Environmental Fiscal Reform (EFR): Key to Realizing Environmental Targets in the Eleventh Five-Year Plan.MA Zhong, WU Jian

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1 Environmental Fiscal Reform (EFR): Key to Realizing Environmental Targets in the Eleventh Five-Year Plan.MA Zhong, WU Jian The Eleventh Five-Year Plan for National Economy and Social Development has clearly defined the environmental targets as reducing pollution by using restrictive forces. Through analyzing capital demands and pressure in realizing environmental targets set by the Eleventh Five-Year Plan, this article discloses problems in China s financial mechanism for environmental protection and argues that Environmental Fiscal Reform (EFR), as a full demonstration of the government s obligation for environmental protection, should be carried out efficiently and comprehensively so as to reach the environmental targets set by the Eleventh Five-Year Plan. Key words: Environmental Fiscal Reform (EFR) environmental protection financial mechanism for I. Capital Pressure of Environmental Targets in the Eleventh Five-Year Plan The Eleventh Five-Year Plan for National Economy and Social Development has set the major environmental target for the following five years: total discharge of major pollutants should be deduced by 10% by It is the first time for the Chinese government to put down environmental protection as an obligatory target with legal force into the Five-Year Plan, clearly pointing out that the specific environmental targets will strengthen government s obligation and will be carried out by rationally allocating public resources and efficiently using the administrative power of the government. Obviously, the environmental targets will play an important role in the government s work in the following five years. China s environmental targets are becoming clearer and more rigorous, which has demonstrated an awakening environmental awareness and stronger political demands in Chinese society. However, as China failed to reach the environmental targets set by the Tenth Five-Year Plan, it is still too early now to predict whether it can achieve its environmental targets set by in the Eleventh Five-Year Plan. According to the Eleventh Five-Year Plan, by the year 2010, total emission amount of sulfur dioxide and chemical oxygen demand(cod)will be 10% lower than that at the end of the Tenth Five-Year Plan which means the emission of the two substances should decline 2% every year or1% every half year for the following five years. Unfortunately, discharge of major pollutants increased in the first half of 2006: emitted COD and sulfur dioxide were million and million tons, an annual increase of 3.7% and 4.2% respectively over last year. China s economic growth may explain this phenomenon: in the first three quarters of 2006, China s GDP increased 10.7% over the same period of last year with an increase of 11.3% in the second quarter. An annual increase of over 10% is ensured in However, this rapid economic growth was mainly driven by 1 The Chinese Statistics Bureau, An Annual Increase of over 10% Is ensured in 2006, 1

2 investment in the energy consuming and pollution generating industrial sector. For example, electricity generated by thermal power plants rose by 12.5% from January to July over the same period of last year which increased the discharge of sulfur dioxide. As for the increase of COD, it was mainly caused by accelerated urbanization, increased volume of wastewater discharge, and incomplete construction and installation of planned wastewater treatment plants as well as the supporting pipelines in some cities. One expert from the State Environmental Protection Administration of China estimated that when China s GDP growth passes 10%, these targets for energy conservation and environmental protection will face the worst failure unless special efficient measures are taken. 2 It is regretful to see that effect of environmental protection in China now is not determined by environmental regulations but by the rate and pattern of economic growth. The background for achieving environmental targets set in the Eleventh Five-Year Plan is rapid economic expansion. So how to strike a balance between environmental protection and economic development is really a problem. II. Rethinking of China s Financial Mechanism for Environmental Protection Failing to reach environmental targets in the Tenth Five-Year Plan was caused by several factors, among which investment shortage was quite obvious, important but yet long ignored. Information about the environmental status and process in realizing environmental protection targets, published by the State Environmental Protection Administration, shows that during the period of the Tenth Five-Year Plan, major projects such as technical improvement of desulphurization and pollution control and prevention in key rivers did not proceed smoothly. By the end of 2005, only 70% of the planned reduction of discharged sulfur dioxide has been achieved; among the 256 projects to prevent acid rain and pollution of sulfur dioxide, only 54% has been completed and put into operation; among the 2130 pollution control projects listed in the Tenth Five-Year Plan, 1378 or 63% of the total projects have been finished. The total investment in environment was 86.4 billion RMB, accounting for only 53% of the planned investment. By the end of 2005, projects in the Huaihe River, Haihe River, Liaohe River, Taihu Lake, Caohu Lake, Dianchi Lake (Three Rivers and Three Lakes) have been finished by 70%, 56%, 43%, 86%, 53%, 54% respectively. 3 Obviously lack of environmental investment is the major problem. In face of this problem, people may ask who is responsible for investment in the environmental protection and who has failed to fulfill his obligation. Environmental protection investment can be divided into private investment and public investment (made mainly by the government). Although the principle of those who pollute the environment are responsible for its treatment defines clearly responsibilities for environmental control and investment, we find that the investment 2 Ding Jun and Wang Shiling, Campaign to Defend Environmental Targets for the Eleventh Five-Year Plan, 21st Century Economic Reports, Sept China Institute for Environmental Planning, Analysis of the Completion of Environmental Targets Set by the Tenth Five-Year Plan, Press conference of the SEPA, April, 12,

3 from government is of great importance. Scale and efficiency of private investment to a large degree, depend on that of the government. Government investment also serves as a policy guide. So government investment plays a special role in the market of environment protection. The first role is coercing. Large investment enables it to monitor and regulate environmental protection and ensure investments successfully from other institutions. The second role is guiding. Government investment creates favorable conditions for social investment to be introduced into environmental protection. The third role is balancing. It balances regional differences, which should be given special consideration especially when the investment is from the central government. Therefore, government investment (or its financial expenditure) in environmental protection should be given primary attention. It is a way for the government to perform its duty of protecting the environment, and it is also the premise and basis of the total scale of investment in environmental protection. A. Inadequate Government Investment and Insufficient Environmental Supervision The capacity of environmental supervision is the precondition for the government to implement its role of regulation. Environmental protection is one of the basic state policies in China. In 1979, the Environmental Protection Law of the People s Republic of China was enacted. However, despite its great responsibility, the government has not yet a special item in its budget for environmental protection; that is to say it has no stable and reliable financial source to fulfill its duties endowed by law. This is quite unusual, not to mention a coordinated development of environmental investment with economic growth. Due to shortage of funds, construction of many environmental protection departments, especially some local ones, have been greatly affected. Usually, environment supervision can not achieve designated tasks and enforcement of law is weak. Last year s Songhua River Toxic Spill Crisis has sounded an alarming bell to all of us in the following aspects: the government lost control in supervision of pollution sources; the environmental protection department is infirm in dealing with such emergencies; information from water quality monitoring administration is inaccurate; the central government has neither channels to get environmental information immediately nor the capacity to directly control pollution sources and protect water heads. Behind this series of problems, shortage of funds is a prominent cause. In a sense, pollution accidents are inevitable under such condition. Regionalism further exacerbated this problem. A number of 45,000 people are now engaging in environmental protection and 38,000 of them are working at the county or district level. Under the current environmental protection managerial system, local environmental protection departments are ruled by local governments and financially dependent on them. So the enforcement of environmental protection laws largely depends on the financial status and the awareness of environmental protection of the local governments. Generally speaking, local environmental expenditure is always in shortage and some local governments usually adopt measures 3

4 such as personnel appointment and allocation of funds to check this work if environmental protection collides with local economic development. B. Low Efficiency in Utilizing Invested Capital 1. Investment did not meet the requirement of environmental control. As far as environmental protection is concerned, government s guiding role for the market should be emphasized. But the status quo in China is government s practice always follows the market, quite negatively influencing the effect of investment. Take waste water treatment for example, the central government has invested 53.4 billion RMB in the construction of city infrastructure of environmental protection by raising national debt during the period But researches show capacities of sewage treatment distribute in an irrational way as revealed in that there is a widening gap in treatment ability between cities even in the same drainage area. Investments are mainly concentrated in cities located by the lower reaches of big rivers, eastern coastal areas, economically developed regions and big cites, while in upriver cities, western regions and less developed areas the treatment rate of sewage is very low. The treatment rate in Shandong province - lying by the lower reaches of the Yellow River, is 43.46% and in upriver Shaan xi Province it is only 20.63% according to officially published figures. The investigation carried out by China Central TV (CCTV) shows that the actual treatment rate is less than 15%. However, no matter how high the treatment rate is in lower reaches, it cannot improve the quality of the water in the whole river. It is the nature of market to lead the capital flow into the economically developed areas where good economic returns can be achieved. But this city-centered and market-oriented investment and construction of wastewater treatment plants ignored the demands of improving the quality of water in the whole river. City wastewater treatment plants spanning over drainage areas are public articles whose effect covers the whole drainage area. Therefore, government intervention is needed in the market to guide the investment flow in order to solve the conflicts between market-oriented construction of wastewater treatment facilities and requirements of water safety. In fact, Chinese market has already become non-effective in the wastewater treatment industry and government intervention is inadequate, which has prevented us from improving water qualities. 2. The invested resources have not been taken full use. In the past several decades, financed by environmental protection investment, some environmental infrastructure has begun to take shape. However, due to low efficiency in its utilization, the effect of the infrastructure is not satisfactory even though investments were increasing. Again, low efficiency of investment hinders further fund raising. For one thing, there is no check mechanism or an effective supervision system. For another, no matching economic incentive policy is in place. Take the electricity price and equipment operation for desulphurization in China s thermal power plants for example. In 2004 the total desulphurization capacity was 30 million kw. If costs for constructing and operating the desulphurization equipment is 1.5 cent / kw and an average of 5500 hours of electricity is generated every year, then the annual cost for desulphurization would be billion RMB. If all these facilities, with a total worth 4

5 of billion RMB (calculated by the construction fee of RMB yuan/kw), are taken full use, the SO2 discharge volume will be reduced by 1.8 million tons every year (or 70% of the environmental target set by the Eleventh Five-Year Plan). Moreover, pollution discharge fee will be cut down by 1.08 billion RMB every year (0.6 yuan/ kg SO2), and 36 billion RMB of loss caused by environmental damage will be saved. Calculation shows desulphurization electricity price can play an important role in bringing the invested environmental resources into full paly, which will create huge economic and environmental benefits. C. Investment in Environmental Protection Not Conforming to the EP Capital Demands. Environmental protection needs steady and long-term investment, related to the rate, scale and pattern of economic growth. However, these basic factors have not been taken into full consideration when investment is made in this field. 1. There is no reliable capital source in China for environmental protection because there is not a uniform and independent account in the government budget. Although government expenditure on environmental protection has been increasing all these years, due to lack of coordinated plans, investments are irrationally allocated to departments and projects. Funds are in great shortage in some departments which bear national security and long-term interests. For example, financial support is badly needed in some areas such as the enforcement of environmental laws, water treatment of rivers across provinces, administration of national nature reserves, treatment of unsolved pollutants, implementation of international environmental agreements, construction of nuclear waste disposal facilities. If this problem is ignored, China s development and environmental security will be threatened by great danger. 2. Allocation of funds to departments and projects is, to some degree, oriented for problem solving, usually to meet emergencies. Changing emphasis of government expenditures may lead to inconsistent financing to environment protection or even cause great waste of the investment made before. For example, investment made for returning farmland to forest has been influenced after the focus of national budget shifted to the rural fiscal reform. 3. We should consider financial demands of environmental protection on the basis of the speed and scale of economic expansion. Over the past 20 years, environmental protection has always been lagging behind large-scale and high speed economic development. In fact, China s investment in environmental protection has been incapable of preventing the ecological environment from degrading under the pressure of economic growth. During the period of the Eighth, Ninth, and Tenth Five-Year Plan periods, investments in this area accounted for only 0.74%, 0.88% and 0.99% of the annual GDP, failing to reach environmental targets, in proportion and growth rate. Compared with the contemporary total investment in fixed assets, there is little increase of investment in environment (EP investment rate was only 2.17%, 2.46%, and 2.37% respectively in the three Fiver-Year Plan periods). Premier Wen Jiabao admitted that inadequate investment in environmental protection was one of the major reasons for the unsuccessful fulfillment of environmental targets set by the 5

6 Tenth Five-Year Plan. Investment in environmental protection in the Eleventh Five-Year Plan is planned to increase 85% over that in the Tenth Five-Year Plan, but even so it can t exceed the GDP growth in China, which grows % every five years over the last 15 years. D. Improper Pricing Unable to Bring Capital into Full Play The characteristics of environmental protection make the private sector reluctant to invest in this field. The environmental protection always seems to be in lack of investment impetus when proper policies are absent. The non-governmental environmental protection investment is not properly brought into play. Take the wastewater treatment in the cities in certain drainage area for example again. As far as water environment administration is concerned, pollution control in upriver cities is more important than that in lower reaches for the water environmental protection of the whole drainage area. As mentioned before, however, the fund for the wastewater treatment is far less in the upriver cities than the downstream areas, which is best proved by the fact that there is a gap of expenditures on wastewater treatment between different cities. Those well-developed cities in the downstream area like Nanjing, Shanghai and Beijing set their treatment fee as 1.00 yuan, 0.9 yuan and 0.9 yuan respectively whereas those less-developed cities like Xi an, Lanzhou and Xining have their treatment fee as 0.36 yuan, 0.3 yuan and 0.27 yuan. The difference of the payment capability makes the business capital flow to the fee collection guaranteed developed areas. This is prescribed by the profit-making nature of capital. As far as environmental protection is concerned, the fund for wastewater treatment should be more directed to the upriver areas which are of more ecological importance. Nevertheless, the market itself is incapable of providing such an impetus, which inevitably results in the market s loss of efficacy. Behind the market s inefficiency is the mal-functional pricing system. At present, the policy of pollutant discharge fee sets a very low standard of charging drainage fee and thus enterprises have no drive to invest in controlling pollution. In this sense, the government is found to be incapable of adjusting the pricing system and providing impetus for environmental protection investment. III. The Significance of Environmental Fiscal Reform (EFR) The fact that there exist problems in the finance of Chinese environmental protection forces the government to regulate the pricing mechanism on the micro level by taking macro-control measures. Environmental finance serves as a micro-measure to readjust the relationship between economic development and environment. Environmental finance concerns governmental revenues and expenditures which occur while the state protects ecological environment and natural resources, provides society and the public with environmental services and ensures environmental safety. The prices fixed by the public sector can directly or indirectly affect governmental revenues and expenditures, and thus environmental finance includes pricing by the environmental public sector. A. The Most Important Executive Measure 6

7 Environmental fiscal mechanism is an important measure to realize the environmental protection targets. When environmental protection targets are set, to raise and utilize the environmental protection fund becomes the crucial factor. Otherwise, the targets can not be carried out due to inadequate fund or no fund at all. Without environmental investment, governmental responsibility for environmental protection is void. Therefore, the government must have the capital means in order to execute its environmental protection accountability. B. Regulating the Market Finance has the function of macro-controlling the market. In the mal-functional environmental protection market, the governmental environment fiscal measures play a special role. Environmental finance, an important measure to carry out the administrative power of the environmental management, reflects the government public management functions and ensures the governmental to fulfill its political commitments. This policy supports the related bureaus of environmental protection in implementing their functions of protecting the environment and natural resources through government expenditures. The government, by financial investment, provides direct public environmental services which can not be offered by the market itself. The government can raise funds for environmental protection by using measures of taxation and price-fixation. The utilization ratio of using resources can be improved by adjusting social economic practice over environment as well as natural resources by taxation, price-fixation and necessary investment. Thus, environmental finance can provide the government with the efficient measure of regulating the pricing system for environmental protection and handling the mal-functional environmental protection market. C. Effective Collocation of Government Finance The government s financial resource is always scarce compared with its many administrative goals. Reasonable collocation of government finance should be achieved to realize government public administration purposes. The collocation must follow the principle of symmetry of administrative power and financial power. Environmental protection, a new government function, is in an inferior position in the public financial system. With the public finance reform, environmental protection fund is challenged by other public sectors. The government is usually inclined to emphasize the traditional public sectors such as education, public health and rural areas when solving the problem of lacking financial support or the problem of funds reaching their designated goals. Therefore, the significance of environmental protection is usually ignored. The financial policy is the basic measure for the government to collocate its financial support to different public sectors and ensures the funds to be used in practical public services. Like other public sectors, environmental protection should be recognized in the framework of public finance. Based on its administrative power of environmental protection, the government should take up the responsibility for the environment fund. 7

8 D. Creating a Market The environmental protection market is a typical market created by policy. The environmental financial measures can help to establish the environmental protection market and redeploys the market resources according to the environmental protection need, regional differences, urban and rural discrepancy as well as ecological difference. For instance, the wastewater treatment fee collection policy is an important factor in establishing the sewage treatment investment market. The unreasonably intensified wastewater treatment in the lower reaches of the drainage area also resulted from the unharmonious regional wastewater fee collection policies. With the environmental financial policy and other corresponding measures, the government can change the overall arrangement of the city-centered wastewater treatment investment and thus have an overall planning of the city wastewater treatment plants for the environmental safety of the whole drainage area. Besides, the government can harmonize the chaotic environmental protection market, encourage the development of a balanced wastewater treatment and help the under-developed areas to establish a market mechanism. Based on the real cost of the wastewater treatment, the government should also set up a standard of charging fees for wastewater treatment to stabilize some regional trend of exorbitant fees, restraining the super profit in wastewater treatment in these areas. Moreover, the government should encourage the investment in the low treatment fee areas, and in poor areas of ecological importance where investment is hard to obtain, and the government should quicken the establishment of a wastewater treatment market by giving financial support to reduce the cost of the establishment of wastewater treatment plants and promote their ability to attract investment. IV. Establishing Environmental Fiscal Reform and Realizing the Environmental Protection Targets Set by the Eleventh Five-Year Plan With the increase of the public finance resource, the time is ripe for solving environmental problems. Since 1998, the Chinese government has implemented active finance policies (i.e. expanding financial policies), which drove the Chinese economy to develop rapidly and steadily. Chinese GDP in 2003 reached billion RMB which was four folds as much as that in Rapid economic growth resulted in a rapid increase of the governmental revenue which kept a two-digit growth in years. The government revenue was billion RMB in 2003, almost 5 times that of 1993, among which the central governmental revenue was billion RMB which was over 4 times more than that of 1994 right after the taxation reform. The national revenue in 2005 topped billion RMB, increasing by billion RMB, representing a growth rate of 19.8% over In the Tenth Five-Year Plan period, the national revenue was billion RMB which was 640 billion RMB more than that of the Ninth Five-Year Plan with the growth rate of 126.5%, and the central governmental financial revenue increased 141.5% with a 111.3% growth rate for local financial revenue. At the end of the Tenth Five-Year 8

9 Plan Period, the national revenue accounted for 17.3% of the GDP which was 3.8% more than the 13.5% of the Ninth Five-Year Plan 4. The growth of national economy and the governmental revenue, in particular the central governmental revenue, would quicken the public finance reforms and make the establishment of the environmental investment easier. A. Clarifying the Investor s Responsibilities and Fulfilling the Environmental Protection Targets Money guarantees the fulfillment of the environmental protection targets. The administrative power of each environmental protection investor should be clarified based on the division of the responsibilities between the government and market as well as the central government and local governments. The feasibility of the investment planning lies in the definite funding responsibilities of relevant investors, and the fulfillment of the environmental protection targets depends on the reliable environmental investment. In the environmental protection programs in the Ninth and Tenth Five-Year Plan, the total EP investment and its proportion in the GDP were both prescribed. However, governmental public financial expenditure and commercial fund were not distinguished in either prescribed investment or actual investment for environmental protection. Due to the information inaccessibility and incorrectness in statistics of fund from enterprises, the investment planning for environmental protection was not feasible while the statistics of the environmental investment were unreliable. The responsibilities of enterprises to control pollution are relatively clear among all the investors. But the funding commitment of enterprises is decided by the government policy and its implementation. Adequate input to build up the governmental supervising ability for environmental protection and governmental financial and policy support should be guaranteed to ensure healthy enterprise development with well protected environment. The jurisdiction of the government administrative power should correspond to the scale of effect of environmental problems. Local governments should solve those problems in particular areas while the central government should be responsible for those transregional or national environmental problems which would involve national public properties. B. Establishing a Stable Environmental Investment Expenditure Account According to the requirement of public financial system and the central governmental responsibilities, an independent and stable environmental investment account should be set up, which would guarantee the fund for governmental environmental protection responsibilities. An independent environmental protection account which appeared in the Budget and Final Accounts of the Central Government (2006) will be carried out in In order to put the account into effect, the fund in 4 Ministry of Finance of the People s Republic of China. Report on the Draft Resolution on the Implementation of the Central and Local Budget for 2005 and the Central and Local Budget for Fourth Session of The Tenth National People s Congress. The 9

10 different sections and different accounts as well as the fund under different categories needs to be brought into the environmental protection budget, ensuring a certain overall scale. Meanwhile, the government should be well aware of and well prepared for the environmental problems of a stagnant, protracted, uncertain and irreversible nature. Governmental environmental expenditure should be stable and continuous. Environmental investment is not the same with the financial policy of macro-economy in the public financial system. The fluctuation and regulation of the economy should not exert influence on the continuation of the environmental investment because it is a functional policy which should have a long-term, continuing and stable influence. C. Fulfilling the Governmental Function of Price-fixation in Regulating the Market Governmental price-fixation should take the environmental protection targets and requirements into consideration to regulate the environmental protection market. Governmental price-fixation is supposed to be an effective mechanism to compensate for the cost of environmental protection and to lead to establish the environmental service market. To ensure the effectiveness of the environment related price-fixation, the validity of the corresponding pollution control should be taken into account. Take desulphurization electricity for example. Its price-fixation should be linked with the environmental monitoring. The monitoring report is the standard to determine if certain enterprises can use environmental price-fixation. Thus, the environmental price-fixation would become an effective measure to improve the environment. In the interest of the fulfillment of environmental protection targets, other financial measures such as tax incentives and financial transfer payment can be used when facing insufficient social financial affordability. But after the establishment of the market mechanism, the financial support should retreat in time. D. Designing the Environmental Taxation Reform within the Frame of Environmental Finance The primary targets of environmental taxation reform include adjusting the social environmental activities rather than financing the protection fund. The environmental expenditure should be independent of the environmental taxation, and the usage of further pollutant discharge fees should be adjusted after the establishment of the environmental financial expenditure system. International experience proves that after the deepening of the public financial system reform, environmental taxation would be an important factor in the sustainable public financial system. Although China is not ready for the levy of environmental taxation at present, its establishment would proceed in an orderly way and step by step from the alteration of the tax category and tax rate gradually to the establishment of a new tax category, and then to the adjustment of the taxation system. The idea of enhancing the environmental tax research from a strategic viewpoint would be 10

11 advisable for the preparation of further public financial system reform in the future. The environmental consideration, including the cost-return analysis of the implementation of environmental effects, should be earnestly taken as one of the basis for important taxation reform projects which are closely related to the environment and natural resources. The tax items and tax rate of the resource tax, vehicle consumption tax and recently re-discussed fuel tax should take the potential environmental effects into full consideration. With increasingly rigorous environmental protection targets, the government should assume its responsibility not only for environmental protection input but also for regulating the currently mal-functional market and inefficient systems to create a mechanism of and external factors for the principle of whoever causes pollution should be responsible for controlling pollution. The environmental finance should be established as soon as possible to bring into full play of macro-control function of finance to regulate the relationship between environmental protection and economic development and improve the funding mechanism for environmental protection which is the key to realizing environmental protection targets set by the Eleventh Five-Year Plan. (Ma Zhong and Wu Jian are with the School of Environment and Natural Resources, Renmin University of China) 11