Environment Policy and Public Expenditure

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Environment Policy and Public Expenditure
ANIL MARKANDYA WORLD BANK

• Public Expenditure Analysis and Management
• Washington DC
• January 12, 2004

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KEY QUESTIONS

1. Why should the government be involved in
   financing environment-related infrastructure?
2. How should this financing be organized?
3. How should the role of the government be
   evaluated?
4. What can we say about current performance in this
   area in non-OECD countries?

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A. Why should the government be involved?

• The private sector will not provide enough to
  meet social objectives of e.g. the MDGs.
• But why does the private sector not provide
  enough?
• Social benefits cannot be captured by the private
  sector (externalities, social objectives)
• Access to finance for such investment is limited
  in developing countries
• Returns to such investment are lower than for
  other private sector investments
• Industry cannot afford the required investment.
  (PPP cannot be applied in all cases).

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Why should the government be involved?

• But these reasons for low private sector
  involvement are not sufficient to justify state
  provision.
• Externalities can be internalized via fiscal
  incentives
• Access to funds can be facilitated by special
  financial agencies
• The problem is that, in many developing and
  transition countries, these instruments are not
  adequately developed and take time.

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Why should the government be involved?

• Hence government financing should be seen as an
  evolving process, where direct provision declines
  over time and indirect instruments are used to
  increase private provision.
• Smaller government share can be enhanced by
  increased leveraging of public funds.
• Nevertheless, there will always be a core of
  financing that will be needed from the
  government, to cover management and regulation,
  protection of pure public goods (water sources on
  public land), and financial support for social
  objectives.

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B. How should the role of the government be
organized?

• Main issues are
• Financing from general taxation versus earmarked
  funds.
• Expenditure from central versus local budgets
• Use of government department, specialized agency
  (e.g. environment fund, water agency), public
  utility?

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General Versus Earmarked Funds

• Case for earmarked funds is strongest when
• Revenues are raised from charges levied on
  environmental services and used to provide the
  services (e.g. protection of water sources)
• When an environmental charge that is
  environmentally and economically desirable can
  politically only be levied when revenues are
  earmarked.
• In many cases pollution charge revenues are
  earmarked in OECD and developing countries (e.g.
  carbon levy, landfill taxes in the UK, EU).

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General Versus Earmarked Funds

• Case against earmarked funds is
• They make fiscal discipline more difficult (i.e.
  control of overall spending). But note that
  earmarking is not the same as making the funds
  extra budgetary.
• Allocative efficiency is less (spending on the
  environment is determined by revenues, not by the
  return on the investment relative to other
  investments.

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General Versus Earmarked Funds

• In general the case for having some earmarked
  funds for the environment is strong.
• On grounds of linking spending on environmental
  services to payments made for those services.
• On grounds that fiscal instruments such as taxes
  can only be levied successfully if they are
  earmarked.

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Central Versus Local Budgets

• If the revenues are to be closely connected to
  the expenditures (the benefit principle), local
  control of the spending is more desirable.
• On the other hand if expenditures are to be based
  more closely to national priorities, central
  control is better.
• In practice both are needed and a compromise has
  to be reached. Central budgets also tend to be
  used more cost effectively (see below).

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Type of Institution

• Budget institutions versus specialized
  institutions.
• The budget institutions apply budgetary control
  rules, which are easier to track, and facilitate
  fiscal discipline and transparency.
• Specialized institutions such as environmental
  funds are often found to have lower levels of
  transparency.
• The cost effectiveness of budget institutions is
  considered to be higher but this should not be
  exaggerated some other bodies can also work
  effectively.

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C. Evaluating the Role of the Government

• The OECD has proposed a number of criteria for
  evaluating this role in the environmental area
• Environmental Effectiveness
• Fiscal Prudence
• Management Efficiency
• But all these are predicated on sound data
  collection, which remains a serious problem!

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Environmental Effectiveness

• Public funds should not be used for investments
  that would have been made anyway.
• Nor should they be used when the same objectives
  can be achieved through policy reforms (e.g.
  removal of subsidies)
• The program of expenditure should be clear,
  consistent and open to scrutiny.
• The environmental objectives should be defined
  and monitored.
• Cost effectiveness indicators should be used to
  design and monitor the program
• The funds should be leveraged as much as
  possible.

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Fiscal Prudence

• All public funds (even if earmarked) should be
  subject to the same fiscal discipline.
• Earmarked funds should be required to adopt
  allocation rules as close as possible to those
  for other funds.
• Spending by environment funds is subject to
  control to avoid quasi fiscal deficit
• Spending is subject to audit and transparent
  ex-post reporting
• All revenue collection is only done by the same
  authority and national procurement rules apply to
  the environmental funds.

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Management Efficiency

• Expenditure program is governed by clear, written
  rules, is based on consultation with civil
  society and carried out by a body representing
  all key stakeholders.
• Day to day management is undertaken by a separate
  technically competent body.
• A sound project cycle is adopted, laying out how
  project are prepared, appraised and selected.
• Communication policy ensures that all applicants
  have equal access to information on funding
  opportunities and equal opportunity to have their
  projects impartially reviewed on a merit basis.
  Those who prepare the projects do not appraise
  them.
• Financial products used are based on capacity to
  manage the risks. Grants are the simplest,
  followed by subsidies, loans, loan guarantees
  etc.

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D. Actual Experience With Environmental Finance

• What do studies carried out by the Bank tell us
  about the actual experience in environmental
  finance?
• Recent studies include
• Dominican Republic
• India
• Ukraine

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Actual Experience

• First and foremost we have a real problem finding
  out what has actually been spent on the
  environment!
• Public spending has to be analyzed in the wider
  context of all environmental spending as the
  public/private division is changing over time.
• In Indian study private sector data were not
  available
• In DR data only partial public spending data were
  available
• In Ukraine public and private data were available
  but private spending looks too high.

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Actual Experience

• Given the problems of measurement it is difficult
  to assess the environmental effectiveness, fiscal
  prudence and management efficiency.
• Both the DR and Indian studies could not make a
  real estimate of these factors, except in a few
  ad hoc cases.
• In the Ukraine study a more detailed estimate of
  these effects was made.

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Reality Check Ukraine Case Study
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In Ukraine Background Data

• At aggregate level, environmental expenditures
  have fallen from around US1 billion in 1996 to
  US600 million in 2000.
• Total expenditure in 2000 as of GDP is
  comparable to other CEE and OECD countries, but
  share of investment in total is less. In OECD it
  averages 27 and is much higher in countries
  catching up (e.g. Portugal). In Ukraine it is
  22.
• Budgetary resources amounted to US35 million in
  2000, making only 6 of total environmental
  expenditure. This is very low and much lower
  than in OECD countries and CEE countries.

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Assessment of Environmental Effectiveness
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Environmental Effectiveness

• By and large public funds are being used for the
  environment where other funds are not available.
  Enterprises and utilities could not afford to
  make the investments on their own.
• Other policies that achieve environmental targets
  are being pursued (e.g. pollution charges are
  being raised to make up for inflation, integrated
  permitting is being introduce) but more can be
  done w.r.t. compliance on environmental standards
  and on leveraging public funds.

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Environmental Effectiveness

• National environmental policy has not been
  formulated in terms of specific environmental
  targets against which one can measure
  achievement.
• The policy statements are mostly declarative in
  nature and do not provide priorities within the
  broad goals.
• There are some specific goals related to
  environmental policy articulated in the national
  and regional Environmental Programs.

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Environmental Effectiveness

• The biggest problem with all these programs
  under funding. They contain much more than can
  be funded and the actually implemented is
  mostly lt10.
• There is no way of knowing whether programs
  actually implemented are the ones with the
  highest priority. Tendency is to start a large
  number of projects and programs then argue for
  funds to complete them. (a practice common in the
  Soviet Union).
• The bulk of state spending is on water resources
  protection, This is broadly consistent with
  national priorities.

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Related Question on Environmental Effectiveness
Is Overall Environmental Expenditure on
Environmental Protection Adequate?
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Environmental Effectiveness

• Data show that while overall level is consistent
  with other countries, public share is too low and
  investment share is too low.
• Composition of environmental expenditure has
  important implications.
• For example The low share of public expenditure
  means that not enough is being spent on public
  goods -- such as monitoring of environmental
  quality, and protection of nature reserves and
  forests. In transition countries the state also,
  rightly, supports investment in water supply and
  sewerage, in other key areas of infrastructure
  and in key industrial enterprises, on public good
  grounds

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Recommendations on Environmental Effectiveness

• Link priorities with specific environmental goals
  and outcomes
• Link expenditures more closely to priorities
• Increase overall public investment on the
  environment.
• Increase flexibility in allocation between public
  investments at different levels.

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Assessment of Fiscal Prudence
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Fiscal Prudence

• The level of prudence is good in that
• Environmental expenditures do not contribute to
  macroeconomic problems
• Environmental funds are subject to audits
• Environmental charges are collected by national
  tax authorities
• The same procurement rules apply for the
  environment funds as for other government
  spending.

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Fiscal Prudence

• The level of prudence is less good in that
• Decisions on environment spending are not always
  made in a manner consistent with other areas of
  spending (but other areas of public spending are
  also not that clearly and transparently done).

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Assessment of Management Efficiency
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Management Efficiency

• Ample evidence expenditures are not efficient in
  the sense of selecting the programs and projects
  with the highest net benefits or obtaining the
  maximum improvement in any physical indicator per
  dollar spent.
• Assessing efficiency is not easy benefits,
  especially from better protection of natural
  resources are difficult to quantify. Also the
  use of cost effectiveness criteria, well
  established for investments in sectors such as
  health and education, are less so for the
  environment.
• Nevertheless, tools and techniques for such
  assessments are increasingly becoming available
  and should be used in Ukraine.

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Management Efficiency

• Efficiency is of course not simply a matter of
  using CBA/CEA.
• Are policies based on proper consultation?
• Ukraine has a reasonable system of consultation
  in deciding its environmental programs but it can
  be improved.
• Is it easy to track expenditures by category and
  know when a spending unit has not delivered or
  has overrun the cost?
• The monitoring of environmental expenditures is
  quite weak and accountability, especially at the
  local level, needs to be strengthened.
• Does the method of allocation prioritize items
  within a program, so that when funds are
  inadequate the highest priority items are
  included?
• It does not.

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Management Efficiency

• Ukraines principal sources of public
  environmental expenditure state and local
  budgets, and special, earmarked environmental
  funds linked to revenue from pollution charges.
• The contributions from the Environment Funds can
  be in the form of direct investments or grants on
  a matching basis. The system of environmental
  funds is extensive and includes over 1,600
  regional and local funds

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Management Efficiency

• The sheer number of these funds is clearly
  inefficient. On the other hand, local government
  control is valued since decisions about how to
  spend resources can be made closer to where
  environmental problems exist. Compromise is
  needed.
• The income of the funds comes primarily from
  pollution charges on emissions of air, water and
  waste. The highest revenues collected were for
  air pollution while the greatest expenditures are
  on mitigating water pollution.

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Management Efficiency

• Data disaggregated by region show that compliance
  rates with charges and fines are lower in the
  regions where pollution is higher and in these
  same regions, fines are less likely to be imposed
  on firms.
• In some regions, this may be an indication that
  where charges become too high, firms have more
  problems paying.
• Most likely however, lack of payment is a result
  of corruption in the system. The empirical
  analysis is at least consistent with a picture
  where large firms lobby successfully for
  exemption, while smaller firms bribe tax
  officials or simply do not pay the charges.

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Management Efficiency

• The purpose of the pollution charges is not to
  reduce pollution given their low levels, they do
  not provide an incentive to make investments in
  environmental improvement.
• Rather it is to raise revenue for environmental
  protection. Over the last five years or so, these
  charges, which were fixed in nominal terms, have
  had their real value eroded. Since there is a
  continued need to maintain this expenditure, and
  there is no other clear source of financing, some
  restitution of their real value is justified.

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Management Efficiency

• More generally, are Environmental Funds an
  important way to finance environmental
  expenditures? For the time being, yes.
• To ensure a minimum level of funding for the
  environment, there is no alternative available
  now and the present system has some features to
  commend it.
• The National Environment Fund does operate
  relatively effectively projects are properly
  processed and it is open to adopting better
  methods of appraisal. It can also act as a source
  pf leveraging of funds for pollution abatement,
  if appropriately designed and if banks see
  support by the Fund as an indication that the
  project is justified.
• At the same time, there is a need to overhaul the
  system of local funds there are too many of
  them and to change the system of subsidization
  across regions.

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Recommendations on Efficiency

• In the longer term, however, the program of
  comprehensive public finance reforms that ends
  all earmarking and subjects all revenues to
  integration into the public finance system
  implies that the Environment Funds will be phased
  out. Some sunset provision is therefore
  needed.

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Recommendations on Efficiency

• Increase transparency and public disclosure
• Consider introducing international expenditure
  standards to better monitor environmental
  expenditures
• Enhance accountability
• Introduce economic appraisal techniques for
  environmental projects and programs

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Recommendations on Efficiency

• Refine the institutional and legal structure for
  environmental funds
• Reduce the number of funds
• Spend resources close to where they collected
• Introduce more rigorous guidelines for use of
  funds
• Introduce more rigorous guidelines for use of
  funds
• Evaluate the success of funds with respect to
  outcomes

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Recommendations on Efficiency

• Phase out Environment Funds in the Long Run
• Increase pollution charges to make up for some of
  the lost value due to inflation (400 since 1996)
• Eliminate exemptions
• Streamline the pollution tax structure (jump at
  Max. allowable emissions is too sharp).
• Strengthen oversight to reduce corruption
• Reduce charges if most enterprises in a region
  cannot pay
• Simplify pollution tax procedures