

No particular mention of inter-agency or bureaucratic delays and other transaction costs.

Insufficient information to code unambiguously

Mentioned in 26 cases: 10 (39%) of which were not implemented; and a 10 reported partial or retired/not operating outcomes.

3. Weak enforcement

Case mentions lack of enforcement as jeopardizing the effective application of the instrument and achievement of its goal.

No particular mention of enforcement problems is made.

Insufficient information to code unambiguously

Mentioned in 5 cases: all 5 reported partial or retired/not operating outcomes.

4. Weak capacity of environmental authority

Case mentions incompetence by environmental authorities as jeopardizing instrument implementation or otherwise a contributing to poor outcomes.

No particular mention of this variable

Insufficient information to code unambiguously

Mentioned in 4 cases: 3 of which reported partial or retired/not operating outcomes. 2 of these were environmental authorities operating in rural and socio-economically underprivileged areas, in contrast to the more industrialized urban centers.

5. Potential impact on low income groups

Case mentions political concerns about the potential impact of the new instrument on low income groups as halting/delaying implementation.

No particular mention of this variable.

Insufficient information to code unambiguously

Mentioned in 2 cases which were not implemented. The instrument was designed but not applied due to fear of political fallout from its impact on low income groups.

6. Opposition or resistance from industry interest-groups

Case mentions organized opposition by industry interest groups as jeopardizing instrument implementation or otherwise preventing effective application.

No particular mention of this variable.

Insufficient information to code unambiguously

Surprisingly this barrier did not feature in the data set. In contrast the only records of opposition are from the State electric company (ICE) in Costa Rica, and from municipalities invoiced for water pollutant charges.

68

The following Figure 3.4 shows the number of cases coded for each of the above variables in the total data

set of 81 cases.

38

26

5

4

2

2

0 5 10 15 20 25 30 35 40

number of cases

poor cooperation between fiscal andenv. authorities

inter-agency transaction costs

poor enforcement

weak capacity env. authority

potential impact on low incomegroups

opposition by industry interestgroups

Figure 3.4 Barriers/obstacles to implementation: number of cases coded for each variable ( n = 81 )

The two most frequent variables that cases point to as barriers to implementation in the dataset were: a)

poor cooperation in the interaction between fiscal and environmental authorities, and b) transaction costs in

the form of administrative delays, red tape, poor coordination or stonewalling in the interaction between

different public agencies and levels of government, that were required to play a role in establishing the

mechanisms to operate the new “market-based ”instrument being introduced into the existing policy mix.

Other variables such as “poor enforcement” and “opposition by industry groups”, which have been

emphasized as explanatory factors in the public choice, political economy, and political science literature

on environmental regulatory outcomes and instrument choice in the U.S and OECD countries, hardly show

up in our data set.

As shown in Figure 3.4 above, the relative high frequency of these two variables, alluded to in nearly 50%

and 33% of all cases respectively, suggests that coordination problems across sectors and between levels of

69

government play a significant role in determining implementation outcomes. It also clearly singles out the

key role played by fiscal authorities in the implementation process of “market-based” environmental

instruments. The dominance of these two variables in terms of the sheer number of cases coded for them,

and the relative “lack of variance” of this trend across countries, suggests that they are picking up systemic

or structural factors which are inherent to the political and institutional make up shared by these countries.

This should not be a surprise, it is well documented that the mainstreaming of environmental policy across

traditionally separate government sectors and policy-making bureaucracies (i.e. agriculture,

water/sanitation, energy, transportation, etc.) is still a pending achievement even in the most advanced

OECD countries. Most countries have yet to institutionalize formal policy coordination mechanisms across

these sectors. Therefore it is reasonable to expect that any policy demanding integrated responses from a

wide range of multiple public agencies and levels of government is likely to encounter obstacles and

coordination problems. Chapter 4 undertakes a more detailed analysis of these findings and the plausible

pathways through which the variables identified above might influence instrument implementation

outcomes.

3.8 Development of working hypothesis The significant finding for our research purposes is that the data clearly points to the interaction between

fiscal and environmental authorities, and between these and other public authorities in sub-national levels

of government, as playing a key role in determining the implementation outcomes of “market-based”

environmental instruments. This led to the formulation of the following working hypothesis:

The implementation of “market-based” environmental instruments in Latin American countries have been

conditioned by policy interactions that inevitably arise in the political and institutional context confronted

by environmental authorities in their attempts to incorporate these new instruments into the existing policy

structure and regulatory mix.

Some examples of the kind of interactions across traditional bureaucratic boundaries illustrated in the data

set include the following: a) the interaction between traditionally isolated fiscal bureaucracies and

70

environmental authorities more recently institutionalized, but nevertheless intent on tweaking incentives; b)

the interactions between simultaneous fiscal and environmental decentralization processes taking place

across the region in both federal (Argentina, Brazil, Mexico) and centralized countries (Colombia, Ecuador

etc.); c) the interaction with public infrastructure policies, such as the deregulation and privatization of

public utilities and water/sanitation infrastructure; d) the interaction with public finance constraints on the

mobilization of resources for environmental infrastructure investment at lower levels of government

(municipalities, watershed jurisdictions etc.); among others.

Although all the above policy interactions fall outside the direct mandate and scope of control of

environmental authorities, they nevertheless are key in determining the ultimate policy outcomes obtained

from environmental policy efforts. These observations led to focusing the analysis of instrument

implementation cases on attempting to shed light and gain a more detailed understanding of the features of

the political/institutional context being confronted by environmental authorities in their implementation

attempts.

3.9 Framing the analysis of instrument case data The third research objective called for examining in more detail the political and institutional dynamics in

which implementation of “market-based” instruments takes place in Latin American countries, in order to

compare observations with alternative hypothesis advanced in the literature. For this purpose our main

empirical base is the n = 81 national survey data documenting cases where environmental authorities have

attempted the implementation of “market-based” instruments in the region. As mentioned before the main

analytical approach consists in identifying common patterns, in terms of clusters of shared variables and

implementation outcomes, within and across cases in this data set. Through this approach we hope to

identify and characterize the main political and institutional dynamics, which the data point to as the most

likely candidates plausibly driving the instrument implementation outcomes observed in the data set.

71

In general the literature looking at environmental policy outcomes in developing country contexts tends to

emphasize the weak technical, financial, and enforcement capacities of environmental authorities69 in these

countries as a key factor behind poor outcomes. This literature ascribes the poor results in experiences with

economic instruments to the weak institutional capacity of environmental agencies, frequently mentioning

lack of technical capacities, weak monitoring and enforcement practices, insufficient budgets and trained

staff. From this diagnosis is only a short step to prescribing more “capacity building” and “institutional

strengthening” efforts as the obvious solutions, which typically characterize the international donors and

development banks agendas.

However in the cases documented for the present research, neither weak capacity of environmental

authorities, nor poor monitoring, or perverse incentives from policy failures, tended to feature prominently.

Indicating that “weak institutional capacity of environmental authorities” might be a catch all diagnosis that

fails to capture the intricacies involved in the process of introducing new instruments that cut across

traditional turfs. For the purpose of framing the discussion of case studies and survey data, we opt for the

simple methodological devise of contrasting our findings whenever possible with the more general

hypothesis advanced in the literature. So as to open as much as possible the “black box” of “weak

institutional capacity of environmental authorities”, in an attempt to shed light on the more detailed stories

lodged inside.

69 The following publications tend to emphasize the diagnosis of “weak institutional capacity” of environmental authorities as the major factor conditioning environmental policy outcomes: UNEP, “Regional Perspectives 1987-2007”in Global Environment Outlook GEO 4,. (Nairobi: United Nations Environment Program, 2007), 240-241. UNEP Global Environment Outlook GEO 2000 (Nairobi: United Nations Environment Program, 2000) OECD Developing Environmental Capacity: A Framework for Donor Involvement. (Paris: Organization for Economic Co-operation and Development, 1995). Richard Huber, Jack Ruitenbeek and Ronaldo Serôa da Motta, “Market Based Instruments for Environmental Policy Making in Latin America and the Caribbean”, World Bank Discussion Paper, No. 381, (Washington D.C 1998). Ronaldo Serôa da Motta, “Applying economic incentives in a context of institutional fragility: the case of Latin America and Caribbean environmental management”, LA3EU World Bank Working Paper, (Washington, DC. 1996). Tom Tietenberg, “Private Enforcement of Environmental Regulations in Latin America and the Caribbean” InterAmerican Development Bank Working Paper No. ENV-101. ( Washington, DC. 1996). D. O’Connor. “Applying economic instruments in developing countries: from theory to implementation”. Environment and Development Economics 4, (1998): 91-110. Ronaldo Seroa da Motta, Richard Huber, Jan Ruitenbeek. “Market based instruments for environmental policy-making in Latin America”. Environment and Development Economics 4 (2), (1999): 177-202. Fourteenth Meeting of the Forum of Ministers of the Environment of Latin America and the Caribbean. Panama City, Panama, 20 to 25 November 2003.

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3.10 Illustrative case studies. The major empirical base for analysis in this dissertation is the n=81 data set of instrument implementation

cases as explained above. Throughout Chapter 4 examples are drawn from individual cases in this data set

to illustrate the common patterns identified across countries, and to provide detailed material for the

examination of the political/institutional context in light of the working thesis. The patterns illustrated in

these case examples are compared with alternative interpretations advanced in the literature, such as for

example: the attribution of poor environmental policy outcomes to the weak institutional capacity of

environmental authorities, or to the low priority of environmental goals relative to other development

priorities (poverty reduction, reducing asymmetries in access to health, education, and basic infrastructure

etc.).

A national case study with a high level of detail has also been included for illustrative purposes at the end

of the dissertation. This case study illustrates how the patterns identified played out in the

political/institutional context of specific countries. For this purposes we draw on the implementation of

water pollution charge at the national scale in Colombia. This case illustrates the complex

political/institutional context that environmental authorities must confront in their attempts to incorporate

“market-based” environmental instruments into the regulatory mix. The patterns borne out by this case are

contrasted with those found in other countries in the data set to illustrate dissertation findings. This case

study was selected for illustrative purposes because it provides a detailed historical record covering several

years, and enough detailed documentation to illustrate the complex political and institutional dimensions

behind instrument implementation processes and outcomes. In the case of Colombia additional studies were

undertaken to clarify initial survey findings taking advantage of the opportunity to do so through other U.N

ECLAC projects coordinated by the author between 2002-2004. Beyond the initial survey reports the

additional studies, four in the case of Colombia, enabled more detailed documentation of case material.

Colombia water pollution charge case study consists of the implementation of the “Tasa Retributiva”. This

case illustrates the implementation of a water pollution charge in the context of ongoing environmental,

fiscal and political decentralization undergone by the country during the 1990s. To complicate matters

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further it also coincided with the dismantling of subsidies for municipal water/sanitation utilities and their

privatization attempts. The next chapter 4 is the core analytical chapter in this dissertation. It undertakes

the analysis of the n = 81 data set to address the first two research objectives of the dissertation.

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CHAPTER 4. ANALYSIS This chapter presents the detailed findings from the data set of 81 instrument cases compiled through

national surveys. The descriptive analysis in this chapter centers on the first two research objectives

outlined previously:

1. Assessing the extent of implementation of “market-based” instruments in the group of thirteen Latin

American and Caribbean countries studied.

2. Identification of plausible independent variables or factors associated with instrument implementation

outcomes.

The chapter is organized into three major sections. The first two sections address research objective 1

above. The third section addresses research objective 2. The first section 4.1 is devoted to the analysis of

implementation outcomes observed in the whole data set. The second section 4.2 further disaggregates the

analysis of implementation outcomes observed by instrument choice, or specific types of “market-based”

instruments (i.e. taxes, charges, subsidies, tax credits, etc.). The analysis of these two sections together, is

used to summarize results on the extent of implementation of “market-based” environmental instruments in

the region (objective 1). The analysis in the third section is focused on the identification of variables or

factors in the data set with plausible explanatory power over the observed implementation outcomes

(objective 2).

4.1 SECTION I Analysis of the extent of implementation 4.1.1 Assessing the extent of implementation of “market-based” environmental

instruments in Latin America The survey data revealed that nearly a third of all “market-based” instrument initiatives that had already

been enacted as law or regulation, or had been championed by national environmental authorities for

official enactment, were never implemented. These 25 cases can be characterized as instrument mortality at

the very beginning of their lifecycle, ex-ante the implementation stage.

Number of cases in data set Instruments that never entered the implementation stage (number of cases)

% share n = 81

81 25 32%

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Among these 25 instruments never implemented, thirteen 13 instruments (16% of data set) had been passed

either as law, executive decree, or official regulation but implementation had not been initiated for various

reasons. The remaining 12 instruments in this group (15%) had been designed as official proposals by

environmental authorities but had failed to receive sufficient executive or legislative political support to be

officially passed as law or regulation.

These were cases in which the environmental authority had conducted the background studies, prepared the

technical design for the instrument, and conducted consultations or submitted an official proposal for

government sanction. However these initiatives did not receive the level of political support required to

move through the executive and legislative processes to obtain final enactment as law or regulation.

Therefore only 56 instruments (after taking out the above 25 cases from the n=81 data set) did enter into the

implementation process.

Within this group of 56 instruments for which implementation was initiated, 44 cases (53% of data set)

were found in operation. The other 12 cases were reported by national surveys to be instruments no longer

operating, either because they had been retired, were not being enforced, or were operating in a very limited

fashion relative to their original design goal. In these 12 cases the instrument had been retired due to

regulatory changes, or changes in the political will of different administrations, or the instrument’s

operation could not be consolidated for various reasons and enforcement had lagged, or had been

abandoned. This outcome was also coded in cases where instruments were not operating according to their

intended purpose, for example in cases of charges with inconsistent collection of payments/revenue, or

fiscal incentives with inconsistent payment of benefits/tax credits or fiscal transfers; or otherwise

inconsistent enforcement and operation of the instrument. As discussed further on in this chapter, the

negative outcomes observed for this group of 12 cases during the first few years of their implementation

being initiated, reflected similar patterns and political/institutional dynamics as those affecting the group of

25 cases whose implementation was never initiated.

Number of cases implemented

Instruments implemented, but found retired, not operating, or not

enforced (number of cases)

% share n = 56

% share n = 81

56 12 21%

16%

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The following Figure 4.1 shows these implementation outcomes as percentage of all cases in the data set.

The group of 56 instruments implemented is broken down to highlight the subset of 12 cases implemented

but found to be either retired / not operating / or not being enforced.

The most striking empirical finding on the extent of implementation in the thirteen countries surveyed is

this relatively high incidence of non-implementation of instruments officially sanctioned as law/regulation,

or officially proposed by environmental authorities, which occurred in 25 cases or nearly a third of all cases

documented. Argentina, Chile and Peru concentrated 14 of these instruments not implemented.

Figure 4.2 below shows the number of cases and the implementation outcomes observed in the thirteen

countries covered in the national surveys. The number of cases varies widely across countries, however 10

of 13 countries had at least 1 case of a “market-based” instrument initiative that did not reach the

implementation stage.

instrument cases n = 81, 13 countries Figure 4.1 Extent of implementation

instrument cases n = 81, 13 countries

Instruments implemented 53%, 44 cases

Instruments never implemented 32 %, 25 cases

Instruments implemented, but found not operating / retired / not enforced

16% , 12 cases

never implemented implemented but retired / not operating implemented

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Figure 4.2 Number of instruments implemented ( 56 ), and not - implemented ( 25 )by country ( n = 81 )

not - implemented implemented

Figure 4.3 bellow shows the group of 56 instruments in the data set for which implementation was initiated,

disaggregating the 12 cases of instruments found retired/not enforced/ not operating ( 21% of n = 56), and

also 9 (16%) other cases found operating only partially. This last outcome (partial operation) was coded

for those cases where: a) instrument implementation had not reached its full intended geographical scope of

application (for example in those cases where the instrument was only being applied in certain sub-national

jurisdictions rather than nationally as mandated); and/or b) instrument implementation had achieved only

partial coverage of their regulatory target groups (for example incomplete coverage of pollution sources, or

resource users, etc.). These outcomes are examined in more detail in the following sections.

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Figure 4.3 Instruments implemented n = 56 Number of cases by outcome and country

operating partial operation retired / not operating / not enforced

4.1.2 Instruments not – implemented: A closer look at the 25 cases that did not reach the

implementation stage (30% of data set). The finding that nearly a third all cases documented in our data set covering thirteen countries never

reached the implementation stage, suggests the need to examine the political and institutional context which

environmental authorities confronted in their attempts to introduce these new “market-based” instruments

into the existing status quo. The following examples illustrate patterns of the political/institutional context

that characterized cases were instrument implementation never got underway (instruments not-

implemented). Examples of the other two implementation outcomes ( retired/not enforced/not operating,

and partial operation) are discussed separately in the next section.

Argentina: fiscal federalism dynamics.

Twelve 12 cases in the data set where instruments that had been legally enacted as law or regulation but

that nevertheless had never been put into practice. Argentina and Peru concentrated 9 of these cases. In

Argentina 4 of these cases were associated with federalism dynamics involving Provinces failing to act on

Federal level mandates. In 3 of these Argentine cases the Provinces rejected the implementation of

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minimum budget requirements mandated by federal laws for watershed basins’ environmental quality

management, and for monitoring industrial hazardous waste, and PCB operators registries as mandated by

Federal laws 25.688, 25.675 and 25.670. These three earmarked budgetary requirements for specific

environmental management expenditures were caught in the thorny politics of fiscal decentralization

between the Federal government and provincial fiscal/budgetary authorities70. Argentine public finance and

fiscal relations has always been characterized by tension between the interests of provincial governments

and the central authority71. In all three cases a national level mandate contained in Federal environmental

law required sub-national levels of government to set aside minimum budgets for specific environmental

use.

Since earmarked budgetary requirements detract from the provincial government’s budgetary flexibility

and autonomy in expenditure allocation, clearly the provincial level bureaucracy had no incentive to act on

these Federal requirements. The fact that provincial governments can repeatedly flaunt these environmental

requirements in Federal laws, also suggests their low political priority for Federal authorities; who are not

willing to press their compliance within the already complex management of fiscal relations with provincial

governments. Similar patterns of misalignment of incentives have been observed in other cases in the

region whenever central authorities try to direct the specific allocation of funds administered by lower

levels of government to specific environmental end points, as discussed further on in this chapter72.

Argentina had also failed to implement 1 national level instrument, the Environmental Compensation Fund

mandated by law 25.675, an instrument to provide a public finance facility or collective guarantee to draw

in cases of environmental damage. Implementation of this fund required concerted actions by both fiscal

authorities in the Provinces and the Federal government, with each making budgetary contributions to the 70 Ernesto Rezk, “Fallas de coordinación: desafíos de política para el federalismo fiscal-ambiental argentino”. Serie Medio Ambiente y Desarrollo no. 115, CEPAL (Santiago, Chile, noviembre 2005). 71 For insight on the dynamics of Argentine fiscal decentralization dynamics please refer to: Marcus André Melo. “Institutional Weakness and the Puzzle of Argentina’s Low Taxation,” Latin American Politics & Society 49.4 (2007) 115-148. For a comparative perspective with Brazil, Colombia and other Latin American countries please refer to: Tulia G. Falleti, “A Sequential Theory of Decentralization: Latin American Cases in Comparative Perspective,”.American Political Science Review. Vol 99 No. 3, (August 2005); and Luiz R. de Mello Jr. “Fiscal Decentralization and Intergovernmental Fiscal Relations: A Cross-Country Analysis”. World Development Vol. 28, No.2, (2000): 365-390 72 See section 4.1.2

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fund. Again the failure to implement the national compensation fund as mandated by law reflects the low

priority of environmental budgetary allocations, which was probably exacerbated in the face of the severe

fiscal retrenchment that followed the 2000 macroeconomic crisis in Argentina. A similar situation applied

to the case of a tax credit for cleaner production and pollution control investment in the Dominican

Republic enacted in 2000, but not implemented at the time of the survey in 2004. Most probably also

associated the fiscal retrenchment and elimination of sectoral fiscal incentives, that the Dominican Republic

committed as part of the agreement signed with the IMF in 2004 to stave off its own macroeconomic crisis

at that time.

Peru and Chile: foreign investment in resource sectors goes first.

Peru accounted for 5 cases of instruments written in laws or regulations but that had not been implemented:

a) a transferable fishing quota system and new environmental regulation of fishing licenses (Fisheries

Ministry MIPE regulation enacted 1999); b) transferable water use rights ( “Ley de Aguas”); c) tradable

industrial emission permits (Ministry of Industry MITINCI “Reglamento Ambiental de Industria

Manufacturera” 1997); nor d) had compensatory user charges for natural resource exploitation been

implemented (law enacted in 1997). Also the polluter-pays provisions in the national Environmental Impact

Assessment (EIA) system (“Código Ambiental” 1990) had been substantially reduced or overruled by the

1997 Law on Promotion of Private Investment. This 1997 decision overturned the previous EIA polluter-

pays provisions which were seen at the time as posing unnecessary liabilities and overburdening EIA

procedures, all of which ran counter to Peru’s effort to court foreign and domestic private investment in

mining and other industries. These outcomes in Peru relate to the Chilean cases across the border discussed

in the following paragraphs.

Chile accounted for 5 of the 13 cases (16 %) in the original data set where national environmental

authorities had designed a “market-based” instrument and submitted an official proposal. But the initiative

had not been able to obtain sufficient political backing within the government to be pushed through the

executive and legislative to its final enactment into law or regulation. The environmental authority in Chile

( CONAMA) has been one of the most proactive in the region in undertaking technical studies for new

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“market-based” instrument design proposals submitted for political approval. As much as seven 7 technical

instrument initiatives submitted by CONAMA have not garnered sufficient government backing to be

pushed through the legislative process, therefore never reached the implementation stage.

In five 5 of these cases the main cause of stonewalling seemed to have been fiscal authorities opposed to

selective environmental taxation (i.e. proposed tax on forestry exploitation of native forests) or extension of

tax credits (i.e. for private protected areas). The feasibility study for environmental taxation by CONAMA

(national environmental authority) faced outright opposition by the politically powerful public finance

bureaucracy and more orthodox legislative faction, arguing that selective taxation of environmental

externalities collided with prevailing constitutional interpretations regarding non discriminatory features of

the tax system across economic sectors. Most probably this bias against introducing environmental

objectives in the tax system relates to the political weight carried in the Chilean State by the large public

and private corporate natural resource extractive sectors (i.e. cooper, forest, paper and pulp sectors, and also

export agriculture) which are the backbone of the Chilean export economy. The lack of endorsement and

political support by the technical fiscal bureaucracy for these CONAMA initiatives, might also reflect the

fact that traditionally these natural resource and mining sectors have been the subject of promotion as

Chilean State policy. In such a policy context the advance of environmental charges or taxes on these

sectors might be perceived as a potential net cost to their export competitiveness, or simply going against

the grain of sector promotion.

Perhaps most illustrative in the case of Chile is that a proposed tax on forestry exploitation of native forest,

which had broad public support, also failed to be enacted in spite of very strong lobby by a wide cross

section of civil society. The rapid growth of the forestry pulp-and-paper and wood-chip cellulose export

industry, along with the salmon, wine and fruit exporting industries, has been one of drivers of Chilean

economic growth after 1985. This industry exploits both plantation and native forests on private land. The

alarming decrease of native forests triggered widespread public concern due to their uniqueness and

aesthetic qualities as humid temperate forests. The fact that even under strong public pressure fiscal

authorities nor legislators moved to develop any proposal for a native forest tax further suggests a strong

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political bias against the use of fiscal instruments for environmental policy in the Chilean political

system73. It is paradoxical that Chile, being the country that has gone further in Latin America in embracing

open trade and effectively harnessing liberal market policies to sustain growth and reduce poverty during

the last twenty years, is also the same country where “market-based” environmental instruments fail to

obtain the required support of fiscal and economic bureaucracies in government.

This outcome in Chile relates to the previous one described for Peru. During the second half of the nineties

both countries reformed their tax codes to extend more favorable fiscal treatment to large scale mining and

other foreign investment. Chile is one of the few countries that has eliminated royalty payments from

mineral extraction, taxing only mining companies’ income. The general bias of these tax reforms has been

towards the expansion of fiscal incentives and tax holidays to lure foreign investment, and suggests a

political bias against incorporating any selective environmental incentive in the tax structure, even in the

case of highly environmentally sensitive industries like mining, forestry and intensive agriculture. The fact

that Chile and Peru, along with Bolivia, have not taken steps to coordinate their tax treatment of foreign

large scale mining investment might have unwittingly engaged these countries in perverse fiscal

competition to attract foreign mining investment. Perverse in the sense that each country acting individually

might have extended preferential tax treatment more than it would have been necessary to obtain the same

investment volumes. And thus these countries might have forgone public revenue and the opportunity to

capture a larger share of the rents from resource extraction74, while at the same time shying away from

taxation of environmental externalities. Mining environmental liabilities pending remediation are well

documented in Bolivia, Chile, Peru, and also Argentina. In many cases these environmental liabilities end

73 During the second annual workshop on Fiscal Policy and Environment organized at U.N ECLAC in 2002 the then treasury minister, Mr. Manuel Marfan told the audience that at one point the fiscal/treasury Ministry (“Ministerio de Hacienda”) had caved in to public pressure and opened to the possibility of designing the new native forest tax. However according to Mr. Marfan when fiscal authorities started consultations with environmental interest groups, these groups did not have or were not able to produce a technical proposal to the Ministry concerning this tax. This claim is notorious, since supposedly it is the fiscal technocracy and not the environmental NGOs pushing for political action, who carry the political mandate to produce technical proposals for new tax instruments that are to be officially submitted for government approval. Also notable is that Chilean fiscal authorities have been noted for their absence in the majority of the regional Fiscal Policy and Environment workshops held annually at U.N ECLAC in Santiago, although they have always been officially invited to attend. These workshops are held as part of the annual Regional Fiscal Policy Workshop which draws fiscal and central bank authorities from most countries in the region which is sponsored jointly by U.N ECLAC, IMF, World Bank, and Inter American Development Bank (IADB). The exclusively Fiscal Policy sessions are indeed attended by Chilean participants. 74 Capturing and reinvesting the rents from non-renewable resource extraction is a basic requirement in both weak and strong sustainability criteria, for countries to maintain a non-declining stock of natural capital.

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up in public balance sheets due to lack of appropriate instruments to internalize them or raise funds for their

redress in the country’s tax policy towards mining.

Barbados: fear of political fall out from charges on low income groups

In two 2 cases the government of Barbados through its environmental and water authorities had undertaken

technical studies and consultations to implement a water use charge differentiated for households and

commercial users, as well as a solid waste disposal fee for landfill use. In spite of having been designed

with broad stakeholder consultations the water use charge could not be implemented due to lack of political

will to charge lower income groups for water. As reported in the survey apparently authorities were not

willing assume the political cost of going against the generalized perception that rainwater was free and

could not be charged. Barbados like a majority of Caribbean islands is faced with water scarcity and the

need for strict water resource management as demonstrated by several government commissioned studies75.

In contrast with this case in Barbados, Jamaica did report the successful application of water use charges. It

is interesting to note that Jamaica’s fiscal system consistently gets high marks in international comparisons

for its institutional capacity. Jamaica’s successful implementation of water use charges surely benefited

from the country’s tradition in effective tax collection and public revenue administration.

Waste disposal and landfill space is also scarce in small island states like Barbados. The second case was a

waste disposal charge applicable to operators disposing in public landfills was also not implemented due to

distributive concerns on the charge impact on small waste collecting private operators, mainly small truck

owners self employed in waste collection services. Authorities feared that the application of the charge

would encourage illegal dumping to avoid payment by small operators. Surprisingly in the whole data set

only these 2 cases in Barbados are the only ones that explicitly mentioned distributive concerns on low

income groups as the main reason why instrument implementation could not take place.

75 Fresh water supply in Caribbean countries depends critically on rainwater for aquifer recharge particularly in the smaller islands.

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Mexico: logistic problems in creating new recycling markets.

Mexico reported 2 cases of deposit refund systems for used motor oil, and for Ni-Cd batteries that had been

designed by the environmental authority (INE-SEMARNAP) in consultation with the private industry

associations (CONCAMIN) with the aim of encouraging recycling operations. Both initiatives were never

implemented, apparently the public-private joint effort was insufficient to solve the logistical issues

required to operate the deposit refund schemes, and failed to generate interest by potential private recyclers.

4.1.3 Main patterns preventing instrument implementation. The above countries cover the majority of the 25 instruments cases were implementation did not take place.

The majority of cases in this group illustrate two major patterns in which “market-based” instruments

initiatives were killed before they were implemented:

a) Political bias against the introduction of tax or charge instruments for environmental objectives.

The majority of the cases of instrument mortality occurring ex-ante implementation were concentrated in

countries showing a strong political bias by fiscal authorities, and/or government policymakers in general,

against incorporating environmental objectives into existing tax structures, or against introducing the use of

selective taxes or charges for environmental goals. In these cases such proposals were perceived by the

political apparatus as running counter to the general economic policy thrust prevalent at the time, which

prioritized the courting of renewed investment flows through deregulation, simplification of tax structures,

and reducing existing regulatory burdens on private enterprise.

The general orthodox bias of the economic policy reforms being undertaken since the mid 1990s,

concentrated the attention of economic authorities on macroeconomic stabilization, inflation control,

privatization, simplification and reduction of trade tariff structures, and tax reforms involving simpler and

more transparent treatment across sectors. It is evident that the economic rationale underlying “market-

based” environmental policy (cost internalization through targeted instruments applied at the source of

environmental externalities to specific economic activities); ran counter to the economic rationale

underlying across-the-board simplification of tax and tariff structures which characterized fiscal and trade

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policy reforms, and the general bias towards liberalization of foreign investment regulation an reduction of

existing red-tape.

This political climate clearly was not conducive to prioritizing the introduction of environmental charges or

taxation, based on the perception that such initiatives would run counter to the general policy thrust towards

investment promotion and simplification of tax structures prevalent at the time. In Latin American

countries the economic and fiscal technocracies undertaking macroeconomic policy reforms are in general

not familiar with environmental policy issues; and no constituencies were pushing for the incorporation of

“green” instruments in the tax reforms undertaken during the 1990s. Furthermore the relatively low revenue

raising potential of “green” instruments, designed mostly to internalize costs and change behavior, further

distanced their prospects with technocracies intent on increasing fiscal pressure, tax bases, and revenue

through simpler blunt instruments such as value-added taxes. Simply put all bureaucratic and political

incentives were stacked against pushing for the introduction of “green taxes”

This political bias in government also had a flipside generic argument too often espoused by industry in

spite that no clear evidence exists to support it. This is the argument that environmental regulation is a net

cost that cannot be afforded without harming national competitiveness76. Since along with investment

promotion, the opening up of trade policy also occupied the central political arena during the 1990s reform

process, the competitiveness concerns of national industries played loud in the ears of policy makers. In this

climate most environmental cost-internalizing initiatives tended to be portrayed by industry lobbies and

interest groups as adding to national production costs (i.e. “cost Brazil”, “cost Mexico” etc.) and running

counter to national export competitiveness in today’s free trade world. Naturally both the mentioned policy

bias and industry lobby portrayal reinforced each other. This pattern was evident in the cases of non-

76 This is the so called “race to the bottom” hypothesis, that suggests that industries will have an economic incentive to relocate globally, or within a federation, in those jurisdictions with laxer environmental and/or labor policies. Empirical studies have failed to find evidence for this “race to the bottom” argument. These studies indicate that environmental regulatory costs are not a significant determinant of industry location and investment decisions, and represent a relatively marginal component of the overall cost structure. For a review of this literature please refer to Wallace E. Oates, “A Reconsideration of Environmental Federalism,” Discussion Paper 01-54. (Washington D.C: Resources for the Future, November 2001).

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implemented instruments in Argentina, Chile and Peru, it is also an argument raised frequently by export

industry lobbies in Brazil, Mexico and most other primary sector exporting countries.

b) Misaligned incentives: fiscal retrenchment vs. mandatory transfers of environmental funds and

minimum budget allocations.

The instruments not implemented in Argentina clearly illustrate how in periods of fiscal retrenchment both

federal and provincial budgetary authorities fail to honor mandatory transfers, minimum budget rules,

transfers to environmental funds, and other earmarked allocations towards environmental end uses. This is

a generic pattern also seen in several other cases of instruments discussed later involving mandatory fiscal

transfers to environmental funds operating in Brazil, Dominican Republic, Guatemala, and Mexico. The

fact that these environmental transfers and fund allocations are used as adjustment variables, reflect the

general low political priority that national environmental expenditure has in most Latin American countries.

In fact even in the larger economies in the region, such as Argentina, Brazil, and Mexico, a significant part

of government investment required for national environmental management infrastructure (environmental

quality monitoring systems, technical studies for policy-making etc.) is paid for via policy loans from

development banks and international donors. Most countries have yet to incorporate environmental

investments as routine items in their national budgets. This situation reflects a more general public finance

problem faced in the majority of Latin American countries, where in a context of intense competition for

overstretched public budgets, emerging environmental constituencies are no match for traditional

corporatist interest groups in the public sector (education, health, infrastructure, the military etc.).

c) Distributive concerns related to the potential impact of user charges on low income groups.

Surprisingly the halting of instrument implementation based on fear of political fall-out from their potential

impact on low income groups was only explicitly mentioned in the case of Barbados. In most Latin

American and Caribbean countries monthly charges for municipal water supply, sanitation, and waste

disposal frequently fail to recover a significant portion of the operational cost of these services and are

already subsidized. Changes in the level of monthly charges/fees for municipal services provision, in

particular water, sanitation and waste collection and disposal, tend to be regarded as highly sensitive

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political issues. Given the actual level of charges, and the fact that a significant portion of the lower income

population already accesses precarious services informally, it is not clear whether these distributive

concerns can be justified on economic grounds (i.e. true inability to pay) or result from simple avoidance

by urban authorities to face the political cost of altering the status quo towards more meaningful charging

for the costs of improved service provision.

However as seen later in the discussion of cases of user charges implemented in several countries, these

issues tend to be washed over by the generalized policy bias towards providing highly subsidized or free

access to public services, in particular water provision. As well as the evident lack of political will to

introduce charges to rationalize resource use and pollutant discharges into public surface waters and other

environmental media by both private economic agents and public entities such as municipal utilities.

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4.1.4 Instruments implemented but found retired, not enforced, or operating only in a limited fashion relative to their original design: A closer look at these 12 cases ( 21% of those implemented).

In contrast to the above, this second group of 12 cases consists of cases for which the implementation

process was indeed initiated by authorities but did not result in successful outcomes. National surveys

reported these cases as instruments considered not operational and clearly not fulfilling their intended role

for all practical purposes.

Argentina: national regime for wind and solar energy

Argentina’s Law 25.019 enacted in 1998, provided for preferential feed in tariffs for wind and solar power

generators (Article 3) and exempted their capital equipment from value added tax payments and additional

taxes for a period of 15 years (Article 5). However the lack of political will on the part of fiscal authorities

to incorporate environmental incentives is evident in the text of the Executive Decree 1220/98 which

promulgated this same law, but objected Articles 3 and 5. As stated in the text of the decree:

“ the Argentine electric sector functions based on principles that guide investment decisions according to market parameters;”….”no reasons exist to justify a distancing from such principles, least of all through the granting of a generic and indiscriminate subsidy to a particular energy source:”…”the imposition of any additional charge to final users with the objective of promoting the development of an alternative energy source in the electric power market, could have the undesirable effect of transferring advantages to neighboring countries”77…

This case reflects a similar political bias as described previously for Chile and Peru. It is paradoxical that

“market-based” environmental instruments were shunned precisely by the same political bureaucracies

(Argentina, Chile and Peru) that were fully engaged in implementing “market-based” macroeconomic

policy reforms at the time. In this case however, the failure to include the fiscal incentives for wind and

solar energy in the Executive Decree of 1998, triggered widespread mobilization of public opinion and

campaigns by environmental groups. This public pressure resulted in the congress insisting on the inclusion

of the incentives which were formally reinstated two years later through Decree 1597/99 and the Energy

Ministry (“Secretaria de Energia”) resolutions 136/2000 and 113/2001.

77 Translated from Spanish by the author, the original citation of Decree 1220/98 appears in the Argentina case study published by CEPAL: Eduardo Beaumont Roveda, CEPAL/PNUD “Desafíos y propuestas para la implementación más efectiva de instrumentos económicos en la gestión ambiental de América Latina y el Caribe: el caso de Argentina,” CEPAL LC/L 2074-P, (Santiago, Febrero 2004): 20-24.

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However even after reinstatement, the implementation of these incentives was mired by the

administratively burdensome benefit application process, and the inordinate delays in making effective

payment of the benefits. The benefit application process involves complicated administrative control of

eligible beneficiaries crisscrossed among the Energy Ministry, the bulk power market administration

company (CAMMESA), and the Federal Public Revenue Administration (AFIP). All of which amount to

saddling potential beneficiaries with very large transaction costs that detract from the incentives and result

in low demand for the instrument. In effect by 2004 four years after the instrument implementation, only

one wind operator has expanded capacity, and ten small wind power operators have registered for the

regime. However payments have been inconsistent, small projects have had difficulties in providing the

“Secretaría de Energía” with the required reliable information on generation records.

This same outcome of weak demand for the fiscal incentives offered was also evident in the majority of

cases of fiscal incentives/subsidies targeted at pollution control and cleaner production investments in the

data set. Reforestation subsidies are a different story as will be seen later. The time delays and

administrative burden involved in both processes seems to have contributed to weak private demand for

pollution control incentives as reported in Argentina, Colombia, Mexico and Venezuela. Granting of tax

credits and disbursements tied to pollution control investments were effectively rationed through

administrative delays which tended to nullify the net incentive effect and private sector demand for these

instruments. This suggests that their ultimate impact on advancing environmental policy objectives has

been rather weak.

Brazil: inconsistent fiscal transfers of oil royalty payments to state level environmental funds.

In Brazil a percentage of federal oil exploitation royalties is transferred back to the states were resource

exploitation takes place. The state of Rio de Janeiro is responsible for 70% of national oil production and

37% of natural gas production, therefore these transfers have particular importance. State level regulation in

Rio de Janeiro established that 20% of all royalty received would go to the state’s environmental control

fund (FECAM), which also receives proceeds from fines from non compliance with environmental

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legislation. The use of FECAM funds is also constitutionally “sealed” and must be applied to finance

environmental projects in Rio de Janeiro state.

This instrument was operating irregularly the available funds were minimal, and their application to

environmental projects was frozen during most years in three consecutive administrations 1991, 1995 and

1999 due to internal audits. Oil royalty payments were being received by the state fiscal authorities from

the federal treasury, but the corresponding share was not being allocated to FECAM. The flow of funds

also suffered due to lack of enforcement in collecting fines for non-compliance with environmental

legislation in the state. In 1995 with a change in administration, stronger enforcement of environmental

fines and fiscal authorities compliance with the 20% royalty transfer succeeded in feeding USD 28 million

to the fund. However no environmental projects were funded for two years as the application of these funds

was again frozen to shore up the state’s public finance, only in 1997 was environmental project selection

reinitiated to be interrupted again in 1999 by another audit stopping the flow of funds and projects.

This case is highly illustrative of the misaligned incentives between the fiscal bureaucracy administering

the flow of funds earmarked for environmental end-uses, and environmental authorities at their mercy and

unable to force the fiscal authority to honor mandatory fiscal transfers. This case also illustrates a similar

pattern characterized by lack of political will to enforce the collection of environmental fines; and the low

priority of public funding of environmental investments demonstrated by the fact that earmarked funds are

frozen arbitrarily and used to shore up short term fiscal balances at the whim of fiscal administrators.

Mexico: poor performance of fiscal incentives for pollution control, and lack of enforcement of

payments for wastewater discharge rights

Mexico concentrated four of these cases. Three were fiscal instruments, an accelerated depreciation

incentive on pollution control equipment (laws LISR, LGEEPA 1996), a zero tariff incentive on imports of

pollution control technology ( INE-SECOFI-SHCP 1997), and a leaded gasoline surcharge applied in

Mexico D.F and earmarked for an environmental investment in the national public infrastructure bank

BANOBRAS, with the metropolitan environmental authority deciding on the application of the fund (INE,

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GDF, Estado de Mexico). Since 1997 this leaded gasoline surcharge had ceased to be transferred to the

environmental earmarked fund, however gasoline prices in Mexico D.F. continue to reflect the surcharge

indicating its capture by fiscal authorities.

The accelerated depreciation and zero tariff instruments had suffered from weak demand due to several

problems including: unclear definition in the law of the types of pollution control equipment eligible,

requiring revisions; lack of dissemination of the instrument to potential beneficiaries in the private sector;

administratively burdensome eligibility certification by trade and environmental authorities in the case of

zero tariff, among other transaction costs. Although environmental authorities (INE Mexico in this case)

had participated in the design of these fiscal incentives, their administration rested with trade and fiscal

authorities and environmental authorities had only limited information on the extent of their use, which

they presumed was very low. For all practical purposes the limited operation of these instruments did not

live up to their intended goal as incentives to increase pollution control investments. These problems were

also found as typical characteristics in most cases of fiscal incentives for pollution control investments in

the data set. These cases were characterized by weak demand, low dissemination of the instruments, and

application processes involving non trivial administrative costs.

The fourth case in Mexico is the payment for industrial wastewater discharge rights, established in 1992 by

the water authority (CNA) with legal base in the Federal Water Law, which applies to firms and

municipalities and also includes fines for discharges exceeding the pollutant limits established in national

norms revised in 1995. The instrument design set the payment for discharge rights at levels comparable

with per unit costs of wastewater treatment for compliance with national norms. Thus introducing an

economic incentive for firms and municipalities to invest in treatment facilities rather than face this

discharge payment. In practice water authorities never enforced these payments. Municipalities and firms

generally failed to build the treatment plants required in the Federal Water Law and between 1991 and

2000 accumulated debt for up to USD 5,000 million in fines. These fines were never enforced and what has

occurred in practice is a process of negotiation between environmental authorities, firms and municipalities

to postpone, roll over or write off these debts; or effect a make believe payment which is devolved back to

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municipalities as budgetary additions by the fiscal authority. Apparently water, environmental and fiscal

authorities have lacked the political will to enforce these payments.

Traditionally water provision in Mexico has been widely subsidized and provided either for free or with

very low charges to agriculture, industry and households. The lack of enforcement might also imply a tacit

recognition that the cost of treatment infrastructure to comply with the national pollutant discharge norms is

beyond the reach affordable by municipalities and the regulated community. The same situation repeated

itself in Colombia’s application of water pollutant charges, which was undermined by municipalities

(responsible for up to 60% of national water pollution loads) failing to the pay their charges, accumulating

debt, and unable to invest in water treatment. This pattern (examined in detail as a separate case study of

Colombia in a later chapter) highlights a key policy interaction between the implementation of water

pollution charges and national water/sanitation infrastructure policy. Infrastructure policy is primarily a

public finance problem requiring the transfer of investment resources to municipalities, and is completely

outside the realm of control of environmental authorities.

Venezuela: retired fiscal incentive for pollution control and deforestation tax.

Venezuela retired in 1991 a corporate tax credit for pollution control investments established in 1986,

similar to the fiscal incentives described above for pollution control equipment in Mexico. This tax credit

was eliminated in the revised tax code of 1991. Apparently this instrument suffered from low demand and

no constituencies lobbied for its permanence under the tax code revisions. Also a deforestation tax which

had operated since the 1970s by the forest authority (SEFORVEN) as earmarked revenue to fund public

reforestation activities, had ceased to be enforced or operate for all practical purposes.

This deforestation tax in Venezuela had been designed for cost-recovery purposes, for the government to

pay for reforestation after private forestry exploitation activities, rather than as an incentive instrument to

discourage deforestation practices. National environmental authorities no longer kept registries of revenues

linked to this instrument. As in the above case of Mexico failing to enforce water discharge rights, this case

also illustrates a political culture characterized by the expectation of free or subsidized provision of public

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services by the State (in this case reforestation), and a general lack of political will to charge for the costs of

using public resources.

Similar deforestation taxes in Bolivia, Brazil and Colombia mentioned in World Bank 1998 assessment,

were not reported in the national survey reports of Brazil and Colombia conducted for this dissertation. A

detailed comparison of results with this World Bank assessment is appended at the end of this chapter.

4.1.5 Main patterns associated with not-operative / not-enforced / retired instrument

outcomes. The above examples illustrate the 12 cases where instruments were found to be not operating according to

their original purpose only a few years after being implemented.

a) Misaligned incentives: Fiscal authorities rationing of revenue transfers for environmental

objectives.

The raison d’être and incentives of fiscal bureaucracies are stacked towards capturing revenue and

rationing disbursements. As illustrated in the Brazilian case of oil royalty revenues passed on from the

Federal to the State level, and then finally on to the State environmental fund, can be co-opted at the

discretion of the fiscal bureaucracies to fulfill short term fiscal balances requirements. The discretionary

rationing of budgetary transfers from the Federal to lower levels of government is routine fiscal practice in

Brazil where it is called “contingenciamiento”, and routinely limits the transfer of approximately 10% of

the approved national budget allocations for investment and new expenditures in various sectors. The

sectors most impacted by “contingenciamiento” are precisely those that are more dependent on public

investment funds, such as infrastructure, water, communications and transportation; which along with low

visibility sectors like tourism and culture, can suffer transfer limitations of up to 70-85% of their budget

appropriations78. With “contingenciamiento” being routine practice by Federal fiscal authorities, it should

be no surprise that State level fiscal bureaucracies in turn, also take the liberty to flaunt mandatory transfers

to State level environmental funds as in the case of Rio de Janeiro FECAM.

78 See Carlos Mussi, “Planificar y Presupuestar en Brasil – Una experiencia de rigideces y reglas,” Serie de Gestión Pública. ILPES-CEPAL, (Santiago Chile. 2006).

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There is a basic incentive problem with all earmarked fiscal transfers to environmental funds, when

recipient constituencies have no credible mechanism to force disbursement from fiscal administrators. This

problem is further exacerbated in the case of environmental public funds like FECAM, designed to

accumulate resources which are then ex-post competitively contested by environmental projects. In this

case the beneficiary constituency does not exist ex-ante, and the only plausible defenders of these transfers

are environmental authorities themselves, which generally do not command the political clout to force the

hand of fiscal administrators intent on shoring up chronic deficits through all available means. In fact the

shoring up of public finances in the short term would tend to trump the environmental project allocations,

as priorities for the executive branch preoccupied by short electoral cycles (Rio de Janeiro state governor in

this case) over lengthier time frame projects.

A related pattern and incentive problem affects the transfer of investment resources to municipal level

governments under fiscal decentralization laws, when the Executive or central government authority

intends that the transferred resources be invested in environmental projects by municipal authorities, or for

that matter in any other specifically earmarked investment. In this case, it is the recipient municipal

authority that lacks an incentive to apply the transferred funds to the specific earmarked end uses that the

central government intends, and which might not coincide with the municipal level priorities. This is a

generic fiscal decentralization problem that also affects the effective application of transferred investment

resources to intended environmental end uses at lower levels of government. For example, Ecuador fiscal

decentralization law requires that 5% of all national revenue be channeled downwards to municipalities as

investment resources. Efforts by the executive and national ministries to influence the allocation of these

transferred investment funds to municipalities to reflect the priorities committed in the Millennium

Development Goals, have not been able to alter existing patterns of environmental investment at the

municipal level79. Urban ornate is often reported as environmental investment by municipalities, rather than

funds being applied in the conservation of local resources or other environmental end uses prioritized by

national level ministries in the central government.

79 This information was obtained by the author from interviews with Environment and Finance Ministry officials during the annual Fiscal and Environment Policy Workshop held at U.N ECLAC headquarters in Santiago Chile during 2002-2004.

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Fiscal decentralization laws have not created the mechanisms required to ensure that transferred funds are

indeed applied at lower levels of government to end uses reflecting central government priorities, or

commitments such as the Millennium Development Goals, or any other multilateral commitment that

central governments might have signed. The resources, once transferred are applied by municipalities

reflecting their own political realities and also their planning/project execution capacity constraints. These

realities and the lack of effective channels and allocation mechanisms to ensure that transferred funds are

indeed applied towards intended end uses, dictates that in practice a large number of conservation activity

and environmental projects in Latin America, effectively by-pass formal government structures. For

example, many conservation projects and related investment in Ecuador and other biodiversity rich

countries in the region, tends to be donor and NGO driven. This project activity and investment is

geographically targeted to specific biodiversity rich areas, but with resources administered at central levels

and generally bypassing local government structures, for all fund disbursement and end use applications.

b) Misaligned incentives: Fiscal authorities rationing of tax credits and fiscal incentives for

environmental objectives.

Tax credits and other fiscal incentives targeted at pollution control and cleaner production investments

generally suffered from weak demand from potential beneficiaries in 5 out of 7 countries applying them:

Argentina, Colombia, Guatemala, Mexico and Venezuela, with Barbados and Chile being the exception.

Implementation problems and partial outcomes were generally associated with the administrative burden

and lengthy delays involved in the benefit application process (benefit eligibility criteria certified by

environmental authorities), and a second administrative process to receive payment of benefits/tax credits

(extended by fiscal authorities). Operation of these instruments is saddled by two sequential administrative

steps by two distinct public agencies. Generally the potential beneficiary must obtain a certification of

eligibility with the environmental authority, before initiating the application for tax credit or subsidy

payments with fiscal authority. The administrative burden and delays involved in these processes resulted

in transaction costs for applicants, which in combination with the modest benefits offered, tended to nullify

the net incentive effect of these instruments. By discouraging instrument demand these administrative

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burdens in effect ration the total amount of subsidies paid, or tax deductions granted, which might in fact

reflect the prevailing bias of fiscal authorities administering these incentives.

Argentina and Colombia also reported that implementation of their clean technology and pollution-control

incentives was mired because the eligibility criteria in the law/regulation had been defined too broadly, and

lacked the required specificity for effective application (i.e. cleaner production investments can mean many

things). Revisions of eligibility criteria had to wait for legal redress further delaying implementation. All

these factors contributed to inconsistent application, and the potential beneficiaries facing high transaction

costs that deter from the intended incentive.

It is interesting to note that as early as 1968 the literature had already identified that tax credits for pollution

control would not generate much demand from businesses. In their 1975 chapter for the National Bureau of

Economic Research (NBER) volume on the “Economic Analysis of Environmental Problems”, Wallace

Oates and William Baumol80 cite earlier work by Kneese and Bower81 on this topic:

In practice subsidies have been used for more extensively in the United States than fees. The federal government has relied heavily on a program of subsidization of the construction of municipal waste treatment plants and on tax credits to business for the installation of pollution control equipment. The serious deficiencies in the first program are now a matter of record in the 1969 Report of the General Accounting Office. The failure to curtail industrial pollution; the subsidization of plant construction but not operating expenses (resulting in many instances of incredibly ineffective use of facilities); and the inappropriate location of many plants have resulted in the continued deterioration of many major U.S. waterways despite an expenditure of over US$ 5 billion. Although we have been unable to find any direct evidence on the tax credit program, there is a simple reason to expect it to have little effect. As Kneese and Bower (pp. 175-78) point out, a firm is unlikely to purchase costly pollution control equipment which adds nothing to its revenues; the absorption of K per cent (where K<100) of the cost by the government cannot turn its acquisition into a profitable undertaking.

Therefore aside from the high transaction costs and lack of incentives by fiscal bureaucracies to expedite

incentive disbursements, pollution control subsidies/incentives are expected to suffer from weak demand by

firms, unless they cover the full costs of the pollution control investment required for compliance, which is

80 Wallace Oates and William Baumol, “The Instruments for Environmental Policy,” in Edwin S. Mills ed. Economic Analysis of Environmental Problems (NBER, 1975) p. 95-154. 81 Knesse, A. and B. Bower, Managing Water Quality: economics, technology, institutions. (Baltimore: John Hopkins, 1968).

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almost never the case. Incentives such as tax credits, accelerated depreciation, zero import tariffs on

pollution control equipment, and soft financing of pollution control and cleaner production investments, as

found in law in the cases examined only offset a portion of the total investment cost borne by firms,

municipalities or individuals undertaking the pollution control project. In general the fiscal incentives for

pollution control investments examined would tend to offset around 30% of less of the costs incurred.

Our data set conformed to this prediction, 5 of 7 tax credit instruments tied to pollution control investments

suffered from weak demand and did not generate much interest in potential beneficiaries. It is noteworthy

how the two countries that did not conform to this trend and reported successful application of tax credits

differed from the rest. Barbados reported successful application of highly targeted tax credits for the

installation of solar water heaters and rain collection systems by the general population, and water saving

equipment for its tourism sector. Note that these are not tax credits for pollution control investments, solar

water heaters (by far the most successful program), is as investment that produces tangible returns to

households in terms of energy savings and reduced electricity/gas bills. Water collection and water saving

equipment tax credits did not enjoy the same degree or success, arguably because the user charge for water

provision in Barbados was still relatively low. Therefore the program contented with similar weak incentive

situation from potential household and firms adopters, as evidenced by the programs offering tax credit

incentives for pollution control investments in other countries.

Chile’s cleaner production program also differed from the trend, since it consists of a much broader set of

incentives in addition to tax credits for pollution control investment. Chile ambitious cleaner production

program is fully integrated within the Chilean government economic development and industrial promotion

agency (CORFO), a highly regarded public institution with over 60 years of experience supporting

industrial innovation and development CORFO has a strong record in the application of financial

incentives, specialized loans and technical assistance to small and medium enterprises and also larger firms,

with broad focus on technological, productivity, and competitiveness upgrading to which cleaner

production and environmental management have been added. Therefore Chile’s CORFO program is much

more than a tax credit for pollution control investment, and actually constitutes one of the more successful

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models for successful public intervention in support of cleaner production investments by small and

medium enterprise sectors in the region.

In contrast to the weak demand experienced by tax credits for pollution control investments, all seven 7

cases documented of reforestation fiscal incentives, tax credits and/or subsidies, were successfully

implemented and operating in the region. It is easy to see why through the above logic. In contrast to

pollution control investments, which incur a capital cost and permanent operational costs, and do not add

anything to firms revenues, reforestation projects are generally profitable undertakings that produce salable

wood and/or other ancillary benefits to land owners (i.e. soil conservation, pest management etc.). Based on

these results the take up of end-of-pipe pollution control equipment, being a net cost to firms’ balance

sheets, would tend to occur exclusively in contexts where regulatory pressure, enforcement fines, or legal

liability from non-compliance, are such that they effectively force compliance by regulatory agents in spite

of this lack of bottom-line incentive. Or alternatively in contexts where a combination of social and

government pressure, and firm reputation losses from regulatory non-compliance, are strong enough to out

weight the above microeconomic incentives against internalizing pollution control costs. Such as context

seems to characterize western European country’s regulatory culture which mix non-compliance fines,

liability and pollution charges, with a tradition of voluntary agreements between industry and

environmental regulators for the attainment of pollution control objectives.

c) An institutional culture of subsidized public service provision, averse to charging the full costs for

water, and much less prepared to internalize the costs of water pollution.

In most Latin American and Caribbean countries monthly charges for municipal water supply, sanitation,

and waste disposal frequently fail to recover a significant portion of the operational cost of these services.

This situation often results in precarious services and lags in the investments required for improved water

quality and waste disposal. It is useful to distinguish this general cost-recovery problem, from the problem

of access to public services by the lower income population concentrated in informal slums with precarious

services surrounding the major cities. In general the precarious public services that reach these informal

settlements are not metered by individual household and are accessed via informal tapping and/or collective

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facilities. Therefore the poorer sectors of the population already access whatever service exists free of

charge or at very low cost.

Given the actual level of charges it is not clear whether distributive concerns can be justified on economic

grounds (i.e. true inability to pay), or are simply the result of fear of political fall out by municipal

authorities and public utilities in charge of service provision. The ideal instrument to address the above

asymmetrical situations consists of differentiated block tariffs and cross subsidies where different

household income groups and economic sectors (i.e. industrial users, agriculture etc.) pay for public

services according to their median ability to pay. In our data set is notorious the generalized absence of

implementation of differentiated block tariffs for municipal water, water treatment, and solid waste

collection services. One of the few exceptions found in the region is the cross-subsidization scheme via

“solidarity funds” implemented in Colombia under the new national environmental law of 1993, whereby

the water and sanitation tariffs paid by upper income household groups and industry are earmarked to

subsidize the costs of service delivery in the poorer sectors of the population.

It is striking not to find more widespread application of differentiated tariffs and cross-subsidization

schemes for various public services. Particularly in a region characterized by the highest income

asymmetries in the world, and by marked spatial segregation between middle and upper income urban

households and the population living under the poverty line in informal settlements around the major cities.

Both characteristics make an ideal case for wider application of cross subsidization schemes. One possible

interpretation is that the current widespread informality and illegal tapping of services in fact substitutes for

cross-subsidization. This might be true for electricity, but water supply and sanitation infrastructure is a

different case.

More in line with the patterns observed in the cases examined in the second section of this chapter, the

implementation of cross-subsidization schemes is information and administratively intensive. It requires

detailed information registries of service users categorized by socioeconomic status, appropriate metering

of service use by different user groups with different block tariffs, and credible administration mechanisms

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that ensure targeted compensation of cost coverage deficits from the surplus collection from higher paying

service user groups. These are similar information and administrative requirements to those needed to

establish water pollution charges based on discharge volumes, or any other environmental charge that

requires information registries of pollution sources or resource users, and their invoicing based on

measurement of pollutant flows or resource use. Judging from the lack of evidence of cross-subsidization

schemes, and the relatively few applications of water pollution charges in the data set, these administrative

and information requirements are still a tall order for municipalities running traditionally subsidized and

precarious service provision dependent on central government transfers.

4.1.6 Summary findings on the extent of implementation

A total of 81 environmental policy instruments in thirteen countries were reported in the national surveys

from thirteen countries. The main findings on their extent of implementation are summarized as follows:

� National surveys revealed that there had been a considerable amount of experimentation introducing

“market-based” instruments in environmental policies (81 cases reported in thirteen countries). In these

81 cases 56 instruments had been implemented (69% of the total).

� They also revealed that “market-based” instrument initiatives were subject to remarkable ex-ante

mortality rates: 25 instruments (31% of the total) were aborted before entering the implementation

stage. Incidence of this outcome disproportionately affected environmental charges (9 not

implemented in 23 charge cases in the data set), environmental taxes (3 not implemented in 4 tax cases

in the data set), and tradable permits (3 not implemented in 5 cases in data set).

� Of the 56 instruments for which implementation was initiated, 12 cases (21% of 56) were no longer in

operation, or were operating in a very limited fashion that clearly was not fulfilling their intended

design goal. Incidence of this outcome disproportionately affected tax credits (3 of 8 implemented),

earmarked fiscal transfers (1 of 2 implemented), and preferential financing for environmental projects

(1 of 3 implemented).

� A further 9 cases were found to be operating partially. This outcome was coded for those cases where:

a) instrument implementation had not reached their full intended geographical scope of application (for

example in those cases where the instrument was only being applied in certain sub-national

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jurisdictions rather than nationally as mandated); and/or b) instrument implementation had achieved

only partial coverage of their regulatory target groups (for example incomplete coverage of pollution

sources, or resource users, etc.).

Figure 4.4 bellow shows the number of cases for each of the above implementation outcomes.

Two major patterns were evident in countries where the implementation of “market-based” instruments was

blocked and never got underway, or where it experienced operational problems once implemented:

� Political bias against the introduction of environmental goals in the tax system. This is a fairly

general or default situation not only in Latin America but also internationally. Where public finance,

fiscal authorities and political interest groups are not permeable, or outright resistant to initiatives

seeking to “green” existing tax structures; or to reduce existing perverse incentives from

agricultural/energy/transport subsidy structure. Or resist modification of existing pro-investment

policies in environmentally sensitive sectors which are granted preferential tax treatment (i.e. mining

etc.), and might incur in fiscal competition which further detracts from the internalization of the full

social costs of these economic activities.

12

13

56

35

9

12

0 10 20 30 40 50 60

number of instruments for each outcome

proposal

official sanction

56 instruments implemented are disaggregated into the

three outcomes above

Operating

Partial operation

not operating/not enforced

NO

T im

plem

ente

d

impl

emen

ted

Figure 4.4 Number of cases coded by implementation outcome ( n = 81 instruments in 13 countries )

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� Misaligned incentives of fiscal bureaucracies in the operation of environmental transfers and

fiscal incentives: such as tax credits, subsidies, fiscal transfers, and earmarked fund allocations for

environmental end uses. This pattern was clearly illustrated in the series of cases highlighted in this

section, which provide empirical support for the assertion that the policy interaction between the

environmental goal of introducing “market-based” instruments, and existing fiscal structures and fiscal

administration practices, is of critical importance in determining the observed implementation

outcomes. This highlights the critical role that revisions to the environment–fiscal policy and

institutional interface, must play in the design of any integrated policy intervention seeking to harness

economic incentives and “price signals” to induce broad based pro-environmental change. The net

effect of environmental incentive instruments will tend to be diluted or neutralized when operated

through institutional channels whose inherent incentive structure follows a public finance logic, rather

than the inducement or modification of the behavior of specific economic agents targeted by the

environmental instruments. This later function is not one that fiscal bureaucracies are familiar with,

particularly if the environmental instruments are not meant to raise revenue as their primary goal.

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4.2 SECTION II Analysis of Instrument Choice 4.2.1 Instrument choice: types of “market-based” environmental instruments

implemented

Figure 4.5 below shows the number of cases by instrument type (i.e. subsidies, tax credits, charges, etc) and

observed implementation outcome. The first bar (light yellow) shows the number of instruments by type for

which implementation was never initiated. Within the 56 instruments implemented in the region ( blue bar),

the majority of cases were: a) positive incentive instruments (subsidies, tax credits, financial transfers and

soft-financing) with 16 cases (32%); and b) user charges with 14 cases (30 %). The last bar (dark red)

shows the number of instruments among the 56 implemented that were found retired/not enforced/not

operating.

Except for direct subsidies for reforestation activities, incidence of non-implementation was found for all

instrument types. However non-implementation outcomes disproportionately affected charges (9 of 23

charges in data set) and taxes (3 of 4 taxes). These results are in line with the patterns described in the

previous section indicating that environmental authorities faced barriers and coordination costs in

establishing the invoicing, payment collection and revenue administration mechanisms required to operate

new environmental charges. The previous section also highlighted the strong political bias against the

introduction of environmental objectives in the tax system. Barriers were also faced by initiatives to

rationalize charges for public service provision, from fear of political fall out from their impact on low

income groups. In Figure 4.5 tradable permits (3 of 5 cases documented), and fiscal transfers (2 of 3

earmarked transfers) also show disproportionate non-implementation outcomes. Again these results are in

line with conventional wisdom, establishing a tradable permit system (or environmental taxes/charges)

entails higher information requirements and administrative costs than other types of instruments in the data

set. The problems of misaligned incentives in the operation of earmarked fiscal transfers by fiscal

authorities were also identified in the examples of the previous section.

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4.2.2 Positive incentive instruments: Environmental subsidies, tax credits, fiscal transfers

and other incentives. The national surveys revealed that the majority of economic instruments being applied in Latin America

towards environmental policy goals were positive incentive instruments. Subsidies, tax credits, fiscal

incentives, subsidized financing, and fiscal transfers accounted for 16 (29%) of the 44 instruments found in

operation (after taking out the 12 retired, not enforced etc.). Approximately half of these instruments (7

cases) were incentives for pollution control and cleaner production investments, in the form of tax credits,

accelerated depreciation and zero tariff provisions for pollution control imports. Tax credits and other fiscal

incentives targeted at pollution control and cleaner production investments generally encountered weak

demand in Argentina, Colombia, Guatemala, Mexico and Venezuela, with Barbados and Chile being the

exception as discussed in the previous section.

7

2

8

3

2

3

1

2

1 1

3

1

9

14

6

3

2 1

2

3

1

4

0

2

4

6

8

10

12

14

num

ber

of c

ases

subsidy tax credit preffinancing

fiscal transfer tax charge tradablepermit

deposit-refund

certification

positive incentive negative incentive other instruments

Figure 4.5 Implementation outcomes by instrument ty pe ( number of cases) n = 81

not implemented implemented retired/not operating

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On the other hand all 7 cases of reforestation subsidies and other fiscal incentives for forest restoration

activities in degraded areas were generally found to be operating according to their design objectives. No

major obstacles in their operation were reported in all countries where they were found being applied:

Argentina, Colombia, Costa Rica, Chile, Dominican Republic, Guatemala, and Mexico). Within Latin

America reforestation subsidies have a long standing tradition and are found in many countries. The

apparent glitch-free operation of reforestation subsidies and the fact that they have been operating for

several decades suggests that they have established constituencies of beneficiaries which have been able to

prevent the derailment of these instruments. They seemed to have some the staying power demonstrated by

agricultural subsidies, which unfortunately tend to environmentally detrimental. This might be related to

the fact that reforestation subsidies are usually associated with the gamut of rural development and

agricultural promotion policies that have been standard within the traditional institutional culture of Latin

American governments. Reforestation subsidies would also traditionally fall under the aegis of national

forestry service or forest sector development policy, which in many cases existed prior to the establishment

of national environmental agencies in a majority of countries.

Figure 4.4 Instrument share by type of incentive (n = 56) pos itive incentive instruments disaggregated

fiscal transfer; 5%

soft financing 5%

tax credits 19%

negative incentives 38%

(taxes, user charges)

other instruments 24%

(permits, certification, deposit-

refund etc.)

positive incentives 3 8%

subsidies 10%

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Costa Rica: Payment for Ecosystem Services (PSA)

Costa Rica’s “Pago por Servicios Ambientales” (PSA, payment for environmental services) is forest

conservation subsidy designed as an annual payment per hectare of standing forest that partially offsets the

landowner’s opportunity cost of converting the forested land to other land uses, such as small scale

agriculture. The instrument targets private forested land covering the upper watersheds, where forest

conservation provides flows of ecosystem services (positive environmental spillovers), such as regulation

of hydrological flow, soil erosion and sedimentation rates downstream; as well as providing biodiversity

protection and carbon sequestration. The PSA is part of a broad ranging set of forest and reforestation

policy instruments and incentives whose implementation was initiated in 1996, as the latest phase in Costa

Rica’s long tradition of using tax incentives, soft credit finance, tax credits, and other economic incentives

in forest policy dating back to 1970s. These policies have been effective in turning around the deforestation

experienced between 1950 and 1990, and the recovery of forested area during the last two decades.

The rationale and original intent in the PSA law was that the beneficiaries from the flow of ecosystem

services protected, such as downstream water users, hydroelectric power plants, etc. would pay a tariff

increment and thus contribute to finance the operation of the PSA. The original intent of the PSA was

market creation for ecosystem services, with payments collected from local downstream beneficiaries, but

also through the sale of carbon sequestration offsets in the international carbon market. This intention

collided with political realities. The natural beneficiary from protection of hydrological flow and control of

sedimentation rates is the Costa Rican national electric utility (ICE) which generates more than 80% of its

power through hydro, and also has the administrative wherewithal to pass on to its customers via electrical

tariffs, the marginal cost increase of contributions to the PSA system. The ICE although a public entity, has

successfully resisted for more than a decade to make any payments to the PSA system, based on the

autonomous statutes of its legal charter that predate the PSA law.

The original PSA law did not seek to impose payments on beneficiaries, but rather mandated that agency

administering the PSA (FONAFIFO, the Costa Rican forest policy agency) enter into negotiated

agreements for contributions from beneficiaries. Although a number of agreements have been reached for

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sustained contributions from water utilities in charge of water provision in several cities, the payments

collected from beneficiaries are insufficient to fund PSA operation, which is financed via an earmarked

percentage of gasoline tax revenues at the national level. This cross subsidy is likely to remain until the

PSA law is amended to introduce mandatory payments from a broader base of national water users, and

economically powerful beneficiaries such as the national electric utility ICE. When the PSA was created in

1996, one year before the signing of the Kyoto Protocol, the expectation also existed that payments would

be forthcoming from the sale of carbon sequestration credits from PSA protected forests in international

markets. Of course from hindsight we know that the international market for carbon sequestration

(LULUCF) never got off the ground in the multilateral climate change negotiations under the United

Nations Framework Convention on Climate Change (UNFCCC).

The successful resistance by the main public beneficiary from ecosystem services, to contribute to the

financing of PSA operation, illustrates the enormous power of public corporate interests in Latin American

countries to resist change and intrusions into their traditional turf, least of all by less politically powerful

environmental agencies. To appreciate the significance of this case one has to bear in mind that the above

situation occurs in Costa Rica, one of the few countries worldwide where Presidents routinely advocate the

country’s “green” policies and natural capital as its major international strategic image and competitive

advantage. It is also one of very few countries with an integrated Environment and Energy Ministry

(MINAE, “Ministerio del Ambiente y Energía”), and yet despite this favorable context the national power

utility, supposedly also a part of government, is still able to forgo paying PSA contributions. The case

illustrates the difficulties of creating markets for previously “un-priced” or “free” environmental services,

and establishing effective mechanisms to collect payment from beneficiaries. The difficulties of creating

functioning environmental markets for global environmental services, are also exemplified at the

international level by the long negotiations and delays in establishing an international market for reduced

deforestation activities (REDD) still waiting to be officially established under the UNFCCC framework.

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Brazil: ICMS tax revenue sharing criteria based on municipalities environmental characteristics

The remaining positive incentive instrument in the data set was a revenue sharing scheme between state

governments and municipalities in Brazil. Municipalities receive 25% of the revenue from the main state

level value added tax called ICMS ( ICMS collected USD 33 billion in 2002), three quarters of which are

devolved in proportion to the municipalities’ value added contribution, and the other quarter (USD 2 billion

in 2002) is devolved based on revenue sharing criteria defined by the states themselves. The states of

Minas, Sao Paulo, Paraná pioneered the introduction of environmental criteria in the revenue sharing rule,

like the proportion of each municipalities’ territory dedicated to forest reserves, water source protection,

and the amount of municipal investment in water treatment and other environmental investments. The rest

of Brazilian state governments have followed suit incorporating environmental criteria in the revenue

sharing rule. Note that what the revenue sharing rule does is to include the municipalities’ environmental

characteristics (such as the area of land under forest reserves or water source protection, and municipal

investment in sanitation) so as to partly compensate the costs from non-development of these lands, or from

sanitation investment, borne by the municipality through the proportional reallocation of state tax revenue

devolved. This scheme makes economic sense, since forest and water source protection, as well as

sanitation infrastructure, all have positive inter-jurisdictional spillovers beyond municipalities’ boundaries

through shared hydrology which often encompasses several states.

4.2.3 Environmental taxes and charges linked to pollution externalities. The data set revealed a marked scarcity of. taxes, pollution charges, and other charges designed with the

explicit objective of internalizing the cost of environmental externalities. No environmental taxes were

found in application. A retired deforestation tax in Venezuela had been designed for cost-recovery

purposes, for the government to pay for reforestation after private forestry exploitation activities, rather

than as an incentive instrument to discourage deforestation practices. Similar deforestation taxes in Bolivia,

Brazil and Colombia mentioned in World Bank 1998 assessment, were not reported in the national survey

reports of Brazil and Colombia conducted for this dissertation. A detailed comparison of results with this

World Bank assessment is appended at the end of this chapter. No instances of national level application of

environmental taxes, nor charges, designed with the explicit goal of internalizing environmental

externalities has yet been consolidated in the region. Only Colombia attempted to implement a water

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pollution charge82 at the national level based on discharged volumes of organic pollutants into surface

waters.

Colombia’s attempt to implement a water pollution charge system at the national level

Implementation of the water effluent charge per unit of volume discharged into surface waters, called “Tasa

Retributiva por Contaminación Hídrica” was initiated by Decree 901 of 1997, which regulates Article 42 of

Colombia’s environmental Law 99 of 1993. This article mandates that the existing 33 decentralized

environmental authorities (“Corporaciones Autónomas Regionales” (CARs)) begin charging a “retributive

or compensatory charge” per volume of water pollutant effluent discharged to national surface waters. The

legal figure of “retributive charge” dates back to Colombia’s Natural Resource Management Law of 1974,

but had never been regulated. In the 1974 law this charge was applicable only to profit-making natural

resource users, basically private facilities. The new National Environmental Law 99 of 1993 rescued this

“retributive charge” but mandated that dischargers, both public and private sources, pay the charge in

compensation for the negative externality of using public surface waters as receiving bodies to carry off

their pollutant streams. The inclusion of public sources was a key point since wastewater discharges by

municipal water/sanitation utilities represented over 60% of total organic waste discharges into Colombia’s

surface waters.

Implementation of the water pollution charge was administratively intensive since it implied the CARs had

to undertake the following tasks: compiling an inventory and registering of dischargers; measuring

discharges and pollution loads; identifying receiving water bodies and their sections; establishing pollution

load targets for each section; communicating and building support for the targets established; establishing a

system to invoice, collect and manage charge payments; monitor water quality to evaluate whether

pollution load targets were being attained in the various water body sections in their respective

jurisdictions. The level of charge per unit of discharge volume was linked to the actual water quality

82 This water pollution charge ( Law 99 “Tasa Retributiva por contaminación hídrica”) is based on discharged volume of organic pollutants BOD and TSS onto surface waters and is applied both to private firms and public utilities organic discharges. BOD refers to Biological Oxygen Demand, TSS refers to Total Suspended Solids, these parameters are easy to measure and indicate the organic content in untreated discharges. .

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conditions in each watershed section, as measured by the local authority in terms of simple parameters

(biological oxygen demand (BOD), and total suspended solids (TSS)) correlated with the degree of organic

waste pollution and untreated sewage being discharged into surface waters. The charge was to be ratcheted

up every six months until the water quality targets negotiated in each watershed section are achieved. This

ratcheting scheme enables the charge to converge to the level required to achieve the target goals, even

though authorities lacked plant level information on the marginal costs of abatement, and other parameters

relating individual discharges to the total pollution load in each section. This design enables authorities to

get around the generalized lack of information on plant-level abatement costs, and discharge volume-

pollutant load parameters, that regulators face everywhere.

Two cases deserve special mention in the data set, Colombia and Costa Rica. Colombia had made an

ambitious attempt at establishing and operating a national system of water pollution charges. Costa Rica

had established a system of payments for ecosystem services linked to positive environmental spillovers

from forest protection in watershed-related jurisdictions. These two cases were selected for in depth case

analysis in the second part of the dissertation.

In the case of Costa Rica it was a system of annual payments per hectare of standing forest in private lands

providing flows of ecosystem services (positive environmental externality), such as the case of forest

covering the upper watersheds which regulate hydrological flow and soil erosion and sedimentation rates

downstream. Known as “Pago por Servicios Ambientales” (PSA, payment for environmental services) in

Costa Rica, it is a positive incentive designed to partially offset the farmer’s opportunity cost of converting

the forested land to productive uses, in this case small scale agriculture and cattle raising. The PSA is part

of a broad ranging set of forest and reforestation policy instruments and incentives whose implementation

was initiated in 1996, as the latest phase in Costa Rica’s long tradition of using tax incentives, soft credit

finance, tax credits, and other economic incentives in forest policy dating back to 1970s. This case is also

examined in depth in Chapter 5

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However at the time of our survey the water pollution charge had only been implemented by decentralized

environmental authorities (CARs) in 14 out of a total of 28 jurisdictions. Some jurisdictions documented

significant reductions in pollution loads in parallel with the implementation of the pollution charges. In

particular the CARs of Antioquia Rio Negro, Valle del Cauca, Cali, Barranquilla, among others. These

were precisely the institutionally stronger jurisdictions among the 28 at the national level. Where

authorities had a prior base of environmental management efforts including adequate information and

registries of polluters, and a established regulatory relationship with firms and municipal dischargers.

However in many jurisdictions the water pollution charge experienced significant implementation

problems. In 2002 the national comptroller office (“Contraloría General de la República”) issued a report

indicating that 40% of CARs still did not have an inventory of waste water discharges.

Aside from the problems of incomplete information and updating of pollution source registries , the main

barrier to implementation at the national level was the resistance of municipalities to pay the water

pollution charges. In Colombia municipal sewerage utilities are responsible for up to 60% of the total

organic pollution loads at the national level. The new pollution charge regulation required that municipal

utilities begin paying the new charge to the environmental authority (CAR) managing the corresponding

watershed jurisdiction receiving the municipal discharges. The law also required municipalities to pass on

this new cost item (i.e. water pollution charge) to their customers as a prorated marginal increase in the

monthly water tariff of each household connected to the public water/sewerage service. For several

municipalities the marginal increase in the monthly tariff per household was equivalent to less than the full

cost of a bus ticket, therefore the inability to pay argument lacked all credibility.

Nevertheless, as shown in the case study of this experience in Colombia included as a separate chapter, the

main political stumbling block in the national implementation of this water pollution charge was the

resistance of municipalities to pay based on their failure to pass onto their customers this new cost item, as

required by law. It is difficult not to interpret this behavior as another case of misaligned bureaucratic

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incentives, this time between levels of government in a decentralized setting, jeopardizing implementation.

Rather than based on any sort of distributional concerns regarding the charge’s impact on lower income

groups, given that the monthly pass through cost per household from this water pollution charge was

minimal as mentioned before.

Misaligned incentives between levels of government: vertical coordination of national mandates

It is to be expected that municipal authorities would drag their feet on any national level mandates requiring

local adjustment of tariffs. All the more so in this case where the additional revenues collected from local

customers had to be paid to a regional environmental authority, rather than remaining in the municipality.

These political dynamics by municipalities and their arrears or outright refusal to pay water pollution

charges, ended up undermining the incentive effect of this instrument with the private sector paying the

charge, since municipalities were responsible for 60% of the total pollution load. In this case the

misalignment of incentives jeopardizing the implementation of the water pollution charge occurs between

municipal entities at the lowest level of government, and environmental authorities higher up. Aside from

this case no other applications of per unit environmental charges, designed primarily as price incentives to

encourage more efficient behavior by users and polluters were found in the countries surveyed. More

recently in 2008 Costa Rica passed a law for a national level water pollution charge (“canon de vertidos”)

but its implementation is still pending.

4.2.4 User charges for water and municipal service provision. The second large group of instruments found in application were user charges with 16 cases (36%) of

which 13 (31% in total data set) were designed to collect funds for partial cost-recovery of service

provision (i.e. charges for water use, sanitation, water treatment, and waste disposal etc.). The only

successful national scale application of water use charges was reported in Jamaica, this case contrasts with

the one in Barbados mentioned earlier, in which the same instrument was not implemented citing a lack of

political will to manage potential reactions of lower income groups. Jamaica’s successful implementation

of water use charges might reflect the country’s tradition in tax collection and public revenue

administration usually ranked as more effective than the regional average.

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The other successful application of water use charges were both in sub-national level jurisdictions in Brazil.

The water stressed northeastern state of Ceará has successfully implemented a differentiated water charge

scheme to create a nominal price signal for water scarcity. The water charge for residential consumers and

agricultural use is very low, and only moderately higher for industrial uses. Through the implementation of

these nominal charges the state water utility has gradually laid the groundwork for water use monitoring

and payment collection systems. Both of which are critical elements to advance the goal of integrated water

resource management in this arid Brazilian state. The Ceará state public water utility also has a long

standing tradition as a competent and professionally managed agency which plays a key role in engineering

the water provision infrastructure for this arid northeastern state. The success in implementing a water use

charge system in Ceará, no doubt depended on the prior groundwork and institutional solvency of this

public agency, and the fact that water users in the Brazilian northeast are acutely aware of water scarcity

and the need to manage competing uses.

The other water use charge in Brazil is being implemented in the Paraiba do Sul watershed in the state of

Rio de Janeiro, under a decentralized watershed management figure established under Federal law. The

model for this semi-autonomous watershed institutional arrangement in the Federal law was piloted by Rio

de Janeiro water and environmental authority, which has also a long standing tradition as a competent and

professionally managed public agency. The water use charge is managed by a decentralized watershed

management authority which incorporates both public and private watershed stakeholders. The water

charge aims to encourage rational use of the resource, and revenues are recycled and managed within the

same watershed jurisdiction. The Paraiba do Sul is a heavily developed watershed connecting several states

Sao Paulo, Rio de Janeiro, and Minas Gerais. Although the problem is not one of water scarcity as in Ceará,

but one of competing water uses among the industries settled in this heavily developed region. The

collective understanding that efficient water use is key to ensure the industrial viability of the region has

driven active stakeholder participation in the watershed management scheme instituting the water charges.

Recent empirical evaluations of the Paraiba do Sul water use charge scheme by Jose Feres and colleagues

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from IPEA ( Brazilian government applied economic research institute) indicate that it has been effective in

inducing more efficient water use practices by firms in the water shed.

Aside from Jamaica and Brazil, the other 10 instances of water use and water treatment charges in the

dataset reported low cost recovery levels and nominally low tariff rates. The typical situation in most small

and medium cities and rural municipalities in the region is that adequate solid waste disposal and water

treatment infrastructure is precarious, and monthly tariffs for municipal service provision are subsidized.

As a result municipal utilities face chronic operational deficits in spite of being already subsidized by

governments. The exception being the larger metropolitan areas where water utilities and solid waste

collection services have been privatized (i.e. Caracas, Cartagena, Sao Paulo, etc.). In practice however even

municipalities in the more industrialized urban areas fail to have adequate levels of water treatment,

resulting in widespread pollution of urban rivers as is the case in several capitals such as Bogotá, Caracas,

Quito, Santiago etc. and other higher income cities such as Sao Paulo.

Public finance of water/sanitation infrastructure: another key policy interaction.

Conceptually the role of environmental user charges must be clearly separated from the public finance

problem of paying for national water and sanitation infrastructure. Water pollutant charges and water use

Figure 4.5 Instrument shares by type of incentive (n = 56)

negative incentive instruments disaggregated

negative incentives 38%

other instruments 24%

(permits, certification, deposit-

refund etc.)

positive incentives 38% (subsidies, tax

credit etc.)

taxes 2%

user charges 36%

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charges cannot be expected to contribute in any significant way to the large capital costs required to install

adequate water supply and treatment infrastructure in municipalities where is doesn’t exists. Water

treatment and sanitation infrastructure investments are better conceptualized as a national level public

finance and resource mobilization problem, than as an environmental policy issue83. However as illustrated

by the cases presented in this section the implementation of water pollution charges and water use charges

necessarily interacts with existing deficits in water supply and sanitation infrastructure. The lack of

adequate water treatment infrastructure and resulting pollution of surface waters is a situation is typical of

most developing countries bellow middle range levels of per capita income (GDP/pop), as has been shown

in the environmental inverted Kuznet’s curve literature for organic water pollutants in surface waters. At

lowers levels of per capita income, countries cannot generally afford the capital and operational costs of

widespread water treatment infrastructure. As a result, where it exists, adequate infrastructure and level of

service provision requires subsidization and financial transfers by central governments for most

municipalities.

The main point here is that environmental outcomes in water resources management are critically

dependent on the status quo of municipal infrastructure investments, which in turn are a function of public

finance and national infrastructure policy decisions required to mobilize the substantial capital flows

required for adequate infrastructure. The case discussed earlier for Mexico, illustrates the common situation

where payments for industrial discharge rights due by firms and municipalities were not being enforced, in

implicit acknowledgement that waste water treatment investments mandated by national water law were not

being complied with. The introduction of “price-signals” on previously uncharged water discharges,

presupposes that polluters, be them private firms or public entities like municipal utilities, will have the

wherewithal to upgrade their pollution control efforts and thus minimize their payments for discharging

pollution. As the case in Colombia illustrate, municipalities are often the major dischargers of organic

83 In environmental policy water use and water pollution charges are instruments designed as price incentives for water use efficiency and reduction of pollutant discharges. The resulting revenue can be used in different ways: a) it can contribute to cover the operational cost of local water supply and treatment provision; b) it can be recycled back through environmental investment funds to the sector or jurisdiction paying the charges; c) it can contribute to cover the administrative, monitoring and enforcement costs of the environmental authority in the jurisdiction; or d) it can contribute to general public revenue at the national or state level.

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pollution loads, but are also locked in by previous infrastructure deficits in their capacity to react

adequately to these charges. Misaligned incentives and political constraints also played a part in this case,

as municipalities failed to pass on through to their customers the additional cost of the new water pollution

charges, although required by law to do so.

Despite these obvious political and infrastructure constraints, cases from Colombia, Costa Rica, Chile,

Jamaica and Brazil document competent efforts to implement ambitious “market-based” instruments such

as water effluent and water use charges. Environmental authorities did not shy away from confronting the

high administrative, coordination, and information requirements involved in their efforts to establish an

operating system of environmental and/or resource use charges. In all these cases, “market-based”

instrument implementation initiatives have contributed important salutatory effects in strengthening

environmental management. In undertaking these efforts national authorities have been forced to confront

existing gaps and incomplete information constraints, such as weak or inexistent databases of polluting

facilities and of monitoring environmental quality parameters; and work to upgrade the information base

required for environmental management, and to use the improved information to mobilize public opinion

and political support required to overcome the political/institutional dynamics mentioned earlier. The

positive effects associated with the increase in transparency and accountability of establishing a price signal

for the first time on pollutant discharges or water use volumes (which being formerly un-priced were also

unrecognized by both polluters and regulators), cannot be underestimated. The information and first-time

accountability conveyed by such a signal, however modest, seems to have triggered a series of important

and unexpected systemic effects. As private firms start accounting for pollution flows for the first time,

they often find quick opportunities for reducing them. And as authorities begin operating the charges, they

are forced to confront glaring omissions and information gaps in their registries of pollution sources,

monitoring of discharges, and environmental quality; and must move quick to solve them under increased

national visibility and public scrutiny of the new instruments coming on line.

The case study data suggests that even when the initial level of charges was modest and achieved only

incomplete coverage of polluters, the increased information and accountability effects were important in

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catalyzing efforts for strengthening environmental management capacities in government and improving

monitoring and enforcement of existing regulation. In the detailed case study of the implementation of a

water pollution charge in Colombia (“Tasa retributiva”, Law 99) it was possible to document that a number

of facilities had undertaken pollution control investments as a direct result of the increased outreach and

enforcement effort by local environmental authorities involved in implementing the new charge system84.

These salutatory effects of increased public transparency and accountability obtained from the environmental authority

having to improve polluters’ registries and environmental information to implement new “market-based” instruments,

needs to be distinguished from the theoretical static efficiency gains of the academic literature.

4.2.5 Other instruments in the data set: tradable permits, deposit-refund, certification. Strictly speaking only 1 case of tradable permits was found operating in the region, this is a pilot

application of tradable fishing quotas applied to a very specific fishery in Chile representing less than 1%

of the total catch. The other tradable quota system in found in operation also in Chile, was a compensation

system for fixed source emitters of particulate air emissions (PM10) in the Santiago metropolitan area. Any

new entrant must compensate its emissions by buying emission quotas from existing facilities. This is a

similar scheme to the bubbles in non-attainment areas under the U.S. Clean Air Act. The compensation

system in Santiago has been characterized by very few transactions. The data set also included five cases of

both preferential financing schemes for environmental projects, and deposit-refund schemes (localized in

scope), with only three of each implemented. Five cases of official certification of environmental

performance were also reported with four implemented and operational. Judging by the number of cases

found retired or not operating ex-post, the data suggested that countries face relatively less complications in

implementing preferential financing and certification schemes than other instruments.

Except for the reduction of pollution loads in the case of the water pollution charge in Colombia, and

estimates of energy savings generated through the uptake of solar water heaters in Barbados, the national

surveys did not report the availability of ex-post evaluation studies of instrument’s impact, or other data

84 This applies in particular to Colombia’s institutionally stronger regional environmental authorities, CORNARE and CVC, which piloted the water pollution charge implementation effort. However pollution control investments by various industries have also been documented in other jurisdictions where environmental authorities were not as strong (i.e. DADIMA etc.)

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indicating their contribution towards the attainment of the policy goals set for it. Therefore as explained in

the methods chapter, the scope of our analysis remains focused on the proximate outcomes of the

implementation effort. That is whether environmental authorities succeeded in incorporating the new

instrument into the existing policy mix or not; and whether the instrument had survived the implantation,

and had indeed been established as an operating policy instrument.

4.2.6 Instrument choice: summary of findings • User charges represent the largest share of instrument choices with 21 cases (26% of total data set).

Implementation was initiated for 14 user charges, 9 were not implemented. Among the 14 cases of user

charges operating, 6 cases reported implementation problems due to inability to either invoice, collect

or enforce payments; or to recover earmarked funds from fiscal authorities collecting the revenue but

failing to devolve it. Only 2 cases of user charges reported achieving full coverage of costs for service

provision. Both cases were metropolitan-level privatized utilities that charged industrial clients for

waste water treatment (Sao Paulo, Brazil) and for industrial waste collection and disposal (Caracas,

Venezuela). In most other instances authorities reported only partial levels of cost recovery for public

service provisions associated with water use and water pollution charges.

• The Colombian water pollution charge was the only case found of an instrument designed specifically

as a price signal to change firms’ behavior (i.e. reduction of pollutant discharges), rather than as a

charge for partial cost recovery of service provision, as those above. This water pollution charge was

mandated by national law but implemented by decentralized environmental authorities in watersheds

under their jurisdiction.

• No instances of environmental taxes were found in the region. On the other hand the prevailing policy

bias suggests that existing tax structures and fiscal incentives for investment in environmentally

sensitive sectors, actually runs counter to internalizing the negative environmental externalities from

these activities, which usually end up in public balance sheets. The same applies to a variety of

agricultural subsidies.

• The second largest group of instruments found were tax credits for pollution control investments

(Colombia, Chile, Guatemala, retired in Mexico and Venezuela), for renewable energy (Argentina, Peru), and

energy efficiency and water saving investments (Barbados). With the exception of Barbados and Chile, most of

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these incentives showed records of weak demand and partial or limited outcomes. As discussed previously there is

indication that tax credits and soft financing for pollution control investment has not been very effective and has

suffered from very low uptake for the reasons discussed previously.

• The third largest group was reforestation/conservation subsidies with 7 cases with mostly successful

implementation records, all implemented and operative.

• In four 4 cases of fiscal transfers earmarked for environmental end use, 2 had not been implemented

and 1 was found to be operating inconsistently. This case was the mandatory fiscal transfer to the

environmental fund (FECAM) of a percentage of the state of Rio de Janeiro’s share of federal revenue

from oil exploitation royalties. Funds were found to be inconsistently transferred as discussed earlier.

The poor outcomes obtained from fiscal transfers for environmental projects in the data set support the

presumption that conflict of interests and misaligned incentive problems in the fiscal bureaucracy

administering these fund transfers tend to detract from their effectiveness as environmental incentives.

• Three cases of successful implementation of water use charges, one in Jamaica and two in sub-national

jurisdictions in Brazil (i.e. water use charges in the State of Ceará and the Paraiba do Sul river basin in

the State of Rio de Janeiro). In all three cases the role of a previously existing fiscal, water, and

water/environment institutions respectively, seems to have been key to the results achieved.

• The data set also contained 5 cases each of preferential finance schemes, tradable permits, deposit

refund schemes, and environmental certification schemes. These instrument types also showed relative

high rates of non-implementation with 2 in 5 cases of preferential finance schemes not implemented, 3

in 5 for tradable permits, 2 in 5 for deposit refund schemes, and 1 in 4 for certification schemes.

Table 4.8 at the end of this chapter shows the subset of 56 instrument cases that reached the implementation

stage, each with its correspondingly coded implementation outcome.

Regarding instrument goals, the choices observed in the data set suggest the following. Nearly 40% of the

total data set consisted of charges designed for partial cost-recovery of public services. Revenue raising

clearly predominated over inducing changes in the behavior of economic agents via price signals as the

most common goal for the environmental charges documented in the data set. This result concurs with the

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literature indicating that administrative collection of funds has been the primary role of “market-based”

environmental instruments in industrialized countries as well. The predominance of revenue raising, over

changing agents behavior as instrument objective, is related to the information intensity and uncertainty

inherent in attempting to affect quantities (of pollution emissions or resource use) by acting on price

variables (through charges or taxes on inputs, emissions, effluents, etc.). Achieving environmental quality

objectives through the application of charges, rates and/or taxes presupposes that at the moment in which

the fees are set, the regulating body has the capacity to anticipate the degree of response (elasticity) by the

polluting agents and resource users. In many cases, the necessary information for anticipating the degree of

response by the regulated agents simply does not exist, or its not accessible to the regulator, and so the

charges must be applied gradually in a process of trial and error until the desired objective is achieved.

Furthermore in order to attain political approval, the applied charges must often be set below the level at

which targeted agents would be motivated to change their behavior significantly enough to improve the

parameters of environmental quality. Experience indicates that in general the regulatory institutions find it

more feasible to design an environmental charge, rate or tax that carries a specific revenue objective, than

to address the technical demands of designing a system of charges that achieves a specific improvement in

environmental quality. Other potential objectives, such as reducing environmental impacts, improving

environmental performance or increasing regulatory efficiency, have not received the same emphasis85.

Some degree of self-finance could in fact be a prerequisite for environmental authorities to overcome

budgetary constraints and be able to invest in monitoring equipment and enforcement. The only case in the

data set where environmental revenue had been decentralized to the level of the jurisdiction responsible for

environmental management was in the case of regional environmental agencies or CARs in Colombia.

These institutions were modeled along the lines of French watershed management authorities, who also

have decentralized revenue raising power within their jurisdictions. The Law of 1993 creating the

decentralized national environmental management system (SINA) in Colombia provided these regional

85 See executive summary in Richard Huber, Jack Ruitenbeek and Ronaldo Serôa da Motta, “Market Based Instruments for Environmental Policy Making in Latin America and the Caribbean”, World Bank Discussion Paper, No. 381, (Washington D.C 1998).

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agencies, with local public finance sources independent of transfers from the national budget. As explained

in the detailed case study in the last chapter, this decentralized structure with self contained finance sources,

enabled Colombia’s national environmental management system (SINA) to maintain its operation

independent of macroeconomic volatility affecting the central government budget balances. The graphs

showing the budget time series in the Colombia case study in Chapter 7 illustrates the new resilience of

CARs’ environmental budgets. Environmental budgets remained in balance even as central government

transfers drastically ebbed with the macroeconomic tightening that followed the East Asian crisis. The

decentralized environmental budgets in Colombia’s SINA, and the ICMS revenue sharing rule with

municipalities in Brazil, were the only examples found of public finance innovations grappling with the

challenges of fiscal-environmental federalism or decentralization.

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4.3 SECTION III Identifying variables associated observed case outcomes. 4.3.1 Identification of plausible independent variables associated with implementation

outcomes As explained in the previous chapter process tracing within cases singled out a reduced set of variables

identified as the major barriers/obstacles plausibly determining implementation outcomes. The following

Figure 4.6 shows the number of cases coded for each of the variables identified in data set of 81 cases.

• Approximately half of all cases in the data set (38 in 81, or 47%) associated the role played by fiscal

authorities as contributing to poor implementation outcomes through various channels. The role that

fiscal authorities played in instrument implementation was generally characterized as a barrier,

suggesting that the nature of the interaction between environmental and fiscal authorities might be

playing a major explanatory role. The absence of environmental taxes in the region, and the

permanence of perverse fiscal incentives in the tax structure (i.e. agricultural subsidies, etc.), illustrates

the strong political bias against modifying existing fiscal structures to make them coherent with

national environmental policy goals. The specific patterns and pathways through which the interaction

38

26

5

4

2

2

0 5 10 15 20 25 30 35 40

number of cases

poor cooperation between fiscal andenv. authorities

inter-agency transaction costs

poor enforcement

weak capacity env. authority

potential impact on low incomegroups

opposition by industry interestgroups

Figure 4.6 Variables identified as barriers/obsta cles plausibly conditioning implementation number of cases coded for each variable n=81

124

with fiscal authorities led to poor implementation outcomes were illustrated in the previous sections for

various countries.

• Nearly a third of all cases (26 in 81, or 32%) pointed to implementation barriers which can be

characterized as transaction costs, faced in establishing the new “market-based” instruments into the

operational routines of existing bureaucratic structures across sectors and levels of government.

Transaction costs associated with delays and administrative constraints impeding effective

coordination between government agencies, public bureaucracies and levels of government, taking part

in the implementation process was the second most often mentioned factor associated with failed or

poor outcomes. This variable (transaction costs) and the previous one (poor cooperation between

fiscal-environmental authorities), seem to be picking up the various patterns of misaligned institutional

incentives evident in the interaction between environmental authorities, fiscal bureaucracies and

municipalities, involved in the implementation process as illustrated throughout this chapter.

• Poor enforcement was mentioned only in 5 cases ( 6% of n=81) , and “weak institutional capacity of

environmental authorities” in only 4 cases as contributing factor to poor outcomes in the process of

instrument implementation. This result contrasts with the available literature on the use of market-

based environmental policy instruments in Latin America, and the broader literature on environmental

policy outcomes in developing countries which generally emphasizes the weak capacity of

environmental authorities as a major explanatory factor86.

Figure 4.7 bellow shows for each of the above variables, the number of cases which also evidenced poor

implementation outcomes such as: a) instrument implementation not being initiated (not implemented), and

b) instrument found retired/not operating/not enforced or operating partially. As illustrated in Figure 4.7 the

presence of any of the above variables is associated with a high incidence of poor implementation

outcomes.

86 Based on this diagnosis this literature generally goes on to advocate for increased capacity building, institutional strengthening and financial resources for environmental authorities as a way to improved environmental policy outcomes. Most of these institutional strengthening efforts have been driven by international development banks and organizations, and financed via sovereign debt or donor grants. In general environmental spending represents a much smaller proportion of government budgets as % if GDP in Latin American countries than in the more industrialized world.

125

poor

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partial operation/ not operating

total number of cases coded for variable

38

26

5

4

22

18

10

54

01

1110

02

21

0

5

10

15

20

25

30

35

40

4.7 Plausible explanatory variables with correspo nding implementation outcomes n=81. number of cases

4.4 Main analytical conclusions from chapter. The data set points to the key role played by “interactions” between the environmental authority and other

government bureaucracies and institutional structures, which whom it must interface in the course of

implementing new “market-based” environmental policy instruments. The patterns identified in the data set

indicate that problems of misaligned incentives and lack of formal policy coordination mechanisms across

several policy interfaces, exert major limiting constraints to the implementation of these instruments; rather

than any inherent instrument design flaws or capacity weakness from environmental authorities per se.

The discussion chapter argues that environmental authorities operate in Latin American countries in

complex political and institutional contexts, where the ultimate policy outcomes from their initiatives

depend on the orchestration of a wide range of multiple incentives across sectoral line ministries and public

agencies (horizontal coordination), as well as between the national, state/province, and municipals levels of

government (vertical coordination).

126

Needless to say these multiple policy interfaces are outside the direct control of environmental authorities;

but rather depend on pre-existing institutional and political features, as well as ongoing policy processes.

Such as for example: a) the effect of national public finance constraints on environmentally sensitive

infrastructure investment in water, sanitation, transport and energy infrastructure; b) fiscal competition and

distributive tensions between levels of government regarding tax sharing of decentralized revenue sources

from natural resource extraction and resource use; c) distributive rules for the allocation of potential new

revenue streams resulting from the introduction of environmental charges and/or taxes, between levels of

government; d) temporary public finance priorities competing with compliance with mandatory fiscal

transfers, minimum budget rules, and public budget allocations for environmental management functions

between levels of government; such as the operational expenditures for environmental authorities

administrative, monitoring and enforcement functions; e) among many others fiscal-environmental policy

interactions recognized in the fiscal federalism and environmental federalism literatures87.

According to the data documented for this research, the locus of intra-governmental interactions

determining outcomes for “market-based” environmental instruments resides in two major policy

interfaces:

1. The environment – fiscal policy interface. This interface was identified as the locus of several

bureaucratic incentive problems identified in this chapter which result in poor implementation

outcomes of environmental instruments involving: fiscal incentives, fiscal transfers between levels of

government, collection and devolution of earmarked environmental revenue, budgetary allocations for

environmental end-uses, and instrument interactions with existing tax structures and fiscal practices,

among others. Cases where fiscal bureaucracies were required to play a major role in the operation of

environmental instruments such as the above, were fraught with implementation problems due to

misaligned incentives. Simply put the environmental fiscal instruments did not match the core thrust of

fiscal bureaucracies which is revenue collection and disbursement rationing. Fiscal bureaucracies lack

of incentives in the operation of environmental instruments generally resulted in high transaction costs,

foot-dragging, discretionary rationing of mandatory transfers and budgetary allocations for

87 For a survey of this literature please consult the various references by Wallace E. Oates indicated in the bibliography.

127

environmental end uses, and general lack of commitment to the effective implementation and operation

fiscal environmental instruments. The group of cases where implementation never got off the ground

also pointed to fiscal authorities as upholders of the prevailing policy bias against taxation for

environmental purposes, or the modification of existing tax structures and traditional fiscal practices

for the sake of incorporating environmental goals. There seems to be still a general lack of awareness

in the majority of Latin American governments of the critical role that improving the coherence of

fiscal policy structures with national environmental policy goals, plays in the attainment of these goals.

2. The environment - infrastructure policy interface. This interface was identified as the locus for

another critical problem determining outcomes from the implementation of water pollution charges,

and water use charges which is the status of water/sanitation infrastructure in particular at the level of

municipalities. The existence and level of adequacy of this infrastructure is a function of public finance

and regulatory decisions at the national level, which determine the investment flows necessary to build

modern water provision, waste treatment and sanitation facilities, all of which constitute major capital

investments. These processes are exogenous to environmental authorities, and are generally a function

of the level of economic development and per capita income attained. Some Latin American countries

have experimented with the privatization of water/sanitation service provision opening up participation

in water/sanitation to foreign investment through international tenders. Such strategy has mobilized

private investment in water/sanitation infrastructure in a few major cities where privatization tenders

have attracted the interest of international water companies, mainly of European origin. However

privatization is not feasible option for a majority of municipalities outside the main metropolitan areas

in the region. Infrastructure investment in these municipalities remain a function of public finance and

national or state level infrastructure policy decisions that impose structural constrains to the effective

application of pollution and user charges for environmental objectives.

The following Table 4.7 attempts to summarize a tentative typology of the various interactions identified in

each of these two policy interfaces. In Table 4.7 ex-ante refers to the period before instrument

implementation was initiated. As seen in this chapter several “market-based” instruments were never

128

implemented due to political opposition among other reasons. Ex-post in the same Table 4.7 refers to the

period after instrument implementation was initiated.

The next chapter is a case study on the implementation of a water pollution charge in Colombia. This case

study was selected for its capacity to illustrate several of the interactions typified in Table 4.7 in the

complex political, economic, and institutional context in which environmental policy takes place in Latin

American countries. The case illustrates several of the patterns identified in this chapter and provides

empirical evidence for the key role played the policy interactions we have attempted to typify in this

chapter.

129

Policy interface Table 4.7 Typology of observed policy interactions

Fiscal – environmental

policy interactions

ex-ante

Blockage or derailment of instrument implementation process

Political bias against incorporating environmental objectives in the tax system. Prior existence of fiscal incentives for investment promotion in environmentally sensitive sectors (i.e. mining etc.) and fiscal competition between countries or jurisdictions to attract investments, runs counter to internalizing environmental costs through the introduction of “market-based” environmental instruments. Persistence of agriculture/energy/transportation subsidies or fiscal incentives in existing tax structures, out-weights the net incentive effect sought after by the introduction of environmental price-signals through new “market-based” environmental instruments laid on top of existing price distortions.

ex – post

Jeopardizing instrument operation and leading to poor implementation outcomes

Misaligned incentives for fiscal authorities to honor mandatory transfers of environmentally earmarked revenue, or revenue sharing transfers to environmental funds at lower levels of government. This baseline bias is exacerbated when no credible mechanisms or organized constituency exists to secure these transfers against the discretionary power of fiscal authorities directly administering the flow of public funds. Misaligned incentives for fiscal authorities to expedite disbursement of fiscal incentives, tax credits and/or subsidies. This baseline bias is exacerbated in periods of fiscal retrenchment, and/or in the face of observed weak demand for pollution control fiscal incentives by firms. No constituencies of potential beneficiaries were observed to be pushing for expedite deliverance of fiscal incentives for pollution control. Misaligned incentives for authorities to accommodate new payment collection and revenue administration mechanisms for environmental user charges with low revenue raising potential, or that are earmarked for transfer to environmental authorities outside the municipality where these charges are collected.

Public infrastructure

– environmental policy

interactions

ex-ante

Determining baseline situation

Prior trajectory of national infrastructure policy and public finance decisions determines the structural baseline conditions, which the new environmental pollution charges, or resource user charges, will face as they are introduced into the policy mix. The stock and quality of infrastructure in water/energy/transportation, and other capital intensive sectors, exhibits characteristics of path dependency and technological lock-in that imbue baseline infrastructure conditions with significant structural rigidities and inertia.

ex – post Baseline municipal water/sanitation infrastructure which can change only gradually, might preclude the options of public municipal utilities, or municipal authorities, to respond effectively to the introduction of new water pollution charges, or the upward adjustment of existing user charges for public service provision. The lack of compliance by municipalities and other public entities discharging significant pollution loads, might undermine the incentive effect intended for private firms and industries complying with the new charges. Municipal authorities, just like private firms, will always have a baseline incentive not to pay environmental charges which cannot be credibly enforced; or for which they incur no-costs from refusing to pay or delaying payment.

130

Table 4.8 ( 1 of 3) Cases of “market-based” instruments implemented n = 56 Implementation

outcome Instruments that entered implementation stage ( n = 56 )

Instruments found operating at the time of the nati onal survey ( n = 44 ). NOTE: 12 instruments were found to have been retire d or not being enforced.

O

pera

ting

Par

tial

oper

atio

n

not

oper

atin

g/no

t en

forc

ed

Number of cases for each implementation outcome 32 11 12 Implementation outcome, Percentage (%) share in n = 55 58 % 20% 22 %

Argentina Subsidy, concessions rural renew electr. generation (PERMER, 2000) 1 Fiscal incentive and feed in tariff wind & solar generation (ley 25019, 1998) 1 Fiscal incentives/grant reforestation, forestry plantations (ley 25080, 2000) 1 Evaluation and fiscalization tax on hazardous waste producers TEF (ley 24.051) earmarked 1

Certification sust. forestry exports. 1 Barbados Deposit-Refund mass consumption bottles 1

Import Fee on durable goods to pay eventual disposal 1 Tax credit for solar water heaters 1 Fiscal incentives imports of water-saving equipment in hotels 1

Fiscal incentives for rain water collection systems 1

Jamaica

User charges based on water consumption volume 1

Brazil Fiscal compensation for oil production (Federal – State) 1991 1 Water use charge, decentralized watershed mgmt ( Paraiba do Sul, SP RJ Ms) 1 Water rights use charge (decreto 23.067/94) Ceará 1 Tariff on industrial effluents (Sao Paulo). water utility 1

ICMS tax revenue sharing env criteria to municipalities (art. 158 Federal Constitution) state-level Paraná, Minas, Sao Paulo etc. 1 Vehicle inspection fee for air pollution monitoring program (Rio de Janeiro) RJ state env. Authority 1

Colombia Water effluent charges in CAR jurisdictions (tasa retributiva) Law 99, 1993 1 Tax credit for cleaner production (VAT, Income tax) 1995 1 Reforestation project lump subsidy (CIF Forestal) 1 Reforestation income tax credit (Art 157 y 253 código tributario) 1

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Table 4.8 ( 2 of 3) Cases of “market -based” instruments implemented n = 56

Implementation outcome

Instruments that entered implementation stage ( n = 56 ) Instruments found operating at the time of the nati onal survey ( n = 44 ).

NOTE: 12 instruments were found to have been retire d or not being enforced.

Ope

ratin

g

Par

tial

oper

atio

n

not

oper

atin

g/n

ot e

nfor

ced

Number of cases for each implementation outcome 32 11 12 Implementation outcome, Percentage (%) share in n = 56 58 % 20% 22 %

Costa Rica Payment for env. services in watershed protection areas (PSA) Forest Law 7575, 1996 1

Chile Reforestation subsidies (Decreto/01 1974) 1 Compensation system for fixed source PM emissions in Santiago (decreto 4/92, 812/95) 1992,1995 1 Cleaner production financial incentives (CORFO, FAT) 1 Individual transferable fishing quotas (CIT 1991) 1 Eco-labeling for ozone-safe and organic agricultural products. 1

Dominican Forestry fiscal incentives and finance (ley 290, 55) 1985-88 1 Republic Renewable energy fund, 2% revenue of fuel taxes (ley 112-20 1 Mining env. compensation liability (ley minería 1971) 1 Guatemala Tradable water rights. "Paja de agua" 1950 (Discontinued /no longer operational) 1 Certification organic export agriculture and ecotourism operations 1997 1

Self-governed indigenous community forestry concessions in Petén (Res. Biosfera Maya RBM) 1990 1 Reforestation subsidy per hectare (PINFOR, decreto 101-96) 1996 1

Env.quality and clean production certification for exporters 1999 1 Financial incentives through Natl env.fund (FOGUAMA, 1997) 1 Integrated municipal fees for water, sewage, solid waste.(recibo único, Quetzaltenango) 1989 1

EIA non-compliance fines (decreto 68-86) only 10% invest. Projects comply with EIA 1

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Table 4.8 ( 3 of 3) Cases of “market -based” instruments implemented

n = 56 Implementation

outcome

Instruments that entered implementation stage ( n = 56 ) Instruments found operating at the time of the nati onal survey ( n = 44 ).

NOTE: 12 instruments were found to have been retire d or not being enforced.

Ope

ratin

g

Par

tial o

pera

tion

not

oper

atin

g/no

t en

forc

ed

Number of cases for each implementation outcome 32 11 12 Implementation outcome, Percentage (%) share in n = 55 58 % 20% 22 % Peru Forestry extraction fees and concessions auction 1

Irrigation water extraction fees 1

Municipal water supply and wastewater treatment charges. (require State subsidies, over 95% do not cover costs) 1

México Accelerated depreciation on pollution control equipment (laws LISR, LGEEPA 1996) ind.associations CANACINTRA consulted in design 1 Zero tariff on pollution prevention/control technology (INE-SECOFI- SHCP 1997) ind.associations CANACINTRA consulted in design 1

Leaded Gasoline surcharge Mexico DF (INE, Banobras, GDF, Gob. E.México) revenue not devolved since 1997) 1

Insurance premium for hazardous waste transport (Art. 22 LGEEPA, SCT, CNSF,1994) 1

Wastewater discharge charges,fines (Ley Federal de Aguas, SHCP-CNA criteria 1995) implemented 2000 not enforced 1

User rights for sport hunting in natural areas (Ley Federal de Derechos LFD, LGEEPA, INE Baja California Sur 1

Deposit-refund system for car batteries (INE) 1

Deposit-refund system for car tires.(INE) in consultation w industrial chambers CONCAMIN 1

Subsidy for forestry plantations in degraded areas (PRODEPLAN 1997) 1

Subsidy for reforestation, forest management (PRODEFOR 1997) 1 Venezuela Deposit-refund for mass consumption bottles (Decree 2216, Art. 24 industrial recycling) Private initiative Owens-Illinois 1

Corporate tax credit on pollution prevention, control investments (LIC 1986-91) discontinued 1 Deforestation tax (SEFORVEN 1970s) partly operational, no information on revenue allocation, no enforcement. 1

Industrial solid waste collection fees. Concession of solid waste collection to private co. COTECNICA 1 sub totals 32 11 12

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4.5 APPENDIX Ch. 4:

Comparing the extent of implementation found with previous studies The most comprehensive previous study on the use of market-based instruments in Latin America was

published by the World Bank88. This study covered eleven countries including Bolivia, Ecuador and

Trinidad and Tobago that were not part of our survey. However in the remaining eight countries that were

covered by both the World Bank study and our survey, we find that 6 (15%) of the 40 instruments reported

in that study had not been implemented, or were not operating in practice. And a further 6 (15%)

instruments were only operating partially relative to their original design goal. Therefore we find an

approximately similar rate of poor implementation outcomes in the World Bank 1998 study as the one

found in our data set. That is 12 in 40 cases (approximately 30%) of the instruments covered in the World

Bank study, had either a) not been implemented; or b) were operating only in a partial or limited fashion

relative to their original design goal. This suggests that the World Bank study reported cases of “market-

based” instruments that were nominally in laws or regulations, or that had been proposed by environmental

authorities, but did not attempt to assess the extent to which these instruments had been implemented in

practice.

The six instruments reported in the World Bank 1998 study that were found to be not operating according

to our findings are the following. In Barbados a differentiated solid waste collection fee instrument was

designed by environmental authorities but never implemented due to concerns for its impact on lower

income groups according to information recorded in our survey. The same situation applies to Chile, where

differentiated waste collection fees were designed by CONAMA and piloted in two low income

neighborhoods in Santiago, but no wider implementation was undertaken beyond the pilot phase. Three

instruments in Mexico and Venezuela reported in the World Bank study were not being enforced or were

no longer operating or had been retired for all practical purposes. Such was the case of industrial effluent

discharge fees in Mexico that were not being enforced with no consistent invoicing or collection of

payments was found in our survey. In Venezuela the deforestation tax was not operating and there were no

88 Richard Huber, Jack Ruitenbeek and Ronaldo Serôa da Motta, “Market Based Instruments for Environmental Policy Making in Latin America and the Caribbean”, World Bank Discussion Paper, No. 381, (Washington D.C 1998).

134

consistent records of revenue collection associated with this tax for a number of years as reported by public

officials in the Ministry of Environment (MARNR). Also in Venezuela a corporate tax credit/fiscal

incentive for pollution control investments that operated for a few years in the late 1980s had been

eliminated under the new corporate tax law of 1994. The sixth case, a fiscal revenue transfer instrument in

Brazil was found operating only intermittently or irregularly and clearly not fulfilling its purpose. The

instrument involved the transfer of a percentage of Federal oil revenues to States were oil/mining

exploitation takes place (i.e. Rio de Janeiro) a portion of which (20% in the case of Rio) is earmarked for

environmental investment through a State level environmental fund (FECAM). In these case funds had

been transferred inconsistently to FECAM, or frozen subject to the whim of State budgetary authorities

(“contingenciamento”), and were reported to be operating only intermittently, since its inception in 1991 to

2000, it operated only from 1992-1994, 1997-1999.

The following instruments, also reported in the World Bank 1998 study, were found in our surveys to be

only partially operational. Industrial waste effluent charges in Brazil had seen partial implementation in Sao

Paulo since 1981, but ceased operating in Rio de Janeiro 1986-1994. In Colombia an ambitious national

level wastewater effluent charge (Law 99) administered by decentralized environmental authorities (CARs)

had seen only partial implementation since the institutional weaker CARs had not been able to establish the

effluent charge system in their jurisdictions, or were ineffective in invoicing and collecting payments from

private pollution sources and municipal sewerage utilities. In Mexico deposit-reimbursement schemes for

used motor oil, and for batteries were also found to be operating partially without reaching the intended

coverage or geographical scope originally envisioned for the recycling scheme. The same applied to the

bottle deposit-reimbursement scheme in Venezuela. The following Table illustrates this comparison. The

check marks circled in red are the instruments reported in World Bank report that were not operating at the

time of our survey in 2000. The check marks circled in yellow are the instruments found operating only

with partial/limited results.

135

, Source: extracted from a summary article of the World Bank 1998 report published by Ronaldo Seroa, Richard Huber and Jack Ruitenbeek in Environment and Development Economics 4 (1999): 177-2

Not surveyed

Not surveyed

not surveyed

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CHAPTER 5 Case study: Colombia’s water pollution charge 5.1 Background Colombia has characterized itself by the high quality of its professional public bureaucracies which have

managed to run responsible macroeconomic policies and prudent sovereign debt management in an

economy buffeted by 40 years of internal civil strife. Some of Colombia’s public infrastructure and services

companies, like “Empresas Públicas de Medellin”, are world class. After suffering four years of stagnation

during 1998-2002 due to macroeconomic fallout from internal strife and the Asian and Argentine crises, the

country has recovered with the improved security situation and the boom in international commodity prices

that benefited most Latin American countries during 2002-2007. Since then Colombia has experienced

private investment growth of nearly 8% of GDP from 2002-2007, real GDP growth has gone from 1.9

percent in 2002 to 6.8 percent in 2006, with unemployment rate falling from over 17 percent in 2002 to less

than 11 percent in December 2006. Inflation has also fallen from 7.0 percent in 2002 to 4.5 percent in

200689.

. Statistical source: Colombia’s National Planning Department (DNP), Ministry of Finance (MHCP), Central Bank (BdR) Colombia has a 50 year old tradition of natural resource management which has focused in river basin

management, reforestation and conservation of biodiversity. The National Parks system covers a quarter of

89 Data extracted from World Bank. Second Programmatic Development Policy Loan for Sustainable Development for the Republic of Colombia. Proposal Report No. 39684-CO ( Washington D.C World Bank 2006).

137

the national territory. However the rapid urbanization and industrialization experienced during the same

period has created new challenges associated with the public health costs of inadequate household water

and sanitation, indoor air pollution, urban air pollution and inadequate solid waste and industrial liquid

waste management, among others. All these, plus intensive agrochemical use in agricultural practices have

caused rapid degradation of surface waters and coastal zones.

World Bank commissioned studies of the cost of environmental degradation in Colombia have produced

estimates on the order of 2.8% of GDP mainly from increased mortality and morbidity caused by

waterborne diseases (particularly diarrhea illness affecting poor children under the age of five), respiratory

infection, and cardiopulmonary disease90. Most of these are associated with the lack of basic sanitation

infrastructure and hygiene, and ambient and indoor air pollution. The burden of these costs falls most

heavily on young children.

Since the early 1990s national environmental management strategy has focused on building the institutions

required to achieve integrated water resource and environmental management in a decentralized and

participatory democratic context. Like many other countries Colombia has found that the elusive holy grail

of integrated natural resource and environmental management is gradual learning-by-doing process.

5.2 Water pollution in Colombia More than 70% of Colombia’s population is concentrated in urban centers, and 40% of the urban

population is concentrated in just four cities Bogotá, Medellin, Cali, and Barranquilla. High population

density and industrial concentration in the Andean region have led to serious degradation of surface water

quality. The Bogotá river is one of the most polluted rivers worldwide, and the Cauca and Magdalena rivers

which are the largest rivers flowing north from the central Andean valleys where most large cities are

located to the Caribbean, are also highly polluted.

90 Bjorn Larsen, Cost of Environmental Damage: a socio-economic and environmental health risk assessment (Study prepared for the Ministry of Environment, Housing and Land Development. Republic of Colombia. July 2004).

138

Surface water pollution in Colombia is largely attributed to untreated sewage discharges from municipal

household sectors, non-point sources of pollution from agricultural activity and industrial discharges.

According to national studies by environmental research institutes the discharge of untreated sewage from

the household sector contributes 75% of BOD pollution loading and industrial point sources the remaining

25%. In many urban areas up to a quarter of the population lives in informal settlements without sewer

systems, and discharges flow directly into urban rivers which are highly polluted. These informal urban

settlements experienced explosive growth throughout the 1990s from rural-urban migration of displaced

rural populations by guerilla strife. Less than 20% of Colombia’s municipalities have sewage treatment

plants and according to government inspection data over 50% of the existing treatment plants sampled do

not comply with effluent standards. Large cities like Cali, Bogotá, Medellin, Bucaramanga and

Barranquilla, are major contributors of both municipal and industrial largely untreated discharges.

This situation persists even though water and sewage service is available to most residents. According to

official reports by the Comptroller General Office of Colombia91 by 2000 water services reached nearly

95%, and sewage services 80% of urban areas. This high coverage still leaves 2 million people without

water service and 5.5 million people without sewage service. The lowest coverage of water and sewage

services, 70% and 45% respectively is found in department capitals with fewer than 100,000 inhabitants.

Colombia’s Comptroller General Office 2002 report estimates that only 1% of municipal sewage is treated

nationwide. Estimates by the Ministry of Environment put investment requirements by municipal sanitation

infrastructure in the order of USD 2.5 billion for the 2001-2010 period. Also according to national reports

treatment of industrial effluent is also very low, with over a half of facilities in major cities discharging

without treatment and in the smaller cities nearly all industrial discharges are untreated. It is evident that the

existing system of water-quality regulation based on discharge licenses and compliance with was not being

enforced.

91 The official name of this office is “Contraloría General de la República de Colombia”, equivalent to the U.S. General Accounting Office (GAO). The “Contraloría General” issues annual assessment reports on various aspects of public policy performance and State functions.

139

5.3 Colombia’s decentralized institutional framework for environmental management Colombia’s decentralized system for national environmental management system was established by the

National Environmental Law 99 of 1993. The Ministry of Environment MMA as the central environmental

authority, establishes and coordinates regulatory policy for water quality management. These policies are

executed by a decentralized network of 33 “Corporaciones Autónomas Regionales” (CARs, autonomous

regional corporations), and 5 “Autoridades Ambientales Urbanas” (AAUs, urban environmental authorities)

in Colombia’s largest cities.92

CARs are decentralized institutions dating back to the tradition of integrated regional development

planning practiced widely in Latin America during the 1950-60s. The first CAR was established in 1954

was CVC in Valle del Cauca (“Corporación del Valle del Cauca”, CVC) with a mandate of promoting

integrated regional economic development with its boundaries defined by the Valle del Cauca watershed.

The institutional design and functions of CVC was modeled after the Tennessee Valley Authority in the

United States, but also reflected trends in integrated regional planning promoted by the United Nations

Economic Commission for Latin America (CEPAL) that were influential at that time93. The CARs

originated as entities to promote integrated regional development, including the financing, building, and

operation of water and irrigation infrastructure. Between 1960 and 1988, eighteen CARs were created.

Most of Colombia’s Departments, analogous to States in the U.S, lobbied to have their own. As a result

CAR’s spatial jurisdiction ceased to be defined by strictly by watershed boundaries. During 1960-68 CARs

were under the Ministry of Economic Development, then under the Ministry of Agriculture (1968–1977),

and finally under the National Department of Planning (1977–1993).

The National Environmental Law 99 of 1993 redefined the role of CARs as decentralized environmental

management authorities. This new Law created a decentralized National Environmental System (SINA)

92 Perhaps the most comprehensive description available in English of Colombia’s CARs and their role in the context of the National Environmental System (SINA) is the report by Allen Blackman, Richard Morgenstern, and Elizabeth Topping. Institutional Analysis of Colombia’s Autonomous Regional Corporations, (Resources for the Future (RFF) Washington D.C. June 2006 ). This report was contracted by the World Bank to RFF as an input for the World Bank’s Colombia Country Environmental Assessment (CEA) (World Bank, Washington D.C. 2006). 93 Mary Gomez, “Política Fiscal para la gestión ambiental in Colombia” Serie Medio Ambiente y Desarrollo No. 107, (CEPAL LC/L 2357-P, Santiago October 2005). Mrs. Gomez served as official staff in the Office of Economic Analysis in the Ministry of Environment from 1998-2002, and participated in the design and implementation of several institutional components of the SINA.

140

comprising institutions, normative standards, policy planning and coordination mechanisms, public

participation mechanisms, and implementation and enforcement mechanisms. Law 99 also established

additional CARs, along with Urban Environment Authorities (“Autoridades Ambientales Urbanas”, AAUs)

in cities of more than 1 million inhabitants, and created the Ministry of Environment (MMA) as the central

authority issuing environmental policy and coordinating its implementation through the network of CARs

and AAUs. Law 99 redefined CARs as corporate public charters with administrative and fiscal autonomy in

territories sharing common watersheds, hydrology, ecosystems, among other homogenous features.94.

According to Law 99, CARs become the principal regional environmental authority, with departments and

municipalities subordinate to CARs in environmental matters, and local regulation adhering to the

minimum standards set by the MMA. Municipalities become responsible for sanitation infrastructure,

including projects for wastewater treatment of the municipality’s effluents, solid waste disposal and

recycling, air pollution and liquid discharges control. (Art. 65). CARs depend on the national police

assigned to municipalities and on local majors for enforcement actions, which municipalities are legally

required to support95.

The above decentralization of environmental management reflects the broader decentralization process

launched with Colombia’s new Constitution of 1991, which gave departments, municipalities and CARs

administrative autonomy of local matters, including local ordinances and revenue sources not transferable

to the central treasury (Art. 300, 313, 362).. The Constitution also mandates that municipalities transfer a

percentage of municipal property taxes to CARs for environmental management (Art. 137); created a

National Royalty Fund earmarked for environmental protection in municipalities with non-renewable

resource extraction activity; and established several mechanisms for public participation in preventive

environmental actions through the court system (Art. 86). 96

94

Allen Blackman et al. Institutional Analysis of Colombia’s Autonomous Regional Corporations, (Resources for the Future (RFF) Washington D.C. June 2006 ). 95 Ibid. 96

Analogous regional institutions with similar functions were also created for indigenous territories, these were called Sustainable Development Corporations (“Corporaciones de Desarrollo Sostenible”, CDS).

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Figure 5.1Map of CAR jurisdictions, Colombia

Source: Ministry of Environment MMA, Bogota. 5.4 Water pollution control The National Renewable Natural Resources and Environmental Protection Act (Executive Order 2811) of

1974 created the regulatory framework for environmental policy in the country. This 1974 Act was one of

the first laws worldwide to incorporate environmental charges and environmental impact assessments. It

established the legal concept of “Tasa Retributiva” (compensatory charge) defined as a user charge

imposed on profitable economic activities making use of natural resources (i.e. water use) and/or

environmental media (i.e. use of public surface waters to discharge effluents). The legal rationale for the

charge is to generate public funds for the maintenance of renewable resources and to rationalize their use.

This definition focused on natural resource uses and pollutant streams from industrial productive activities,

but left public sector entities such as municipalities sewerage utilities outside the scope of the law. This

compensatory charge was never implemented but the legal concept was reincarnated with the new national

environmental law of 1993.

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5.5 Law 99 economic instruments

Law 99 created three economic instruments designed with the dual purpose of creating price incentives for

the reduction of water pollutant discharges, and to generate revenue. Article 42 requires CARs to impose

pollution charges (“tasas retributativas”) on all sources of pollution released to any environmental media,

air, water or soil. It also established compensatory charges (“tasas compensatorias”) on users of natural

resources to pay for conservation and maintenance of these public resources. The third instrument is a

water use charge on all water uses at a level set by the national government, to be used for the

maintenance of water resources. The legal grounding of all three instruments is the application of Art. 338

of the new Constitution, that enables government to recuperate costs from the use of natural resource use,

or service provision. The Law 99 also established the principle that the level of charges should reflect social

benefits/costs from pollution reductions and natural resource use.

5.6 Design of the Pollution Charge instrument “ Tasa Retributiva”

Direct or indirect use of the atmosphere, water or soil to dispose of agricultural, mining or industrial wastes or residues, sewage or waste water of any type, smoke, vapor, or harmful substances that result from human activity or from activities resulting from human activities, or economic or service activities (whether or not profit-making) shall be subject to payment of environmental charges to compensate for the harm caused by the activities involved.

Article 42 of Law 99, of 1993 The Article also establishes the method for the Ministry of Environment to establish the level of the charge:

The Ministry of the Environment should set the charge level each year, taking into account the social and environmental costs of the damage, as well as the cost of returning the affected resource to its prior state. The amount levied shall take into account full depreciation of the affected resource. The level of charge should be set by a formula that includes quantitative variables to measure the damage incurred by the activity and weight coefficients that take into account the pollutants involved, the diversity of regions, availability of resources and its capacity for assimilation, the opportunity cost of the resource, and the socioeconomic conditions of the population affected.

Decree 901 of 1997 issued the specific regulation for the pollution charge instrument. The Ministry of the

Environment solved the charge level problem in a very practical and ingenious way, closely following

normative theory for setting charges under uncertainty97. Under these conditions theory dictates that a

pollution reduction goal be established in each relevant section of the watershed, and then the charge level

97 As is generally the case when authorities lack information on plant-level marginal costs of pollution abatement, as well as on current levels of environmental damage (therefore also the marginal social benefits from pollution reduction are also unknown).

143

adjusted through a ratcheting process until the goal is pollution reduction is achieved. This strategy

circumvents the information problems, enables the authority to start with a low price signal to avoid

outright opposition, but also provides for a scheduled sequence of upward ratcheting in the charge level to

ensure that the incentive reaches the levels required to achieve the local water quality goal. It is not a

welfare maximizing strategy, since no information is available to determine the optimum pollution

reduction goal. But is a strategy that in theory should achieve the politically established pollution reduction

goal for each watershed section at the least possible cost aggregating across all discharge sources.

Decree 901 did not specify the pollutants to be subject to the charge, but stated that the MMA would make

this determination. Another decision of practical importance is that the Ministry decided to initiate the

system by charging only the most ordinary and simple to measure pollutant parameters, total suspended

solids (TSS) and biological oxygen demand (BOD), which basically measure organic pollutant loading (i.e.

sewage and other organic waste). Decree 901 also established the basic implementation tasks for CARs and

AAUs:

1. Prepare inventories of all facilities discharging BOD and TSS and establish baseline levels of

discharges for each of these pollutants.

2. Identify and map the relevant basin sections for which 5 year pollution reduction goals were to be

established. This required dividing each watershed into different attainment zones based on technical

criteria. Each zone would then have to establish a pollution reduction goal to be achieved during a 5

year period. This goal is specified as a target in water quality parameters (BOD and TSS) to be attained

in each of these basin management zones.

3. The pollution reduction goal for each basin management zone would be established by the CAR Board

of Directors through a politically negotiated process with stakeholders. This process should be

informed by local studies of pollution damages as well as regional differences in basin absorptive

capacity, socioeconomic conditions, and local opportunity costs of resources.

4. The MMA established the minimum charge level to be applied nationally. The charge level would

ratchet up in a prescheduled and automatic manner every 6 months, according to a formula that

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effectively increased the charge level by 50% every semester until the pollution reduction goal

established for the management zone would be met. Resolution 372 in 1998 determined also an annual

inflation adjustment factor. Authorities would monitor water quality parameters in each management

zone, periodically measuring the BOD and TSS pollution loading to check progress towards the

pollution reduction target.

5. Once the pollution reduction goal was attained the charge level would remain fixed for the rest of the

five year period, after which a new further pollution reduction goal would be negotiated.

6. Monitoring of facilities discharges every six months through random inspections. Discharging facilities

were required to register and self-report discharges based on approved methods, inspectors would

randomly check if actual discharges were consistent with self-reported effluent flows. CARs and

AAUs were to invoice facilities on a monthly basis.

7. The charges did not exonerate from compliance from the previous 1984 effluent standard requiring

minimum 80% of BOD removal, they were applied on top of that standard on whatever effluent was

ultimately being discharged into surface waters.

8. Every six months CAR and AAU directors had to issue a report with data on the evolution of pollution

loads, invoicing and payment collections to the CAR’s Board of Directors and the Ministry of

Environment as overseeing bodies. The previous regime lacked this reporting requirement which

played a key role in the overhaul of water quality monitoring , updating of discharge inventories, and

improvement of data quality and upkeep for transparency and accountability purposes.

Decree 901 made CARs and AAUs responsible for implementation, the MMA would set the minimum

charge, provided oversight and support. These tasks were obviously demanding and the Ministry of

Environment created a technical assistance program to support CARs and AAUs in fulfilling the tasks

required including: registering and creating an inventory of dischargers, issuance of rules and guidelines,

establishing a database and information management system, monitoring discharges and pollution loadings,

identifying different attainment zones in each basin, establishing pollution reduction goals for each zone,

establishing mechanisms for invoicing of charges, payment collection, and administration of the new

145

revenue stream, and finally to monitor progress towards the goal and ratchet the system accordingly every

six months.

5.7 Implementation of the Pollution Charge instrument The MMA developed an ambitious and comprehensive plan to support implementation with World Bank

assistance. This included technical assistance, best practices and information dissemination workshops with

CAR directors, public and private sector polluters, industry associations, chambers of commerce, in several

cities. The Ministry also worked closely with the leading and institutionally stronger CARs (CVC,

CORNARE and CARDER) to demonstrate successful implementation models and record best practices. It

also established a technical assistance program, where the leading CARs would support institutionally

weaker ones in implementing the new charge system.

5.7.1 Description of the implementation process during the first three years 1997-2000 By the end of the first year only 3 CARs had successfully implemented the 901 Decree, and only 1 was

invoicing the charge. These were the institutionally stronger CARs nationwide: CORNARE (Medellín,

Antioquia Department), CVC (Valle del Cauca) and CMDB. The Ministry of Environment worked closely

with CORNARE, CVC and CMDB in the early implementation of the new pollution charge system seeking

demonstration effects for the rest of the country. After these early successes the program moved slowly, in

1998, 7 CARs had begun invoicing and 6 were collecting on average 30% of due payments. The collection

rate and lag between invoicing and collection varied significantly across CARs. For example in 1998, CVC

widely known as the most competent and stronger CAR nationwide had collected only 11% of pollution

charges invoiced; CDMB had collected 100%; and CORNARE 57%. In 1999, 11 CARs were invoicing and

8 collecting, with CVC still remaining at a low 8% collection rate, and CORNARE improving collection to

85% of charges invoiced. In 2000, 15 CARs were invoicing and 14 collecting; CVC had moved up to 15%

collection rate, CORNARE down again to 55%. At the national level during the first three years of the

program between 1997 and 2000, on average collection rates were just bellow 30% of pollution charges

invoiced98.

98

146

In spite of these problems the success of the pilot implementation in CORNARE in terms of reducing

industrial pollution loads had been none other than spectacular. The following Figure 5.5 shows the

reported reduction relative to the baseline before implementation of nearly - 60% BOD and - 90% TSS

reductions in industrial discharges to the Rio Negro during the period 1997-2000.

By 2001 four years after the 1997 start of the new system, the Ministry of Environment (MMA) issued an

evaluation report stating that 27 CARs had achieved significant progress the implementation of the “ Tasa

Retributiva” . However only 16 of 33 CARs had invoiced dischargers in their jurisdictions, and only 10 had

established the required local environmental fund were charge revenue had to be channeled. By 2002, 24

CARs were invoicing and 21 collecting payments. The Ministry of Environment report acknowledged that

the program experienced several problems at the national level. The first problem encountered had to do

with the lack of a transparent system for administering the new charge revenues. This brought on a series of

legal challenges and payment refusal from several actors which delayed implementation in several CARs.

Each CAR had its own pre-existing administrative procedures and the design of the instrument

concentrated on the technical details, and not on the establishment of new mechanisms for payment

collection, administration and earmarking of the new revenue streams. According to the spirit of Law 99

-

200.000

400.000

600.000

800.000

1’000.000

1’200.000

1’400.000

Semestre A Semestre

B Semestre A Semestre

B Semestre A Semestre

B Semestre A Semestre

B 1997 1998 1999 2000

AÑO

Car

ga c

onta

min

ante

(K

g/se

mes

tre

DBO SST

Figure 5.5 Reported reduction of industrial discharges, CORNARE (BOD, TSS) during 1997-2000

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the charge funds should be channeled to pollution damage remediation investments. This was largely

symbolic, since the lion’s share of CARs revenue were transfers from municipal property taxes, and electric

power sales, with the new charge revenues representing a minor portion (less than 10%). To resolve this

problem in 1998 the MMA issued directives for CARs to establish local environmental funds to channel the

new pollution charge revenues.

The Ministry of Environment next report on the program in 2002 showed that, where properly

implemented, the pollutant charge had demonstrated to be quite effective in achieving reductions of

pollutant loads. As shown in Figure 5.6 bellow in the nine 9 CAR jurisdictions where implementation has

been complete, biological oxygen demand (BOD) loads fell 27% between 1998 and 2002, and total

suspended solids (TSS) loads fell 45%; however in the remaining CAR jurisdictions, impacts have been

significantly smaller. Also in spite of collection rates being on average only 30% of total charges invoiced,

the amounts collected already were comparable to the central government budget transfers allocated to the

CARs that were successful in implementing the pollution charge program. However revenue from pollution

charges is not a significant source of total CAR revenue, and represented between 1998 and 2005 only

1.8% of total revenue.

Source data: Ministry of Environment MMA, Bogotá 2002.

Figure 5.6a Environmental effectiveness. Total reduction of BOD and TSS discharges in nine CARs 1998-2002 Ministry of Environment (MMA) 2002

Baseline Last semester 2002

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5.7.2 Early successes and environmental effectiveness

CORNARE and CVC are the oldest CARs in Colombia widely recognized by their effective management

and environmental management performance records. Both CORNARE and CVC had effectively

implemented the prior command-and-control water quality regulation, through a rigorous monitoring and

enforcement of water effluent quality standards. These CARs had also strong records in imposing the

construction of treatment plants to those facilities outside of compliance with effluent quality standards.

However in spite that a majority of facilities in their jurisdictions were in compliance with effluent

standards, total pollutant loads in the Rio Negro had kept growing due to the exodus of manufacturing

industries from Medellin to the industrial parks in the Rio Negro valley since the early 1990s99. Prior to,

and in preparation to the introduction of the pollution charge in Rio Negro, CORNARE implemented an

ambitious program of cleaner production voluntary agreements with most industrial sectors in the

jurisdiction.

During the first two semesters of the application of the pollution charge BOD and TSS loadings dropped

significantly from pulp and paper, textile, sand mining, and other manufacturing firms. The fact that

effluent pollution loads fell so dramatically in such a short time suggests that these industries had

significant unrealized effluent abatement opportunities (so called “low hanging fruit”) that were not being

executed in the absence of a price signal, however modest, like in the case of the introduction of the “ Tasa

Retributiva” . Apparently compliance with existing command-and-control regulation, rigorously enforced

by CORNARE, which is not the case in many other CAR jurisdictions in Colombia, still left a significant

amount of pollution reduction potential untapped. In spite of these caveats the early successes of

CORNARE were widely noticed, and the World Bank included the case study in its Greening Industry

report 100.

During the launch of the World Bank report by the bank’s New Ideas in Pollution Regulation group (NIPR)

on November 22, 2000, the director of World Bank’s NIPR group Mr. David Wheeler declared:

99 During the late 1980s and early 1990s Medellín suffered from urban violence driven by drug cartels, the major leader of which was the controversial Pablo Escobar. 100 World Bank. Greening Industry: New Roles for Communities, Markets, and Governments (New York: Oxford University Press, 2000).

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Our group has been directly involved in the design and implementation of environmental taxes with officials from China, the Philippines, Indonesia, France, Canada and Brazil during the last seven years, and we have had the opportunity to see where, in practice, there are problems related to the implementation of taxes. After having evaluated the Colombian tax, our conclusion, comparing this with the experience in other countries, is that the Colombian mechanism represents the state of the art in the design and implementation of taxes. It is a system based on cost-effectiveness and on minimizing costs. It is a mechanism notable for its simplicity and transparency, and for the fact that is objective and gradual. It also stands out for the way in which it actually incorporates the regional community in the setting of cleanup goals that reflect local preferences. It is based on a fairly practical system and method, and empirical evidence indicates that the mechanism can be implemented with existing institutional resources to reduce pollution in a very cost-effective manner101.

In 2002 with resources from the U.N ECLAC/GTZ Fiscal Policy and Environment Project and evaluation

was undertaken of the progress in three CARs, CVC, CORNARE and DADIMA in Barranquilla the coastal

city at the estuary of Magdalena river into the Caribbean. The ECLAC study, undertaken by national

consultants Luis Fernando Castro, Juan Carlos Caycedo, Andrea Jaramillo and Liana Morera, from the

Andean Center for Environmental Economics (CAEMA)102, found the following pollution load reductions

in the these jurisdictions ( Figure 5.7 below). This evaluation also undertook three plant level assessments

with interesting results. For example in the “Industria Azucarera Rio Cauca”103, that already had a treatment

plant the pollution charge apparently motivated additional reductions of -24% BOD and -65% TSS.

101 As reported by Mr. Thomas Black, Director of the Office of Economic Analysis of the Ministry of Environment who attended the report’s launch. 102 CAEMA is an independent research center, although led by Mr. Thomas Black, former Director of the Office of Economic Analysis of the Ministry of Environment and one of the leading figures in the design of the pollution charge between 1993 and 1999. 103 The sugar industry cluster in Valle del Cauca comprises 13 plants, 1200 sugar cane producers, 40 food and beverage industries, 11 alcohol and liquor producers, 2 bagasse cogenerators, 1 paper industry and hundreds of small and médium enterprises providing services and equipment. This sugar cluster accounts for 10% of Valle del Cauca GDP, 18% of industrial GDP, 42% of agricultural GDP, employing directly approximately 35,000 workers and indirectly 210,000. Its exports totaled USD 370 million, on nearly half of all Valle del Cauca exports between 1999-2000.

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A second industry in CORNARE jurisdiction, “Canteras Yarumal”, a sand mining operation contributing

only TSS had also a prior history of working with CORNARE to implement water use rationalization and

cleaner production improvements of which CORNARE financed 25% since 1993-1994. However is was

not until 1997 when the pollution charged kicked in, that the firm found the motivation to implement the

effluent management plan that saved the company approximately USD 200,000 in the following two years

in avoided charges. The third firm was a chemical industry “Monómeros Colombo-Venezolanos” in the

DADIMA jurisdiction. DADIMA was requesting this plant to build a treatment plant since 1996, imposing

a fine nearing USD 400,000 in 1998. Prior to the start of the pollution charge in DADIMA’s jurisdiction,

authorities in consultation with plant managers estimated that the pollution charge bill would be over USD

450,000 annually for the company. The company’s management decided to go ahead and invest in the

treatment plant at a cost of USD 452,000. The following Figure 5.8 shows the pollution load reductions and

corresponding investment effort in two of these firms.

0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000 9,000,000

CVC CORNARE DADIMA

Kg.

de

Car

ga V

ertid

a po

r S

emes

tre

DBO LB DBO Sem B 2000 SST LB SST Sem B 2000

Figure 5.7 BOD and TSS reductions relative to Baselines for CORNARE, CVC and DADIMA

data source CAR reports to Ministry of Environment (MMA, 2002)

TSS baseline TSS 2nd sem. 2000

BOD baseline BOD 2nd sem. 2000

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Figure 5.8 Firm level BOD and TSS reductions with corresponding investments

0

1.000.000

2.000.000

3.000.000

4.000.000

5.000.000

6.000.000

7.000.000

1995 1996 1997 1998 1999 2000

AÑO

CA

RG

A C

ON

TA

MIN

AN

TE

(K

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0

50.000

100.000

150.000

200.000

250.000

300.000

350.000

400.000

450.000

INV

ER

SIO

NE

S (

Mile

s de

Col

$ C

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de 1

998)

DBO5 SST Inversiones

Source: Industria Azucarera Rio Cauca. data: Asocaña. Gerencia Ambiental-CVC. Subdirección de Gestión Ambiental.

-

10.000

20.000

30.000

40.000

50.000

1992 1993 1994 1995 1996 1997 1998 1999 2000 AÑO

CA

RG

A C

ON

TA

MIN

AN

TE

(TO

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ÑO

)

-

5.000

10.000

15.000

20.000

25.000

30.000

INV

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SIO

N (M

ILLO

NE

S D

E P

ES

OS

C

ON

ST

AN

TE

S D

E 1

998)

DBO5 SST Inversión (En millones de pesos de 1998)

Source: Monómeros Colombo-Venezolanos S.A. data: Operations Vicepresident Mr. Camacho and DADIMA environmental quality director Mr. Escobar

152

5.7.3 Problems of implementation at the national level.

Several problems arose in implementation at the national levels due to various factors perhaps the most

critical of which was not compliance by the leading dischargers, and the fact that these were none other

than the municipalities themselves. Municipal sewage discharges by municipal water/sanitation utilities

constitute the largest source of BOD and TSS discharges into surface waters in Colombia. Municipalities

represented between 32-38% of total invoicing for pollution charges every year from 1997 to 2002. During

the first three years of the program 1997-1999 recovery rates for municipalities had been low, but from

2000 to 2002 municipalities were paying approximately 50% of invoiced pollution charges. According to

estimates municipalities paid approximately 40% of the pollution charges invoiced to them between 1997

and 2002. However the collection rate for municipalities was still higher than for industries, bringing the

average collection rate at the national level to approximately 30% of the invoiced pollution charges104.

According to a Ministry of Environment report issued in 2002:

With some exceptions, the municipalities and the municipal sewerage authorities fail to fulfill the program norms and resist the legal requirement to pay their fees for pollution charges. The municipal sector is responsible for 70% of the contamination that is discharged without treatment. These discharges are particularly harmful because of their high concentration of pathogens, fecal coliforms, viruses and discharges of the industries connected to the sewerage systems. Although some municipalities and their water/sanitation authorities are outstanding, the sector in general has responded more slowly to the effluent charge program than the industrial sector105.

Municipalities argued that they did not have the resources to pay the pollution charges, and also did not

have the capital resources to invest in the upgrading of the treatment plants that would enable them to avoid

the pollution charge. Prior to the implementation of the pollution charge at the national level in 1997 the

Ministry of Environment had undertaken a study to estimated the impact of the pollution charge relative to

the wastewater treatment costs in nine municipalities in Cundinamarca Department. This 1997 study

concluded that the pollution charges would exceed the marginal abatement costs of most municipalities and

that it would induce municipalities to invest in improving their wastewater treatment. However a great

number of municipalities either had not built or did not have a functioning wastewater treatment plant,

therefore their economic alternative to paying the charge was not the marginal cost of abatement but instead

104 Allen Blackman, “Colombia’s discharge fee program: Incentives for polluters or regulators?” Journal of Environmental Management no 90 (2009): 108-111. 105 As translated to English and cited in: Allen Blackman, “Colombia’s discharge fee program: Incentives for polluters or regulators?” Journal of Environmental Management no 90 (2009): 111, footnote 25.

153

the full capital cost of building new infrastructure. A key element in this situation was that municipalities

were unwilling to pass on the pollution charge costs on to their customers through an appropriate raise in

the monthly water fees.

Coordination with water sector policy reforms

The problems observed had deeper roots in water sector reform. Law 99 which created the pollution

charges in 1993, was followed by the Public Service Utilities Law 142, which created a new Water and

Sanitation Regulatory Commission. The new law opened the provision of water and sewage services to

either public or private specialized entities. Prior to reform, each municipality had its own public company

in charge of water/sanitation provision, but these public utilities were plagued with deficits aggravated by

lags in tariffs adjustment to keep up with costs and inflation. Nominal tariff rates were regulated nationally

by the former National Tariff Council, a political committee that avoided taking any action as long as

possible. Municipal water/sanitation utilities’ margins were under stress because the National Council of

Tariffs did not use technical or consistent methods to set municipalities’ tariff rates, and rarely allowed

increases for fear of political fallout. By the mid 1990s, just before the introduction of the “tasa retributiva”

the water sector was in crisis, with almost all municipal entities facing financial and administrative

problems that affected their ability to provide high-quality service. Most analysts pointed to the regulated

and artificially low tariffs that did not meet operating costs, neither allowed the accumulation of needed

investment funds for municipalities to undertake required investments106..

The Public Service Utilities Law 142 or 1994 also specifically mandated municipalities to transfer the

pollution charge costs onto their monthly utility service tariffs, in order to cover average operating costs.

The law mandated the pollution charges be transferred to water/sanitation utility customers in proportion to

the quantities discharged into municipal sewers. However municipal water/sanitation utilities argued that

specific regulation on how to effect such transfer of pollution charge costs onto their customer tariffs had

not been issued by the newly created Water and Sanitation Regulatory Commission, and that until a

clarifying ruling was issued they were at a loss on how to adjust service tariffs and pay the new “tasa

106 LaDawn Haglund and Gabriel Gomez. “Context matters: how state forms and reforms influence water provision in Latin America.” (Arizona State University, Draft Mimeo. November 2006).

154

retributive”. The national association of municipal sewerage utilities, ANDESCO (“Asociación de

Empresas de Servicios Públicos Domiciliarios y Actividades Complementarias”), categorically opposed

implementation of the pollution charge from the very beginning and a majority of its members refused to

pay it, and initiated several lawsuits against the “ Tasa Retributiva” .107 Perhaps symbolic of this conflict

was the fact that “Empresas Públicas de Medellin”, Medellin’s public utilities company that is widely

regarded as a model public company for its efficiency and performance, refused to pay the pollution charge

and only began doing so reluctantly in 2000. The basic financial problem here was that as long as

municipalities did not transfer the pollution charge costs onto their customers, the pollution charges were

drawing directly from their already very slim operating margins.

In the meantime the environmental authorities, following their own mandate which was independent of

water sector policy reforms, proceeded with the invoicing of municipalities for the new water pollution

charges, ratcheting the charge up in fixed intervals as specified in the law. The new water pollution charges

accumulated and effectively sent non-paying municipalities into a debt spiral that further undermined the

municipalities credit rating and access to credit, thus further obstructing the possibility that the needed

wastewater treatment investments were undertaken. This perverse positive feedback, with the

implementation of the pollution charge further undermining the capacity of municipalities’ to undertake the

required wastewater treatment investments, was neither the environmental authority or the municipalities’

fault. It arose naturally from previously existing conditions and the transition in water sector policy reform.

Municipal sewerage utilities were caught in the middle of the water pollution charge being launched, and

the mandate to transfer these charges onto their tariffs not yet regulated by the newly created water

authority.

Most probably the politically charged issue of raising water tariffs was being delayed or evaded by both the

national level commission and municipalities. However Professor Guillermo Rudas, expert in water and

environmental policy issues from Universidad Javeriana in Bogotá, points out that monthly water tariffs

107 Zulma Guzmán Castro, “Case study: the Colombian Water Tax.” , in Economic Instruments for Water Management: Experiences from Europe and Implications for Latin America and the Caribbean, eds R. A. Kraemer, Zulma Castro Guzmán, R. S. da Motta, and C. Russell (Washington, DC: Inter American Development Bank, 2003)

155

were so low at the time as to be comparable to the cost a 2-3 bus tickets, therefore it is difficult to judge if

the failure of municipalities to transfer the costs of the pollution charge was due to genuine fear of political

reaction by low income groups, or simply an excuse to delay adapting to the new system.

The problem of non-payment by municipalities had ripple effects that undermined the incentives of the

water pollution charge being implemented in several CARs. Industrial and agricultural dischargers

protested loudly about having to pay the pollution charges when the largest contributors to the problem

were the municipalities contributing 60-70% of total pollution loads. The non-compliance by municipal

authorities had the further effect of undermining the achievement of the 5 year pollution reduction goal

established for each basin attainment sector. And as the charge level was raised automatically every six

months, this led to the continued ratcheting up of the charge level in the non-attainment basin sectors. This

had the problem of further compounding industry protests on their having to carry the burden of non-

attainment of pollution reductions that depended on non-compliant municipalities. The ratcheting up of the

charge, also further aggravated the debt situation and credit standing position of municipalities

guaranteeing a virtual deadlock.

The end of the “Tasa Retributiva” water pollution charge

The problems discussed above led to two modifications of the water pollution charge Decree 901 of 1997,

through Decrees 3100 and 3440, in 2003 and 2004 respectively. These modifications changed the design of

the instrument considerably. The first Decree 3100 introduced the following changes: a) it capped the

automatic charge increases at 5.5 times the initial level, and made the charge increases inversely

proportional to the percentage of the target achieved; b) it excluded municipal discharges from the

calculation of total pollution loads; c) it allowed CARs to set specific goals for water utilities and large

sources; and d) reduced the national scope of application of the pollution charge limiting its application to

only those watersheds considered priority given their water quality problems. These are substantial

modifications that changed the whole original design and conception of the “tasa retributiva”. Particularly

worrisome is the amendment that excludes municipal discharges from the calculation of total pollution

loads. This modification is hard to reconcile with the fact that municipal discharges are responsible for up

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to 60-70% of organic pollution discharges nationwide. Other amendments in the Decree suggest that the

modified instrument will be used in a much more limited scope, targeting particular watersheds and

sources, and allowing custom fit goal to be negotiated between CARs and water utilities and other major

sources. Therefore in this case we can no longer speak of the same “tasa retributiva” instrument that

incorporated many of the features of the textbook case for a “market-based” environmental instrument.

5.8 Differing assessments

Analysts differ in their assessment of the results from the implementation of the pollution charge in

Colombia. The assessment of the Colombia’s National Environmental System (SINA) commissioned by

the World Bank in 2005 at the closure of Colombia’s first programmatic loan for sustainable development

of USD 200 million argues that the performance of effluent fees for wastewater has not matched the

expectations of those who drafted Law 99 and that a great number of CARs did not have the institutional

resources, political clout or political will to apply the program:

Colombia’s effluent fees for wastewater face a number of challenges. First, in most cases CARs simply do not enforce fee programs. Only a few high-functioning CARs actually collect a significant percentage of effluent fees. Self-reported 2002 data collected by the Association of Autonomous Regional Corporations, Sustainable Development Corporations and Urban Environmental Authorities (“Asociación de Corporaciones Autónomas Regionales de Desarrollo Sostenible y Autoridades Ambientales de Grandes Centros Urbanos”,ASOCARs) indicates that for all 32 CARs, of the 45,625 “potential” sources that could be charged effluent fees, only 5,356 (11.7%) are actually charged. Evidently, most CARs lack the capacity or political will (or both) to collect the fees108.

One interviewee cited by the same report said that, in part, this was because the framers of Law 99 held

unrealistically high expectations for the effectiveness of this instrument. Their view—strongly influenced

by the environmental economics literature on instrument choice—was that economic incentive instruments

were more efficient than poorly performing command-and-control regulations and therefore were likely to

be more effective than these “first generation” instruments. However, the policymakers failed to appreciate

that like command-and-control instruments, economic incentive instruments are ineffective absent strong

environmental regulatory institutions and stringent enforcement. Other interviewees argued that

108 Allen Blackman, Richard Morgenstern, and Elizabeth Topping. Institutional Analysis of Colombia’s Autonomous Regional Corporations, (Resources for the Future (RFF) Washington D.C. June 2006 ). Report contracted by the World Bank as an input for: World Bank, Colombia Country Environmental Assessment (CEA) (World Bank, Washington D.C. 2006).

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investments in the provision of potable water are more urgently needed than investments in wastewater

treatment. Therefore, the revenues raised by the fees, and the institutional resources spent enforcing them,

should be reallocated.

The adequate operation of a pollution charge system requires the same basic information on discharging

sources, as those required by licensing, monitoring, and enforcement tasks necessary for the operation of

the traditional water quality command-and-control regulation that existed previous to the implementation of

the new water pollution charge. Therefore if these basic functions were not in place already, it is likely that

the introduction of the pollution charge system would run into the same problems as the previous water

quality control regulation. The monitoring and enforcement situation varied enormously across jurisdictions

with some CARs, in general those in the more highly industrialized areas of the country, performing quite

competently whereas others lacked basic capacities to perform basic elements of their mandates. The

asymmetries in CARs performance are highlighted in other national assessments:

The annual reports issued by the office of the Comptroller General of the Republic during 2001 and 2002 found that 13 CARs (nearly 40% of total) did not have the inventories of dischargers mandated by law, and in the remaining 20 CARs that did maintain registries, a majority were found to be outdated and incomplete. The Comptroller General 2002 report notes that CARs had failed to implement the discharge licensing required by law, with approximately two thirds of the facilities that supposedly were required to obtain them still without license.109

In the U.N ECLAC 2003 study, Mary Gomez argues that in spite of all its problems the environmental

effectiveness shown by the pollution charge in reducing BOD discharges by 27% and TSS by 45% from

1997 to 2002 is a significant accomplishment, in particular considering that pollution loadings in Colombia

were growing in absolute terms prior to the introduction of the pollutant charge. The author also notes that

the pollution charge application of the “polluters-pays-principle” enabled the generation of almost 25,000

million pesos since its inception (approximately USD 15 million) of additional environmental revenue. The

report also argues that aside from environmental effectiveness, from the standpoint of public expenditures

the program has been very efficient with the administrative cost of the program being approximately 15%

of collected charge revenues. Arguing also that the program has also reduced the costs of the existing water

109 Allen Blackman et al. Institutional Analysis of Colombia’s Autonomous Regional Corporations. (RFF Report. Washington D.C June 2006). Ernesto Sánchez Triana, “Autonomous Corporations: From Economic Development to Environmental Conservation”, (Instituto de Estudios Ambientales, UNA Bogotá June 1999).

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quality control regulation, by reallocating CARs efforts to monitoring of pollution discharge loadings,

instead of negotiating directly with each facility conditions for construction and operation of new treatment

plants. In the conclusion Gomez writes:

The “Tasas Retributivas” for point effluent discharges, are an instrument that has achieved important pollution reduction results, but faces payment collection problems with municipalities. Evidently the management of this type of instrument is more complex, but also more enriching as a policy instrument. All the CARs have not assumed the same degree of commitment and the results have been very different among them. The revenue potential of the pollution charge in a good application and compliance scenario is very interesting and we need to keep working towards that goal.

Perhaps one of the most important salutatory effects of the pollution charge program has been to induce a

nation-wide upgrading of the information required for effective water pollution management. In the

previous control system CAR enforcement incentives were low and had low public visibility. The

introduction of the new program made CARs Board of Directors accountable to the Ministry of

Environment through the progress reports on the implementation of the pollution charge and the advance

towards the pollution reduction goals in each jurisdiction. The introduction of the new system created a

complete new set of incentives and accountability relations for the environmental authorities themselves, as

well as for dischargers. Allen Blackman argues that the new accountability and public visibility brought

about through the water pollution charge implementation, forced the CARs to update their polluters

registries, upgrade environmental monitoring and enforcement efforts, along all the other tasks required by

the charge implementation effort. And that is quite possible that the important reductions in pollution

discharges observed, reflect these increased enforcement effort of standard regulation110, rather than being

induced via the net economic incentive effect created by the “tasa retributiva” in the CAR jurisdictions

where it was effectively implemented.

110 Allen Blackman, “Colombia’s discharge fee program: Incentives for polluters or regulators?” Journal of Environmental Management no 90 (2009): 108-111.

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5.9 Concluding comments on the “Tasa Retributiva” case study

This case study illustrates the complex political and institutional dynamics that are faced by environmental

authorities attempting to implement a “market-based” instrument at the national level. The sheer variety of

challenges faced by implementation efforts in real world contexts is amply illustrated. The implementation

of the “tasa retributiva” faced simultaneous political processes of decentralization of environmental

mandates with new instruments, coinciding with water sector policy reforms establishing new national

water authorities and rules for municipal utilities. The case shows how these two processes in turn

interacted with each other, and with structural features such as existing municipal infrastructure deficits,

public finance and institutional constraints, and the politics between the different levels of government,

among other dynamics. Overlying this complexity is the ambitious initiative by the Ministry of

Environment initiative to implement a water pollution charge at the national level. The ingenious design of

the “Tasa Retributiva” instrument is matched against this complex context.

The case study serves the purpose of illustrating in detail the complexity of the political and institutional

context faced by environmental authorities in their attempts to introduce new environmental instruments. It

touches on the themes highlighted in the previous chapters on the importance of policy interactions, both

horizontally across sector bureaucracies, and vertically between levels of government; as important factors

conditioning implementation outcomes. It also touches on the importance of key structural features, such as

the status of existing infrastructure, which might constraint short term responses to price-signals; and

responds only to the very different and longer term dynamics of capital and technology investment flows.

These observations should make the working thesis seemed obvious, its major point is to underscore the

importance and variety of political and institutional factors which often determine implementation

outcomes in real world contexts, even for the most ingeniously designed instruments like Colombia’s “Tasa

Retributiva”.

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On the environmental effectiveness of “Tasa Retributiva”

Our reading of the “Tasa Retributiva” case study is that the observed environmental effectiveness (pollution

load reductions) achieved in the CARs where the charge was effectively applied, resulted from a

combination of factors:

a) The introduction of a price signal for the first time on previously un-priced discharges, contributed to

make these discharges visible to both firms, municipalities and regulators. It created an economic incentive

to measure and reduce discharges in firms, but it also created an incentive to increase monitoring and

enforcement efforts by CARs, who invoiced and administered the new charge revenues.

b) The tasks required of CARs for the charge implementation, were the same tasks required for more

effective operation of the existing pollution control regulation. Therefore as the pilot CARs (CORNARE,

CVC) moved to implement the charge, and during the previous year of preparation, these CARs intensively

engaged firms and municipalities in their jurisdictions. In this process CARs negotiated agreements and

investment commitments with many non-compliant firms, prior to start invoicing the new charges. Given

the previous situation of weak monitoring and enforcement of the water quality control licensing system in

many CARs, these increased efforts by themselves, would have resulted in reductions in pollutant

discharges111.

c) The implementation of the “Tasa Retributiva” program was accompanied by great mobilization of public

opinion by the Ministry of Environment, as well as media attention. It can be argued that this increased

public visibility and media exposure at the national level, also played an important incentive effect both in

inducing firms to tidy up their compliance record, and to upgrade environmental management efforts at

least in the most visible CARs selected to pilot the program. The important incentive effects of increased

transparency and information disclosure of environmental performance, on both polluters and regulatory

agencies responsible for environmental management, has been underscored in the empirical literature.

These observations suggest that in real world contexts, environmental effectiveness results from the

combined incentive effect of a mix of regulatory actions, including improved information, the introduction

111 Ibid.

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of price-signals, increased enforcement pressure, and increased transparency and accountability from public

information on the environmental performance of polluting sources and the results of regulatory efforts.

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5.10 Appendix Ch. 5: Fiscal and environmental decentralization: CAR revenue sources.

Law 99 establishes CAR revenue from three sources.: a) a transfer of part (15-25%) of the municipal

property tax to pay for environmental management, the exact percentage is determined by the municipal

council; b) a tax on power sales by electricity generation utilities within their jurisdictions differentiated by

source112; c) transfers from the national royalty fund; d) proceeds from fines, permitting fees, licenses,

authorizations and concessions within their jurisdiction. The majority of CARs revenues originated from

the percentage transfer of municipal property tax (35% of total CAR revenue in 2001), and electric power

sales (10%) from the municipalities and utilities in their jurisdiction

.Because of this structure of decentralized finance, CARs located in the more industrialized and urbanized

areas of the country have access to substantial revenue sources relative to those CARs located in sparsely

populated and less developed areas of the country, such as the Amazonia and Orinoquia regions in the

south and south east frontiers of the national territory. In effect as Figure V1.b shows 8 CARs of a total of

33 concentrate nearly 75% of revenue, the remaining 25 CARs share the remaining 25%. Law 99 includes

several provisions that address this asymmetric revenue problem. The law allows CARs to receive direct

allocations from the national budget, it also created the National Compensation Fund with the specific

purpose of redistributing CAR revenues to less favored CARs. Law 99 also mandated that CARs receive

appropriations from the National Royalties Fund (Art. 46), and it created two specific national

environmental funds (FONAM, and Fondo Ambiental de Amazonia) which by statute must give priority to

poorer regions.

The following figures illustrate the results of environmental revenue decentralization. Figure A.1 bellow

shows the rapid growth of CARs revenue in the national environmental management system almost

doubling during the 1995-2002 period. The bottom half of Figure A.2 shows the national budget deficit

sustained after 1999 due to structural adjustment program. The growth of self-generated CAR revenue is

112 Hydroelectric generators pay 6% half to the CAR and half to municipalities located in the water basin of operation; thermal generators pay 4%, 2.5% to the CAR and the rest to municipalities. A maximum of 10% of this revenue can be used for operating expenses.

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accompanied by a parallel reduction of national budget transfers. The Ministry of Environment budget

suffered a reduction of almost 40% during the same period due to the fiscal retrenchment that accompanied

the 1998-2002 Asian and Argentine crises. The decentralized revenue structure established by Law 99

enabled CARs to isolate themselves from the brunt of central government expenditure reduction and fiscal

retrenchment during 1998-2002, enabling the national environmental management system to remain

operative through its independent public finance structure. This is one of the few examples of successful

fiscal-environmental decentralization in the region.

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Figure A.1 CAR revenues 1995-2002

Sustained fiscal deficit after 1999: structural adjustment program

Source: Ministry of Environment (MMA. República de Colombia 2003)

Evolution of CAR revenues 1995 - 2002 Base 1995 = 100 constant pesos

National Fiscal Deficit (% GDP) 1994 - 2002

Between 1995 and 2002 CAR revenues almost doubled ( 90% absolute growth)

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Chapter 6. DISCUSSION and CONCLUSION

The theoretical rationale for greater use on “market-based” policy instruments in environmental policy is to

correct existing market failures; such as un-priced pollution discharges and inefficient resource use,

induced by market prices that do not reflect the full social costs of resources. Aligning the economic

incentives that drive production/consumption decisions with the pursuit of national environmental goals,

and increasing overall economic efficiency in the process, is no doubt a very desirable proposition from a

national and global policy standpoint. Harnessing price-signals and economic incentives to work for, and

not against the attainment of environmental policy goals, will always be an indispensable component in any

integrated policy response that hopes to be effective in either the national or international level. How do we

reconcile this expectation with the fact that we see so few instances of application of “market-based”

instruments in environmental policy in the real world?

6.1 Key findings

The difficulty of introducing “market-based” instruments into the existing policy mix was illustrated by the

fact that, for as much as a third of the eighty one cases documented in Latin America and the Caribbean, the

barriers encountered were such that instrument implementation was never initiated. And the fact that a

further third of the fifty six instruments implemented, were found to have been retired, or were no longer

operating or being applied in practice by the time that national surveys were undertaken. The majority of

cases where instruments enacted in law or regulation were never implemented, indicated the uncooperative

interaction between traditional fiscal bureaucracies and environmental authorities as the main obstacle to

the incorporation of “market-based” environmental instruments into the existing regulatory mix.

Our working thesis was that the observed outcomes from the implementation of “market-based”

instruments that have taken place in Latin American countries since the 1990s, have been conditioned to a

great extent by structural features of the political and institutional context in which environmental

authorities operate in these countries.

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The following sections discuss our major findings in relation to this working thesis, and how findings

conform with the main insights already highlighted in the literature. Then the alternative hypothesis of

“weak institutional capacity of environmental authorities” emphasized in the literature is also discussed.

Our findings suggest that in practice, the effectiveness of “market-based” environmental policy is

conditioned by political and institutional features that seem to be largely exogenous to environmental

authorities, or environmental policy itself. The data indicates the critical role of interactions between

environmental and fiscal policy; as well as the constraints that the existing stock of infrastructure and

infrastructure investment dynamics, imposes on environmental policy outcomes. The inevitable interaction

of “market-based” environmental instruments with fiscal bureaucracies, existing tax structures, and public

finance practices; stands in the way of the proposition that price-signals aligned with environmental

objectives provides an easier, or administratively less costly route, to achieve environmental policy goals

compared with the current struggle to enforce standard environmental regulation. The implementation of

“market-based” environmental instruments entails substantial information, administrative, and coordination

costs which are on par, if not larger than those required to operate standard command-and-control

environmental regulation, which most countries already struggle with.

The structural constrains imposed by the status of key infrastructure, such as energy, transportation, and

water/sanitation and waste treatment in municipalities, firms and industry; also negate the proposition that

better alignment of price-signals will be sufficient to take us a long way towards the attainment of

environmental policy goals. This seems unlikely without recourse to broader policy interventions to address

dynamic accumulation constrains in the long term. Such as for example cleaner technology, energy and

infrastructure investment policies, each with their corresponding long term planning horizon, public finance

commitments, regulatory framework, and specifically targeted research and innovation policy. instruments.

6.1.1 The key role of fiscal authorities in “market-based” environmental policy

An important finding and remarkable feature of the data set is that in half of the eighty one cases

documented, fiscal authorities played a key role in instrument implementation and operation. Therefore

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fiscal authorities, and not environmental authorities, were the operative agent in government responsible for

establishing and operating the majority of environmental “market-based” instruments mandated in national

environmental law or regulation. This is consistent with the fact that about half of the fifty six “market-

based” instruments which were actually implemented, were subsidies, tax credits, fiscal transfers, and other

positive incentives operated by the fiscal authority. Fiscal bureaucracies also played a key operative role in

the few cases documented of earmarked fiscal transfers to environmental funds, and other administration of

earmarked revenue; and also would have played an operative role in the collection of proceeds in the four

cases of deforestation and other taxes in the data set that were found to be retired or not implemented.

Also remarkable is the finding that the role played by fiscal authorities in instrument implementation was

generally characterized as a barrier or obstacle associated with poor outcomes. Fiscal authorities in the

region have generally shown very little interest in the operation of fiscal instruments with environmental

objectives. Chapter 4 argued that this situation might reflect the misaligned incentives of fiscal

bureaucracies in the operation of environmental transfers and fiscal incentives: such as tax credits,

subsidies, fiscal transfers, and earmarked fund allocations for environmental end uses. Lack of cooperation

by fiscal authorities was also cited in most cases where the introduction of environmental charges, fees

and/or taxes (i.e. pollution charges, water effluent charges, water use charges etc.) required the

establishment of new payment collection and revenue administration channels. This might reflect the fact

that these were largely administrative charges of modest value and with earmarked end uses, rather than

broad based environmentally related taxes with significant revenue raising potential.

The Latin American data provides empirical support to assert that fiscal authorities generally lack

incentives to implement “market-based” environmental instruments. The main thrust and rationale of new

environmental instruments is to induce changes in the behavior of economic agents, not to raise revenue.

Establishing the operation of these new instruments also entails substantial administrative, information and

monitoring costs; since by their very nature these instruments need to be selective and specifically targeted.

Both features, low revenue raising potential and high administrative costs, do not endear them with

traditional fiscal bureaucracies.

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As seen in chapter 4 our data set also showed scarcely any evidence of implementation of cost-internalizing

instruments, such as environmental taxes and charges per unit volume of pollution explicitly linked to

sources of environmental externalities. The only exception to this general trend was the attempt to

implement a water pollution charge on organic pollutant discharges in Colombia. Simply based on their

relatively higher design costs from information requirements, and higher administrative costs from the

monitoring and enforcement efforts required by their operation, we would expect cost-internalizing

environmental taxes and charges (i.e. carbon tax, water pollution charges, etc.) to be the most difficult and

resource demanding to establish. Our data conforms with this, not a single case of environmental or natural

resource tax designed explicitly to internalize the inevitable negative spillovers from resource intensive

economic activity was found operating in this natural resource rich region.113

Internationally there are also very few operational examples of environmental taxation explicitly designed

to internalize the cost of environmental externalities into the price system. Also according to this logic the

much higher prevalence of administrative charges (public service charges, water user charges etc.), and

revenue raising environmentally related charges or taxation in developing countries, is explained by their

lower information intensity (design costs) and lower administrative costs of operating them. Our data also

conforms with this logic. Administrative charges were the largest group of instruments in the data set,

followed by tax credits and subsidies. These as argued in the previous paragraph, are also relatively easy

for fiscal authorities to administer at their discretion.

Not a single case of environmental or natural resource tax designed explicitly to internalize the inevitable

negative spillovers from resource intensive economic activity was found operating in this natural resource

rich region. Moreover the tax structures in resource based exporting sectors such as mining, forestry pulp

and paper, agro industry, and tourism, do not seem to have incorporated any specific fiscal measures to

113 In particular taxes/charges that try to approximate Pigouvian internalization of environmental externalities; or any price-instrument aiming to achieve a certain “quantity” target of pollution reduction, since the response elasticity of economic agents is not known beforehand by the regulator. When remaining within a certain “quantity” threshold in environmental parameters is imperative, direct controls or establishing a regulatory “cap” on emissions and letting the price be determined by market forces, is a better instrument choice.

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recoup the inevitable environmental spillovers from these large scale economic activities114. The

possibility that in their zeal to attract foreign investment in their capital intensive resource sectors, countries

might be incurring in perverse fiscal competition and, not only failing to internalize the full environmental

and resource use costs, but also forgoing the capture of part of the economic rents from their exploitation,

was also mentioned in earlier chapters.

These observations highlight the critical role that revisions to the institutional interface between

environmental and fiscal policies, must play in the design of any integrated policy intervention seeking to

harness economic incentives to induce broad based pro-environmental change on economic agents. The

policy interaction between “market-based” environmental policy goals, and existing fiscal structures and

practices, was shown to be of critical importance in determining the observed implementation outcomes in

our data set. Most fiscal and environmental authorities in the region have hardly any experience with this

sort of interaction, and there are no established institutionalized mechanisms for policy coordination or

interaction between fiscal and environmental officials to ensure a minimum coherence of policy incentives.

Most countries in Latin America have yet to develop the institutional mechanisms required to deploy

integrated policy responses to manage current natural resource degradation trends, and deterioration of the

urban environment observed in megacities in the region. This fiscal-environmental policy interface seems

to be a critical area where institutional innovation and increased policy coordination is required.

6.1.2 The key role of infrastructure and public finance constraints in “market-based” environmental policy

The case data also illustrated how the introduction of “market-based” environmental instruments into the

existing policy and regulatory structure necessarily overlays, and interacts with, public investment finance 114 The last decade has seen growing evidence from economic valuation studies that the public health costs, and productivity losses associated with pollution externalities are not negligible, and sooner or later end up accumulating in public balance sheets. These losses have been estimated in World Bank studies to run in the order 2.8% of annual GDP for Colombia, and are probably higher in other Latin American countries with lower per capita income ; and being socialized via increased. These estimates would be in the lower end, since they do not include the economic costs from the loss of biodiversity and the loss of ecosystems services and resilience (which are very difficult to approach analytically). These latter losses of natural capital and ecosystems resilience directly impact the economic productivity of soil, coastal zones, and forests; as well as the hydrology of the country with implications for crop irrigation and water supply infrastructure, hydroelectric power, etc. These studies make a strong economic argument for the significant public finance implications in the medium and long term, of not taking policy action to halt these continued trends of environmental deterioration and depletion of natural capital.

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processes and infrastructure policies at various levels of government. During the 1990s various Latin

American countries were undergoing processes of fiscal decentralization and public finance reforms,

including revisions of tax structures. Most governments in the region were also engaged in macroeconomic

stabilization efforts which implied cutting expenditures to reduce public deficits, including the privatization

of public utilities in several countries, and retrenchment of public investment in infrastructure. These

processes not only affected national environmental management budgets, but even more relevant to

environmental outcomes, they also reduced the net public finance position and investment capacity of

municipalities and state/provinces; whose expenditure/investment decisions in water, sanitation, waste

disposal, soil/forest conservation, etc. are key structural determinants of environmental outcomes.

Public and private investment and accumulation processes in national infrastructure, are driven by public

finance and private resource mobilization constrains, in turn determined by macroeconomic and regulatory

stability. Unfortunately the prevalence of macroeconomic volatility experienced in Latin America, which

reached its peak during the 1990s decade of policy reform, seriously aggravated the public investment

constraint. And contrary to reform expectations, data on infrastructure investment shows that private capital

investment in infrastructure has not been able to make up for the retrenchment of public investment ( as

shown in Figure 6.1 in the following page). With the net result Latin America has experienced continuous

reductions in infrastructure investment (relative to GDP) during the last two decades, with the exception of

the telecommunication sector as shown in Figure 6.2 below. The most dramatic fall in public infrastructure

investment has been in the energy sector, as it was deregulated and opened for privatization during the

1990s.

As seen in Figure 6.2 private investment has not been able to compensate for the State retirement from the

energy sector, public investment in water infrastructure has seen some recuperation relative to past levels.

These data makes clear that energy, land transport and water infrastructure investment in Latin America are

highly dependent on public investment. The quality of accumulated infrastructure represents a key

structural constrain on environmental outcomes, that does not readily respond to short term price signals.

The dynamics of infrastructure accumulation depend rather on longer term processes which are completely

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outside the domain of environmental policy. Current infrastructure constraints in Latin America are the

product of the previous trajectory of public investment and the evolution of regulatory frameworks

governing water/sanitation, electric power markets, and transportation infrastructure. Alongside the more

recent privatization efforts which have so far failed to mobilize sufficient private investment to compensate

for the decreased public role in infrastructure accumulation since the 1990s.

The detailed case studies in this dissertation show that Latin American environmental authorities have been

highly creative in working within existing constraints in the State apparatus, and around the high

administrative coordination and information requirements involved in operating any system of

environmental policy instruments. The implementation of “market-based” environmental instruments

entails substantial information, administrative, and coordination costs which are on par, if not larger than

those required to operate standard command-and-control environmental regulation, which most countries

already struggle with.

Source: Calderón and Servén (2008) Presentado en Seminario Infraestructura 2020, CEPAL, MOP-Chile. Santiago 10 de Noviembre 2008

Figure 6.1 Infrastructure Investment in Latin Ameri ca (% GDP, 6 major economies, GDP-weighted average)

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6.2 Discussion of “weak institutional capacity” hypothesis

The main hypothesis emphasized in the literature attributes poor environmental policy outcomes in Latin

American countries to the weak technical, financial, and enforcement capacities of environmental

authorities, noting the large asymmetries between mandates and the public resources allocated. This

literature frequently mentions weak monitoring and enforcement practices, insufficient budgets and trained

staff. The data collected for this dissertation indicate that this diagnosis might be “too narrow” in pointing

only to the institutional weakness of environmental authorities, and failing to capture the broad range of

exogenous policy interactions and structural constrains illustrated by the findings described in the previous

sections.

The diagnosis of “weak institutional capacity” of environmental authorities, confronted with the high

information and administrative intensity involved in the design and operation of “market-based”

Figure 6.2 Infrastructure Investment in Latin Ameri ca (% GDP, 6 major economies, GDP-weighted average)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

TotalPublicPrivate

0.0%

0.5%

1.0%

1.5%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

0.30%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 20060.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Source: Calderón and Servén (2008) Presentado en Seminario Infraestructura 2020, CEPAL, MOP-Chile. Santiago 10 de Noviembre 2008

Water

Land transport

Telecom.

Energy

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instruments, has become a “catch-all” or “black-box” to account for disappointing outcomes. As such the

diagnosis of “weak institutional capacity” might hide, rather than illuminate, the inner workings of

environmental policy in complex real world settings. Perhaps the main contribution of the empirical

research undertaken for this dissertation is the attempt to look inside this “black-box” of “weak institutional

capacity”; and try to identify the specific or fine grain factors operating, in order to give a more detailed

account of the outcomes observed from the implementation of “market-based” instruments in the region.

The obvious appeal of the “weak institutional capacity” argument is based on the straightforward logic of

contrasting the typically modest technical/administrative resources of environmental authorities in

developing countries, with the significant information requirements and administrative costs to design and

operate “market-based” environmental instruments. While this reasoning seems obvious, it cannot however

explain the general fact that environmental taxation is almost non-existent at the international level, even in

the most advanced industrial countries where environmental authorities do not suffer from technical

capacity or budgetary resource constraints. The international experience with “market-based”

environmental instruments, suggests that the major constrain that stands in the way of their broader

application is of political nature; and not one of institutional and technical capacity constrains related to the

high information and administrative intensity demanded by their design and operation115.

115 The theoretical literature is clear on the assumptions of perfect information, competitive markets, complete definition of rights, and frictionless transactions and adjustment, among others, that underlie theoretical models of optimum environmental regulation such as price-based Pigouvian taxation, quantity-based cap-and-trade market creation; or rights-based Coasean bargaining in fictional zero-transaction-costs judicial systems. Needless to say these conditions are not present in real world settings, which are rather characterized by imperfect and incomplete information, prevalent economic and policy induced distortions, incomplete property rights, significant transaction costs, and less than perfect competition, among others. Normative theory acknowledges this situation through the concept of “second best” setting, which is simply the recognition that we start from a non-optimal policy setting which is riddled by pre-existing distortions and/or market failures. Recent theoretical work points to the optimality of instrument mixes, over single instruments, in the context of second best settings. Such instrument mixes might combine a tax with a cap-and-trade system for example; or these two with some form of direct regulation such as minimum emission standards, allowance price ceilings or floors, etc. In moving the analysis of theoretical models to real world settings, the normative literature also points out the role of information constraints and operational costs in explaining policy instrument choices. Therefore the point is already made in the theoretical and normative literature that design of “market-based” environmental instruments is intensive in information requirements. For a detailed treatment of instrument mixes in “second best” scenarios please refer to: Lori S. Bennear and Robert N. Stavins, “Second-Best Theory and the Use of Multiple Policy Instruments,” in The Use of Multiple Policy Instruments for Environmental Protection: an economic perspective, OECD [ENV/EPOC/WPNEP(2005)5] (Paris, OECD 2005).

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Looking at the international experience in the most advanced industrial countries that have moved forward

with environmental taxation, like Germany, Finland or Sweden, what one finds is a strong political

commitment to the full integration of environmental objectives into mainstream economic policies,

including “green” tax reforms. Germany for example has achieved a substantial increase in renewable

energy generation through the aggressive use of “market-based” instruments such as subsidized feed-in

tariffs for wind and other renewable power generation. Spain has achieved the same for solar generated

electric power with the same instrument. The Scandinavian countries have moved ahead of the European

Union and begun the application of carbon taxes in spite of the international competitiveness implications

of taxing their own energy intensive industries and electric power sector, while the rest of the EU and

international competitors refuse to follow suit.

What Germany and the Scandinavian countries have in common is that their top political leadership, not

just environmental authorities, have installed environmental objectives as an integral part of State policy,

on par with other top national priorities. It seems that nothing less than such State-level political

commitment is required before countries can seriously move forward in modifying the incentives implicit

in existing tax structures, incur the political costs of reducing existing distortions; and/or succeed in

installing net marginal incentives of sufficient magnitude to induce significant changes in the

environmental performance of economic agents. To date even the above leading countries have only taken

the first steps in that direction, experimenting with tentative “green” tax reforms, and public finance

commitments to back more aggressive use of positive fiscal incentives and subsidies for renewable energy

and energy research and development. So far even the most progressive European countries have shied

away from more aggressive removal of agricultural subsidies and other distortions that continue to work

against their own environmental agenda. No comparable level of political commitment, or institutional

development for the incorporation of environmental goals into State-level policy, is yet evident in Latin

American countries.

Only 4 of the 81 cases documented in our data set explicitly mentioned the variable “weak institutional

capacity” of environmental authorities as the main factor acting as barrier or obstacle to instrument

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implementation. This fact lends support to the argument that the major constraints to the implementation of

market-based environmental policy reside beyond the reduced locus of the institutional capacity of

environmental authorities, or environmental policy itself as applied at present in Latin American countries.

Pointing rather to the absence of this higher level of State-policy commitment, required to effect the fiscal

policy coordination and other institutional reforms, that seem to be necessary prerequisites to achieve the

theoretical goal of aligning price-signals and environmental goals in real world contexts. The detailed case

study in Chapter 5 demonstrated that Latin American environmental authorities have been highly creative

in working within existing constraints in the State apparatus, and around the high administrative,

coordination, and information requirements involved in operating any complex system of environmental

charges such as the “tasa retributiva”. Many other such examples of creativity and genuine efforts to work

around existing constraints abound in the region. Even in the light of the partial results achieved, the

capacity and performance of environmental authorities undertaking such initiatives can be characterized as

anything but weak.

176

6.3 CONCLUSION

In theory the role of “market-based” environmental instruments within this complex scenario is limited to

the introduction of marginal economic incentives, or price-signals, to “nudge” economic agents towards

production/consumption decisions better aligned with relative resource scarcities and the environmental

costs of such choices. The Latin American findings show that implementation of economic incentives

aligned with environmental goals, and their integration into existing fiscal structures and sectoral policy

incentives (agriculture, energy, transport, water etc.) if often very difficult; and sometimes impossible

under present political and institutional conditions. Market-based environmental policy often implies the

need to adjust existing tax structures and subsidies, and the revision of inherited distortions and policy

incentives that are incoherent with environmental objectives but enjoy strong political backing that prevents

their withdrawal under present conditions.

The economic incentives that environmental regulators can manipulate directly are relatively modest

signals. If the underlying fiscal structure determining end-user prices is stacked in the opposite direction, as

if often the case with agricultural and energy subsidies, there is little chance of installing a net price-signal

at the margin that can function as an effective economic incentive towards environmental objectives. The

same applies in relation to trade tariffs and investment policy incentives when they fail to internalize the

environmental costs of trade and investment decisions. The key role that a coherent fiscal policy plays in

the successful installation of “green” price signals across the economy goes often unrecognized. And the

obvious need for greater overall policy coherence across fiscal, trade, investment and environmental arenas

cannot be overemphasized. All the more in the case of Latin American countries whose current pattern of

insertion in the global economy depends on the sustainable management of their natural resource

endowments.

In the international arena the political momentum to align economic incentives to support the long term

transition away from fossil-fuels, and on to economies powered by renewable energy and low greenhouse

gas emissions, is expected to steadily move forward in the decade ahead. Even at the crawling pace of

multilateral negotiations, developing countries can count on steadily building pressures from OECD

177

countries as the richer nations begin efforts to stabilize greenhouse gas concentrations in the atmosphere

within the next few decades. Developing countries can benefit in this game by growing with increased

energy use efficiency while capturing international resource and technology flows in the process. This

prospect however depends on the credibility of national level energy efficiency policy interventions, which

will require political leadership to overcome existing policy biases, and to create new policy coordination

mechanisms biz-a-biz high inertia fiscal and public finance bureaucracies. These are pretty much the same

challenges that have stood in the way of successful implementation of “market-based” environmental

policy in Latin American countries during the past decade.

The dissertation findings are a sobering reminder that in practice there are no easy and quick policy

solutions to correct for market failures and inherited policy distortions. Most Latin American and

Caribbean countries are still on their learning curves to develop effective policy responses to their complex

environmental challenges. While there is no doubt that harnessing price-signals to work are an important

ingredient, any answer will also have to emphasize much broader public interventions such as: enacting and

enforcing ambitious regulatory goals, overcoming political resistance to dismantling perverse incentives in

policy structures, reversing current trends in infrastructure investment, rebuilding long term energy

planning capacities116 and technology absorption policies, as well as committing the required public finance

to attain them. All these tasks require a great deal of political leadership and institutional innovation.

116 State energy planning departments which played an important role in the past, were dismantled in most countries in parallel with the retreat of public role in the energy sector as it underwent deregulation and privatization processes in several countries.

178

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