Green Tax for Development The Role of Aid Agencies in Mitigating Climate Change through Environmental Taxes

The collective need to reduce greenhouse gas (GHG) emissions is well-documented, so are the financial and social costs associated with climate change – for both developed and developing countries.

However, how to achieve this has not been fully explored. This note seeks to go behind the headlines with the aim of providing a balanced snapshot of the potential for, and obstacles to, implementation of green taxes in developing countries. The objective of the note is to explore how a bilateral development agency like Norad can contribute to reducing GHG emissions in partner countries through a green tax approach, and to inform how Norad can manage green taxes in within its tax for development secretariat as well as through other program portfolios.

Under the auspices of the UN Tax Committee, a broad group of officials from developing and developed countries have suggested that for many developing countries, climate taxation can be a more appropriate carbon pricing mechanism than other alternatives. Compared to an emissions trading scheme, climate taxes require less administrative capacity and investment. The taxes can also have an effect even for small economies independent of other countries and global processes. An argument echoed by both the International Monetary Fund and World Bank experts.

Climate taxation can, under the right circumstances, have a triple dividend – reducing GHG emissions, increasing government revenue and improving public health through reduced air pollution. Expert advice recommend that developing countries should start with a low rate and limited scope, which means that the benefits will be limited in the short term but this can translate to better results in the long term. It is important to note that climate taxation can have negative effects on poverty, depending on the tax design, consumption patterns and how the generated revenue is used (revenue recycling).

While the technical design can be relatively straightforward, especially if the tax builds on existing fossil fuel excises, green taxes are generally not easy to implement. Aside from the administrative challenges, a key obstacle is often political and social opposition – because of legitimate concerns with the poverty and distributional effects of the tax, a weak social contract leading to low trust in the government, and/or opposition from elite groups who benefit from the status quo. If the government’s capacity or willingness to implement public expenditure reforms to offset some of the adverse distributional impact (via social protection for example) is limited, then green taxes, like any tax change will meet strong opposition.