public finance restructuring for sustainable development...
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PUBLIC FINANCE RESTRUCTURING
FOR SUSTAINABLE DEVELOPMENT IN
EMERGING MARKET ECONOMIES
THERESA BRADLEYEDITOR
W O R L D R E S O U R C E S I N S T I T U T E
PUBLIC FINANCE RESTRUCTURINGFOR SUSTAINABLE DEVELOPMENTIN EMERGING MARKET ECONOMIES
Theresa Bradley, editor
W O R L D R E S O U R C E S I N S T I T U T E
September 1998
Carol RosenPublications Director
Hyacinth BillingsProduction Manager
Environmental ActionCover Photo
Each World Resources Institute Report represents a timely, scholarly treatment of a subject of public concern. WRItakes responsibility for choosing the study topics and guaranteeing its authors and researchers freedom of inquiry.It also solicits and responds to the guidance of advisory panels and expert reviewers. Unless otherwise stated,however, all the interpretation and findings set forth in WRI publications are those of the authors.
Copyright © 1998 World Resources Institute. All rights reserved.ISBN 1-56973-274-4Library of Congress Catalog Card No. 98-87590
Printed on recycled paper
CONTENTS
I. OVERVIEW 1
A. Public Finance and the Environment . . . . 1
B. Case Study Findings andRecommendations 2
C. A "Greener" Public Finance System 7
D. Envisioning the Optimal Public FinanceSystem 8
E. Direction of Public Finance Reforms . . . . 9
F. Policy Recommendations 11
II. INDIA CASE STUDY 17
A. Introduction 17
B. Policy Instruments for Air PollutionAbatement 18
C. Electricity Pricing 19
D. Challenges and PotentialBenefits of Long-run MarginalCost (LRMC) Pricing 23
III. MEXICO CASE STUDY 25
A. Introduction 25
B. Transportation Policies 26
C. Consideration of a Gasoline Tax 27
D. Environmental and EconomicEffects of a Gasoline Tax 27
E. Design and Implementation of aGasoline Tax 30
IV. POLAND CASE STUDY 33
A. Introduction 33
1. Air Pollution Legacy of CentralPlanning 33
2. Toward Sustainable Development... 34
B. Public Finance Restructuring 36
1. Energy Pricing 36
2. Taxing Pollution 40
a. Shifting the Tax Base 42
b. Cleaning Up Past EnvironmentalDamage 42
c. Earmarking for EnvironmentalInvestments 43
C. Challenges and Opportunitiesfor Reform 44
TECHNICAL APPENDIXIndia Case Study Estimation ofLRMC Prices 49
m
FOREWORD
As natural resource degradation threatensprospects for economic development inmany industrializing countries, govern-
ments need to do a better job at integrating envi-ronmental issues into their economy-wide policyreform agendas. At an early stage of acceleratedeconomic growth, emerging market economiesthat adopt an energy-efficient and clean technol-ogy development strategy will avoid or at leastreduce the use of dirty industrial processes andenergy sources that have harmed the environ-ments of developed countries. Because taxes andother public finance policies play a critical rolein determining the incentives that drive eco-nomic decision-making in market-based sys-tems, they are powerful instruments to promotean economy-wide shift toward more resourceand energy efficient technologies. Governmentsshould eliminate faulty subsidies that harm theenvironment, correct market distortions that en-courage pollution and resource waste, and setprices for extraction, harvesting and use of pub-licly owned resources at the level the marketwill bear. These policies would bring economicas well as environmental benefits. As marketforces strengthen in these emerging economies,opportunities to adopt these measures are un-folding. Yet to date, use of these instruments isnot widespread.
Dr. Bradley and her co-authors explore the po-tential application of public finance policies topromote sustainable development in emergingmarket economies using energy sector case stud-ies of India, Mexico and Poland. A number of
findings emerged. Public finance instruments thatcomplement a country's system of environmentalregulations can lead to efficiency gains and im-provements in both the local and global environ-ment. The study also indicates that these reformscan generate significant government revenuesthat could be used in a variety of beneficial ways,depending upon the country's fiscal conditionsand priorities. Equity concerns arising from pub-lic finance reforms should be adequately ad-dressed by packaging these reforms as part of alarger program of revenue generation and gov-ernment expenditure aimed to improve economicefficiency and alleviate poverty. This study alsoindicates that public finance reforms are most ef-fective when complemented by a system of envi-ronmental regulations, macroeconomic stability,and framed within an overall macroeconomic re-form program that creates a stable, competitiveenvironment for private investment and long-term economic growth.
Public Finance Restructuring for SustainableDevelopment in Emerging Market Economies is thelatest in the World Resources Institute's continu-ing series of reports on options for revising taxpolicy and other economic incentives to curbpollution and wasteful energy use worldwide.This report's recommendations extend those ofsuch previous WRI studies that focus on devel-oped country issues as Green Fees: How a TaxShift Can Work for the Environment and theEconomy and The Right Climate for Carbon Taxes:Creating Economic Incentives to Protect theAtmosphere.
Further work is needed to realize the fullpotential of these instruments in emerging mar-ket economies. Information on pollution damagesand abatement costs need to be compiled and re-fined and government capacity to administerpollution abatement policies needs to bestrengthened.
Appreciation is expressed to the followingagencies for their intellectual foresight and gener-ous financial support: the American ConservationAssociation, Inc.; the Dutch Ministry of Foreign
Affairs; the Ford Foundation; the W. Alton JonesFoundation; The John D. and Catherine T.MacArthur Foundation; the Merck Family Fund;The Nathan Cummings Foundation; the UnitedNations Environment Programme; the U.S.Environmental Protection Agency's Office ofPolicy, Planning and Evaluation; and Dr. StephanSchmidheiny.
Jonathan LashPresidentWorld Resources Institute
VI
ACKNOWLEDGMENTS
This report is the product of a collaborativeresearch effort. The participants, listed onthe following page, made great contribu-
tions in defining the issues studied and provideda wealth of information, research experience, andexpertise. Case study collaborators supplied thelargest share of information in this report. Thelead author had the limited role of synthesizingthe more extensive background papers con-tributed by the case study research teams, andmaterial from other sources into an integrated re-port. This process inevitably required the lead au-thor to make judgments, and not all collaboratorsnecessarily agree with all that this report contains.
Research assistance for the Polish case studywas provided by Elzbieta Broniewicz, JoannaBukowska, Maciej Cygler, Joanna Drozyner, andJoanna Spyrka. The Mexican team of collaboratorsbenefitted from material prepared by Luis MiguelGalindo, Fidel Aroche, Elba Ortiz, HeribertoCastillo, Soledad Hernandez, and Lilian Saade.Alejandra Elizondo, Paola Arredondo, ManuelVilla, Santiago Lobeira, Sofia Cortina, and MarciaSanroman provided research assistance.
Many thanks go to numerous colleagues whogave generously of their time and expertise andprovided encouragement at various stages of this
project. The report benefitted from comments andsuggestions by WRI staff, including AlanBrewster, Paul Faeth, Tom Fox, Carolina Katz,Crescencia Maurer, and Walt Reid. BeataSmarzynska, a summer intern at WRI, providedvaluable research assistance on the Polish casestudy. Constructive and extensive comments wereprovided by the following external reviewers:Carter Brandon, Colin Bruce, Gunnar S. Eskeland,Mudassar Imran, Theodore Panayotou, R.K.Pachauri, David Reed, and Victor Urquidi.Deepest thanks goes to Robert Repetto who gener-ated the idea to undertake this study and did allof the groundwork needed to assemble the inter-national team of researchers. He continued to pro-vide leadership, guidance, and intellectual sup-port throughout the process. The report greatlybenefitted from his involvement. Notwith-standing gratitude to all of these colleagues fortheir valuable contributions, the lead author takesfull responsibility for the report's contents.
Special thanks go to Tine Nielsen and MarcaHagenstad for their administrative assistance, toMelissa Edeburn for her skillful editing of the re-port, to Hyacinth Billings for her management ofthe production process, and to WRI's PolicyAffairs Program for management of the distribu-tion process.
vn
CONTRIBUTORS
Dr. Theresa Bradley, lead authorWorld Resources Institute
India Case Study:Dr. Om Mathur, team leaderNational Policy Research Institute
Professor U. Sankar, team leaderMadras School of Economics
R. AnuradhaMadras School of Economics
G. MythiliMadras School of Economics
Mexico Case Study:Dr. Juan Carlos Belausteguigotia, team leaderSecretaria de Medio Ambiente, RecursosNaturales y Pesca
Hugo Contreras, team leaderSecretaria de Medio Ambiente, RecursosNaturales y Pesca
Alejandra ElizondoSecretaria de Medio Ambiente, RecursosNaturales y Pesca
Paola ArredondoSecretaria de Medio Ambiente, RecursosNaturales y Pesca
Manuel VillaSecretaria de Medio Ambiente, RecursosNaturales y Pesca
Santiago LobeiraSecretaria de Medio Ambiente, RecursosNaturales y Pesca
Sofia CortinaSecretaria de Medio Ambiente, RecursosNaturales y Pesca
Poland Case Study:Professor Boguslaw Fiedor, team leaderEconomics Department of Wroclaw Academy ofEconomics
Dr. Habil Wojciech BienkowskiWarsaw Economic University and National Fundof Environmental Protection and WaterManagement
Dr. Stanislaw CzajaWroclaw Academy of Economics
Dr. Andrzej GraczykWroclaw Academy of Economics
Professor Bazyli PoskrobkoBialystok Technical University
Dr. Grzegorz PeszkoCracow Academy of Economics
Dr. Tomasz ZyliczWarsaw University and the Ministry ofEnvironmental Protection, Natural Resources andForestry
IX
I. OVERVIEW
A. Public Finance and theEnvironment
Evidence that urban pollution in developingcountries poses significant public healthrisks—particularly for the young, elderly,
and the poor—is growing.1 With increased ur-banization and rapid economic growth, air pollu-tion and other environmental problems are likelyto worsen in many cities unless corrective actionis taken. Even under optimistic assumptions ofenergy efficiency gains, energy use in developingcountries is expected to triple during the next 30years, implying much more fossil fuel combus-tion. By 2020, energy use in these countries willbe double that of countries of the Organizationfor Economic Co-operation and Development(OECD.)2
In the 1990s, policy-makers in emerging mar-ket economies3 are at a pivotal point. As they facerapid economic changes, the opportunity to guidetheir countries onto sustainable developmentpaths and protect public health has never beengreater. At the early stages of accelerated eco-nomic growth, countries that adopt an energy-efficient and clean-technology development strat-egy will avoid or at least reduce the use ofindustrial processes and energy sources that haveharmed the environments of developed countries.As Stanley Fischer, first deputy managing direc-tor of the International Monetary Fund, has said,"Natural resource degradation that threatens[economic] growth cannot be ignored. Taking ac-count of such environmental concerns [in f ormu-
lating macroeconomic policy] is just goodeconomics."4
Public finance policies—taxes, subsidies, andpublic-sector pricing can promote an economy-wide shift toward more resource and energy-efficient technologies. Emission taxes, for exam-ple, force polluters to pay the costs of theiractions, providing incentives to reduce the scaleof polluting activities. But despite a wide array ofpublic finance policy tools and other market-based instruments designed to reduce pollution
Public finance policies—taxes,subsidies, and public-sector pricing—can promote an economy-wide shifttoward more resource and energy-efficient technologies.
(see Box 1), environmental issues are by no meansfully integrated into the economy-wide policy re-form agendas of emerging market countries.
This report explores the potential applicationof public finance policies to promote sustainabledevelopment in emerging market economies.Conclusions are drawn on the basis of case stud-ies in India, Mexico, and Poland, which were
Box 1. Market-Based Instruments forEnvironmental Protection
A. Public Finance Tools1. Fiscal Policies
a. Direct: Effluent Charges/PollutionTaxes
b. Indirect: Product Charges (taxes oninputs or outputs), Subsidies forSubstitutes and Abatement Inputs
2. Pricing Policiesa. Electricity Tariffsb. User Fees for Water and Sanitation
Servicesc. Royalty and Concession Fees for
Natural Resource Extraction andHarvesting
B. Other Instruments1. Tradable Permits for Emissions2. Deposit Refund Systems and
Performance Bonds (used to guaranteecompliance with an environmentalstandard or other desirable outcome)
3. Liability Insurance (against environ-mental damage)
chosen, in part, because they suffer from seriousenvironmental degradation and are involved inpublic finance restructuring and other major eco-nomic reforms. Each case study examines howbest to design and implement public finance re-forms within the subject country's unique social,political, and economic context.
Policy issues addressed in the three case stud-ies primarily concern the energy sector. Thisfocus was chosen, in part, because large subsidiesand other public finance policies affecting the en-ergy sector of many developing and transitionaleconomies have harmed both economic efficiencyand the environment; therefore, the potential ben-efits from reform of these policies are likely to belarge. The Polish study examines the potentialscope for increased taxes on air pollution, withparticular attention to the restructuring of energy
prices to reflect the full economic costs of energyproduction and consumption. The India casestudy also investigates opportunities for moreefficient pricing of electricity. The Mexican casefocuses on the economic and environmental ef-fects on Mexico City of a gasoline tax.
These case studies may provide guidance forpolicy-makers in other emerging marketeconomies of central and eastern Europe, LatinAmerica, and southern Asia that are restructuringthrough trade liberalization, deregulation, andprivatization to strengthen the role of marketforces. Eastern European and Asian countries areabandoning central planning and creating newinstitutions, economic policies, and regulatorystructures to transform themselves into market-based economies. As market forces are strength-ened, these public finance tools become poten-tially powerful instruments for governments toprevent environmental damage.
B. Case Study Findings andRecommendations
Although each case study has unique charac-teristics, several broad findings and policy recom-mendations emerge from a cross-country analysis.
In all three case studies, relyingprimarily on regulatory instruments toprotect the environment has not beensufficient.
1. Public finance instruments can complement acountry's system of environmental regulations.In all three case studies, relying primarily on reg-ulatory instruments to protect the environmenthas not been sufficient. In India, the govern-ment's regulatory effort to control air pollutionthrough emission standards could be supportedby fiscal reforms. In the meantime, large subsi-
dies for electricity use are leading to wastefulconsumption and an unreliable power supply.Emission taxes and tradable permit schemes arenot being used although they could help preventand control air pollution as well as complementand strengthen the effectiveness of environmentalregulations.
Mexico's regulatory approach to reduce gaso-line consumption—El Dia Sin Auto—has notworked.5 Mexico City's regulations to increasethe use of cleaner fuels and reduce vehicularemissions through emission standards and car in-spections should be complemented by a gasolinetax aimed at reducing fuel consumption. Onestudy demonstrates that the welfare cost of re-ducing vehicular emissions through the imposi-tion of a gasoline tax and other measures is lowerthan that of sole reliance on the other measures.6
A country needs to employ a wide rangeof regulatory and market-basedinstruments to reduce pollution cost-effectively.
This finding confirms that ultimately a countryneeds to employ a wide range of regulatory andmarket-based instruments to reduce pollutioncost-effectively. As one study states, "The role ofenvironmental taxes must be assessed in the con-text of the range of environmental policy instru-ments that could be employed.... In practice, acombination of policy instruments is likely to berequired to address environmental damage withthe relative importance of tax and other environ-mental policy instruments determined by theirrelative cost effectiveness."7
2. Public finance reforms can benefit both thelocal and global environment, although synergiesbetween local and global abatement objectivesmay be limited. According to the India casestudy, if electricity prices are raised to cover the
long-run marginal cost, the rate of growth of elec-tricity demand over the medium term would bebetween 1.5 and 2.25 percentage points below the6 percent baseline estimate. The decline in thisrate of growth would decelerate the rate ofgrowth of carbon dioxide (CO2) emissions and re-duce levels of particulate matter and other pollu-tants in urban air. The India case study indicatesthat "getting the price right" in a phased mannerover a period of seven years would lower the rateof increase in CO2 emissions to 30-36 percentcompared with a 50 percent rate of increase in theabsence of price reform.
Although a decline in energy demand wouldyield global benefits (CO2 emission savings) inmost countries, it might not always lead to imme-diate improvements in local air quality. The airquality model simulations conducted for theMexico study indicate that although a gasolinetax could bring about substantial emissions re-ductions, the relationship of these reductions toambient air quality is not always proportionate.According to the simulations, a 30 percent gaso-line tax would reduce up to one-quarter of trans-portation-sector pollution emissions, but effectonly a marginal decrease in peak ozone concen-trations. The relatively small decrease in peakozone concentrations can be attributed to highbackground concentrations of reactive hydrocar-bons and to adverse climatic conditions that pro-mote ozone formation in Mexico City.8
From a broader perspective, the choice of in-struments to reduce pollution should be deter-mined on the basis of their cost effectiveness.
3. Immediate environmental benefits from publicfinance reforms are small where price elasticitiesare low, but a portion of the tax revenue gener-ated can reduce obstacles that contribute to theinelasticity of demand. Studies of energy demandelasticities9 in developing countries indicate thatthe long-run price elasticity of energy demand isabout -0.5, although estimates vary across coun-tries. In the short-term however, demand is lesselastic because substitutes are not readily avail-able, and other factors impede the ability of firmsand households to respond to price signals.
Under these circumstances, environmental taxesand energy pricing reforms have little effect onpolluting activities but are a good source of gov-ernment revenue. The Poland case study indi-cated that the economy's responsiveness tohigher coal prices has been weak. In Poland's res-idential sector, energy demand is price inelasticin part because cleaner fuel substitutes are notreadily available. Households are also unrespon-sive to changes in heating prices because in manyapartment buildings residents are charged forheating by size of the unit rather than by thequantity of heat they consume.
If a portion of environmental taxrevenues is earmarked for environmentalexpenditure, there must be well definedobjectives and priorities as well asmechanisms to monitor, evaluate and,when necessary, reform the allocationsystem.
To address the problem of residential heatingwith coal stoves, several cities in Poland haveprograms under way to eliminate the use of thesestoves and provide alternative heating sources.There are a few programs to install metering sys-tems in residential buildings. Financed by envi-ronmental taxes, these programs could be ex-panded to other cities, and implementation ofexisting programs could be accelerated.
The responsiveness of Poland's industrial sec-tor to higher energy prices has also been limited.Many industrial firms are in weak financial con-dition and have little capital to invest in energyefficiency nor have they acquired the skillsneeded to ascend the technological ladder.Industry associations, in partnership with gov-ernment, should play a major role by providinginformation and training to build up firms' capa-bilities to choose, finance, and adapt advanced
technologies. Again, a portion of revenue fromenvironmental taxes could be earmarked tofinance the public-sector contribution to trainingand information programs.
If a portion of environmental tax revenues isearmarked for environmental expenditure, theremust be well defined objectives and priorities aswell as mechanisms to monitor, evaluate and,when necessary, reform the allocation system.Systems of earmarked environmental funds arecommon among transitional economies; Poland,for example, has one of the most extensive sys-tems. These funds have provided a stable sourceof financial assistance, mainly through soft loans,for environmental investments during a period ofgreat economic instability and transformation.But only limited attention has been paid to eco-nomic performance criteria in the distribution ofthe funds across investment projects.10 The objec-tives and priorities of the National EnvironmentalFund need to be examined, and systems to moni-tor and evaluate the investment decisions of theFund need to be made more effective. Some rev-enue from pollution taxes could be earmarked tofinance a cleanup fund to pay for environmentaldamages from state enterprises. Such a fundmight help accelerate the process of privatization.By lending credibility to a government's commit-ment to accept liability for past damages, a gov-ernment cleanup fund would reduce the financialrisk of purchasing state-owned enterprises.11
For countries such as India, which areburdened by high fiscal deficits, reducingenergy subsidies would result in a morefavorable fiscal balance.
4. Once needed public environmental investmentsare financed, revenues from public finance re-forms can be used in a variety of productiveways, depending on a country's fiscal conditionand priorities. For countries such as India, which
are burdened by high fiscal deficits, reducing en-ergy subsidies would result in a more favorablefiscal balance. The India case study indicates thatat current tariff rates, the Indian governmentdished out a net Rs 80 billion in electricity subsi-dies during 1994-95. According to the EconomicSurvey 1996-97, the net subsidy for 1997-98 is es-timated to be Rs 175 billion, which accounts forabout one-half of the gross fiscal deficit of India'sstate governments.
The most innovative and unexploredoption for public funds mobilized byenvironmental taxes is to reduce the taxburden of the economy's productiveelements.
The poor may stand to gain the mostfrom removal of energy subsidies.
The most innovative and unexplored option forpublic funds mobilized by environmental taxes isto reduce the tax burden of the economy's pro-ductive elements. The Mexico case study findingsindicate that the economic effect of a gasoline taxon output is minor when the revenue collected isredistributed through reductions of taxes on capi-tal and labor. The Poland case study demonstratesthat Poland's newly formed tax system has greatscope to shift the tax base onto polluting activitiesand reduce the currently excessive burden onpayroll and income taxes. Thus, public finance re-forms can improve environmental protection aswell as reduce the burden of direct taxes on pro-ductive economic activities.
The gains in economic efficiency are likely tobe large. Income taxes, payroll taxes, and salesand trade taxes impose substantial costs on theeconomy by distorting the incentives for produc-tion and consumption. Yet only a few studiesmeasure this burden in developing countries.12
5. Equity concerns arising from public finance re-forms can be adequately addressed. Equity issues
arise in the debate of environmental taxes be-cause these taxes often raise the price of con-sumer goods that comprise a large share of thepoorest households' expenditures. Yet the poormay stand to gain the most from removal of en-ergy subsidies. A study of Poland's subsidies fordistrict heating presents evidence that the middleand upper classes spend a larger fraction of theirincome on energy consumption than the poor. Inthis case, the rich—not the poor—are the mainbeneficiaries of these subsidies. There is also evi-dence that the health of the poor is disproportion-ately harmed by pollution, in part because thepoor tend to be more exposed to pollutants andare more susceptible to disease because of overallpoor health (see endnote 1). The poor stand to gainthe most from removal of energy subsidies. Toaddress this issue on a case by case basis, solidempirical research on distributional effects of re-form proposals is needed.
Where equity is of true concern, large andwidespread energy subsidies are not the mostcost effective way to address this social issue. Asdiscussed in the Poland case study, one policyoption is to use direct cash payments to compen-sate low-income households for energy price in-creases. However, targeting subsidies to theneedy is difficult to implement in practice.Alternatively, the government could charge alow, subsidized price for a fixed, modest energyquota to all consumers, and charge the full cost tothose households that consume beyond thequota.13 Although this policy would be less effi-cient than a direct compensation program be-cause it would subsidize all consumers, not justthe poor, its design ensures that the large major-ity of consumers will pay a price for energy thatis close to economic cost at the margin.
Considering equity issues within a broad per-spective is important. Even though lower-incomegroups spend a disproportionately higher per-centage of income on taxed income-elastic com-modities, in aggregate the rich still pay moretaxes in absolute terms—revenue that could beinvested in poverty alleviation programs, trans-portation, and other progressive projects. Thus, toaddress equity concerns, public finance reformsto improve environmental quality should bepackaged as part of a larger program of revenuegeneration and government expenditure aimed atimproving economic efficiency and alleviatingpoverty.
institutions to make and enforce environmentalpolicies, macroeconomic stability, and the inclu-sion of inflation-adjusting mechanisms enhancethe effectiveness of public finance reform. Inmany developing and transitional economies,structural and institutional rigidities are dampen-ing the effectiveness of public finance reforms.
The Poland case study shows that fiscalpolicies are effective only to the extentthat firms are concerned about theirbottom line.
To address equity concerns, publicfinance reforms to improveenvironmental quality should bepackaged as part of a larger program ofrevenue generation and governmentexpenditure aimed at improvingeconomic efficiency and alleviatingpoverty.
This task may be difficult for countries facinghigh fiscal deficits. Although exploring newsources of tax revenue would be appealing tomost governments, increasing public resourcesfor poverty alleviation to cushion the economichardship imposed by tax increases on the poor isdifficult in an economic and political environ-ment of fiscal cutbacks. Nevertheless, distributionissues should be addressed mainly through gov-ernment expenditure policies, and efficiency con-cerns should guide the choice of instruments forpollution reduction.
6. Public finance reforms are most effective whenaccompanied by complementary, economy-widepolicies and institutional capacity building.Competitive forces, the capacity of government
Competitive forces must exist if market-based in-struments are to be effective. To take an extreme ex-ample, the more than 400 environmental taxes inPoland's system of central planning had ab-solutely no effect on investment or productiondecisions of state enterprises during the days ofcentral planning. Even though tax rates wererevalued upward several times in the 1970s and1980s, they had little economic significance forfirms whose performance was measured by theircapacity to fulfill production orders regardless ofcosts and whose losses were covered by centralgovernment credits. Poland's state of environ-mental degradation after years of central plan-ning is testimony to the failure of these environ-mental taxes to encourage pollution preventionand control. The Poland case study shows thatfiscal policies are effective only to the extent thatfirms are concerned about their bottom line.Without competition from other firms, state en-terprises do not try to keep costs low—they sim-ply pass on rising costs to consumers. Even dur-ing Poland's transition, competitive forces fromnewly formed private companies and interna-tional markets are dampened by state-owned en-terprises' indifference to costs. Their budgetaryconstraints are softened by the guarantee that thegovernment, as owner, can bail them out if finan-cial problems occur. Consequently, the slow paceof privatization in Poland, as in many other tran-
sitional economies, is mitigating the effect of fis-cal restructuring efforts. The main lesson is thatfiscal restructuring and other public finance re-forms should be framed within an overall macro-economic reform program that creates a stable,competitive environment for private investmentand long-term economic growth.
The effectiveness of fiscal policies are dampened byweak government institutions and conflicts of interest.In Poland, the government often waives emissiontax payments for state-owned enterprises—an in-herent conflict of interest exists when the govern-ment is in effect mandated to tax itself. One WorldBank study finds that tax arrears in general haveproven to be "the most difficult 'subsidy' to elimi-nate, in part because tax administration is weak."14
Privatization will help reduce government inter-ference in industries' economic decisions andenable environmental regulatory institutions toenforce environmental laws and policies.
In some cases, new laws and institutions arerequired to implement fiscal and other public fi-nance reform programs. In the case of India, es-tablishing an independent tariff committee thatwould be able to set electricity tariff rates withoutgovernment interference would greatly enhancethe prospects for achieving long-run marginalcost pricing. In the case of Mexico, legal issues re-garding the constitutionality of state gasolinetaxes would need to be addressed.
Macroeconomic instability discourages householdsand firms from adopting a long-term perspective whenmaking economic decisions. In an atmosphere ofeconomic instability, fiscal and other public fi-nance reforms intended to affect investment deci-sions are weakened. Households and firms are re-luctant to make a long-term commitment ofcapital in periods of economic uncertainty. Asharp economic downturn, not investments in en-ergy-efficient plants, equipment, and durablegoods, was primarily responsible for Poland's airquality during the early stages of transition.Sharp declines in income and high inflation ratesduring a period of enormous social, economic,and political change did not provide a favorableinvestment climate. Only later, as the macro econ-
omy stabilized, did firms begin to react to envi-ronmental taxes and other fiscal incentives.
High inflation erodes the incentive effect of somemarket-based instruments unless they include an auto-matic inflation-adjusting mechanism. The potentialeffectiveness of Poland's vast system of emissiontaxes quickly diminished when inflation soaredover 100 percent in the second half of 1989. Sincethen, the government has raised rates severaltimes in attempts to match expected inflation.Environmental funds, financed by pollution fees,now collect 15-20 percent more revenue in realterms than in 1990. However, to ensure that thetax base does not erode in the future, the systemof pollution taxes would need to be redesigned toinclude an automatic inflation-adjusting mecha-nism. Ad valorem energy taxes embody such amechanism.
C. A "Greener" Public FinanceSystem
The Poland, Mexico, and India case studiesdemonstrate the potential use of public financetools to address environmental concerns in the en-ergy sector. From a broader public finance per-spective, environmental considerations have notguided tax reform in emerging market economies,however advantageous that would have been.With respect to fiscal reforms, large and persistent
From a broader public finance perspec-tive, environmental considerations havenot guided tax reform in emerging marketeconomies, however advantageous thatwould have been.
fiscal deficits and the expected decline in govern-ment revenue as tariff rates are reduced have beenthe forces driving domestic tax reforms and sub-sidy reductions in many countries.
Both the World Bank and InternationalMonetary Fund have supported fiscal reform ef-forts as an important component of a strategy topromote long-term economic growth. Althoughadvice on tax reform needs to be country specific,the World Bank and IMF adhere to three generalprinciples. First, simplify the design of tax instru-ments, with fewer rates and fewer adjustments tothe tax base—in particular, eliminate or trim spe-cial tax incentives for investment, production, andtrade. Second, strengthen tax administration toimprove collection and enforcement. And third,avoid taxing the poor while recognizing that "it ispublic finance broadly defined—taxes and spend-ing together—that matters for equity."15
In practice, shifting the base of indirect taxesby replacing sales taxes with a value-added tax(VAT) is at the heart of most tax reform programsof emerging market countries. A VAT systemlevies taxes on the value-added at each stage ofproduction. Some VAT systems tax only manu-facturing, but most systems cover the retail levelof transactions as well. Although a uniform taxrate is applied to most sectors of the economy,basic necessities and exports are often taxed atlower rates. The rationale for this shift away frominternational trade and sale transaction taxes andtoward a VAT or other broad-based consumptiontax is that structural changes would reduce tax-induced distortions on consumption and produc-tion decisions. In a World Bank survey of ten de-veloping countries that had recently restructuredtheir tax system, a VAT became a major source ofrevenue, typically accounting for one-third ormore of total national tax revenue. This surveyfound that replacing numerous cascaded com-modity taxes by a VAT resulted in unambiguousgains in efficiency, equity, and ease of adminis-tration.16
This conventional approach to tax reform,however, does not necessarily benefit the envi-ronment. VAT, which at best is neutral towardthe use of labor, capital, and natural resources,provides no incentive for businesses or individu-als to curtail activities detrimental to the environ-ment. Despite important problems of environ-mental degradation and natural resource
depletion, environmental considerations have notbeen a guiding concern of tax reform in either de-veloping or transitional economies.
D. Envisioning the OptimalPublic Finance System
A public finance system should create an eco-nomic incentives structure that promotes sustain-able development by relying on a robust, broadtax base to generate government revenue and byincorporating environmental considerations intothe design of policy instruments. To achieve theseobjectives, a top priority of fiscal policy reformshould be to do away with subsidies that harmthe environment. Eliminating these subsidies,particularly in energy, agriculture, and transport,will improve economic efficiency as well as theenvironment by realigning the fiscal structure infavor of sustainable development practices. Thegovernment's fiscal balance will improve as well.Second, tax instruments should be used to correctmarket distortions. Market-correcting instru-ments, such as emission taxes, are among the
Market-correcting instruments, such asemission taxes, are among the leastburdensome revenue sources available tothe government.
least burdensome revenue sources available tothe government. They improve economic effi-ciency by making polluters pay the costs of theiractions while generating government revenue.Third, the government should ensure that royaltyfees for extraction and harvesting of forest andother natural resources are priced at levels themarket can bear. These fees will generate addi-tional government funds without creating incen-tives to misuse resources. Once subsidies thatharm the environment are eliminated and mar-ket-correcting and rent-capturing opportunities
are exhausted, governments should collect addi-tional revenue through neutral, broad-basedtaxes, such as the VAT and income taxes. In de-signing each of these elements of the public fi-nance system, governments need to ensure thattheir capacity to enforce and administer taxes andother public finance policies is sufficient.
In summary, policy reforms aimed at eliminat-ing subsidies that harm the environment, forcingpolluters to pay for their actions, and capturingeconomic rents from the harvest of natural re-sources would have three positive effects: miti-gating environmental degradation and unsustain-able resource extraction, promoting economicefficiency, and contributing to the revenue base tofinance needed public services.
E. Direction of Public FinanceReforms
Across emerging market economies, progresstoward integration of environmental issues intopublic finance reform programs is uneven.Recently, great strides have been made world-wide to reduce or eliminate subsidies in the en-ergy sector. In the past, many governments of de-veloping countries heavily subsidized energy inthe hope of accelerating industrialization andproviding cheap energy supplies to households.Between 1990 and 1992, total fossil fuel subsidiesin developing countries were about $235-245 bil-lion.17 Faced with balance of payment and fiscaldeficit problems, many countries are now elimi-nating these subsidies. Removal of all energy sub-sidies in non-OECD countries is estimated toreduce local pollution and to lower carbon emis-sions by as much as 25 percent in some countriesand 7 percent worldwide. According to recent es-timates, the total value of fossil fuel subsidies inthe 22 most heavily energy-subsidized emergingmarket economies fell by two-thirds between1990 and 1995. Some of the world's heaviest sub-sidizers of fossil fuels were the centrally plannedeconomies. Progress in these economies is mostremarkable. Between 1991 and 1995, the subsidyrate18 for coal fell from about 55 to 25 percent andthat for petroleum products dropped from about
25 to 5 percent in five eastern European countries.In total, the reduction in subsidies was equivalentto about 4.3 percent of the region's GrossNational Product (GNP).19
Progress has been made in eliminatingenergy subsidies, but subsidies that harmthe environment are rampant in othersectors of the economy.
Much more, however, remains to be done.Progress has been made in eliminating energysubsidies, but subsidies that harm the environ-ment are rampant in other sectors of the econ-omy. According to the most recent estimate, envi-ronmentally damaging subsidies to energy,roads, water, and agriculture in developing coun-tries are more than $240 billion per year.20
Pesticide and irrigation subsidies to farmers areburdening government budgets and leading toenvironmental degradation and excessive con-sumption of water resources in many developingcountries. Subsidy rates for pesticides in develop-ing countries vary between 20 and 90 percent.21
In most developing countries, farmers pay littleor nothing for access to irrigated water. InBangladesh, Indonesia, Pakistan, and thePhilippines, irrigation fees are 20 to 90 percentbelow the costs of operation and maintenance.22
Given the scarcity of water in many regions of thedeveloping world, irrigation subsidies are actu-ally much larger because these estimates of irriga-tion subsidy rates only reflect the cost of con-veyance, ignoring the much larger opportunitycost of forgoing alternative uses, such as watersupply to residential areas. These agriculturalsubsidies, by encouraging farmers to use exces-sive amounts of pesticides, water, and other agri-cultural inputs, lead to losses in soil nutrients andgroundwater pollution, which in turn causehealth problems, including weakened immunesystems.23 Developing countries use on average20 percent more electricity than they would use if
electricity prices were raised to equal the long-run marginal cost of supply.24
Polluters are not being forced to pay forthe costs of their pollution.
Aside from these remaining subsidies, pol-luters are not being forced to pay for the costs oftheir pollution. An IMF worldwide survey of taxsystems indicates that with the exception ofeconomies in transition, emission taxes are notused extensively.25 And in these transitionaleconomies, rates, for the most part, are set toolow to have much incentive effect. Instead, theseinstruments serve primarily as a source of gov-ernment revenue. Product charges are more com-mon than emission charges; with the exception ofpetroleum product taxes, even these charges arenot widespread among emerging marketeconomies.
Another survey of more than 120 countriesfound that all nonpetroleum exporting countriesimpose some type of petroleum tax, although therate of taxation varies considerably.26 In develop-ing countries, petroleum tax revenue generally ac-counts for about 7 to 30 percent of total govern-ment revenue and is equivalent to about 1 to 3.5percent of Gross Domestic Product (GDP). Insome parts of the developing world, petroleumtaxes have declined sharply since the 1973 oil cri-sis—a negative trend if an incentive structure thatpromotes fuel use efficiency and conservation is tobe created. On average, petroleum taxes in Asiahave declined by 79 percent for gasoline, 17 per-cent for diesel, and 15 percent for kerosene. Thetrend in the western hemisphere is somewhatmore positive. There, the average percentage taxrates on gasoline have increased marginally; in-creases in these rates for kerosene and diesel fuelhave been somewhat larger.
In most developed and developing countries,industrial firms do not pay the full cost of dump-
ing industrial waste products into waterways.Effluent charges levied on polluting industrieswould help conserve water and reduce pollution.In Sao Paulo, Brazil, such charges have helped tocut industry's demand for water in half, releasingmore and cleaner water for use by households.27
Many governments also fail to set prices fornatural resources as high as the market will bear.Several studies indicate that forests, for example,are greatly undervalued in developing countries.A recent study of forestry policies in Suriname in-dicates that the government is collecting virtuallynone of the economic rents from logging.28 By un-derpricing the rights to harvest or extract naturalresources, the Suriname government is discour-aging sustainable forest management practicesand forgoing tens of millions of dollars in annualrevenues—as much as 10 percent of GDP.Evidence from Indonesia suggests that rent cap-turing mechanisms can be an important source ofgovernment revenue. There, a billion dollar fundfor forest restoration and conservation activitiesis financed by a small fee on all timber-extractingactivities.29 Without adequate environmentalsafeguards and policies to capture economicrents, governments are leaving their natural re-sources vulnerable to mismanagement by compa-nies that are paying virtually nothing to depletenations' wealth.
Many governments fail to set prices fornatural resources as high as the marketwill bear.
In summary, natural resource use is taxedlightly, if at all, in emerging market economies.Instead of helping to create an economic incentivestructure that promotes sustainable development,the objective of public finance reform in mostemerging economies has been to expand the in-come tax base and replace the traditional sales taxwith a VAT or other broad-based consumptiontax. Yet neither income nor consumption taxes
10
To the fullest extent possible,governments' public finance powersshould be used to eliminate subsidiesthat harm the environment, correctmarket distortions, and captureeconomic rents.
provide mechanisms to address environmentalproblems. To the fullest extent possible, govern-ments' public finance powers should be used toeliminate subsidies that harm the environment,correct market distortions, and capture economicrents. These opportunities for government policyto simultaneously generate environmental bene-fits, economic efficiencies, and government rev-enue should not be lost.
F. Policy Recommendations
Public finance reform is a potentially powerful,yet unused, policy tool to achieve both economicand environmental objectives. Governments ofemerging market economies should explore this"win-win" opportunity to protect the environ-ment and promote economic growth. Three broadrecommendations are offered to take advantageof this opportunity.
1. Governments of emerging market economiesshould eliminate faulty subsidies that harm theenvironment, correct market distortions that en-courage pollution and resource waste, and setroyalty fees for resource extraction at the levelthe market will bear. Regulatory efforts to pro-tect the environment are often overshadowed bypublic finance policies, such as energy subsidiesand underpricing of natural resources, and by thelack of fiscal instruments to correct the failure ofsome markets to value pollution and otherspillover effects. As rising populations, urbaniza-tion, and economic growth take a toll on the envi-
ronment, emerging market economies need to en-sure that the economic incentive structure is sig-naling consumers and producers to use resourcesefficiently and reduce waste. To do so, govern-ments often restructure their public finance sys-tems, an action that will reduce environmentalrisks to the public's health and improve long-runeconomic prospects by increasing the efficiency ofresource distribution, the conservation of scarceresources, and the reduction of waste.
2. Implementation of social cost pricing willtake time and requires collecting information,conducting research and building institutionalcapacity. Governments can accelerate this processby compiling and refining information on pollu-tion damages and abatement costs and bystrengthening their capacity to administer pollu-tion abatement policies. In many countries, notenough is known about human exposures to pol-lutants, pollution damages, and abatement coststo set priorities and make informed policychoices.30 More sophisticated and extensive airquality monitoring systems, studies of human ex-posure to air pollution, and other data collectingefforts are needed. Further research on pollution
As institutional capacity andinformation improve, relativelysophisticated market-based instruments,such as tradeable permits and pollutiontaxes, can be more easily adopted. In themeantime, product charges and otherindirect taxes that are relatively easierto design and administer should beconsidered, although these instrumentsare not as efficient.
damages, for example, would help determine themagnitude of environmental taxes that would cor-rect market distortions. As institutional capacityand information improve, relatively sophisticated
11
market-based instruments, such as tradeable per-mits and pollution taxes, can be more easilyadopted. In the meantime, product charges andother indirect taxes that are relatively easier todesign and administer should be considered, al-though these instruments are not as efficient.
Although the "polluter pays" principle is wellknown, market-correcting taxes and other policyinstruments to reduce pollution are not wide-spread. Some of the technical design and imple-
mentation issues regarding environmental taxescan be addressed (Box 2). The sparse use of theseinstruments is a consequence, in part, of the lackof political will to undertake reforms, particularlywith regard to raising or creating new taxes andreducing subsidies. Polluters, resource extractors,and segments of the population benefitting fromsubsidized energy and water services lobbyagainst paying the financial costs for utilities andcreating taxes for the environment. But throughseveral channels, government officials and envi-
Box 2. Environmental Taxes: Design and Implementation Issues
Technical design and implementation issueshave impeded the use of environmental taxes inemerging market economies. Indeed, it "is thedifficulty in designing and administering envi-ronmental taxes that is the most significant ob-stacle, especially in developing countries, to: effi-ciently mitigating environmental damage via thetax system."31 Three types of pollution taxes are:emission taxes (Pigouvian taxes;) indirect envi-ronmental taxes, which are taxes on goods, suchas gasoline/whose use is related to environmen-tal damage; and environment-related provisionsin other taxes, such as incentives for firms to in-vest in pollution abatement equipment.Choosing among the types of pollution taxes en-tails trade-offs between economic efficiency andimplementation costs. For an emissions tax to beefficient, pollution damages must be quantifi-able/allowing the right tax rate to be determined.For some pollutants, this rate would vary overtime and space. Although basic information onpollution abatement benefits and, to/a lesser ex-tent, abatement costs, is lacking, research is be-ginning to fill in these information gaps.32
Indirect environmental taxes offer an alterna-tive, intermediate policy instrument to abatepollution until more efficient and easier-to-administer instruments can be designed and ad-ministrative capacity is strengthened. To controlpollution from many sources, such as vehicles,often the best policy option is to impose indirect
environmental taxes in combination with com-plementary regulatory measures. The downsideof indirect environmental taxes and environ-ment-related provisions in other taxes is thatthese instruments are not efficient. They do notprovide incentives to adopt all possible pollu-tion abatement activities. For example, a fuelstax will not induce vehicle owners to install cat-alytic converters or take other actions thatwould reduce emissions per unit of fuel con-sumed because the tax base is not direct emis-sions. However, emission standards that effec-tively mandate catalytic converters in all earssold can be used to complement indirect envi-ronmental taxes. Combining fiscal and regula-tory instruments is a potentially powerful pol-icy means to reduce air pollution. = :
One broad concern regarding both emission:taxes and indirect environmental taxes is thattheir base may erode with time, particularly as •:demand becomes more responsive to pricechanges, and rates are set at levels that provideincentives to reduce pollution. With a strong in-centive effect, emissions per unit of output willfall, but in rapidly growing developing coun-tries, environmental taxes may continue to be arobust source of revenue evert after demand be-comes more price elastic. A rapidly expandingindustrial sector will continue to emit large vol-umes of pollutants even though emissions per:
;
unit of output are declining.
12
ronmental and public health advocates can worktogether to build political consensus for a pack-age of public finance and expenditure reforms.First quantifying the public health and othercosts of policies that encourage polluting activi-ties and effectively conveying these findings togovernment officials, public interest groups, andthe public at large would raise awareness thatmaintaining the current economic incentive struc-ture is costly. Without this information, politi-cians only hear one side of the story, that is, thecosts of pollution abatement. Politicians alsowould benefit from an estimate of the magnitudeof government revenue that could be generatedby public finance reforms. In some cases, particu-larly in the short term and when scale effectsfrom rapid economic growth are large, the rev-enue potential of environmental taxes is quitelarge. Documenting the magnitude of the revenueeffect may help build support for public financereforms from the ministries of finance, local gov-ernments, and segments of the private sector thatmight benefit from revenue redistribution.
3. The IMF and Tlie World Bank should highlightand encourage public finance reforms in waysthat produce co-benefits. The development assis-tance community, in particular the IMF and theWorld Bank, should provide support throughpolicy dialogue and lending operations to en-courage governments to incorporate environmen-tal concerns into their public finance systems.Recognizing the need to make an explicit link be-tween macroeconomic planning and the environ-ment, some Bank and Fund staff have advisedgovernments to reduce subsidies in the energyand water sectors, to correct market distortions,and to capture rents from the extraction and min-ing of natural resources. For example, a jointBank/Fund team recently identified key fiscalpolicy reforms needed to turn the Philippinesinto an Asian "green tiger."33 These reforms in-clude introducing water pollution charges, rais-ing fuel excise taxes, and setting royalties thatprovide a secure revenue stream for governmentand proper incentives to resource exploiters.World Bank staff recognize the economy-widebenefits of integrating environmental issues intofiscal reform programs. According to the 1992
World Development Report, environmental taxes"may be advantageous for governments whenthey replace more distortionary sources of rev-enue common in developing countries, such astariffs and corporate taxes. [The objectives of] rev-enue generation and environmental protectionare then complementary."34 For certain environ-mental problems, some research staff at the IMFagree: "if energy is being subsidized—as it hasbeen in many developing countries andeconomies in transition in particular—there isprobably a strong efficiency case for eliminatingthose energy subsidies, and perhaps imposingenergy taxes, rather than imposing other taxes."35
Beyond this advisory role, in-country progressto date is mixed. On the positive side, the WorldBank is active worldwide in supporting govern-ment efforts to reduce energy subsidies andachieve cost recovery in public water and sewageservices. Currently it is undertaking a major re-view of its work on energy environmental issuesand will recommend actions in the areas of energyefficiency, pollution prevention and climatechange. With respect to both energy and watersector issues, the World Bank is calling on govern-ments to raise user charges to cover long-run mar-ginal costs. Some governments have responded.In India, the Bombay Sewage Disposal Project im-poses direct charges to the beneficiaries of watersupply and sewage services.
In a general sense, World Bank staff recognizethat more needs to be done to integrate environ-mental sustainability into all development pro-grams.36 But more could be done. Financial cost re-covery is only a benchmark toward achievingsocially optimal conditions in the water and energysectors. The Bank and the Fund should seek oppor-tunities to endorse government policy reforms thatraise energy and water prices to cover environmen-tal as well as financial costs. The World Bank'sdrafted "The Pollution Prevention and AbatementHandbook" is clearly a step in the right direction.The development assistance agencies could also domore to help governments provide the proper in-centives to timber and mining firms to manage nat-ural resources in a sustainable manner. Of theWorld Bank lending projects operating between
13
The Bank and the Fund should seekopportunities to endorse governmentpolicy reforms that raise energy andwater prices to cover environmental aswell as financial costs.
1986 and 1996,37 only one operation explicitlycalled for implementation of user fees for forestproduct extraction. Perhaps most fundamentally,pricing policies, rent capturing mechanisms, andenvironmental taxes should be integral compo-nents of sectoral and structural adjustment pro-grams. To date, fiscal reforms in almost all struc-tural adjustment loans have been narrowlyconfined to broadening the base of direct taxes, in-troducing a VAT system, and enhancing the capac-ity of government to administer these taxes.
Notes1. See for example: Smith, K. "Fuel Combustion,
Air Pollution Exposure and Health: The Situ-ation in Developing Countries." Annual Re-view of Energy Economics, Vol. 18,1993, pp.529-66; Borja-Aburto, V.H. et al. "Ozone, Sus-pended Particulates and Daily Mortality inMexico City," American Journal of Epidemio-logy, Vol. 145, No. 3,197, pp. 258-68; andAdrian, A. et al. "A Survey of Street Sellers'Exposure to Carbon Monoxide in MexicoCity." Journal of Exposure Analysis and Envi-ronmental Epidemiology, Vol. 3, Supplement 1,1993, pp. 21-35.
2. "Advancing Sustainable Development: TheWorld Bank and Agenda 21 since the RioEarth Summit." Rio+5 Edition, Draft for Dis-cussion." Washington, DC, The World Bank,p. 8.
3. Emerging market economies include devel-oping and transitional economies that aretransforming their structure into a market-based economic system through economy-wide and sector reforms.
4. Informal remarks at a luncheon talk duringthe May 10-11,1995, International MonetaryFund seminar "Macroeconomy and the Envi-ronment." Quoted in McMorran, R. and Wal-lace, L. "Why Macroeconomists and Environ-mentalists Need Each Other." Finance &Development, December 1995, p. 48.
5. Eskeland, G. and Feyzioglu, T. "RationingCan Backfire: 'The Day without a Car' Pro-gram in Mexico City." Policy Research Work-ing Paper 1554, The World Bank, 1995.
6. Eskeland, G. "A Presumptive Pigouvian Tax:Complementing Regulation to Mimic anEmission Fee." World Bank Economic ReviewVol. 8, No. 3,1991, pp. 374-94.
7. McMorran, R. and Nellor, D. "Tax Policy andthe Environment: Theory and Practice." Inter-national Monetary Fund Working Paper 106,September 1994, p. 19.
8. The air quality model simulates only shortterm ozone peak reductions. Over time, how-ever, continuous reductions in emissions fromthe transport sector will decrease accumu-lated pollutants, and pollution abatementmeasures enforced over time will have a moresignificant effect on ozone peak reductions.
9. Own-price elasticity of demand is defined asthe percentage change in demand of a goodresulting from a percentage change in theprice of that good.
10. Panayotou, T. "Effective Financing of Envi-ronmentally Sustainable Development inEastern Europe and Central Asia." HarvardInstitute for International Development Dis-cussion Paper 10, October 1995.
11. "World Development Report: From Plan toMarket." The World Bank, 1996, p. 54.
12. See for example, Ahmad E. and N. Stern. "Al-ternative Sources of Revenue: Illustrationsfrom India 1979-1980." In D. Newbery andN. Stern (eds.) The Theory of Taxation for Devel-oping Countries. New York: Oxford UniversityPress.
13. Freund, C. and Wallach, C. "Raising House-hold Energy Prices in Poland: Who Gains?Who Loses?" World Bank Policy ResearchPaper 1495,1995.
14. "World Development Report 1996: From Planto Market." The World Bank, 1993, p. 45.
14
15. "World Development Report 1988: "Oppor-tunities and Risks in Managing the WorldEconomy, Public Finance in Development,World Development Indicators." The WorldBank, 1988, pp. 85 and 102; Tait, A. "IMF Ad-vice on Fiscal Policy." Finance & Development,March 1990, pp. 33-36; Hemming, R. andKochhar, K. "Formulating a Growth-OrientedFiscal Policy." Finance & Development Decem-ber 1990, pp. 37-38.
16. Thursk, W. "Lessons from Tax Reform: AnOverview." Working Paper Series 576, Janu-ary 1991.
17. Larson, B. and Shah, A. "Combating theGreenhouse Effect." Finance & DevelopmentDecember 1992, pp. 20-23.
18. The subsidy rate is the difference in price ofwhat the users pay for a good and what theywould have paid in the absence of the sub-sidy, expressed as a proportion of the unsub-sidized price.
19. "Environment Matters." The World Bank,Fall 1996, p. 36.
20. Gandhi, V.D., et al. "A Comprehensive Ap-proach to Domestic Resource Mobilizationfor Sustainable Development." Presented tothe Fourth Expert Group Meeting on Finan-cial Issues of Agenda 21. Santiago Chile, Jan-uary 6-8,1997.
21. Repetto, R. Paying the Price: Pesticide Subsidiesin Developing Countries. Washington, DC:World Resources Institute, 1985.
22. "World Development Report 1994: Infra-structure for Development." The World Bank,1994, p. 49.
23. Repetto, B. and Baliga, S. Pesticides and the Im-mune System: The Public Health Risks. Wash-ington, DC, World Resources Institute, 1996.
24. "World Development Report 1994: Infra-structure for Development." The World Bank,1994, p. 83.
25. McMorran, R. and Nellor, D. "Tax Policy andthe Environment: Theory and Practice." Inter-
national Monetary Fund Working Paper 106,September 1994.
26. Gupta, S. and Mahler, W. "Taxation of Petro-leum Products: Theory and Empirical Evi-dence." International Monetary Fund Work-ing Paper 32, March 1994.
27. "Environment and Development in LatinAmerica and the Caribbean: The Role of theWorld Bank." The World Bank, June 1992,p. 14.
28. Sizer, N. and Rice, R. Backs to the Wall in Suri-name: Forest Policy in a Country in Crisis.Washington, DC: World Resources Institute,1994.
29. Sizer, N. and Rice, R. Backs to the Wall in Suri-name: Forest Policy in a Country in Crisis.Washington, DC: World Resources Institute,1994, p. 30.
30. Detailed arguments are described in Hammerand Shetty (1995).
31. McMorran, R. and Nellor, D. "Tax Policy andthe Environment: Theory and Practice." Inter-national Monetary Fund Working Paper 106,September 1994, p. 10.
32. Ostro, B. "Estimating the Health Effects ofAir Pollutants: A Method with an Appli-cation to Jakarta." Policy Research WorkingPaper No. 1301, The World Bank, May 1994.
33. "Environment Matters." The World Bank,Fall 1996, p. 36.
34. "World Development Report 1992: Develop-ment and the Environment." The WorldBank, 1992, p. 77.
35. Nellor, D. "Energy Taxes and MacroeconomicPolicy Objectives." International MonetaryFund Working Paper 9, April 1994, p. 8.
36. "Advancing Sustainable Development: TheWorld Bank and Agenda 21 since the RioEarth Summit." Rio + 5 Edition, Draft for Dis-cussion, The World Bank, 1997, page 6.
37. "World Bank Environmental Projects: July1986-June 1996." Environment Matters, TheWorld Bank, 1996.
15
. INDIA CASE STUDY
A. Introduction
High concentrations of airborne particulatematter are a major environmental andpublic health problem in India—particu-
larly in urban and industrial areas. In 1991, 90percent of the air quality monitoring stations na-tionwide reported mean concentrations of partic-ulate matter exceeding the 75 |xg/m3 midpoint ofthe standard range recommended by the WorldHealth Organization (WHO). Air pollution prob-lems are severe in the large mega-cities. Averagelevels of total suspended particulates are at leastthree times as high as the WHO standard in six ofthe ten largest cities: Bombay, Calcutta, Delhi,Ahmadabad, Kanpur and Nagpur. In Delhi,Calcutta, and Kanpur, averages are more thanfive times the WHO standard.1 In Delhi, one ofthe world's most polluted cities, particulate mat-ter levels are two to three times the WHO stan-dard, and heavy metals are also present in highconcentrations. The major causes of high levels ofparticulate matter in India's cities are motor vehi-cles, domestic heating and cooking, and indus-trial emissions. Dust also adds to urban air pollu-tion in many cities.
India's heavy reliance on coal-based powergeneration and use of poor quality coal posemajor health problems. Communities near ther-mal power plants suffer from high ambient levelsof particulate matter and sulfur dioxide (SO2). InDelhi, for example, the mean of the maximumconcentration of SO2 exceeds the national stan-dard of 120 fxg/m3. Nationwide, almost 60 per-
cent of demand for commercial energy is met bycoal-fired power plants, and four-fifths of the coalused in power generation is low quality, with ashand moisture contents exceeding 35 percent.
The high ambient level of particulate matter inIndia's cities is creating significant public healthrisks. In New Delhi alone, about 7,500 peopledied in 1996 from ailments related to this matter.Estimates of the costs of pollution-related healthproblems nationwide range between $517 millionand $2.1 billion annually.
Lead emissions are also a major public healthconcern. Gasoline sold in India contains a highlevel of lead (0.56 g/1). Unleaded gasoline is sup-plied to only four Indian cities. Studies haveshown that up to 75 percent of children livingnear high traffic areas have blood lead levelsabove 10 |xg/dl. Average urban air lead levels of1 fxg/m3 are not uncommon, compared with lev-els of 0.2 |xg/m3 found in U.S. cities.2
Rapid motorization is a major source of carbonmonoxide (CO), hydrocarbons (HCs), and nitro-gen oxide (NOx) emissions in Indian cities. By1991, more than 14 million two-wheelers andmore than 4 million four-wheel motor vehicleswere on the roads.3 This scale effect is exacer-bated by the outdated, fuel-inefficient enginetechnologies with which much of India's vehiclestock are equipped. In addition, the state-ownedrefineries supply mostly low-quality transporta-tion fuels—gasoline contains high levels of sulfurand has low octane. Diesel also contains high
17
levels of sulfur, fn 1991, the government set ex-haust emission standards for motor vehicles butto date enforcement has not been effective. As aresult, vehicular emissions are on the rise inIndia's major urban areas.4 Although monitoringstudies indicate that NOx, CO, and HC emissionsare currently not a risk to human health, therapidly growing vehicle stock and use of dirtyfuels is cause for concern.
From an economic development perspective,one of the most important factors contributing toIndia's air pollution problems has been the gov-ernment's previous inward-looking economic de-velopment strategy. During the first four decadessince Independence, the government attemptedto spur economic development by selling cheapelectricity and investing heavily in energy-inten-sive industries, including steel, paper, chemicals,and transportation. As a direct result of this ap-proach to development, India's economy today ishighly energy-inefficient and energy-intensive.
If current trends continue, India's prospects forpollution prevention and control will worsen.Transportation is expected to expand as continuedurbanization and rising incomes bring more vehi-cles to India's cities. In addition, according to agovernment estimate, the power supply will haveto double to meet demand for electricity over thenext decade. Hence, coal production by the year2000 is expected to be nearly double the 1991 levelof 200 million tons. More than two-thirds of thegrowth in electricity-generation capacity is com-ing from thermal power plants.
On a global scale, India's contribution togreenhouse gas emissions is a growing environ-mental concern. On a per capita, annual basis,India's 2.1 tons of greenhouse gas emissions arewell below the 8.3 world average and 18.3 OECDaverage, but India's pollution problems haveglobal significance because of the country's sizeand rate of economic development. India is theworld's fifth largest producer and, after China,the second fastest growing source of greenhousegas emissions. On the basis of current trends,India is expected to surpass Japan and Germany'sproduction of greenhouse gases by 2010.5
B. Policy Instruments for AirPollution Abatement
By and large, the government is attempting toimprove air quality through regulatory instru-ments focused on end-of-pipe pollution control.Seventeen industries, including thermal powergeneration, are subject to special monitoring andenforcement of air quality and effluent regula-tions. Standards for inspection and monitoringfrequency are industry specific. Pollution regula-tion is also locale specific: 22 critically pollutednonmetropolitan areas are targeted for special at-tention; "sensitive areas" face more stringent airquality standards and environmental assessmentrequirements.
Enforcement of these environmental regula-tions has strengthened recently. According to onestudy, compliance with requirements to installpollution control equipment is rising among the17 targeted industries.6 In 1991, less than 10 per-cent of the 1,500 facilities in these industries werein compliance, but by March 1995, more than 75percent of the facilities had installed the requiredequipment. The government is also taking legalaction against the laggards. The cumulative num-ber of court cases involving violations of India'swater and air acts rose almost three-fold between1987 and 1993. Of the 2,353 cases that had beenadjudicated by 1993, about two-thirds were de-cided in favor of the government, and more thanhalf of these cases resulted in either the imposi-tion of a prison term or a fine.
Efforts are being made to require thermalpower plants to use washed, noncoking coal.Most recently, new environmental regulations re-quire that all new coal-based power plants usewashed coal and make provisions to dispose offly ash. The Environment Ministry has proposedextension of these regulations to all thermalpower plants by 2001.
Opportunities to include market-based instru-ments in India's pollution control strategy areemerging. Macroeconomic and structural reformsalready under way will make such instrumentsmore effective. Macroeconomic stabilization poli-
18
Opportunities to include market-basedinstruments in India's pollution controlstrategy are emerging.
cies are setting a strong foundation to encouragelong-term private investment. Trade liberaliza-tion and deregulation of the investment regimeare providing greater access to advanced tech-nologies and spurring increased competition.Pressure from competitors to keep costs down isproviding incentives to firms to invest in modern,energy-efficient equipment. Likewise, some of thegovernment's fiscal policies are providing incen-tives to firms to invest in pollution control.7
Recognizing this opportunity, the Ministry ofEnvironment recently indicated a desire to com-plement its regulatory framework with market-based instruments for energy conservation andpollution prevention and control. The challengenow is to muster the broader political consensusnecessary to adopt these measures. The economy,as well as the environment, would likely benefitfrom these policy reforms. To illustrate these ben-efits, WRI and its partners examined the eco-nomic, environmental, and political aspects ofone of India's most important public finance pol-icy options: raising the price of electricity to coverinvestment, operating and maintenance costs ofpower generation, transmission and distribution.
C. Electricity PricingState governments in India subsidize the con-
sumption of power by keeping electricity pricesbelow long-run marginal cost (LRMC). To mea-sure the extent of the overall subsidy and thedegree of cross subsidies, WRI and its partnersestimated the cost of power generation and distri-bution to different voltage ends and categories ofconsumers. The resulting figures reflect the finan-cial as well as some of the environmental costs ofelectric power generation and distribution.
The study team estimated the costs of build-ing, operating, and distributing power from apower plant with state-of-the-art technologiesand processes that minimize damage to the envi-ronment. An integrated gasification combinedcycle (IGCC)8 power plant was chosen because itis suitable for the quality of Indian coal andmeets stringent environmental standards.9 Themeasure of LRMC includes the costs of reducingthe ash content of the coal used by the powerplant from 40 to 30 percent.10 It is unlikely thatan IGCC plant could operate efficiently with coalhaving ash content at the 40 percent level typi-cally found in Indian coals. The threshold of 30percent was chosen because the marginal cost ofcoal washing begins to rise rapidly once the ashcontent falls below 32-30 percent, as Figure 1 in-dicates. The cost of electricity supplied to variousconsumer groups was estimated by aggregatingcapital costs (the sum of the costs of constructingand operating an IGCC power plant, transmis-sion, and distribution), and energy costs (thesum of the costs of coal consumption, oil con-sumption, auxiliary consumption of power gen-erated, and coal washing). To the study team'sknowledge, these calculations represent the firstattempt to estimate the long-run marginal cost ofproducing electricity with state-of-the art "cleancoal" technologies and distributing it to differentconsumer groups.
LRMC pricing alone will not achieve sociallyoptimal levels of electricity consumption. In thepresent case, such pricing underestimates thesocial cost of electric power generation becauseit does not reflect the environmental costs ofenergy production from an IGCC power plant.Thus, even if India restructures its tariff systemto cover the team's estimates of the long-runmarginal cost at each user end, socially optimallevels of electricity consumption will not result.Estimation of the full social cost would requirean assessment of the local and global environ-mental damages from electricity generation.Although estimates of these damages for Indiaare highly uncertain, price increases higherthan those recommended by the team wouldclearly be needed to ensure socially optimaloutcomes.
19
Figure 1.
II)
8 -
6 -
4 -
2 -
03
———
*
4
Marginal Cost
— Dipka
of Reducing
* .
•« •
32
Mine
Ash Content (Rs.)
30
— — Kalinga Mine . . . .
. . • • - • -
25
Piperwar Mine
To summarize the findings presented in moredetail below, the calculations of long-run mar-ginal cost indicate that electricity use in India isheavily subsidized for most consumer categories,distorting patterns of consumption. LRMC elec-tricity pricing would increase economic effi-ciency, mobilize public funds, make power sectorinvestments more attractive to the private sector,
Electricity underpricing is leading tolarge inefficiencies on both the demandand supply side of the electricity market.
reduce the rate of increase in carbon emissions,and improve air quality at the local level. The ef-fectiveness of such price increases would be en-hanced by complementary market-based policies,such as peak-load pricing and contingency pric-ing for unforeseen excess demand.
Finding: Electricity use in India is heavily subsi-dized, leading to inefficiencies in production and con-sumption. Table 1 presents LRMC estimates of de-livering electricity to various types of consumersand illustrates the large gap between these costs
and the current prices that consumers pay. For allseven categories of consumers, tariffs on averageare below long-run marginal cost. The estimatesindicate that the degree of electricity underpricingvaries across consumer groups. The ratio of theaverage tariff to long-run marginal costs rangesfrom only 3 percent for agriculture to almost 88percent for continuous process industries.
Electricity underpricing is leading to large in-efficiencies on both the demand and supply sideof the electricity market. On the supply side, un-derpricing has created a huge financial mess forthe government. Unable to generate sufficientrevenue, the state electricity boards lack the fi-nances needed to increase capacity and to operateand maintain transmission and distribution lines.As a result, transmission losses are double the in-ternational average, and plant load factors insome states are below 30 percent. On the demandside, electricity subsidies are discouraging con-sumers from investing in energy-efficient tech-nologies. In India today, one unit of energy inputin manufacturing produces about half the outputproduced in OECD countries.
These market inefficiencies combined with therapidly increasing demand for electricity neededto fuel India's economic growth has broughtpower outages and shortages to many parts of
20
the country. In 1994, excess demand averaged16.5 percent during peak demand hours.According to the 1991 census, 25 percent of urbanresidents and 75 percent of rural residents had noaccess to electricity. Instead of using the pricingmechanism to correct these shortages, the govern-ment has imposed rationing schemes, such asquotas, power cuts, and long waiting periods forhookup to a grid.
Finding: The structure of tariffs within individualconsumer categories distorts consumption patterns.Even where long-run marginal costs are coveredby tariffs, the design of the tariff structure canstill lead to highly distorted incentives. As illus-trated in Table 1, Tamil Nadu's monthly capacitycharge to high-tension users does not cover capi-
tal costs, even though the tariff covers the long-run marginal cost of supply. Tamil Nadu's tariffstructure provides an incentive for high-tensionconsumers to increase their connected load. Thus,even in cases in which this cost is covered in ag-gregate, tariff reform for high-tension consumersmay be needed to set the appropriate breakdownof capacity and per kilowatt hour (kwh) charges.
For households and low-tension industries, thetariff is not tiered—governments set only a com-bined demand and energy charge per kwh. Foragriculture, many states charge large farms ratesbased on the horsepower of pumpsets, and pro-vide electricity free of charge to small farms; inthese cases, the marginal price per kwh is zero.This aggregated tarriff structure for low-tension
Table 1. Average Tariff for Electricity Does Not Cover Long-run Marginal(1994-95 prices, Rupees)
Consumer Category
Extra High Tension,continuous processindustries
High Tension, industry
High Tension, othersectors
Low Tension, industry
Low Tension, agriculture
Low Tension, domestic
CapitalCost
?er kwh
1.19
1.50
1.69
4.99
6.24
4.58
Low Tension, commercial 4.68
Short-RunCost (coal
consumption,including
coalwashing)per kwh
1.11
1.20
1.20
1.38
1.38
1.38
1.38
TotalCost
per kwh
2.30
2.70
2.89
6.37
7.62
5.96
6.06
AverageTariff
in Indiaper kwh
2.20
2.20
2.40
2.40
0.22
0.88
1.19
Cost
Averagein Tami(January
FixedCharge
100 per KVAof maximumdemand
100 per KVAof maximumdemand
100 per KVAof maximumdemand
30 permonth
free
50 permonth
10 permonth
TariffNadu1995)EnergyCharge
per kwh
2.40
2.40
2.60
2.30-2.70
free
0.60-2.20
2.75-3.25
21
consumers is distortionary, providing a disincen-tive to conserve electricity use at the margin. Atwo-part tariff structure should be devised, re-flecting capacity and energy costs at each con-sumer end.
Despite these shortcomings, important finan-cial, equity, and political factors deter the govern-ment from immediately hiking up prices to coverlong-run marginal costs. First, sharp price hikes forhigh-tension consumers would encourage theseconsumers to leave the grid and invest in theirown generators. Such an exodus of reliable payingconsumers would hurt the financial position ofstate electricity boards, which supply power to thegrid system. Second, with more than 35 percent ofIndia's population in poverty, steep price hikes forelectricity would be financially burdensome formany households. To ease the burden of adjust-ment across the board, some experts11 have pro-posed that LRMC pricing should be implementedin a phased manner—for example, 7 years for allconsumer categories. However any prolonged ap-proach has its costs. Electricity subsidies should beeliminated as quickly as possible.
Finding: Equity concerns should not be met throughelectricity subsidies. Arguments that small farmersand low-income households cannot afford to paythe LRMC price and that small-scale industryneeds to be subsidized to encourage rural eco-nomic development are ill founded. Clearly,India's current system, which is designed to cross-subsidize poor households, farmers, and rural de-velopment, is not working. Instead of helping thepoor, electricity subsidies are misdirected to thebetter-off segments of society, such as higher-in-come, urban households and farmers who can af-ford irrigation pumps. Consequently, state elec-tricity boards are forgoing revenue that couldhave been spent on expanding the grid systemand services to rural and poor communities. Thus,instead of helping the poorer segments of society,electricity subsidies are reducing the capacity ofgovernment to serve the poor. Equity concernsand rural development objectives are best ad-dressed through targeted poverty alleviation pro-grams instead of through indirect and inefficientchannels, such as electricity subsidization.
Instead of helping the poorer segments ofsociety, electricity subsidies are reducingthe capacity of government to serve thepoor.
Finding: Institutional reforms are needed to imple-ment LRMC pricing. The India government recog-nizes that it is subsidizing electricity by below-LMRC pricing. However, it has yet to muster thepolitical will necessary to raise consumer pricesfor electricity. To divorce tariff-setting decisionsfrom the political process in India, an indepen-dent tariff commission should be created. Such arecommendation was made by the FinanceMinister in the 1991-1992 government budget buthas never been implemented.
Finding: LRMC pricing will benefit both the local andthe global environment. It LRMC pricing was imple-mented, not all consumers would immediately re-duce their electricity demand because the powershortage in India is severe. However, over time con-sumers in all categories would lower their demand.To quantify this response, WRI and its partners as-sumed a range of price and income elasticities foreach consumer category on the basis of severalstudies' estimates of these parameters.12 The teamalso assumed growth rates of 6 percent in GDP, 9percent in industry, 7 percent in commercial enter-prises, and 2 percent in agriculture during the1997-2002 period. In the absence of electricity priceincreases above 1996 levels, electricity demandwould be expected to grow 6 percent per year.Assuming that the price elasticity ranges between -0.2 and -0.3, income elasticity ranges between 1.0and 1.5 for the residential sector and 1.0 for all othersectors, and that electricity tariff reforms are phasedin over 7 years, the rate of growth of electricity de-mand would be between 1.5 and 2.25 percentagepoints below the 6 percent baseline estimate.
The potential of increased tariffs to reduce therate of growth of CO2 emissions from coal-based
22
power plants is significant. Given the estimated1.5 to 2.25 percentage point decrease in the rate ofelectricity demand, and assuming that CO2 emis-sions are proportional to the power generatedfrom coal-based plants, the proposed tariff re-forms would be expected to lower the rate of in-creasing CO2 emissions to 30-36 percent com-pared with the 50 percent increase expected in theabsence of price reform. Particulate matter andother pollutants would also be significantly re-duced, improving local air quality.
Finding: Complementary policies increase the effec-tiveness of fiscal reform. Reductions in the rate ofgrowth of electricity demand could be even largerif the government complemented tariff reformswith peak-load pricing and contingency pricingfor unforeseen excess demand. Introduction oftime-of-day pricing, at least for high-tensionusers,13 could stabilize the load curve, loweringthe frequency of power outages. A recent studyby the Tata Energy Research Institute finds thatpeak-load pricing could save as many as 3,800megawatts of capacity per year.14 Introducingtime-of-day pricing for low-tension consumerswould conserve energy use at the margin butwould require a large investment in new meter-ing systems. In addition, promoting efficiency im-provements at the consumer level would reduceelectricity use and peak generating requirementsby approximately 20 percent.15
Eliminating electricity subsidies wouldgreatly improve the government'sfinancial position.
Finding: LRMC pricing for electricity generatesfunds. With the central government deficit at al-most 6 percent of GDP, India is facing a signifi-cant fiscal problem. Viable options to increasegovernment revenue and control expendituresare needed. Eliminating electricity subsidieswould greatly improve the government's finan-cial position. At current tariff rates, as noted pre-
viously, the government provided an estimatednet Rs 80 billion in electricity subsidies during1994_95. The Economic Survey 1996-1997 projectsthe net subsidy for 1997-1998 at Rs 175 billion,which accounts for about half of the gross fiscaldeficit of India's state governments.
D. Challenges and PotentialBenefits of LRMC Pricing
With a rapidly growing economy, rising in-comes, and further urbanization, the currentstrain on India's environment and risk to its pub-lic health will increase unless the governmenttakes actions to prevent and control air pollution.
The economy, the environment, and publichealth would benefit from LRMC pricing of electric-ity. Higher electricity tariffs would reduce the rateof growth of electricity demand, and consequently,lower the rate of growth of emissions of particulatematter and other pollutants that are threateningpublic health. Equity concerns for poor households,small farms, and small-scale industry would be bet-ter addressed through targeted poverty alleviationand rural development programs than through pro-vision of low-priced electricity.
The government can also take complementaryactions to enhance the effectiveness of LRMCpricing. These include promoting cogenerationprocesses and energy-efficient technologies andimplementing demand-side management strate-gies such as peak-load pricing. Some of thesemeasures are quite cheap to implement.
Mandatory coal washing is a cost-effectiveway to improve the efficiency of power genera-tion and reduce air pollution. The technology of-fers great potential to improve the gross calorificvalue of India's domestic coal. Reducing the ashcontent from 42 to 30 percent would raise thegross calorific value per kilogram of coal by 30percent. This would not only improve India's en-ergy efficiency but provide benefits on a globalscale by reducing CO2 emissions. At Rs 1.13 perton of CO2 reduction, coal washing is a relativelycheap method for India to reduce CO2 emissions.
23
Inter-fuel substitution would be much more ex-pensive: the cost of reducing CO2 emissions byreplacing coal with gas turbines is about $20 perton.16 Already implemented in India's newerpower plants, coal washing should be promotedfor use at those older power plants that are lo-cated within 1,000 kilometers (km) of the nearestcoal mine. Because of the high costs of transport-ing coal, natural gas or naptha should be used forpower plants located beyond the 1,000-km range.
Although raising tariffs to cover the long-runmarginal cost is a step in the right direction, itwill not account for the environmental damagecaused by power generation. Environmentallyfriendly technologies would be financially moreattractive investments if power plants were heldaccountable for polluting the air. Pollution taxesor permit trading schemes could be implementedto incorporate environmental costs into producerand consumer decisions.
Notes1. Brandon, C. and Hommann, K. "The Cost of
Inaction: Valuing the Economy-Wide Cost ofEnvironmental Degradation in India." Paperpresented at the "Modeling Global Sustain-ability" conference, United Nations Univer-sity, Tokyo, October 1995.
2. "The Global Dimensions of Lead Poisoning:An Initial Analysis." Alliance to End Child-hood Lead Poisoning and Environmental De-fense Fund, 1994, pp. 47-49; and Ellen K. Sil-bergeld, "The International Dimensions ofLead Exposure," International Journal of Occu-pational and Environmental Health, Vol. 1. No.4,1995, pp. 336-348.
3. See Brandon, C. and Ramankutty, R. "Towardan Environmental Strategy for Asia." WorldBank, Discussion Paper 224,1993, p. 50.
4. Mitra, A.P. "Climate Change in Asia: IndiaCountry Report." Asia Development Bank,July 1994.
5. "A Strategic Approach to Environmental Pro-tection." USAID/India, January 1994, p. 2.
6. "India: Recent Economic Developments andProspects." World Bank Country Study, 1995,p. 78.
7. Businesses that locate in noncongested areasreceive capital gains tax exemptions, and in-vestment in pollution control equipment is en-couraged through accelerated depreciationrules, slightly below-average tariff rates, exciseduty rebates, and some state sales tax rebates.
8. Integrated gasification combined cycle(IGCC) plants convert coal to fuel gas, whichis burnt in gas turbines to generate power.The hot exhaust gas from this process pro-duces steam used for power generationthrough a conventional steam turbine.
9. Compared with conventional pulverized coalplants, IGCC power plants reduce emissionsof SO2 by 95 to 99 percent and CO2 by 55 per-cent, lower emission levels of suspended par-ticulate matter (SPM) and NOX and improveplant efficiency.
10. Coal washing reduces emissions per unit ofcoal used but also creates water pollutionproblems.
11. Sankar, U. et al. "Environmental Problems inIndia's Energy Sector and Policies for Correc-tive Action." Madras School of Economics,Anna University, Madras, India, 1996.
12. See: Sankar, U. et al. "Environmental Prob-lems in India's Energy Sector and Policies forCorrective Action." Madras School of Eco-nomics, Anna University, Madras, India,1996; and Bates, R. and Moore, A. "Commer-cial Energy Efficiency and the Environment."Background paper to "Development and theEnvironment." World Bank Development Re-port, Washington DC, 1992.
13. High-tension lines refers to consumers suchas some industries that demand high voltageelectric power.
14. Technical Paper for a Preliminary Demand-Side Management Plan for the Gujarate Elec-tricity Board. Tata Energy Research Institute.
15. "Opportunities for Improving End-Use Elec-tricity Efficiency in India. Bureau for Scienceand Technology, U.S. Agency for Interna-tional Development, November 1991.
16. Mathur, A., et al. "India Paper" In Pachauri,R.K. and Bhandari, P. eds., Global Warming:Collaborative Study on Strategies to Limit CO2
Emissions in Asia and Brazil. New Delhi: AsiaEnergy Institute, 1992.
24
III. MEXICO CASE STUDY
A. Introduction
Mexico City is notorious for its poor airquality to which suspended particles,volatile organic compounds, carbon
monoxide, sulphur dioxide, nitrogen oxide, lead,and ozone contribute. For much of the year, theconcentration of pollutants is hazardous to peo-ple's health. Emission of at least one of the mon-itored air pollutants exceeded the national stan-dard on 345 days in 1994.1 Although the numberof days per year with severely poor air qualityhave declined since then, on average air qualityis worsening. Moreover, the most recent data onair quality indicate that the city still suffers fromacute episodes of air pollution. In 1995, five en-vironmental emergencies were declared, and inthe early part of the 1996-1997 dry season, threesuch emergencies were declared, one of whichlasted a record four days. Other industrializingurban areas are beginning to follow in MexicoCity's footsteps: for the first time ever, an envi-ronmental emergency was declared in mid-October in Guadalajara, Mexico's second largestcity.
Local industry, electric power generation,motor vehicles and the domestic activities ofthe 20 million people living in the metropolitanarea generate much of the pollution in MexicoCity. One recent study documents that liquifiedpetroleum (LP) gas emissions—produced main-ly from domestic cooking and heating—play amajor role in the production of ozone in themetropolitan area.2 Urbanization has also
brought an ever-increasing demand for trans-port in the city, so much so that transportationaccounts for about one-half of Mexico City's airpollution problems.3 Geographical characteris-tics exacerbate the environmental damage frompollution, as the surrounding mountains are anatural barrier against dispersion, and the highaltitude accelerates the formation of ozone.
The quality of public health is a growingconcern. Children exposed to ozone at levels of0.13 parts per million (ppm) or greater for 2consecutive days are 20 percent more at risk ofhaving a respiratory ailment.4 Hospital emer-gency admissions for respiratory problems sky-rocket during periods of high SO2 emissions orgenerally poor air quality5 and the city's mor-tality rate rises during days on which the levelof total suspended particulates in the air ishigh.6 About 6,400 people die in Mexico Cityeach year from exposure to high levels of sus-pended particulates.7
The health costs and other negative effects ofair pollution episodes in Mexico are significant.One study estimates that air pollution inMexico City costs nearly $1 billion annually.8
Particulates contribute $360 million dollars peryear in morbidity-related costs and $480 mil-lion in mortality-related costs. Exposure to leadpoisoning costs $130 million each year.According to one study, people on averagemiss 24 work days each year because of respira-tory and other illnesses caused by airpollution.9
25
Dealing with immediate pollutioncrises as they arise is not the cost-effective solution to urban pollution inMexico.
During periods of particularly poor air qual-ity, the Mexican government has been forced totake drastic measures to protect public health.During government-declared emergencies, out-door school activities are suspended, cars arekept off the streets for two instead of the usualone day per week, and industrial production iscut by as much as 40 percent. These short-termmeasures are very costly. Dealing with immedi-ate pollution crises as they arise is not the cost-effective solution to urban pollution in Mexico.
B. Transportation PoliciesResolving urban transportation problems must
be a key component of any successful strategy toreduce air pollution in Mexico's major cities.Spurred on by economic growth, urbanization,and low fuel prices, the number of motor vehicleson the roads, and the number of kilometers trav-eled per vehicle are increasing, and traffic conges-tion is worsening. Nationwide, consumption ofgasoline rose from two million barrels per monthin 1990 to more than three millions barrels permonth by the end of 1994. New approaches tourban transportation problems are needed.
The government is beginning to attack thetransportation problem on two major, comple-mentary fronts: reducing use of cars and thelevel of vehicle emissions. To implement thisstrategy, the government has predominantlyused regulatory measures and direct public in-vestment. To reduce the level of vehicle emis-sions, emission standards effectively mandatecatalytic converters in all cars produced after1990. The local government of Mexico City is alsoreplacing or retrofitting public buses with vehi-
cles equipped with emission control systems. Toimprove the quality of fuels, the government in-troduced unleaded gasoline in 1991 and reducedthe lead content in regular gasoline by 92 per-cent. Since unleaded gasoline was introduced in1991, its share of the market has risen to 36 per-cent. Since October 1993, only diesel fuel with amaximum sulphur content of 0.05 percent can besold in the metropolitan area of Mexico City. Toensure availability of supply, PEMEX is directinglow-sulfur fuel oils and diesel fuels to MexicoCity and other heavily polluted areas.10 Nation-wide, LP gas was introduced in more than 25,000public transport and haulage vehicles, an actionestimated to have reduced their emissions by 90percent. To encourage use of the public trans-portation system, the district government ofMexico City has expanded the metro system. Tocomplement these measures, it has also imposeda two and four centavo per liter (one and twoU.S. cents per gallon) surcharge on the price ofunleaded and leaded gasoline, respectively.Revenue generated by the surcharge is ear-marked to finance the installation of vapor recov-ery equipment at retail gas stations.
The government is beginning to attackthe transportation problem on twomajor, complementary fronts: reducinguse of cars and the level of vehicleemissions.
Regulations to make cars and fuels cleaner arecommendable, but Mexico City's attempts to reg-ulate driving are failing. The best known pro-gram to reduce the demand for private trans-portation is the "Dia sin Auto" (Day without aCar) in Mexico City. This program assigns toeach car one day of the week on which it cannotbe driven. One study, however, indicates thatthis program is harming, not improving, the en-vironment. Gasoline consumption has been
26
boosted by the regulation, or at best held con-stant.11 Eskeland and Feyzioglu have docu-mented that in response to this regulation, manyhouseholds are either concentrating the samenumber of trips in fewer days or buying an addi-tional car so that they can drive all seven days ofthe week. For those households that buy an addi-tional car, total driving would likely increase ifthe number of drivers exceeded the number ofcars in the family before the purchase. Moreover,given the exorbitantly high cost that a new carrepresents for many households, this additionaldemand for cars is keeping older, more pollutingautomobiles operating longer.
Better designed policies to reducegasoline consumption wouldcomplement efforts to make fuels cleaner.
Better designed policies to reduce gasolineconsumption would complement efforts to makefuels cleaner. Mexico's prices for gasolines andindustrial fuels are among the cheapest in LatinAmerica, second only to Venezuela, the othermajor oil exporter in the region.12 In the trans-portation sector, Mexican prices for regular un-leaded gasoline are on par with U.S. prices butare significantly lower than most other OECDprices.13 Moreover, gasoline prices in Mexicohave been declining in real terms since 1990.Because Mexico's regulated pricing mechanismis adjusted to inflation and exchange ratechanges on an infrequent basis, the real price ofgasoline has been falling during the recent pe-riod of high inflation and devaluation, as Figure1 indicates. Underpricing of gasoline is signalingpeople to drive more and discouraging the use offuel-efficient vehicles.
C. Consideration of a Gasoline TaxIn an effort to move toward a more market-
based approach to pollution prevention and con-
trol, the National Ecology Institute, in coopera-tion with the Secretaria de Hacienda y CreditoPublico, has considered taxes on productsknown to damage the environment. One optionunder discussion is a gasoline tax. Such a taxwould be a more powerful and cost-effectivemeasure than the "Dia Sin Auto."14 For mobilepollution sources, such as vehicles, taxes are su-perior to regulatory instruments because theyare more selective in reducing demand whenpossible and are also easier to enforce andcheaper to administer.
Consideration of a gasoline tax is timely froma macroeconomic perspective. Mexico is under-taking its second phase of structural adjustmentreforms, which began in 1987. A wide range ofpolicy reforms are taking place to improve eco-nomic efficiency by strengthening the role of theprivate sector and enhancing competition,through privatization and other public sector re-forms, trade liberalization, fiscal reform, and fi-nancial-sector restructuring. With regard to fis-cal reform, the government has reduced directand indirect tax rates, widened the tax base, andreduced tax evasion to create a stable revenuebase and a neutral tax system. It has not yettaken this opportunity to integrate environmen-tal or other market-correcting taxes into its fiscalreform agenda. A gasoline tax could be one po-tential component of a broader fiscal restructur-ing effort to create a structure of economic in-centives conducive to sustainable development.
D. Environmental and EconomicEffects of a Gasoline Tax
The effect of a gasoline tax on the economyand the environment is heavily dependent on theprice and income elasticities of demand for gaso-line.15 These parameters help to determine howmuch gasoline consumption will decline after atax is imposed. Many studies have modeled thedemand for gasoline in Mexico, resulting in awide range of estimates of elasticities. On thebasis of Eskeland and Feyzioglu's 1994 econo-metric estimates and a review of recent studies,the short-run price elasticity of gasoline demandappears to range between -0.4 and -0.8. In other
27
words, a 10 percent increase in retail price wouldresult in a 4 to 8 percent decline in demand.
WRI and its collaborators explored the poten-tial economic and environmental effects of agasoline tax in Mexico. One means of reducingpolitical opposition to a gasoline tax is to use therevenue it generates, at least in part, to reducetaxes on labor and capital. Most citizens wouldapprove a reduction in payroll taxes and directincome taxes. A computable general equilibrium(CGE) model was used to simulate the economy-wide effects of a 30 percent tax on motor fuelsafter government revenue collected from the taxis used to reduce levies on capital and labor.16
For sensitivity analysis, simulations of a 30percent gasoline tax were run for three estimatesof the price elasticity of demand for gasoline—(-0.3, -0.5 and -1.0)—with the base scenario corre-sponding to Galindo's (1996) estimate of -0.5. Forthe base case scenario, a 30 percent gasoline taxwould be expected to lower consumption of gaso-line by 15 percent. Even in the conservative casethat demand for gasoline is inelastic, the modelsimulations indicate that gasoline consumptionwould fall by almost 9 percent. A motor fuels taxwould result in a significant decline in gasolineconsumption in Mexico.
The Instituto Mexicano del Petroleo (IMP) andLos Alamos National Laboratory's air quality
model for Mexico City was used to examine theeffect of a gasoline tax on the environment inmajor urban areas. The model's baseline simula-tion of the pattern of emissions from stationaryand mobile sources across Mexico City's metro-politan area relies on traffic flow information andindustrial activity indicators during a typicalwinter day in Mexico City. To estimate the envi-ronmental effects of a decline in gasoline con-sumption, the emissions inventory was modifiedto reflect the expected effects of a change in gaso-line consumption on NOx tail pipe emissions andreactive hydrocarbon emissions, and simulatedagain. The results that reflect the environmentaleffects of a change in gasoline consumption werecompared to the baseline. Three modified simula-tions were run, corresponding to the three priceelasticity parameters used to estimate the effect ofa gasoline tax on gasoline consumption.
Finding: Emissions reductions can be substantial,but for some pollutants, the relationship to ambientquality is not proportional. As illustrated in Table 1,the simulation results indicate two sets of envi-ronmental effects: a marginal reduction in ozonepeak concentrations and a larger reduction inmean pollutant emissions. The relatively small ef-fects of a decline in gasoline consumption onozone concentrations can be attributed to the veryhigh background concentrations of reactivehydrocarbons and to the adverse climatic condi-tions that promote ozone formation in Mexico
Table 1. Environmental
Case No.
Base123
*Reactive
PriceVariations
0+33.73+34.92+37.71
Hydrocarbons
Effects of a 30-percent Increase in Motor Fuels Tax(percentage change from baseline scenario)
GasolineSales
Reduction
0-9.0
-14.0-27.0
RHC*
0-6.8-9.6
-18.5
NOX
0-5.0-7.0
-13.6
CO
0-8.5
-13.2-25.5
SOX
0-0.4-0.6-1.0
o30
-1.6-2.4-5.1
28
City. Although these results indicate that largechanges in ozone peaks would not be observed inthe short term, the effect of a gasoline tax wouldlikely strengthen over the longer term as continu-ous reductions in emissions decrease the accumu-lated pollutants present. The model also indicatesthat emissions from all pollutants, except sulfuroxides, fall substantially as a result of reducedgasoline consumption. A 14 percent drop ingasoline consumption would generate a 13 per-cent decrease in CO and more than a 9 percentdecrease in reactive hydrocarbons. Assumingthat transportation contributes 54 percent of reac-tive hydrocarbons emissions, a 30 percent gaso-line tax would reduce as much as one-quarter ofthe pollutants emitted by the transportationsector.
Finding: With revenue recycling, economic and dis-tributional impacts are small. The economy-wideeffects of the gasoline tax would be relativelyminor. The base case simulation of the CGEmodel indicates that a 30 percent tax would im-mediately generate 16 percent more revenue forthe government. If this additional revenue is usedto offset reductions in taxes on capital and labor,the simulation results indicate that the effect of amotor fuels tax on economic activity and inflationwould be minor. (See Tables 2 and 3.)
As in the case of electricity prices in India, oneargument put forth is that raising gasoline taxeswill hit lower-income families disproportionatelyharder and will not reduce total gasoline con-sumption significantly. The magnitude and distri-bution of the welfare effect of a gasoline taxwould depend in part on the relative importanceof gasoline expenditure within total expenditureon all goods, on the availability of substitutessuch as public transportation, and on the redistri-bution of government revenue generated fromthe tax. The model simulations indicate that theoverall effect on consumer welfare is minor: itwould fall by less than 1 percent, excluding envi-ronmental benefits. Regarding the distributionaleffects, the model simulations indicate that thewelfare effect would be slightly regressive.However, this result may be biased downwardbecause the model specification does not take intoaccount the public health effects of reduced pol-lution, which would likely disproportionatelybenefit the poor. As in India, equity issues shouldbe analyzed from a broad perspective. Other poli-cies, such as government expenditures onpoverty alleviation and other progressive socialservices are more effective instruments to addressequity concerns. They allow the choices of mecha-nisms to mobilize government revenue to bebased on grounds of efficiency.
Table 2. Minor Consumption Effects
Consumer Goods (quantities)
GasolineAutomotiveVehicle servicesReading and relaxationClothes and jewelleryFurniture and electrical goodsAlcohol and tobaccoTransportFinancial servicesPublic ServicesHousingFoodstuffsNon-durables
of Gasoline Tax
e=-0.3
-8.61%-0.09%0.05%0.08%0.15%0.16%0.16%0.17%0.21%0.24%0.36%0.42%0.63%
Outside Petrochemicals Sector
e=-0.5
-14.16%-0.10%0.05%0.08%0.15%0.16%0.17%0.18%0.20%0.24%0.36%0.42%0.63%
e=-1.0
-27.48%-0.06%0.07%0.06%0.14%0.21%0.19%
-0.01%0.23%
-0.15%0.47%0.46%0.35%
29
Table 3. Minor Inflationary Impact
Consumer Goods (prices)
GasolineSavingsHousingAutomotive vehiclesFurniture and electrical goodsFinancial servicesServicesFoodstuffsClothes and jewelleryAlcohol and tobaccoReading and relaxationTransportNon-durablePublic services
of Gasoline Tax
e=-0.3
33.73%-0.06%-0.07%-0.18%-0.18%-0.20%-0.23%-0.24%-0.28%-0.28%-0.28%-0.57%-0.71%-0.87%
€=-0.5
34.92%-0.04%-0.04%-0.11%-0.11%-0.12%-0.14%-0.15%-0.17%-0.18%-0.17%-0.34%-0.43%-0.53%
e=-1.0
37.71%0.02%0.02%0.06%0.06%0.07%0.07%0.05%0.09%0.06%0.09%0.18%0.23%0.28%
In conclusion, the results of the economic andenvironmental model simulations imply that a30-percent gasoline tax would provide a strongincentive for consumers to reduce their gasolinedemand. This reduction in demand would im-prove air quality in Mexico City, without signifi-cantly affecting most sectors of the economy.
E. Design and Implementation ofa Gasoline Tax
The prospect of a gasoline tax in Mexico raisesseveral design and implementation issues. Policy-makers need to decide which level of governmentshould implement the tax and how the revenuecollected should be spent. The CGE model simu-lations consider the effects of a federal gasolinetax with revenues fed back into the economythrough reductions in taxes on capital and labor,deficit financing, or investment in public trans-portation or other public services.
Alternatively, each state could impose its owngasoline tax or surcharge. This strategy wouldmake sense from an economic efficiency perspec-tive because optimal rates would vary geographi-cally, with rates higher in regions with large urban
centers, where pollution damages are higher. Thestates' revenue base would increase. Currently, thestate and municipalities' combined share of totaltax revenue collected is only slightly more than 1percent. With the states gaining greater financialindependence, a state tax or price surcharge ongasoline could also release a substantial amount offederal revenue previously obligated to the states.Currently, three-quarters of state government ex-penditure is financed through transfers from thefederal government. This federal revenue could beused by the national government to finance otherimportant public services, to reduce taxes that aredistortionary, or both.
Policy-makers also need to decide the rate of thegasoline tax. The CGE model simulations considera 30 percent tax. A rate is close to the 26 percent taxrate suggested by Eskeland's 1994 empircal study17
of the marginal costs of pollution abatement inMexico's transport sector. In 1995, the President ofMexico's anticrisis plan included a 30-percent nom-inal increase in gasoline prices that would havebeen phased in over 1 year. A more accurate andcomprehensive assessment of the benefits of re-duced air pollution would provide the informationneeded to determine an appropriate gasoline taxrate, which might well differ from state to state.
30
Price incentives to reduce driving needto be complemented by investments inalternative forms of transportation.
Finding: Price incentives work when close substi-tutes are available. Price incentives to reducedriving need to be complemented by invest-ments in alternative forms of transportation.Mexico City needs to build an efficient publictransportation system, which will require long-term vision, urban planning, and mobilization ofinvestment funds. A portion of the revenue gen-erated from a gasoline tax could be earmarkedfor this purpose.
Reduced emissions from the transport sectorwill not solve all of Mexico City's air pollutionproblems. Industrial activities, power generation,and household demand for liquified petroleumgas are also important contributors to the air pol-lution problem in Mexico City. The benefits ofimproved transportation and petroleum pricingpolicies would increase if complementary mea-sures to reduce emissions from industry, energy,and household sectors were also implemented.Under the National Ecology Institute's leader-ship, the Mexican government is considering sev-eral market-based instruments to reduce air pol-lution from industry and power generation. In1994, the government authorized the creation of amarket of tradable permits to control SO2 emis-sions from power and industrial plants. Legal re-forms and decisions regarding the scheme's de-sign need to be made before any trading can takeplace. A similar trading scheme for NOX emis-sions is under consideration.
Notes1. Mexico City Air Quality Research Initiative. In-
stituto Mexicano del Petroleo and Los AlamosNational Laboratory, New Mexico, 1994.
2. Blake, D. and Rowland, S. "Urban Leakage ofLiquified Petroleum Gas and Its Impact onMexico City Air Quality." Science, Vol. 269,August 18,1995, p. 953.
3. Eskeland, G. "Attacking Air Pollution inMexico City." Finance & Development, Decem-ber 1992, p. 28.
4. Romieu, Isabelle, et al. "Air Pollution andSchool Absenteeism among Children in Mex-ico City," American Journal of Epidemiology,Vol. 136, No. 12, United States, pp. 1524-1531.
5. Santos-Burgoa C, et al., "Hospital EmergencyServices and Air Pollution in Mexico City."
6. Borja-Aburto V.H., et al., "Ozone, SuspendedParticulates, and Daily Mortality in MexicoCity." American Journal of Epidemiology, Vol.145, No. 3,1997, pp. 258-68.
7. Bartone, C. et al., "Toward EnvironmentalStrategies for Cities: Policy Considerationsfor Urban Environmental Management inDeveloping Countries." Strategic Options forManaging the Urban Environment, No. 18,UNDP\UNCHS\World Bank, 1994.
8. Margulis, S. "Back-of-the-Envelope Estimatesof Environmental Damage Costs in Mexico."Latin American and the Caribbean CountryDepartment II, Policy Research Working Pa-pers, No. 824, January 1992.
9. Bartone, C. et al., "Toward EnvironmentalStrategies for Cities: Policy Considerationsfor Urban Environmental Management inDeveloping Countries." Strategic Options forManaging the Urban Environment, No. 18,UNDP\UNCHS\World Bank, 1994.
10. Quintanilla, J. and Bauer, M. "Mexican Oiland Energy Policy." Challenge, May/June1995, p. 26.
11. Eskeland, G. and Devarajan, S. "Taxing Badsby Taxing Goods: Pollution Control with Pre-sumptive Charges." Directions in Develop-ment, The World Bank, 1996, pp. 24-26.
12. March 1995 data provided by the National In-stitute of Ecology.
13. "Energy Prices and Taxes," International En-ergy Agency, OECD, First Quarter 1996.
14. Eskeland, G. and Feyzioglu, T. "RationingCan Backfire: The 'Day Without a Car' inMexico City." Policy Research WorkingPaper 1554,1995.
31
15. Price elasticity of demand is the percentagechange in demand for a good from a 1 per-cent increase in the price of that good. Incomeelasticity of demand is the percentage changein demand for a good from a 1 percent in-crease in income.
16. Constructed by Dr. Roy Boyd of the Univer-sity of Ohio, this CGE model for Mexico'seconomy is based on a 1988 input-productmatrix comprised of 13 productive sectors, 14consumer goods, and three basic inputs: land,
labor, and capital. The model is based on theconcept of the economy as a circular incomeflow, with producers, consumers, a govern-ment, and international trade. Four types ofhouseholds are categorized according to in-come level.
17. Eskeland, G. "A Presumptive Pigouvian Tax:Complementing Regulation to Mimic anEmissions Fee." The World Bank Economic Re-view, Vol. 8, No. 3, pp. 373-394.
32
IV. POLAND CASE STUDY
A. Introduction
Poland's central planning system left an en-ergy-intensive, inefficient economy and abacklog of environmental problems. As
market forces strengthen through privatization,trade liberalization, and deregulation, the publicfinance instruments that Poland adopts during itstransition will greatly influence the country's fu-ture path of economic development. This chapterexplores the potential role of taxes and other pub-lic finance instruments to promote economic de-velopment and protect the environment.
Poland can offer other transitionalcountries insights into how to create aneconomic incentive structure that bothpromotes economic growth andstrengthens environmental policies.
The Poland case study also might guide othercountries in transition. As a leader of economicand environmental policy reforms in Central andEastern Europe, Poland can offer other transi-tional countries insights into how to create aneconomic incentive structure that both promoteseconomic growth and strengthens environmentalpolicies.
1. Air Pollution Legacy of Central Planning
With an economic development strategy favor-ing energy-intensive industries and without anymarket forces to drive plant managers and house-holds to reduce inefficiencies and waste, thePolish economy became energy intensive and in-efficient. Energy-intensive sectors, including pulpand paper, metallurgy, chemicals, and buildingmaterials, accounted for 30 percent of value-added manufacturing—a much higher percent-age than in OECD countries. More than 80 per-cent of Poland's stock of capital in the late 1980swas more than 5 years old, compared with 40percent in western Germany. In the residentialsector, no efforts were made to build energy-effi-cient housing, with the result that in the 1980s theheating requirement of Polish homes was abouttwice that of homes in western Europe. As a re-sult of these inefficiencies, the energy intensity ofthe economy was two to three times higher thanin most OECD economies.1 Making mattersworse, Poland relied heavily on coal, the dirtiestfossil fuel, which accounted for more than 75 per-cent of primary energy used. Consequently, coalburning is the major source of air pollution, gen-erating more than 98 percent of particulate mat-ter, almost 90 percent of SO2 and almost 80 per-cent of NOx.
On the eve of transition, Poland was thelargest emitter of SO2 and NOx per GDP, the sec-ond largest emitter of particulate matter, and thefourth largest emitter of CO2 per capita inEurope. Air pollution was, and still is, particu-
33
larly severe in the south, where major urban andindustrial areas are located. The Upper Silesia re-gion, which contains only 10 percent of the popu-lation and 2 percent of the land mass, contributesabout one-third of all SO2 and particulate matteremissions and one-fifth of NOX emissions.Katowice, a major district in Upper Silesia, hosts22 of the 80 most polluting firms in Poland.2
Decades of excessive air pollution have af-fected the health of many Poles. Indeed, healthconditions in Poland are significantly below west-ern European standards. Within Poland, healthand environmental quality are highly correlated.For example, residents of the heavily polluted re-gion of Upper Silesia have 47 percent more respi-ratory diseases than the national average.3 Themortality rate in Bytom-Rozbark, one of the mostcontaminated municipalities in Upper Silesia, isthree times the national average. Public healthrisks will only worsen unless the governmenttakes action to prevent and control pollution.
2. Toward Sustainable Development
During the past six years, Poland's prospectsfor sustainable economic development have im-proved. In 1990, the country made an abruptswitch to a market-based economic system. Afteran initial, severe economic downturn and hyper-inflation in 1990 and 1991, economic growth ac-celerated, rising from 2.6 percent in 1992 to 7 per-cent in 1995, and inflation decreased from 43percent to 28 percent. Today, Poland's privatesector produces 60 percent of GDP, twice as muchas in 1990. Environmental quality is also improv-ing during transition. Since 1990, emissions of al-most all major airborne pollutants have de-creased, as shown in Tables 1, 2, and 3.
Initially, the 1990-1991 economic downturnwas the major contributor to the improvement inenvironmental quality. Industrial output fell 24percent in 1990 and 12 percent in 1992, depress-ing energy use. The government also became astronger watchdog for the environment. In 1990,it updated national ambient standards for morethan 40 pollutants. The new standards for SO2
and NOV emissions for all new combustion instal-
lations greater than 200 kW are similar toEuropean Union standards, although the stan-dard for particulate matter is considerablyweaker.4 In the early 1990s, citizens' demands toshut down coal mines, steel mills, coke plants,and chemical plants encouraged environmentalinspectors to exercise their prerogatives, an actiondiscouraged under the centrally planned eco-nomic system.5 Between 1990 and 1991, morethan 100 plants were closed for environmentalreasons—a substantial improvement over thepre-1990 period, in which only two facilities wereshut down in 40 years.
The government has undertaken numerousmeasures to ensure a supply of cleaner fuels. Toreduce pollution from the production and use ofpetroleum products, it has set targets to raise theproportion of unleaded and low-lead gasoline,low-sulfur diesel, and gas oil in the fuel mix andto reduce refineries' emissions.6 Stricter limits onthe sulfur content of diesel fuel and tighter speci-fications for leaded gasoline have also made thesefuels cleaner. In the mining sector, the system ofcoal prices was changed in 1990 to induce miningcompanies to improve coal quality. As a result,coal companies have invested in coal washing tolower ash and sulfur content. Between 1989 and1992, the average calorific value of coals rose 15percent, ash content fell 20 percent and sulfurcontent fell 25 percent.
Since the early 1990s, increasedinvestment in environmental protectionhas helped environmental improvementsto continue as economic growth pickedup.
Since the early 1990s, increased investment inenvironmental protection has helped environ-mental improvements to continue as economicgrowth picked up. Financed in part through ris-ing revenue from pollution taxes, such invest-
34
Table 1. Total Emission of Atmospheric Air Pollutants, 1988-1993 (Million tons)
Pollutant 1988 1989 1990 1991 1992 1993
DustsSO2
NO
2.64.21.6
GDP growth rate n.a.
2.43.91.5n.a.
1.93.21.3
-11.6
1.73.01.2
-7.0
1.62.81.12.6
1.52.71.33.8
Note: Estimates are based on the fuels consumption and technological coefficients.Sources: Ochrona rodowiska (Environmental Protection), 1992,1993,1994; Warszawa: GUS (Main Statis-tical Office), 1992, p. 142; Warszawa: GUS, 1993, p. 153; Sprawozdanie z realizacji polityki ekolog-icznej panstwa (Report on the Realization of State Ecological Policy), 1991-1993; the Government ofPoland, September 1994.
Table 2. Ambient Concentrations of SO, in Major Cities
WarsawKrakowLodWroclaw
(annual average,
1989
23693240
p,g/m3)
1990
20662751
Source: Ochrona rodowiska (Environmental Protection).
1991
20653234
1992
15602422
1993
20592530
Table 3. Ambient Concentrations
WarsawKrakowLodWroclaw
(annual average,
1989
82506555
i of NOX in Majorixg/m3)
1990
57435345
Cities
1991
37404232
Source: Ochrona rodoiviska (Environmental Protection).
1992
45393624
1993
45473737
35
ments rose almost 50 percent in real terms in 1991and remained stable at about $850 million during1992 and 1993, raising the investment to GDPratio to the level of that of OECD countries. Manyinvestments are on end-of-pipe pollution con-trols. For example, to combat acid rain, the gov-ernment obliges new coal and lignite-fired plantsto install a flue gas desulfurization (FGD) system.After 1997, these standards will apply to existingplants as well, and all plants will be required tohave low-NOx burners and improved dust re-moval equipment.
B. Public Finance Restructuring
Although some of these regulatory and publicinvestment efforts are commendable, they maynot be the most cost-effective way of abating airpollution. One major drawback is that the gov-ernment's capacity to monitor emissions of morethan 40 air pollutants and to enforce the stan-dards is limited. Some regulations will requiresubstantial investments. Retrofitting old plantswith FGD equipment removes about 90 percentof SO2 and NOX emissions, but at a cost of about$500 to $600 per ton of SO2 abated. Moreoversuch retrofitting creates other environmentalproblems. Because it reduces plant efficiency—
Although some of the regulatoryand public investment efforts arecommendable, they may not be the mostcost-effective way of abating airpollution.
2mis-
requiring more fuel to produce one unit of elec-tricity than conventional coal-fired plants-sions of CO2 are comparatively higher. Inaddition, the disposal of sludge, a waste productof the FGD process, is an environmental problem.Perhaps most important, this regulatory, end-of-pipe approach to pollution foregoes great oppor-
tunities to prevent pollution by creating fiscal in-centives to improve energy efficiency and switch-ing to cleaner fuels and technologies. Modest in-vestments by producers and consumers in energyconservation and efficiency, such as installationof waste heat recovery equipment and the pur-chase of energy-efficient durable goods, wouldreduce pollution substantially.
Since Poland's transition began, energyprices have risen, energy subsidies havedeclined, and pollution charges haverisen. However, energy subsidies forsome fuel uses remain, and mostpollution tax rates are still too low.Further fiscal reforms and othercomplementary measures are needed.
To some degree, Poland is on the right track.Since Poland's transition began, energy priceshave risen, energy subsidies have declined, andpollution charges have risen. However, energysubsidies for some fuel uses remain, and mostpollution tax rates are still too low. Further fiscalreforms and other complementary measures areneeded.
1. Energy Pricing
At the onset of transition, per capita fossil fuelsubsidies were the world's largest.7 TodayPoland's energy pricing structure is much lessdistorted. In real terms, energy prices rosesharply with the liberalization of Poland's econ-omy in 1990. Between 1990 and 1995, the unitsubsidy rate8 of fossil fuels in Poland fell from 50percent to 15 percent.9 Direct subsidies for all en-ergy industries have been eliminated, except forbudgetary support to tenant associations for dis-trict heating. Even there, the subsidy rate hasfallen from 78 percent in 1991 to 27 percent in1994. Lower energy subsidies have led to im-
36
provements in energy efficiency. The efficiency offossil fuel use (measured as quantities of fuelsused per unit of real GDP) has increased 20 per-cent from mid-1980s levels.10
Some indirect subsidies, however, remain. Inparticular, state-owned coal mining companiesreceive large subsidies through a backlog of un-paid taxes, fines for violation of environmentalregulations, and obligations to the Social SecurityFund and state-owned banks. In 1994, the coal in-dustry owed $50 million in unpaid taxes, $425million in environmental fees, and $680 million inobligations to the Social Security Fund. The over-all indebtedness of the industry was equivalent toone-quarter of their revenues. By and large,though, domestic energy prices in purchasingpower terms are on a par with internationalprices, as shown in Table 4.
A public policy of full-cost pricingwould require higher energy prices, evenaside from environmental costs. Yet,since 1990, little progress has been made.
Finding: Energy prices need to rise to cover irun marginal cost. Despite these gains, prices fornontraded fuels and energy services in Poland re-main below long-run marginal cost. According toOECD, households and industry pay gas pricesequivalent to only about 50 percent and 80 per-cent of supply costs, respectively. Prices cover op-erating costs but do not generate sufficient funds
Table 4. Energy Carrier Prices in the OECD countries in 1990 and Their Counterparts in Poland in1992
Maximum Average OECD-price price Europe
Unit (country) (country) Average* Poland
Coal
Natural gas
Gasoline
Electricity
Heat
t
m3
1
MWh
GJ
158.8(Sweden)
0.08(Finland)
0.5(Switzerland)
46.0(Sweden)
7.1(Austria)
283.5(Germany)
0.589(Switzerland)
1.6(Turkey)
192.2(Portugal)
8.3(Sweden)
220.8 (10)
0.306 (12)
0.7(18)
96.0 (18)
7.6 (3)
125-200
0.297
1.05
92
12.6
* () indicates the number of countries.Note: Current consumer prices in USD were computed according to purchasing power parities ofnational currencies.Source: Polish Energy Sector Against a Background of Highly Developed Countries: Current State andProspects. Data Processing Center of Polish Energy Sector, Warsaw, 1992.
37
Without further fiscal restructuring, thecurrent incentive structure will continueto send signals to firms to adopt lowenergy-efficient technologies during thiscritical period of rapid privateinvestment and economic growth.
to finance capital investments. District heatingprices are closer to covering supply costs, butgaps remain. Electricity prices are 40 to 50 percentbelow supply costs. Several studies suggest thatthe price of coal is 20 to 30 percent below supplycost.11 Clearly, a public policy of full-cost pricingwould require higher energy prices, even asidefrom environmental costs. Yet since 1990, littleprogress has been made. Among the network-based energy forms, electricity and household gasprices have remained stable in real terms, and gasprices for industry have fallen by about one-thirdfrom 1991-1994 levels. Only residential districtheating prices have continued to appreciate fasterthan inflation. Coal prices have remained stablein real terms since 1990, but motor and industrialfuel prices and industry gas prices have actuallyfallen. Without further fiscal restructuring, thecurrent incentive structure will continue to sendsignals to firms to adopt low-energy-efficienttechnologies during this critical period of rapidprivate investment and economic growth. OECDestimates that energy price reform could reducethe level of particulate matter in the air by 80 per-cent as well as significantly lower SO2, NOX, andCO2 emissions.12
Finding: Equity impacts can be managed. Thoughthe government is aware that full-cost pricing isneeded to turn Poland into an energy-efficienteconomy, timing is the issue. The governmentfears that households are already overburdenedby recent price hikes in the face of falling income.They spend an average of 9.3 percent of dispos-able income on energy, almost three times asmuch as their western European neighbors.13
Indeed, public outcries have slowed down energyprice adjustments since the early 1990s. The gov-ernment is particularly concerned that higherheating and electricity prices would be dispro-portionately burdensome for the poor. However,other countries, despite similar implementationproblems, have demonstrated that full-cost pric-ing is politically feasible—even in the context ofrapid structural adjustments. For instance, inHungary, electricity prices cover almost all eco-nomic costs.14
One policy option that addresses this equityissue is to compensate low-income householdsfor price increases through direct cash pay-ments.15 However, targeting subsidies to theneedy is difficult to implement in practice.Alternatively, the government could charge alow, subsidized price for a fixed, modest energyquota to all consumers, and charge the full cost tothose households that consume beyond thequota.16 Although this policy would be less effi-cient than a direct compensation program be-cause it would subsidize all consumers, not justthe poor, its design does ensure that the large ma-jority of consumers will pay a price for energyclose to economic cost at the margin.
Without a metering and billing systemthat charges per unit of heat consumed,residents have no reason to insulateapartments or to conserve heat.
Finding: Pricing reform is not enough to get house-holds to cut back on energy consumption. Chargingper unit of consumption is needed. In the residentialsector, the ability of households to respond to ris-ing energy prices depends on the mechanismsthat utilities use to charge customers. For exam-ple, households responded to the initial rise inelectricity prices in the 1990s by lowering de-mand, but rising coal prices had virtually noeffect on the demand for district heating.
38
Differing responses to rising heating and electric-ity prices is understandable because homes withdistrict heating are charged according to the sizeof the dwelling, not according to the amount ofenergy consumed, as is the case for electricity.Without a metering and billing system thatcharges per unit of heat consumed, residentshave no reason to insulate apartments or to con-serve heat.
Since 1992, the government has had a pro-gram, budgeted at about $75 million per year, tosubsidize the renovation of housing cooperatives.The funds cover as much as 80 percent of thecosts of installing thermostatic valves, water andheat meters, and other energy conservation mea-sures. Recently, the government has targeted thisprogram to housing cooperatives under construc-tion. However, according to one study, devisingincentives for owners and tenants to retrofit exist-ing buildings remains the biggest challenge in theresidential sector.17 Revenues from higher energytaxes could be used, in part, to finance such in-centives. Because more than 90 percent of house-holds are still without metering devices to regu-late their consumption of heat, more effectivemeasures are needed to expand their use.
The electric utility industry couldpromote demand-side managementprograms targeted to residential as wellas commercial and industrial consumers.
The electric utility industry could promote de-mand-side management programs targeted toresidential as well as commercial and industrialconsumers. These programs could include partialrebates for purchases of energy-efficient lightingand fixtures and equipment for heating, cooling,and refrigeration. Such programs would benefitboth the power company and the consumer. Inthe United States, demand-side management isexpected to reduce demand by an average of 3 to7 percent over the next decade, with energy sav-
ings equivalent to 30 percent of new capacityrequirements.18
Finding: Pricing reform is effective only if affordableenergy substitutes are available. Many householdswithout district heating use inefficient coal-basedstoves to heat their homes. Reduction of low-stackemissions will require substitution of these stovesby district heating or gas systems. Public invest-ments in these systems would be needed beforehouseholds with coal stoves could switch tocleaner fuels. Yet, even in communities with gasdistribution networks, the residential sector hascontinued to rely on coal as its price has risen, inpart because the costs of converting cooking andheating systems to gas are 3 to 4 times higher thanthe average net monthly income of Polish families.The commercial sector, with access to larger poolsof finance, has been more responsive to rising coalprices. For example, in the Katowice District (lo-cated in the heavily polluted Upper Silesia region)the government's expansion of the gas distributionnetwork, coupled with stricter rules for air pollu-tion permits, induced commercial firms to switchfrom coal to gas heating. Several cities have pro-grams under way to eliminate the use of coalstoves for residential heating. These programs, fi-nanced in part by national and local environmen-tal funds as well as the regional EcoFund, shouldbe implemented more rapidly and expanded toother cities.
Finding: Industry's adjustment to higher energyprices takes time. The sharp rise in energy prices inthe early 1990s has not resulted in substantialchanges in energy use. In fact, economy-wideenergy intensity actually rose during the initialyears of the transition of 1990 and 1991 as plantmanagers focused on the immediate need to sur-vive under a new regime by marketing their pro-jects instead of making long-term investments toimprove the energy efficiency of their productionprocesses.19 Even as market reforms began to takehold, many industrial firms continued to useoutdated technologies and poorly maintainedequipment.
OECD estimates that industries using coal asthe primary energy source will need to invest
39
Even as market reforms began to takehold, many industrial firms continued touse outdated technologies and poorlymaintained equipment.
about $2.5 billion to meet national air emissionstandards.20 However, many industrial firms arein weak financial condition and have not ac-quired the skills needed to make steep steps upthe technological ladder. A shortage of invest-ment funds and limited technological capabilityare preventing firms from immediately investingin energy-efficient and cleaner production
processes21
Adjusting to market incentives takes time, par-ticularly for firms just learning to operate underprivate market conditions. Eventually, firms willimprove energy efficiency as part of plant mod-ernization investment programs. Industry associ-ations, in partnership with government, shouldplay a major role by providing information andtraining that builds firms' capability to choose, fi-nance, and adapt advanced technologies.
Finding: Further progress on privatization andother structural adjustments will strengthen the effec-tiveness of fiscal policies. With 54 percent ofmedium and large state enterprises still in gov-ernment hands,22 the state continues to play amajor role in Poland's economy. The slow pace ofprivatization and continued subsidies to state-owned enterprises weaken the response to mar-ket signals. As long as public enterprises can ex-pect to be bailed out by the central government,their viability is not dependent on efficientlyusing energy, raw materials, and other inputs.
Gradually, privatization, deregulation andother structural adjustment policies are funda-mentally changing firms' behavior. Enterprisesare becoming profit-oriented—allowing outputvolume to be determined by market forces in-
stead of by a bureaucrat from the central govern-ment. Further progress on privatization and otherstructural adjustments will strengthen the incen-tives for industry to improve the energy effi-ciency of existing operations and to invest incleaner production processes. As industry re-vives, firms will also be in better financial shapeto make needed capital investments in new tech-nologies and processes.
2. Taxing Pollution
Poland has one of the most extensive systemsof emission taxes in the world. In the 1970s, cen-tral planners began taxing emissions of severalhundred pollutants from the largest emitters.Today, small-scale as well as large-scale pollutersare subjected to these taxes. More than 50 of thesetaxes are on airborne emissions. Some tax ratesare high enough to provide some incentive forpollution abatement. For example, Poland's $70to $80 tax per ton of SO2 emission—on par withthe trading price of SO2 permits in the UnitedStates—has encouraged coal mines to invest incoal-washing equipment as a result of a decline indemand by plants for high-sulfur coal. Other taxrates are too low to have any incentive effect andserve fundamentally as a source of governmentrevenue.
Poland has one of the most extensivesystems of emission taxes in the world.
Poland's system of pollution taxes is experi-encing several problems. First, the governmenthas had a difficult time keeping the tax base fromeroding, particularly during recent periods of hy-perinflation and enormous price uncertainty.During the second half of 1989, Poland's vast sys-tem of emission taxes quickly eroded as inflationsoared to more than 100 percent per year. Thegovernment's attempt in the early 1990s to indexpollution taxes to the inflation rate failed to pre-
40
vent further erosion because the taxes were in-dexed to the inflation rate in previous periods.Eventually, the index mechanism was disman-tled, and the government has since relied on peri-odic rises in tax rates to keep up with inflation. Amore effective and reliable solution would be tocreate an indexing mechanism that automaticallyadjusts to rising prices. Ad valorem taxes embodysuch a mechanism.
The capacity of government toimplement a wide array of emissiontaxes is limited. Regional governmentsissue pollution permits and collect finesfor noncompliance, but their bark islouder than their bite.
The capacity of government to implement thiswide array of emission taxes is also limited.Regional governments issue pollution permitsand collect fines for noncompliance, but theirbark is louder than their bite. In practice, thegovernment can monitor only a few of the pollu-tants it taxes. In addition, state-owned enter-prises, particularly those in poor financial shape,are often granted waivers from payment of feesand fines.
Finding: Poland needs to simplify its pollution taxstructure and raise tax rates. Imposing a largenumber of environmental taxes is not the mostcost-effective way to reduce pollution. Instead oftaxing many pollutants at low rates, the govern-ment should consider focusing its efforts on themost damaging pollutants and on setting taxrates high enough to create incentives to reducepollution.
Taxing energy sources according to their car-bon content is one option that would reduce bothglobal and local pollution. A carbon tax wouldfall most heavily on coal, relative to the cleaner
fossil fuels, natural gas and oil. Over the long-runa carbon tax would not only provide direct incen-tives to reduce CO2, a key contributor to globalwarming, but would also reduce other pollutantsthat combine to form acid rain and smog.
Poland has a very small $0,042 per ton of CO2
tax, which is too low to provide economic incen-tives to reduce air pollution. However even if thegovernment raised the carbon tax rate, the incen-tive effect would be weak initially. Demand forsome fuels, particularly electricity and residentialheating fuels, is not likely to be very price elastic,even in the medium term. A large stock of out-dated energy-inefficient equipment and appli-ances will take time to replace, and metering andbilling systems that charge households accordingto the amount of heat they consume need to beinstalled. A carbon-based fuels tax would nothelp Poland meet its environmental objectives forsome time, unless other measures were taken toenable households and industry to readily switchto cleaner fuels and adopt more energy-efficienttechnologies.
Finding: If elasticities are low, environmental taxesare good sources of government revenue. Althoughthe incentive effect to reduce carbon emissionsfrom a fuels tax would be weak in the short run, acarbon tax would generate substantial govern-ment revenue. For an example, rough projectionsindicate that a $2.10 carbon tax would initiallygenerate about $782 million of government rev-enue. This sum is 75 percent greater than the sumof revenue from all environmental fees and regu-latory fines collected in 1994 by all regional andnational environmental funds combined. GivenPoland's heavy dependency on fossil fuels and agrowing economy, a carbon tax would continueto generate a robust and significant revenuestream for the government.
Finding: Revenue can be used in a variety of pro-ductive ways, including reducing the tax burden onproductive elements of the economy, eliminating obsta-cles that contribute to the price inelasticity of demand,and financing the cleanup of environmental damagesleft over from state-owned enterprises. All three op-tions merit further consideration.
41
a. Shifting the Tax Base
The government could shift the tax base awayfrom income and other market distorting taxesand rely more on market-correcting taxes as rev-enue sources. Poland's tax system has amplescope to reduce the tax burden of workers, in-vestors, and corporations. The average salariedworker must work from January 1 to April 23 tocover his annual tax liability. People with above-average income must work until June 2 to paytheir tax bill. The corporate world is also overbur-dened by taxation. Employers are mandated tocontribute 45 percent of gross wages to theGeneral Social Insurance Fund and an additional3 percent to the Labor Fund that administers un-employment benefits. This combination of heavytaxation on individuals and corporations is a sig-nificant source of distortions in the economy. Thehigh 17 percent unemployment rate in Poland in-dicates that these taxes may be pushing economicactivity underground and discouraging job cre-ation. Replacing labor charges with energy taxeswould produce both environmental and eco-nomic benefits by encouraging productive activi-ties that benefit the economy and discouragingactivities that harm the environment.
Poland's tax system has ample scope toreduce the tax burden of workers,investors, and corporations.
b. Cleaning Up Past EnvironmentalDamage
Poland needs to mobilize billions of dollars toclean up past environmental damage. (See Box 3.)To date, environmental liabilities from formerlystate-owned enterprises have been transferred tothe new private owners. But these owners may inthe future protest paying the full cost of remedia-tion, arguing that they were unable to assess en-vironmental liabilities at the time of sale because
r Box 3. Financing Constraints forEnvironmental Protection
Poland's need for pollution abatementand other environmental investments is esti-mated at S12—13 billion dollars by the year2000. According to one projection, invest-ments totaling as much as $5 billion will beneeded before all combustion installationscan meet new ambient standards.1 Most sig-nificant, the cost to clean up pre-transitionenvironmental damage could reach hun-dreds of billions of dollars.2 One study indi-cates that meeting EEC or U.S. environmen-tal standards, will cost Poland as much as$300 billion.3 As a prerequisite for entry intothe European Union, Poland is under in-creasing pressure to improve environmentalquality.1 Mobilizing the finances needed forthis task is a major concern. Thus far, gov-ernment investment is inadequate, the fi-nancial system is not sufficiently developed,and firms' revenue streams are too small tomobilize the volume of funds needed.
1. Energy Policies of Poland: 1994 Survey.OECD/lnternational Energy Agency,Paris, 1995, p. 22,100.
2. Bluffs tone, R. and Panayotou, T. "OptimalEnvironmental Liability Policy for Centraland Eastern Europe." HUD EnvironmentDiscussion Paper, Winter 1996.
3. Boyd, J. "The Allocation of EnvironmentalLiabilities in Central and EasternEurope." Resources No. 112, Resources forthe Future, Summer 1993.
4. Vlarlise Simons, "Eastern Europe: EUTells Nations to Move on Env't Reforms,"The New York Times, September 25,1996.
of time constraints or lack of information, or thatregulators have since imposed tougher environ-mental standards. Most likely, government willhave to pay at least a portion of the cleanup
42
costs.23 One study indicates that a publicly fi-nanced cleanup fund would create a more attrac-tive climate for foreign and direct investment.24 A1992 survey by The Economist of 1,000 foreignfirms considering investment opportunities ineastern and central Europe revealed that liabilityfor past contamination was a greater concernthan political instability and inadequate infra-structure.25 About half of these firms decided notto invest, at least in part on environmental liabil-ity grounds.26
Given that dismantling these funds after theyhave served their purpose might be politicallydifficult, the challenge of designing a cleanupfund is to ensure that the new owners believe thatthey will bear the burden for the social costs oftheir polluting activities. One recommendation isto limit the duration of coverage for liability andset requirements for eligibility.27 For instance,new owners might be required to invest in pollu-tion abatement equipment before they can receivefinancing for cleanup costs from past environ-mental damage.
c. Earmarking for EnvironmentalInvestments
A portion of the revenue generated from amore streamlined pollution tax system could con-tinue to be earmarked for environmental invest-ments and large-scale infrastructure projects,such as sewage treatment plants, that private in-vestors find unattractive. The NationalEnvironmental Fund, the major institution inPoland that finances environmental protection,provides soft financing, mostly through below-market interest rates and other favorable paybacklending terms and through direct grants and sub-sidies for co-financing investments. (See Box 4.)Environmental funds are also administered at re-gional and local government levels.
These earmarked funds have offered a securesource of finance for environmental investmentsin times of tight government budget constraintsand low levels of private savings and investment.However, they have important weaknesses. Thefunds have invested mostly in capital-intensive,
end-of-pipe technologies, neglecting investmentsin cleaner production processes and technologies.With regard to air quality objectives, investmentsfinanced by these funds should aim to reduce theobstacles that contribute to the price inelasticityof demand of energy. There is also strong evi-dence that the projects actually selected for fi-nancing may not be cost-effective in their respec-tive categories, although in principle, the fundsapply abatement-effectiveness criteria to the se-lection of projects. For instance, the cost-effective-ness ratios of the cheapest and the most expen-sive sulfur-abatement projects financed by theNational Fund differ by as much as four orders ofmagnitude.28
With improved project screening andassessment procedures ensuring efficientallocation, environmental funds could beuseful instruments to implementenvironmental policy during Poland'stransition to a market-based economy.
With improved project screening and assess-ment procedures ensuring efficient allocation,these environmental funds could be useful instru-ments to implement environmental policy duringPoland's transition to a market-based economy.In this respect, an immediate, rigorous evaluationof the National Fund's project appraisal proce-dures and institutional organization is in order.Investment priorities should be determined bybenefit-cost analysis, and the management boardshould have greater independence from theMinister of Environment in making investmentdecisions. By restricting the role of the environ-mental funds to those investments that cannot befinanced by the private sector, the remaining por-tion of revenue generated by a streamlined sys-tem of pollution taxes could be allocated to thecentral government and used to reduce the taxburden currently falling on productive economic
43
Box 4. Poland's System of Environmental Funds
Poland has one of the largest sets of envi- •ronmental funds among countries in economictransition. Its environmental funds are admin-istered at the national, regional, and municipallevel. These funds include the National Fundfor Environmental Protection and WaterEconomy; 49 regional (voivodship) environ-mental funds, one for each region in Poland,and municipal (gmina) environmental funds.1-2
Within this system of environmental funds,which raise as much as $400 -̂500 million peryear, the three largest sources of revenue areemissions of NOx and SO2 and discharge ofsaline water from coal mining. Revenue fromthese three pollutants are earmarked to financeabatement projects related specifically to thepollutants. Revenue from most of the otherpollution taxes are not earmarked for specificabatement projects.3
These environmental funds account for al-most one-half of total environmental invest-ments in Poland, and their role in financing en-vironmental investments is expanding.^ 5 As a
consequence of increasing pollution tax ratesand transition to a market-based system, rev-enue from these funds increased more than :ten-fold, from US$12.9 in 1991 million to •. . :US$334.4 million in 1994.
The National Fund is the largest singlesource of financing for environmental invest- :
ment, contributing about 23 percent of the totalexpenditures on environmental investment in1992 and 1993. The Fund's board of directorsfollows some basic, broadly defined fundingpriorities issued by the Ministry of Environ-ment. Its main activity is to finance invest-ments through concessional loans issued bythe Bank for Environmental Protection, whichwas created by the government specifically forthis purpose. The Fund covers the 20 to 80 per- .•cent difference between market and preferen-tial credit rates. On average, the main recipi-ents of financing from the Fund are air qualityprotection (42 percent), water quality prptec- '•;tion and water management (42 percent) andland surface protection (6 percent).
activities. As the private sector develops andfirms' ability to mobilize needed sources of in-vestment financing improves, the role of nationalenvironmental funds should diminish.
C. Challenges and Opportunitiesfor Reform
needs to be done. The government should elimi-nate all energy subsidies, particularly to industryand residential district heating. Prices for electric-ity, heating, and gas for all consumer categoriesneed to be raised to cover long-run marginal cost.
To improve air quality, a combination of policytools will be needed to create the most cost-effec-tive incentive structure that sends signals to in-crease energy efficiency, substitute cleaner fuelsfor coal, and adopt pollution control technologies.Energy pricing is perhaps the most important toolthat the Polish government has to influence en-ergy consumption patterns and improve air qual-ity. Policy reforms are on the right track, but more
Energy pricing is perhaps the mostimportant tool that the Polishgovernment has to influence energyconsumption patterns and improve airquality.
44
In 1993, Poland created a system of munici-pal funds into which a portion of the revenuescollected by environmental taxes arc de-posited. Almost 70 percent of expendituresfrom the municipal funds were used to financemodernization and investments projects for en-vironmental protection and water-sector man-agement. Revenues from the municipal fundsalso support environmental education pro-grams, environmental control and monitoringsystems, organization and maintenance ofparks, and other environmental protectiongoals determined by the municipality's coun-cil. To date, the role of the municipal funds aresmall, contributing 1 percent of the total fi-nancing for environmental protection activitiesin Poland.
Notes1. Those funds were established by law in
1.993, however, not all 2460 municipalitieshave created these funds.
2. Two other funds that administer fees some-what resembling resource taxes are theForestry Fund and Farmland Production
Fund. These funds are not analysed becausethe Forestry Fund is a very peculiar fund($300-400 million annually) serving redistrib-utive purposes in the State Forest Enterpriseand the Farmland Protection Fund is negligi-ble (less than $10 million annually).
3. The other major funding sources for envi-ronmental protection are private investment(30 percent), local government budgets (10percent), state budgets (7 percent), and for-eign aid (5 percent). Source: The F.mergingEnvironmental Market, 1995, p. 37.
4. For a more extensive analysis of the role ofecological funds in financing the environ-mental protection expenditures in Polandsec: 13. Fiedor, Finansowanie ochronysrodowiska w Polsce. Proba oceny(Financing Environmental Protection inPoland. An Attempt at Evaluation), "Aura,"No. 7/1995, pp. 7-9.
5. Zylicz, 1. "Taxation and Environment inPoland," in Taxation and the Environment inEuropean Economies in Transition. OJr'CD,Paris, 1994, pp. 36-56.
Raising energy prices is not enough. Forhouseholds and industry to change theirenergy consumption habits, othermeasures are needed.
Raising energy prices, however, is not enough.For households and industry to change their en-ergy consumption habits, other measures are
needed. Nationwide, government needs to bancoal stoves, the most environmentally damagingresidential heating system, and provide districtheating, or better yet, gas heating services forhomes. For district heating services, programs toinstall heat metering systems and charge cus-tomers according to how much heat they con-sume need to be expanded and implementationaccelerated. In addition, gas distribution net-works need to be expanded to offer a greaternumber of households a cleaner substitute fordistrict heating. As income rises along with over-all economic growth, households will be in a bet-ter financial condition to afford the investmentsneeded to switch to cleaner heating systems.
45
Regarding the industrial sector, government andindustrial associations should form partnershipsto facilitate information flow, acquisition of skills,and access to technology markets so that firmscan develop the technological capability to re-spond swiftly to price signals.
Government also needs to enhance the effec-tiveness of fiscal restructuring by creating a busi-ness-friendly investment climate and by fosteringcompetition through macrostabilization, trade lib-eralization, deregulation, and other structural re-forms. In this arena, much progress has alreadybeen made. Poland's combination of rapid transi-tion to a market-based economy and strengthen-ing of environmental policies have benefitted theenvironment. Further market reforms, includingan acceleration of the privatization program,would help to ensure that the recent improvementin environmental performance will continue. Asprivatization proceeds and other structural adjust-ments take hold, the private sector will be able torespond with greater force to market-correctingtaxes and other fiscal policy reforms.
Eliminating subsidies in the energy sector is animportant step for Poland to take; however, this ac-tion does not address the problem that marketprices for energy do not account for the damagethat polluters cause by disposing of wastes in theair and water. Poland's current approach to correctthis market failure—a system of hundreds of pollu-tion taxes—is not working well. The governmentshould consider streamlining this complex system.Many of the taxes on air emissions could be re-placed with a fuels tax based on the carbon content.By improving the efficiency of fossil fuel use, sucha tax would also lead to a reduction in emissions ofother pollutants, not just carbon. In addition to re-ducing ambient pollutants, substantial tax revenuewould be generated, which could be used to cleanup environmental damages, finance investments inthe energy, petroleum, and manufacturing sectorsto control air pollution, and reduce the excessiveburden of payroll and other taxes that fall on pro-ductive elements of Poland's economy.
With the common legacy of an inward-lookingdevelopment strategy and central planning that
favored energy-intensive industrialization, othereconomies in transition face economic and envi-ronmental problems similar to Poland. Poland'sexperience with energy pricing reforms andstreamlining of a pollution system offers insightsfor other transitional economies into the most ef-fective ways to integrate environmental issuesinto economy-wide and sectoral policy reformsand to seize opportunities for environmental pol-icy reform that arise during transition.
Notes1. Energy Policies of Poland: 1994 Survey.
OECD/ International Energy Agency, Paris,1995.
2. Adamson, S. et al., "Energy Use, Air Pollu-tion, and Environmental Policy in Krakow:Can Economic Incentives Really Help?"World Bank Technical Paper No. 308, EnergySeries, Washington, DC, 1995, p. 3.
3. Quoted in French, H. "Green Revolutions:Environmental Reconstructuring in EasternEurope and the Soviet Union." WorldwatchPaper 99, November 1990.
4. Energy Prices of Poland: 1994 Survey.OECD/International Energy Agency, Paris,p. 184.
5. G6rka,K. "Instrumenty ekonomiczne w poli-tyce ekologicznej w Polsce." ["Economic In-struments in Poland's Environmental Pol-icy."] Discussion paper, Academy ofEconomics, Cracow, 1993.
6. Energy Policies of Poland: 1994 Survey.OECD /International Energy Agency, Paris,1995, p. 32.
7. Larson, B. and Shah, A. "Combating the'Greenhouse Effect.'" Finance & DevelopmentDecember 1992, pp. 20-23.
8. Unit subsidy rate is the subsidy divided bythe amount consumed.
9. "Monitoring Environmental Progress: A Re-port on Work in Progress." The World Bank,Washington, DC, 1996.
10. Environment Matters The World Bank, Fall1996, p. 36.
11. Energy Policies of Poland: 1994 Survey.OECD/International Energy Agency, Paris,1995, p. 93.
46
12. Energy Policies of Poland: 1994 Survey.OECD/International Energy Agency, Paris,1995, p. 198.
13. Energy Policies of Poland: 1994 Survey.OECD/International Energy Agency, Paris,1995. p. 111.
14. From Plan to Market, World DevelopmentReport 1996, The World Bank, Washington,DC, 1996, p. 24.
15. Energy Policies of Poland: 1994 Survey,OECD/International Energy Agency, Paris,1995, p. 18.
16. Freund, C. and Wallich, C. "Raising House-hold Energy Prices in Poland: Who Gains?Who Loses?" World Bank Policy ResearchPaper 1495, Washington, DC, 1995.
17. Energy Policies of Poland: 1994 Survey.OECD/International Energy Agency, Paris,1995, p. 66.
18. Brandon, C. And Ramanjutty, R. "Toward anEnvironmental Strategy for Asia." WorldBank Discussion Paper 224, p. 100.
19. Energy Policies of Poland: 1994 Survey, IE A/OECD, 1994, p. 58.
20. Energy Policies of Poland: 1994 Survey, IE A/OECD, 1994, p. 193.
21. "Energy Policies of Poland: 1994 Survey."OECD/International Energy Agency, Paris,1995, p. 24.
22. "From Plan to Market, World DevelopmentReport 1996, The World Bank, Washington,DC, 1996, p. 53.
23. From Plan to Market, World DevelopmentReport 1996, The World Bank, Washington,DC, 1996, p. 54.
24. Boyd, J. "The Allocation of Environmental Li-abilities in Central and Eastern Europe." Re-sources No. 112, Resources for the Future,Summer 1993.
25. Klavens, J. "Survey of Western Direct Invest-ment and Environmental Issues in Centraland Eastern Europe." World Bank/OECD,1992. (Quoted in Panayotou, 1995).
26. Quoted in Bluffstone, R. And Panayotou, T."Optimal Environmental Liability Policy forCentral and Eastern Europe." HIID Environ-ment Discussion Paper No. 7,1996.
27. Boyd, J. "The Allocation of Environmental Li-abilities in Central and Eastern Europe." Re-sources No. 112, Resources for the Future,Summer 1993.
28. Jedrejewska, A. And Stanczuk, I. "Analizaefektywnosci kosztowej inwestycji finan-sowanych przez Narodowy FunduszOchrony srodowiska I Gospodarki Wodnej."("Cost Effectiveness Analysis of Projects Fi-nanced by the National Fund.") WarszawskiOsrodek Ekonomii Ekologicznej, WarsawUniversity, mimeo, Warszawa, 1994.
Dr. Theresa Bradley is a Senior Associate in WRI's Economics and Population Program. She has workedfor over ten years as a development economist, leading major policy research studies for the World Bank,the U.S. Agency for International Development, and other international institutions. Spanning Asia, LatinAmerica, and Eastern Europe, her applied research has focused on analyzing economic policy issues af-fecting sustainable economic development of low-income countries. Before joining WRI, Dr. Bradleyworked at the World Bank in both the research and lending operations branches, Abt Associates leadingseveral U.S. AID-funded natural resource and agricultural policy studies, and for the International FoodPolicy Research Institute, studying agricultural policy issues of Brazil. Dr. Bradley received her doctoratein economics at the University of Pennsylvania.
47
Technical Appendix: India Case StudyEstimation of LRMC Prices
The long-run marginal cost (LRMC) ofpower generation, transmission, and distri-bution was estimated primarily on the basis
of 1994-1995 price-related data from the TamilNadu Electricity Board (TNEB). The procedureentailed aggregating the capital costs of buildingan IGCC power plant, the costs of operating andmaintaining it, the capital costs and operatingand maintenance costs of transmission and distri-bution of power to consumer groups, and the costof coal washing.
Capital Cost of an IGCC Power Plant
The unit capital cost of building an IGCC plantis about Rs 40000 at 1994- 95 prices. Details areprovided in Table Al. The investment expendi-ture is assumed to be evenly distributed over afour-year period. The present value of investmentexpenditures and generating capacities over thelife of the plant is computed with a 15 percentdiscount rate.1 Zero scrap value and an expectedlife of 30 years from the date of plant commis-sioning are assumed.
Operations and Maintenance of an IGCCPower Plant
The operation and maintenance costs ofpower plants consist of repair and maintenancecosts, labor cost, and interest on working capitalon a normative basis. After correcting the TNEBcost estimate for a possible improvement in op-erational efficiency, the study team projectedoperations and maintenance costs to be Rs 655
per KW per year. Thus the capital-related gen-erating cost per KW per year is Rs 8,260 at1994-1995 prices. The generating capacity costper kwh can be estimated if an estimate of kwhper KW is available. In recent discussions onpower purchase agreements between indepen-dent power generators and state electricityboards, two estimates of the utilization rates,68.5 percent and 80 percent are used. The ratesimply kwhs per year of 6004.71 and 7012.8, re-spectively. The capacity costs per kwh that cor-respond to the utilization rates are Rs 1.38 andRs 1.18, respectively.
Capital Costs of Transmission andDistribution
Table A2 presents the estimated cost of build-ing and operating power transmission and distri-bution systems. The 26th Report of the Parlia-mentary Standing Committee on Energyobserved that a desirable share for transmissionand distribution in the total investment for powersector is 50 percent, but that the actual sharesduring Sixth, Seventh, and Eighth Plans wereonly about 30 percent. To arrest the decliningtrend, to cope with the steep increase in expectedpower generation, and to reduce line losses, aninvestment outlay for transmission and distribu-tion (T&D) of Rs 30 million, corresponding to aninvestment of Rs 40 million, one MW of generat-ing capacity is assumed. Construction is expectedto take two years and the equipment is expectedto last 25 years. Of the proposed investment, 20percent is allocated for extra-high-tension (EHT)
49
Table Al. Investment, Operations, and Maintenance Cost of a Power Plant
Investment cost per MWCommissioning periodAssumed capital expenditure in each yearDiscount ratePresent value of investmentExpected life of plant from date of commissioningPresent value of capacityCapital cost per MW per yearCapital cost per KW per yearOperating and maintenance cost per KW per yearCapital-related generation cost per KW per year (investment + O&M)Capital-related generation cost per kwh
a. When capacity is available 68.5 percent of time in a yearb. When the capacity is available 80.0 percent of time in a year
Rs 40 million4 years25 percent15 percent1
Rs 28.55 million30 years3.7541 MWRs 7605 millionRs 7,605Rs655Rs 8,260
Rs 1.38Rs 1.18
lines, 10 percent for high-tension (HT) lines, and70 percent for low-tension (LT) lines.
Operating and Maintenance Costs ofTransmission and Distribution
The operating and maintenance costs providedin Table A2 are projected on the basis of TNEBfigures with adjustments for possible cost sav-ings. Capital-related T&D costs per KW per yearare Rs 1,133 for EHT, Rs 648 for HT, and Rs 4,542for LT lines.
At present, T&D losses in India amount to 22percent of the power supplied at the generatingend. For TNEB, these losses are about 17 percent,even though Tamil Nadu has achieved 100 per-cent rural electrification. And even though T&Dlosses could be reduced with additional invest-ment and better management practices, at the na-tional level a target of only 17 percent is feasiblein the next five years. The average and peak-linelosses at voltage ends are provided in Table A2.Using the peak-loss estimates and the proportionof peak capacities in each voltage category as per-centages of additional generating capacity, thegeneration, transmission, and distribution costsper KW per year are computed and provided inTable A3. These costs are Rs 10,187 at the EHT
end, Rs 12,333 at the HT end, and Rs 27,352 at theLT end.
Capital-Related Costs at Consumer Ends
To shift capital-related costs from the voltageends to different consumer categories, three addi-tional parameters are required: system peak de-mand (SPD), simultaneous maximum demand(SMD), and aggregate maximum demand for theseven categories of consumers. The monthly capi-tal cost per KW for each category is calculated bymultiplying the SPD/SMD and SMD/AMD ra-tios by the relevant voltage-end costs reported inTable A3 and dividing by 12. The combined costsper KW per month of the investment and opera-tions and maintenance of a power plant and itsT&D systems is provided in the last column ofTable A4.
Energy Cost
Energy cost of power generation is the sum ofcoal washing, coal transportation, coal consump-tion, oil consumption and auxiliary consumptionof power. With the assistance of Envirotech Instru-ments Private Ltd., New Delhi, coal cleaning costestimates were calculated on the basis of data fromthe Dipka and Kalinga mines. The cost of reducing
50
Table A2. Cost of Transmission and Distribution
Investment in T&D per MWCommissioning periodAssumed capital expenditure in each yearDiscount ratePresent value of investmentExpected life of equipmentPresent value of T&D Capacity
Capital cost per MW per yearEHT 20 percentHT 10 percentLT 70 percent
Operating and maintenance cost per MW per yearEHTHTLT
Capital-related T&D costs per KW per yearEHTHTLT
Rs 30 million2 years50 percent15 percent1
Rs 24.386 million25 yearsRs 4.8878 per MW
Rs 4.989 millionRs 0.9978 millionRs 0.4989 millionRs 3.4923 million
Rs 0.1352 millionRs 0.1492 millionRs 1.0500 million
Rs 1,133Rs648Rs 4,542
Averageas
percentageof energy
passed
Line Losses
cumulativeloss
factor
Peak Lineas
percentageof energy
passed
Losses
cumulativeloss
factor
Peak Capacityas
percentageof generating
capacity
EHTHTLT
4.447.71
12.56
1.0461.1341.297
6.56010.53314.313
1.07021.19621.3960
0.900.7650.409
Table A3. Generation,
125. EHT:
HT:
LT:
(1
(1
(1
- 0.0656)
1
- 0.1053)
1
- 0.1431)
Transmission and
1,133(8,260 +
(10,187 +
(12,333 +
0.9
648
0.765
4,542
0.409
Distribution Costs per KW per Year
) = Rs 10,187
) = Rs 12,333
) = Rs 27,352
51
Table A4. Capital-Related Cost: Generation, Transmission, and Distribution Costs persumer Categories
Category
EHT continuous process industriesHT other industriesHT othersLT industryLT agricultureLT domesticLT commercial
* (1 month = 730.5 hours)
Ratio SPDtoSMD
0.850.800.800.600.800.800.80
Ratio SMDto AMD
0.900.800.750.800.750.550.75
Load Factor
0.750.600.500.300.300.300.40
KW for Con-
Capital CostperKW
per Month*Rs
649658617
1,0941,3681,0031,368
Table A5. Energy Cost at the Generating End per
Coal cost per ton
(a) Coal consumption at 0.72 kg/kwh(b) Cost of cleaning coal(c) Oil at 1.25 ml/kwh at Rs per litre
Total
kwh (Rs)
Case A
1200
0.86400.13000.0088
1.0028
Auxiliary consumption (5.5 percent) of power-generated cost of energy per kwh:1.0612 under Case A0.6040 under Case B
CaseB
600
0.43200.13000.0088
0.5708
Table A6. Energy
Cost of Power at
Generating endEHT endHTendLTend
Cost at Voltage End (Rs)
Case A
1.06121.0612x1.046 =1.0612x1.134 =1.0612x1.297 =
1.11001.20341.3763
CaseB
0.60400.6040 x 10.6040 x 1
.6949 x 1
.046
.134
.297
= 0.6318= .6849= 0.7834
52
Table A7. Capital and Energy-Related Costs per
Consumer category
EHT continuous processindustries
HT other industriesHT othersLT industryLT agricultureLT domesticLT commercial
Capital-related Cost(investment +
O&M of powerplant and
T&D systems)
1.191.501.694.996.244.584.68
KWH for Consumer Categories (Rs per kwh)
EnergyCase A
1.111.201.201.381.381.381.38
costCaseB
0.630.680.680.780.780.780.78
LRMC(capital-related
+ energyrelated cost)
Case A Case B
2.30 1.822.70 2.182.89 2.376.37 5.777.62 7.025.96 5.366.06 5.46
the ash content of coal to 30 percent is estimated atRs 0.13 per kwh. Because any further reduction inash content could result in a steep increase in thecost of energy, the 30 percent threshold was cho-sen. Two cases of the costs to transport coal wereconsidered: a power plant located about 1,000 kmfrom the fuel source (Case A) and a power plantlocated at the pit head (Case B). For the TNEBplant, the cost per ton of transporting coal is Rs600. To estimate the other components of energycost of power generation, data on the most effi-cient thermal power plant in TNEB was supple-mented with data on the cost of using cleaned coalin power generation. Details are presented inTable A.5. The computation of unit costs of energyat the voltage ends is provided in Table A6.
Unit Costs of Electricity
Because meters used for some HT users and allLT users record only the quantity of energy con-sumed during a billing period, the weighted (com-bined capital and energy) costs of electricity perkwh at the consumer ends needs to be measured.
Using information about load factors and costsper KW per month of the investment and opera-
tions and maintenance of a power plant and itsT&D systems (provided in the last two columnsof Table A4), the capital costs per kwh at the cus-tomer ends are calculated and provided in TableA7. The long-run marginal cost is estimated bysumming the energy costs and the investmentand operations and maintenance costs. This cal-culation is provided in Table A7. These are therelevant retail prices for the consumer categories.In Case A, these unit costs range from Rs 2.30 forHT continuous process industries to Rs 7.62 forLT agriculture.
Note1. The discount rate chosen is lower than the 16
percent rate of return on equity now permit-ted by the Indian government. The 16 percentreturn is granted only for the first eight fast-track, private-sector power projects, and onlyactual interest is applicable for the debt por-tion. Given the adoption of competitive bid-ding procedures for selection of private powerproducers and a shift from rate-of-return typeregulation to regulation based on a two-parttariff, an overall 15 percent rate of return is areasonable assumption.
53
World Resources Institute
1709 New York Avenue, N.W.Washington, D.C. 20006, U.S.A.
WRI's Board of Directors:Maurice F. StrongChairmanJohn FirorVice ChairmanManuel ArangoFrances G. BeineckeRobert O. BlakeDerek BokBert BolinRobert N. BurtDavid T. BuzzelliDeb CallahanMichael R. DelandSylvia A. EarleJose Maria FigueresShinji FukukawaWilliam M. Haney, IIICalestous JumaYolanda KakabadseJonathan LashJeffrey T. LeedsJane LubchencoC. Payne LucasWilliam F. MartinJulia Marton-LefevreMatthew NimetzPaulo Nogueira-NetoRonald L. OlsonPeter H. RavenFlorence T. RobinsonRoger W. SantStephan SchmidheinyBruce SmartJames Gustave SpethMeg TaylorMostafa K. TolbaAlvaro UmanaVictor L. UrquidiPieter Winsemius
Jonathan LashPresidentJ. Alan BrewsterSenior Vice PresidentWalter V. ReidVice President for ProgramDonna W. WiseVice President for Policy AffairsKenton R. MillerVice President, International Developmentand ConservationMarjorie BeaneSecretary-Treasurer
The World Resources Institute (WRI) is an independent centerfor policy research and technical assistance on global environmen-tal and development issues. WRI's mission is to move human so-ciety to live in ways that protect Earth's environment and its ca-pacity to provide for the needs and aspirations of current andfuture generations.
Because people are inspired by ideas, empowered by knowl-edge, and moved to change by greater understanding, the Insti-tute provides—and helps other institutions provide—objective in-formation and practical proposals for policy and institutionalchange that will foster environmentally sound, socially equitabledevelopment. WRI's particular concerns are with globallysignificant environmental problems and their interaction with eco-nomic development and social equity at all levels.
The Institute's current areas of work include economics, forests,biodiversity, climate change, energy, sustainable agriculture, re-source and environmental information, trade, technology, na-tional strategies for environmental and resource management,business liaison, and human health.
In all of its policy research and work with institutions, WRI triesto build bridges between ideas and action, meshing the insights ofscientific research, economic and institutional analyses, and prac-tical experience with the need for open and participatory decision-making.
WORLD RESOURCES INSTITUTE1709 New York Avenue, N.W.Washington, D.C. 20006, USAhttp ://www.wri. or g/wri
