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How much does Uruguay’s environmental fiscal policy cost?
Governments use tax expenditures (TEs) as a public policy tool. Exemptions, reduced rates, tax credits and other exceptions to the standard or benchmark tax system accounted for 6.85 per cent of Uruguay’s GDP in 2023. The Dirección General Impositiva (DGI), Uruguay’s tax administration, publishes a detailed inventory containing around two hundred TE estimates every year, in line with international standards. However, until now there has been no quantification of what proportion of this revenue forgone has an environmental impact. This is precisely what our working paper sets out to do.
What do we mean by Tax Expenditure with Environmental Impact?
Tax Expenditure with Environmental Impact (TEEI) is the subset of TEs that explicitly pursues an environmental objective or generates a predominant environmental effect, either positive or negative. Our work classifies and quantifies these TEs, but it does not assess their effectiveness. The distinction is important: classifying TEs according to its foreseeable environmental effects is a necessary first step, but it is distinct from assessing whether it achieves its policy objectives.
The methodology we apply is in line with the OECD’s green budgeting proposals and the French report on the environmental impact of the State Budget, and closely follows the experience of Costa Rica, the most advanced country in the region in this type of analysis. To classify each measure in terms of its expected environmental impact, we used the six environmental objectives of the European Union’s Green Taxonomy as a reference, and assigned to each TE a score based on an ordinal scale from -1 to 3, depending on whether its expected environmental effect is negative, neutral or positive; and whether that effect is linked to the provision’s stated objective or is a side effect.
The main finding: four out of five pesos are heading in the wrong direction
The estimation of TEEI for 2023 shows that almost four out of every five pesos that Uruguay forgoes in environmental taxes encourage activities with a negative environmental impact. In terms of GDP, the TEEI with a negative impact accounted for 0.49 percent of GDP, whilst the TEEI with a positive impact amounted to just 0.09 percent of GDP. In relation to total TE, the revenue forgone with a positive environmental impact accounts for just over 1 per cent of the total.
The main components of the negative TEEI are the tax treatments applicable to Value Added Tax (VAT) and the Specific Internal Tax (IMESI, from its name Spanish) on fossil fuels, and the exemption from corporate income tax (IRAE, from its name Spanish) for maritime and air transport companies – two of the most carbon-intensive modes of transport.
With regard to VAT and IMESI, the Uruguayan case presents significant peculiarities given the coexistence of contradictory signals. On the one hand, Uruguay applies an IMESI to certain fuels that incorporates components linked to carbon dioxide (CO₂) emissions, placing it amongst the highest implicit carbon prices internationally, albeit with relatively limited coverage. However, some fuels receive preferential treatment in terms of VAT or IMESI. For example, diesel is taxed at the standard VAT rate (22 percent) but is not subject to IMESI, whilst petrol is subject to a high IMESI rate but is not subject to VAT. On the positive side, there is the VAT credit for public passenger transport, tax benefits for electric and hybrid vehicles under IMESI, incentives for afforestation, and the credit for returnable containers.
When compared with Costa Rica, the only country in the region with an equivalent estimate, the TEEI accounts for around 10 per cent of total TE in both countries. However, in Uruguay, the weight of the TEEI with a negative impact is larger.
The grey areas: where classification is more difficult
A significant part of the work involved identifying TEs with potential environmental impacts that were ultimately excluded from the estimate due to a lack of information. Exemptions linked to investments promoted by the Executive could be classified as positive TEEI provisions if information were available on the indicators used to score each project, which would make it possible to identify those involving investments in cleaner technologies. In the case of tax deductions for the purchase of labelled seeds, there is no information available to link them to good environmental practices. This lack of transparency highlights the information gaps that limit the analysis and which it would be valuable to address.
The study also highlights cases where a positive classification warrants caution: the benefits of afforestation generate mixed environmental effects depending on the species and industrial use, and the impact of electric vehicles depends on how the disposal of batteries at the end of their useful life is managed. A future work program could incorporate the concept of ‘transitional TEEI’, recently developed in the ECLAC report on TEs for environmental sustainability, to account for measures that promote intermediate technologies – which are less polluting than those they replace, even if they are not fully “green”.
A metric to inform public policy
According to CIAT, in 2021, Uruguay collected between 1.7 percent and 2.2 percent of GDP in environment-related taxes. Understanding the magnitude of revenue forgone due to TEEI is a necessary complement to get the complete picture of the country’s environmental fiscal policy.
The challenge ahead is not merely to improve the quantification of TEEI. It requires to make progress in assessing its impact: linking every peso of revenue forgone to indicators of greenhouse gas emissions, water use or biodiversity conservation. Institutionalizing this type of analysis as part of the annual TE report would be a concrete step towards aligning fiscal policy with the country’s environmental commitments.