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Better Use Of Energy Taxes Could Strengthen Developing Country Finances While Cutting Pollution, Says OECD

Developing countries could raise much-needed public revenues, while cutting emissions and air pollution, by making better use of energy taxes and reducing energy subsidies, according to a new OECD report.

Taxing Energy Use for Sustainable Development: Opportunities for energy tax and subsidy reforms in selected developing and emerging economies examines energy taxation in 15 developing and emerging economies in Africa, Asia and Latin America and the Caribbean. The report finds that well-designed energy and carbon taxes can strengthen efforts to improve domestic revenue mobilisation. While the revenue potential varies across countries, the report finds that, on average, the countries could generate revenue equivalent to around 1% of GDP if they set carbon rates on fossil fuels equivalent to EUR 30 per tonne of CO2.

Energy tax and subsidy reform is key to achieving the triple objectives of decarbonisation, domestic revenue mobilisation, and access to affordable energy. Developing and emerging economies battling to recover from the COVID-19 crisis with much lower tax revenues than advanced economies would benefit from better-designed energy taxes accompanied by targeted support to low-income groups. Tax-to-GDP ratios in the 15 countries studied average just 19% compared to 34% across OECD countries.

None of the 15 countries applies an explicit carbon price or uses CO2 emissions trading systems. To support poor households, fossil fuels used for heating, cooking and lighting are often taxed at low rates or subsidised, yet this weighs on public finances and in some cases can encourage excessive fuel use. In four of the 15 countries, the cost to public finances of energy subsidies exceeds income from energy taxes. Reducing subsidies, which tend to benefit wealthier consumers, and improving tax design could provide additional revenues for more targeted support to enhance energy access and affordability.

Across the 15 countries in the report, 83% of energy-related CO2 emissions are entirely untaxed. In the 44 OECD and G20 countries included in Taxing Energy Use 2019, around 70% of energy-related emissions are untaxed, underlining the need for all countries to do better in aligning tax policy with the negative effects of energy use.

On a positive note, five of the 15 countries do not use any coal and the use of wind and solar energy is growing fast. However, Morocco and the Philippines still use coal extensively for electricity generation. Importantly, the report notes that 13 of the 15 countries have experience with fuel excise taxes, meaning carbon tax reform would be relatively straightforward to implement in administrative terms.

Providing reliable and affordable access to clean energy is crucial for strong economic development. A long-term commitment to carbon pricing and phasing out fossil fuel subsidies can incentivise infrastructure investments that are in line with low-carbon and development objectives and reduce the risk of stranded assets and jobs. Carbon pricing can also help to tackle the high levels of informality that weigh on developing country economies as energy taxes are harder to avoid than direct taxes.

The 15 countries studied are Côte d’Ivoire, Egypt, Ghana, Kenya, Morocco, Nigeria and Uganda in Africa; the Philippines and Sri Lanka in Asia; and Costa Rica, Dominican Republic, Ecuador, Guatemala, Jamaica and Uruguay in Latin America and the Caribbean. None of the countries are high emitters, but all have signalled an interest in energy tax and subsidy reform through their participation in the Coalition of Finance Ministers for Climate Action (CFMCA) the Carbon Pricing Leadership Coalition (CPLC), or recent reforms.

The OECD will publish Effective Carbon Rates 2021 in the coming months, analysing how the price put on carbon emissions from energy use in advanced and emerging countries compares with actual climate costs.

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