The government of Costa Rica has been working to develop a methodology for classifying tax expenditure by its environmental impact to align the country’s fiscal policy with its environmental goals.
Aligning fiscal policy with climate goals is a key challenge to achieve the goals set in the Paris Agreement. Between 2020 and 2021, the government of Costa Rica with support from the IKI project Green Economy Transformation (GET) has developed a methodology for classifying tax expenditure by its environmental impact. The methodology generates the necessary information for decision-making to align the country’s fiscal policy with its environmental goals.
The Climate Change Directorate within Ministry of Environment and Energy emphasize the importance of such a tool for the pursuit of the countries climate targets: “As a country with clear goals to comply with the commitments under the Paris Agreement, it is critical to understand clearly: are our public finances promoting a decarbonized economy? Are our public finances consistent with our environmental policies?”
The new classification of tax expenditure provides a methodological basis to analyze both the current tax expenditure and that which may be proposed in future bills. An analysis of the current tax expenditure has revealed that only 1.6% of the tax expenditure has a positive impact, 26.7% has no impact, and 71.6% has a negative impact on environmental goals. The largest share of tax expenditure creating environmentally harmful incentives falls on tax exemptions for jet and shipping fuel as well as exemptions and reduced tax rates for pesticides and machinery used in agriculture.
The new methodology was developed by a working group of technical experts from the Ministries of Environment, Finance and Planning with the support of an international expert. In a next step, it will be integrated into the Ministry of Finance’s institutional framework, delivering relevant information used for decision-making based on evidence and transparency. In the process, a new understanding has been established between the fiscal and environmental authorities of the government of Costa Rica fostering inter-institutional cooperation. For the Fiscal Policy Division of the Ministry of Finance, this is just a starting point: “This work built a bridge between the ministries of Finance and Environment. It marks a milestone for the country to address how to comply with the National Decarbonization Plan in a technical and dedicated way.”
The methodology enables the identification of tax expenditure line-items based on the disaggregated analysis of the current framework, the application of internationally recognized standards, and their incidence on six strategic environmental public policy areas. For each expenditure line-item, incidence factors are assigned per each public policy area, ultimately resulting in an overall incidence factor estimation that facilitates their qualification, i.e., positive, neutral, or negative.
Based on the analysis, the involved parties have outlined a roadmap for the implementation of the methodology. This roadmap includes setting up an inter-institutional working group to monitor and analyze new tax expenditure proposals and ensuring access to information for different public entities, as well as the private sector and the civil society actors. This shall help a diverse set of actors to understand the scope of the data and utilize them for the country’s international environmental goals and national policies.
The implementation will facilitate the use of the evidence to support reforms that encourage environmentally-positive tax expenditure and scaling back such with adverse environmental impact. Additionally, the continuation of the methodology includes complementing the environmental impact analysis with a comprehensive economic and social assessment to understand the transition actions' impacts (intended and unintended) and devise the necessary compensation measures when social welfare is negatively affected.