How fiscal policy can help save forests

The world is facing unprecedented economic and environmental challenges. While climate change increasingly poses risks to macroeconomic and fiscal stability, deforestation and forest degradation impair the ability of forests to act as carbon sinks and reduce the resiliency of local communities to climate damages. The loss and decay of forests also threaten global biodiversity, the provision of ecosystem services, and other core ecological functions that economies worldwide rely on.

A green recovery must include fiscal reforms for forest sustainability

Against this backdrop, the COVID-19 pandemic has presented governments across the world with a serious public health emergency and thrust the global economy into crisis. Recovery packages must immediately address the health and economic crises. Longer-term responses must also tackle the underlying causes of the pandemic, to reduce the chance of similar future predicaments.

Beyond their immense impact for climate stability and broader sustainable development, deforestation and forest degradation also increase the risk of and exposure to emerging zoonotic diseases. As humans encroach on natural forests, the chances for outbreak and transmission of such diseases from animals to humans increase. This risk further adds to the urgency to proactively include forests in a comprehensive green recovery.

Improving fiscal incentives helps align environmental and fiscal sustainability

Responding to these multiple challenges will require massive investments. For example, the estimated investment needed for countries to achieve their Nationally Determined Contributions to the Paris Agreement exceeds $1 trillion per year over the next 15 years. Governments must mobilize and channel these resources during a time of increasingly tight fiscal space, especially as most categories of government revenue decline and available funding is committed to recovery efforts.

Policy makers are thus increasingly looking for instruments that can help meet climate, development, and recovery goals without diverting large amounts of public funds or increasing the public debt. Fiscal policy reforms can greatly reduce the cost of achieving sustainability by improving incentives for private-sector stakeholders to co-invest in the sustainable use of resources. Environmental fiscal policy reforms that value natural capital can even contribute toward net domestic resource mobilization.

'Fiscal policy reforms can greatly reduce the cost of achieving sustainability by improving incentives for private-sector stakeholders to co-invest in the sustainable use of resources.'

Fiscal policies influence forest conservation and ecosystem health, for better or worse

Such fiscal instruments have so far been underutilized. However, there is growing interest among policy makers, who are responding to a developing body of evidence pointing to the effectiveness and urgency of green fiscal policies, including for forests and other sustainable land uses. This growing interest has coincided with the development of new fiscal instruments and policy combinations that can help policy makers better target and influence incentives to manage land use change and slow deforestation in a revenue-neutral or even revenue-raising manner.

A new report, 'Designing Fiscal Instruments for Sustainable Forests,' shows how fiscal reforms can positively influence forest conservation and ecosystem health as part of the climate and sustainable development policy mix. For example:

• In many countries, current tax rates on commodities fall short of the price signals needed to provide adequate incentives for the sustainable use of resource bases. Apart from raising these taxes, their environmental effectiveness can be significantly improved by letting tax rates vary according to the sustainability of production of commodities, alongside other reforms to the structure of forest-related tax systems such as enforcement using choke points such as ports where products are shipped.
• Reducing distortionary agricultural subsidies is another way of modifying the balance of private incentives for land use change that can also free up additional revenues.
• Ecological fiscal transfers are a revenue-neutral instrument that can influence the incentives of public actors to enforce forest laws within their jurisdictions.
• Fiscal policies on forestry and other competing land use sectors often contradict each other. Reforming these sectoral policies with a whole-economy perspective can reduce the overall cost of achieving sustainability objectives effectively.

While fiscal policy is not a silver bullet, there are many fiscal instruments that can influence forest conservation and should be part of a comprehensive policy package that encourages sustainable land uses.

The report builds the case for reforming and implementing fiscal policies that reduce private and public incentives for deforestation, forest degradation, and land use change, and instead encourage forest conservation, sustainable management, and green global value chains. It is also an urgent call to action.

Fiscal policy will always impact forest production and conservation incentives; thus, the question is not whether to use it, but how to use it consciously. Existing fiscal policies are already providing incentives one way or the other - oftentimes incentivizing short-lived growth through exhausting natural resources and merely turning natural into physical capital without creating net value. We need to empower decision makers to harness the power of fiscal policy for consciously creating incentives that direct future development onto a more sustainable path.

This post is part of a series featuring the World Bank Group's climate-related work in the Equitable Growth, Finance and Institutions practice group including the following Global Practices: Governance; Finance, Competitiveness and Innovation; and Macroeconomics, Trade and Investment.

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