Green Budget Tagging

4. Key challenges in designing and implementing green budget tagging

In designing and implementing an approach to green budget tagging, some aspects pose greater challenges and it is important to be aware of these, and prepare for them. This section identifies the most prominent challenge, and how they can be addressed. In particular, it looks at the challenges of identifying the appropriate level of granularity for tagging, deciding what to do with budget measures relating to adaptation; tagging negative budget measures; and balancing environmental, social and economic objectives.

4.1. Identifying the appropriate level of granularity for tagging

One of the key challenges faced by countries in implementing green budget tagging is identifying the appropriate level of granularity for budget measures to be tagged. Tagging broader budget lines on the one hand provides a high-level overview of budget alignment to green goals, but sacrifices granularity and overlooks the fact that different activities within the budget line may have different or even contrary effects on environmental and climate goals. For instance, should a country tag a budget line as contributing to climate or environmental objectives where only a portion of activities are relevant, external stakeholders may accuse the government of “greenwashing” expenditures. Should it not tag the budget line, then the government may have concerns that the tagging process does not include the full set of programmes which address the country’s climate objectives. Decisions on tagging can also be challenging when budget items are difficult to classify or where additional funding is provided in a budget line to make it climate sensitive (UNDP, 2019[8]). France, for example, noted the challenges of identifying whether budget lines relating to housing projects positively or negatively impact its green objectives.

Tagging at a more granular level is often more attractive, given that it provides greater levels of accuracy. However, it also brings its own risks, given that it requires greater resources (in terms of time and capacity for tagging). Additionally, considerations for the breadth (the number of sectors to be counted) creates an added dimension for countries along with the depth (level of granularity) of coverage.

Given the challenges of both broad and granular tagging, countries have to select an approach which balances their need for accuracy with the need to operate within the government’s capacity, as well as the purpose of the tagging (e.g. mainstreaming, accountability and transparency). Decisions on the appropriate level of granularity can be taken in tandem with decisions on the appropriate weighting system in order to reduce trade-offs. For example, when tagging at a higher level, using a weighting system which allows only part of the budget item to be included facilitates greater understanding of the budget’s alignment towards green objectives.

4.2. Deciding how to deal with budget measures relating to disaster risk management and adaptation

When designing a tagging approach, it is important to consider the extent to which spending related to disaster risk management and adaptation efforts are consistent and coherent with a country’s national environmental and climate goals and therefore how they should be tagged. One of the reasons that this activity is difficult to categorise is because it is contextual and differs for each country, depending on its needs. This can be particularly challenging as potentially many government actions can count towards adaptation efforts (e.g. health and education programmes along with flood prevention measures). In addition, one country’s efforts may also have negative externalities for another country – raising the importance to consider spillover effects of adaptation measures.1 For example, building a floodwall in a region may be appropriate to prevent instances of future flooding, but can have negative spillovers to the local ecosystem and biodiversity and affect neighbouring regions’ ability to adapt to climate change. In other cases, certain measures considered effective today may have negative consequences in the future or likewise, measures considered effective by a majority of society may undermine the resilience of ethnic minority groups. As such, it may be important to consider the risks of maladaptation, where adaptation actions can serve to potentially exacerbate existing vulnerabilities to climate change.

Furthermore, tagging certain mitigation or adaption measures may largely depend on the country’s specific methodology, as many of these dimensions (particularly in the development context) can be counted towards development interventions (e.g. expanding electricity via renewable energy or ecosystem rehabilitation to reduce flooding) (World Bank, forthcoming[2]). Thus, there is a strong argument for tagging disaster risk management and adaptation measures separately from mitigation activities.

4.3. Tagging negative budget measures

Most countries do not tag budget measures which make a negative contribution to climate and environmental goals. Given that the intent and purpose of green budget tagging is often to help inform decisions, not having a sense of areas which negatively contribute to a country’s green objectives limits the ability to have a full understanding of a country’s progress. For example, analysis in Finland and Indonesia has shown that negative expenditures can outweigh positive climate expenditures (World Bank, forthcoming[2]). Oftentimes, this includes overlooking budget measures related to fossil fuel subsidies, as well as agricultural and construction measures. For example, Finland has recently found that its budget contains about EUR 3.5 billion of harmful energy subsidies, twice the amount dedicated to subsidies for becoming carbon-neutral and resource-wise (Finnish Ministry of Finance, 2019[53]; Annukka et al., 2019[54]). In Ireland, a study analysed several scenarios on increases in carbon taxes and removal of fossil fuel subsidies. Results showed that removing fossil fuel subsidies would lower total economy-wide CO₂ emissions by 20% in 2030. Emissions were estimated to be 31% lower in 2030 if an increase in the carbon tax was added to the removal of the fossil fuel subsidies (de Bruin, Monaghan and Yakut, 2019[55]).

To overcome this challenge, it is recommended, as a starting point, to identify priority sectors and large expenditure areas which are known to already have a negative impact on climate change, such as fossil fuel subsidies and programmes which facilitate deforestation, mining and burning coal (UNDP, 2019[8]). The OECD, the International Monetary Fund and the World Bank continue to work with countries to assist in this effort. The OECD identifies over 1 300 budgetary transfers, tax breaks and spending programmes providing support to the production and consumption of coal, oil, gas and other petroleum products in 44 OECD and G20 economies to shed light on how public resources are used (OECD, 2020[56]; 2020[57]). Government support for the production and consumption of fossil fuels in these 44 advanced and emerging economies remains high, at USD 178 billion based on 2019 figures, representing a 10% increase from 2018. This increase was dominated by a 38% year-on-year rise of direct and indirect support for fossil fuel production, predominantly in OECD countries (OECD, 2020[57]). The International Monetary Fund, which incorporates external cost estimations such as road use and congestion costs and health impacts of air pollution in its estimates of fossil fuel support, found in its assessment that global subsidies remained high, at USD 4.7 trillion in 2017, with three-quarters of subsidies due to domestic factors such as energy pricing reform (Coady et al., 2019[58]). In other contexts, countries have relied on the World Bank’s Energy Subsidy Reform Assessment Framework to identify and quantify energy subsidies in relation to their impact and to evaluate the enabling environment for reform efforts (ESMAP, n.d.[59]). Though these initial approaches may rely on subjective judgements of programmes, just as in categorising positive expenditure, it provides an opportunity to balance the discussion among decision makers. An example of a country that is tagging negative budget measures is France (Box 21).

Box 21. Tagging negative expenditures in France

In 2017, France committed to the Paris Collaborative on Green Budgeting, launched by the OECD, to assess the compatibility of its public finance trajectories with the Paris Agreement and other environmental goals. As part of these efforts, France experimented a methodology in 2019 and then developed its first comprehensive “green budget” as part of the 2021 Budget that provides an overview of budget measures and their alignment with France’s green objectives. Specifically, measures are categorised according to the extent to which they have a favourable or negative impact on six environmental dimensions. The scale is shown below:

3: Very favourable, environmentally targeted expenses

2: Favourable, no explicit environmental target, but indirect positive impact

1: Favourable but controversial, e.g. short-term favourable effects but presence of a long‑term technology lock in risk

0: Neutral, no significant impact of information

-1: Unfavourable, environmentally harmful expenditure

Sources: Ministry of Ecological Transition (2020[20]); Government of France (2020[60]).

4.4. Ensuring consistency and quality of tagging

Budget tagging processes are often subjective and susceptible to significant exclusion and inclusion errors. Furthermore, localised approaches and different methodologies make it difficult to compare across countries and in some cases, within countries across sectors. In some situations, the subjective nature of tagging can give opportunity for “greenwashing” or result in undertagging. For instance, tagging programmes on coal mine dismantling as having a positive impact towards green objectives may be viewed with scepticism by certain stakeholders.

Clear guidance for green budget tagging, together with support on how to deal with the more ambiguous budget lines, and validation processes can help (as outlined in Section 2.3). While this can increase capacity requirements (World Bank, forthcoming[2]), these actions help build the system’s credibility. For example, reviews by senior officials may provide incentives to improve the quality of the tagging as well as increase the visibility of the process to facilitate appropriate engagement across all levels of government.

As part of the continuous improvement process, it can be useful to conduct internal ex post checks that help improve tagging processes over time. External stakeholders may also be able to help, such as the supreme audit institution, parliament, independent fiscal institution or civil society. These stakeholders may do so through general scrutiny of tagging reports or by conducting ex post reviews, audits and evaluations that provide a view on the correctness of tagging. A good practice example is provided by Bangladesh, where performance audits have been introduced for certain climate-tagged projects with a pilot currently also being discussed in Pakistan (World Bank, forthcoming[2]).

4.5. Balancing environmental, social and economic objectives

It is important to remember that the information from green budget tagging highlights how budget measures contribute to environmental objectives, but these measures have varying impacts on broader social and economic objectives. It may be that budget measures contributing to environmental objectives also have positive social and economic benefits. In particular, there are often benefits for future generations, who would otherwise be affected through the damaging effects of climate change (IMF, 2013[61]). Recent events have illustrated that there can also at times be tensions between these objectives. For example, France’s efforts to adopt carbon taxes have been met with social opposition from the Gilets Jaunes protests as a result of the increased tax burden they placed on the working class with limited access to public transportation, in context to concurrent a rise in fuel prices. In other instances, pursuits for climate or environmental goals conflict with policies aimed at addressing inequality. In efforts to address some of these tensions, Ireland has an approach to use revenues from carbon taxes to protect communities most at risk – bringing wider social acceptance to carbon tax increases.

Green budget tagging can be useful in identifying budget measures which negatively impact green goals (e.g. fuel subsidies), stimulating reforms in this area. To ensure that work such as green budget tagging does not inadvertently give rise to social or economic tensions, the evidence that it provides should not be considered alone in decision making. Instead, the information should be used to frame policy discussions on how to reduce the negative environmental impact while managing any associated social and economic trade-offs. These can be in the form of identifying plans to phase out subsidies over time, as observed in Ecuador (Box 22). Consideration should be given to the socio-economic implications of different options.

Box 22. Understanding the distributional impact of subsidy reform in Ecuador

With 7% of Ecuador’s annual spending comprised of energy subsidies, identifying ways to reduce the amount of public spending on subsidies can yield economic and environmental benefits. However, given perceptions that subsidy reductions are felt by the most vulnerable households, reforms have been met with political resistance. A study by the Inter-American Development Bank found that energy subsidies, in absolute terms, largely benefit richer households. By shifting funding from subsidies to an existing social protection programme (Bono de Desarrollo Humano) by about USD 50 per month, a net benefit of almost 10% is felt by those in the poorest quintile. The study recommended reforms to eliminate subsidies on gasoline while increasing transfers to vulnerable households and replacing liquefied petroleum gas (LPG) subsidies with targeted LPG vouchers that can benefit the poorest 40% of households in the country.

Source: Schaffitzel et al. (2019[62]).

Note

← 1.  Note, mitigation spend may also have negative externalities.