SOFIA INITIATIVE ON ECONOMIC INSTRUMENTS

Preface and Executive Summary of the

Sourcebook on Economic Instruments

for Environmental Policy in Central and Eastern Europe

A Regional Analysis

Edited By
Jurg Klarer
Jim McNicholas
Eva-Maria Knaus

Szentendre, Hungary
April 1999

This report was published with the support of:
The Danish Environmental Protection Agency;
the Swiss Agency for the Environment, Forests and Landscape;
the Ministry of Environment of France;
and the Czech Ministry of Environment.

Chair of the Sofia Initiative on Economic Instruments:
Ministry of Environment of the Czech Republic

Secretariat of the Sofia Initiative on Economic Instruments:
The Regional Environmental Center for Central and Eastern Europe

Published by the Regional Environmental Center for Central and Eastern Europe.

The full version of this publication is available in print form. Click here to order.

CONTENTS

NOTE: The online version of this publication contains only a summary. You can read it by clicking on the links above. To read an abridged version of the full document:

PREFACE

The 1995 Environment for Europe Ministerial Conference in Sofia, Bulgaria, approved the Sofia Initiatives which were set up by high level officials from Central and Eastern Europe (CEE). One of these four Initiatives is the Sofia Initiative on Economic Instruments (SIEI). Initiated and chaired by the Ministry of the Environment of the Czech Republic, the SIEI has sought to support the improved application of economic instruments for environmental policy since the Sofia conference. In 1998, at the Fourth Environment for Europe Ministerial Conference in Aarhus, Denmark, the work completed under the SIEI was welcomed and the SIEI mandate was renewed. One important output of the SIEI is the present "Sourcebook on Economic Instruments in Central and Eastern Europe."

There are many good reasons for increased application of economic instruments in environmental policies. In specific situations, economic instruments can advance sustainable development by playing an important role to:

This Sourcebook is analyzing the present use of economic instruments for environmental policy in the light of the possible advantages mentioned. For a number of the 13 countries covered in the report, a comprehensive survey on the use of economic incentives in environmental policy was carried out for the first time for this Sourcebook. The report illustrates that a large number of such instruments are already applied in CEE countries and that their use is considered successful in many cases. In some countries, the evaluation of pollution charges is under way to examine the environmental effectiveness and economic efficiency of these instruments. Many new economic instruments are proposed throughout the region. Often, ministries of environment in EU candidate countries are considering such options in order to ensure that required environmental investments related to the successful adoption of the acquis communautaire can be financially backed up by providing public support. In addition, economic instruments can also be seen as tools to help decrease the overall financial burden of the EU accession process.

For the first time such comprehensive information on economic instruments in our region is available to the international community. I believe this report is a very timely contribution which can serve as an important reference document for the discussion on environmental policy aspects of the European Union enlargement for the countries of Central and Eastern Europe. I do hope that this material will contribute to intensified experience exchange and further research on the application of economic instruments both on the international level and especially within the CEE region.

I would like to congratulate the many experts from CEE countries who contributed to this publication and the SIEI Secretariat at the Regional Environmental Center for Central and Eastern Europe. I would also like to acknowledge the generous financial support of the Danish Environmental Protection Agency, the Swiss Agency for the Environment, Forests and Landscape and the Ministry of Environment of the Republic of France which made the preparation of this Sourcebook possible. Milos Kuzvart, RNDr. Minister of Environment of the Czech Republic

EXECUTIVE SUMMARY

1. CEE Regional Analysis

In 1993 European Environment Ministers adopted the Environmental Action Plan for CEE (EAP), an internationally developed methodology for addressing environmental concerns in CEECs. The EAP philosophy emphasizes the need for priority setting among environmental problems and devising cost-effective strategies for solving priority problems. In this framework, proper pricing and the application of economic instruments as incentive measures play important roles. On the basis of the EAP approach, national environmental strategies have been developed in most countries. These national strategies reiterate the need for the extended use of economic instruments.

Economic instruments (EIs), in theory, have all the efficiency properties of competitive market pricing: they trigger actions both among producers and consumers that allow the achievement of given environmental objectives at the lowest costs. The efficient nature of economic instruments is due to the flexibility given to the polluters for devising a cost effective compliance strategy. Environmental charges and taxes are direct payments from polluters and therefore, they represent a clear application of the Polluter Pays Principle (PPP). PPP states that polluters must bear full financial responsibilities for pollution reduction. It is generally accepted that the scope of such financial responsibility is determined by environmental legislation. Additional advantages of economic instruments are their capacity to integrate environmental concerns with sectoral policy goals and to promote a gradual shift in the allocation of a society's resources required for sustainable development.

Conditions in Central and Eastern Europe (CEE) since 1990 have created a dynamic context for the implementation of economic instruments for environmental policy. The region is characterized by economic restructuring and social and legal institutions in transition. Limited experience has been accrued with economic instruments in developed countries which is directly transferable to the CEE situation. Environmental policy in the West emerged largely after -- often as a response to -- economic growth, and relied heavily on strong legal foundations, focusing primarily on the enforcement of environmental standards in the early stages. Given the recession of the early 1990s, low per capita GDP, and weak legal institutions throughout CEE, the mere transposition of standards often proves to be costly and ineffective as a control for environmental pollution. Though much progress has been made in the region regarding EIs in recent years, much remains to be done to reap the full benefits of cost-effective environmental strategies and implementing the PPP. The continued analysis of the role of economic instruments for environmental policy is regarded as a priority for public policy makers. This Sourcebook includes a comprehensive assessment on the following types of EIs in 13 CEE countries:

Current Implementation of Pollution and Product Charges
Environmental charges in CEE, in some cases dating back to the 1970s and 1980s, were adapted to the new conditions which emerged with the political and economic transformation. In the period of transition to a market-oriented economy, the cost and profit implications of the charges became real and it required political strength to re-establish charge levels. Given the experience accrued with instrument design and the perceived lack of environmental funding in the region, more attention has generally been given to the revenue raising function of EIs rather than their ability to provide incentives to polluters. Revenue raising instruments also have an incentive impact, but, in some cases, alternative economic instruments, which could address a given environmental problem more effectively and efficiently, are ignored and environmental charges are favored due to their revenue raising potential.

Poland, Czech Republic, the Baltic States, and Slovakia have implemented economic instruments primarily following the pollution permit/charge/non-compliance fee model. Such systems generally have a two-tiered charge rate structure: a base rate applies to emissions below the permitted level and a penalty factor is added for emissions above that level. Hungary has relied more on product charges on environmentally damaging products, and has recently started to consider introducing elements of an emissions charge system. To varying degrees each of these countries earmark the revenues from EIs for environmental funds. Ideally, environmental funds support environmental policy goals on a priority basis by providing support (usually grants and soft loans) to co-finance environmental projects. In this way funds help leverage environmental finance from enterprises and municipalities and catalyze environmental improvement.

Slovenia has begun to implement fully unearmarked taxes, including a waste water tax in 1995 and the CO2 tax in 1997, as part of a fiscally integrated environmental strategy. Although it is too early to comment on the environmental effectiveness of these taxes, continued monitoring of progress in this area vis a vis earmarked charges is important. Croatia has implemented an interesting wastewater effluent charge and it would be desirable from a CEE regional perspective to evaluate this instrument in detail (it raises the highest per capita revenue of all pollution charges currently in force in the region). In addition, recently adopted new legislation created an initial platform for introducing additional EIs and this potential should be used.

Bulgaria and Romania have experienced major problems in developing economic instruments as part of coherent environmental strategies. Another wave of recession which started in 1996-97, low ability to pay, limited monitoring capacity, enforcement difficulties, and inefficient environmental financing mechanisms rank high in the list of challenges remaining in these countries. A similar situation regarding implementation problems of EIs can be found in Bosnia and Herzegovina and Yugoslavia where the war has even amplified problems mentioned above. Nevertheless, important ground work related to more integrated economic instruments has been completed in Bulgaria and Romania and numerous proposals for new EIs have been prepared. These initiatives should be further pursued by domestic policy makers. The international community should support these efforts and facilitate more intensive transfer of know-how and experience. There is no doubt that these four countries could benefit from regional experience sharing.

Apart from the extensive use of emission charges and non-compliance fees, tax differentiation encouraging the use of unleaded gasoline is in place in nine of the 13 surveyed countries. Tax differentiation is used in connection with additional fiscal measures (excise taxes, vehicle and road taxes) which encourage changes in the composition of the car fleet. A variety of economic instruments with environmental provisions are in force in agriculture, forestry and mining. These include land use charges (on the use of agricultural or forest land for purposes other than agriculture or forestry), land taxes, tree cutting charges and timber extraction taxes, and charges or taxes on natural resources extraction and/or mining. Several environmentally motivated tax allowances and exemptions from VAT, excise taxes, sales taxes, income and profit taxes are enacted.

Many of the economic instruments considered in this report have been in place for many years, and there is at least anecdotal experience with their performance in the transition period. However, few attempts are known to systematically evaluate the environmental and economic impacts of these instruments and there are only a few examples in the legislation of any economic instruments that require regular and systematic monitoring and evaluation of the instrument's performance. Interestingly, much needed environmental information required for performance assessments is more difficult to get than financial information.

Evaluation of the economic instruments in CEECs has several difficulties, some of which are specific to the region in comparison with applications in OECD countries. Such difficulties include a) an evaluation of emission charges and fines cannot be separated from the performance of the underlying permit system and b) since pollution charges are being utilized primarily as revenue raisers, direct economic and distributional impacts of the charges are largely changed via their earmarked spending - a full impact analysis must include an assessment of this spending. Regular and systematic evaluation is considered a high priority.

The following concerns have been identified related to the implementation of pollution charges in CEECs:

Earmarking of charge revenues to environmental funds remains a much-debated issue. Environmental policy makers perceive earmarking as an important means to securing necessary finances for environmental protection. Sometimes it is also introduced in order to gain political acceptance. With few exceptions, environmental policy makers in the region expect a direct incentive impact of only one economic instrument, and that is a subsidy. Carefully administered, earmarked pollution charges may still implement the Polluter Pays Principle. By making polluters as a group responsible, earmarking of environmental taxes and charges can function as mechanism for recycling revenues from polluters in general to the polluters responsible for activities requiring remedial action on a priority basis. In this way, the combined charges/subsidies system may retain the efficient property of an economic instrument.

Public negotiations were not part of the preparation of the charge systems developed before 1989, at that time the most important hurdle was to persuade the political leaders. Meanwhile, households were largely protected from the potential price impact of the charges since the consumer prices did not really reflect production costs in the central planning context. Interest reconciliation between producers, consumers, and policy makers was surprisingly difficult when revisions and new instruments were initiated in the 1990s and environmental regulations, including economic instruments, started to impose real costs on privatized companies and households. The main lesson from the preparation of and negotiations surrounding the newly introduced charges is that the government must consider new methods to articulate the interests of affected parties, producers and consumers. Information on the particular environmental problem, the design of the planned instruments and alternative consumption options has become very important.

Cost Coverage of Public Services through Prices (water, waste management)
Prices of public services such as health care, education, energy and water were low or services were free before 1989. There were few, if any, taxes on final consumption. Correspondingly, wages were set at a low level. Increase in income for large segments of the population have been well below the price increases resulting from recent subsidy removal in public services such as water supply and treatment and municipal waste management. Public opinion polls and surveys in the region indicate that people do recognize environmental quality as an important concern. However, they expect the state to foot the bill. Cost recovery pricing for publicly provided services is a difficult political issue. Low willingness to pay, however, can gradually be addressed by governments with proper information policies and clear pricing signals.

One of the most important recent institutional changes has been the decentralization of power and responsibilities. In the case of publicly provided environmental services it is likely to create a closer match between local demand and supply of such services, and in turn, induce more proper pricing mechanisms for these public services. However, there are some drawbacks to the decentralization process: (i) local authorities often lack experience and expertise in designing and implementing environmental management systems; (ii) they often lack the financial resources necessary to carry out their new responsibilities in these areas. Also, economies of scale cannot be exploited if each small municipality is required to have their own waste disposal site or waste water treatment plant.

Waste water and waste management are identified in most country evaluations of EU Agenda 2000 as areas that need particular attention. Investment needs for complying with the relevant EU directives represent the bulk of total environment related costs of EU accession. Moreover, these are services largely provided by companies in the public sector. Special long term financing strategies need to be developed and financing mechanisms must be designed to address these specific needs. Subsidy elements are a likely part of those mechanisms, but commercial borrowing components must be substantial. Bank loans can be taken only with well-planned repayment schedules which need to rely on revenues generated from service charges. It also should be noted that the establishment of basic public infrastructure, such as wastewater collection systems, was heavily subsidized in many EU countries, and then there was a gradual movement toward full cost recovery pricing.

EU Accession Context
EU accession provides the dominant policy framework in CEECs. One major task for policy makers in the EU approximation is implementing the "acquis communautaire" which means adopting, implementing and enforcing EU legislation and policies in all areas. In most of the recent CEE applicant country evaluations in the frame of the EU's Agenda 2000, there was strong reference made to environmental issues. The finances required to transpose and properly implement and enforce key EU legislation in the areas air, water and waste management is estimated as high as EUR 120 billion for the 10 applicant countries. On a per capita basis, expenditure on environmental protection may need to raise manifold. The lion's share of financing should come from domestic resources.

Current EU environmental legislation is dominated by command and control measures. The accession negotiations center on those and seem to leave little room for flexible mechanisms. Phased-in implementation is likely to be unavoidable for some directives, i.e. Urban Waste Water Directive. While official documents often refer to environmental charges as possible instruments to address EU approximation financial needs, few mention the use of economic instruments in a flexible manner that would reduce implementation costs through direct incentive impacts. Meanwhile, inside the EU, it is increasingly recognized that the cost of compliance is becoming prohibitive and in some member states even non-compliance is present. Several new environmental policy initiatives are under discussion which aim at introducing more cost-effective approaches into the EU policy, and many of these call for more extended application of economic instruments.

Environmental funds' operation must certainly undergo some examination in the context of EU harmonization. Subsidies provided by the funds constitute state aid, which is strictly regulated at EU level. The present operation of environmental funds is not yet in line with the EU guidelines. The rules for comprehensive environmental funds, however, could be streamlined to fit into the Community guidelines. It is important to note that exemptions from environmental charges also constitute state aid. Therefore, charge waivers schema must also be defined in accordance with the Community guidelines.

Potential for Eco-Taxes and Eco-Tax Reform in CEE
In OECD countries, the current trend in the use of economic instruments is to integrate environmental externalities into the overall fiscal system by: (i) replacing revenues from distortionary taxes (mostly taxes on labor) with environmental tax revenues; (ii) eliminating environmentally harmful tax exemptions and subsidies. Such an approach is also promoted by the European Commission and is being discussed (and partially implemented) in several member states. Considering the extensive set of environmental charges already in force and the ongoing process of reforming fiscal policies, the possibility of eco-tax reform may be present in CEECs. The Slovenian CO2 tax can be seen as one step in that direction. Also, there are some preliminary discussions on eco-tax reform in the Czech Republic, Hungary and Poland.

Present reality, however, is likely to limit the scope for immediate eco-tax reform in the region. Overall tax burden is high but so is tax evasion. There are few environmental charges in the region which raise enough revenue to be seriously considered for a revenue switch (or, if sizeable revenues are raised with high charge rates, the charge base might not provide the needed stability). Current earmarking is also incompatible with the eco-tax shift and current state environmental financing systems (with environmental funds playing key roles) would have to be completely redefined. For preparing CEECs for eco-tax reform, careful preparatory steps, including detailed analysis, would be required in the short term. Depending on their results, some new instruments, particularly in the field of energy/carbon taxes, could emerge in the long run. Very limited research has been carried out to date on identifying and eliminating environmentally harmful tax exemptions and subsidies. Such work should be initiated too.

Below, summaries review country specific conditions which have influenced the implementation and effectiveness of economic instruments for environmental policy in CEE.

2. Bosnia and Herzegovina

Bosnia and Herzegovina is in the early stages of economic, political, and legal institution building. The foundations of economic and environmental policy integration, including the ability to pay for the public and private use of natural resources, have yet to be created. A poignant example of this is the disappearance of stretches of forests surrounding cities which were cut to provide for basic heating needs during the war. Cooperation between the Federation of Bosnia and Herzegovina and the Republic of Srpska has been weak and environmental protection has not received priority attention on the political agenda thus far. In such a context, the social and economic framework required for the introduction of economic instruments has been lacking. The few charges that did exist in the past, i.e. charges for air emissions and wood cutting, were not effectively enforced. Today, no modern pollution charge system is in place. The water supply and public waste management sectors face price levels which do not cover maintenance costs (if pricing is in place at all), yet payment collection remains very weak.

The potential introduction of economic instruments with environmental motives must be adapted to the following current conditions: extensive industrial shut-down due to the war and the lack of public infrastructure (Bosnia and Herzegovina has no functioning water treatment plants, insufficient waste disposal/treatment facilities, and low pollution monitoring capacities). The need to provide for immediate basic needs of citizens may in itself pose a challenge to the implementation of more expensive, long-term, and environmentally sustainable infrastructure projects. Nevertheless, environmental law is now being drafted. Carefully designed pollution charges and non-compliance fines, introduced as political and legal institutions strengthen and purchase power increases, may prove environmentally effective while serving to generate revenues for financing public investment in sound infrastructure development. In addition to the short-term attractiveness of such instruments to public policy makers, there would be an opportunity to provide consistent signals to municipalities and industry to develop long term environmental strategies throughout the rebuilding process.

3. Bulgaria

Until recently, Bulgaria has relied primarily on traditional non-compliance fines to prevent pollution above standard levels. The pollution fine system, introduced in 1978, has encountered several difficulties even though it was reformulated in 1993. Collection efficiency wavered at around 50 percent of the fines levied through 1995. Inability of industry to pay fines and specific collection problems in the state-supported, coal-fired energy sector were among the primary reasons cited for poor performance. The real value of the already low fine rates, and hence their ability to provide incentives or generate revenues, were severely eroded by the national rate of inflation which remained high through 1997. The value of environmental fines in Bulgaria in 1997 was USD 0.34 million.

Since 1995, however, collection efficiency has been considerably improved (up to 80 percent in some cases) by allowing tax authorities to collect fines which remain outstanding. In 1997, the fine rates were increased several times and linked with the national minimum salary. These represent positive steps toward creating a context for the introduction of more comprehensive pollution charges, which is currently being considered. Air and water emission charges, product charges, and user fees in the area of nature protection are planned, with the intention of further capitalizing environmentally earmarked funds. With such measures, the Ministry of Environment attempts to gradually improve the environmental financing system and create a stronger market for environmental investments. A Nature Tax providing for annual payments from tourist facilities located in protected territories is also being developed. Continued improvements in the administration of the charge system, including consistent monitoring, will be required.

4. Croatia

Although economic recovery is underway in Croatia and framework laws providing for the creation of a comprehensive system of environmental charges largely exist, environmental objectives have yet to become fully integrated into economic policy goals. Certain key areas, most notably air emissions, continue to be regulated by standards and non-compliance fees only. Currently few "typical" EIs are in force, and the potential benefits of cost-efficiently obtaining policy goals are not fully exploited. A notable exception is the water sector which exhibits both the highest average user prices in the region and significant water effluent charges. The water effluent charge was successfully phased-in over a five-year period, and the charge system now yields the highest per capita water revenues in the region. Under-priced water is a primary obstacle to financing investments needed for water supply and treatment facilities, especially in the EU Accession context. For this reason, a detailed analysis and evaluation of the Croatian water price/effluent charge system could deliver useful experiences for other sectors and/or countries.

Recent profound fiscal policy reforms have incorporated several taxes which have an affect on the environment. With the exception of certain environmental allowances, these taxes are primarily designed as revenue raisers for the state budget and are not earmarked for environmental expenditures. Croatia is one of three countries in the region (Bosnia and Herzegovina and Romania) without an Environmental Fund, and the lack of a comprehensive environmental financing system is noted by environmental policy makers. Taxes on oil derivatives, vehicles, roads, use of forest land, mining and tobacco, however, do contribute substantial revenues to the public coffers. The implementation of environmentally effective eco-taxes, following current trends in the EU, will require an analysis of specific environmental targets and the elaboration of a sound financing strategy to achieve policy goals.

5. Czech Republic

In the early 1990s, the Czech Republic successfully introduced a comprehensive system of economic instruments for environmental policy. The current system of environmental charges includes: air emission charges, CFC product charges, water extraction and pollution charges, sewage charges, charges for waste disposal, land conversion charges, and an airport noise tax. Revenues from charges have largely been earmarked into the State Environmental Fund which provides grants and soft loans for environmental investments on a co-financing basis. In 1996, economic instruments generated USD 97 million for the State Environmental Fund. Czech Republic's total environmental expenditure from public and private sources reached an estimated USD 1.4 billion or 2.7 percent of GDP in that year.

While maintaining revenue flows from charges has been a primary goal, incentive effects appear to have been more fully realized in the Czech Republic than other countries. It is estimated that water effluent charge rates have approached the marginal abatement costs they are intended to trigger. Total income from pollution charges peaked in 1994/5 in both nominal and real terms, and there are indications that the taxable base (pollution) continued to decrease even after the economy began to recover from the recession early in the decade. The conclusion that economic growth has been de-coupled from pollution intensity in some sectors is supported by relevant emission indicators from stationary air pollution sources and estimates of water effluent levels.

Notwithstanding the relative success of many instruments, charge rates in other sectors have been characterized as low. The rates are not adjusted for inflation, and administrative costs of emission charges in the air sector are criticized for being high. Air emission charge rates are proposed to be increased and the number of chargeable pollutants decreased. Charge collection efficiency, however, is estimated to be high. Czech Republic has had success phasing-in charge rate increases allowing enterprises to gradually adapt to new environmental policies.

The future direction of environmental policy in the Czech Republic, and the economic instruments to assist its implementation, are being fully considered in the context of accession to the European Union. In this context, the Ministry of Environment is again considering strategies for eco-tax reform. Pricing reform in certain sectors, i.e. coal, electricity, and natural gas, remains to be completed. Revenues generated from the current EIs is decreasing along with pollution levels, and the Czech Republic is considering other options for achieving continued pollution control and financing goals, i.e. tradeable pollution permits and eco-taxation.

6. Estonia

Estonia has exhibited initial success implementing a permit-pollution charge-fine system for reducing pollution from larger industrial point sources. Economic instruments including water extraction fees, mineral resource extraction charges, and environmentally relevant excise taxes have also been included in the policy mix. One stated principle guiding the use of economic instruments for environmental policy in Estonia has been to encourage the rational use of natural resources. In regional comparison, many charge rates are rather low which is reflected in a somewhat lower revenue raising potential of the Estonian pollution charges.

An interesting application of economic instruments in Estonia has been the implementation of a package excise tax on drink containers to stimulate the re-formation of an efficient deposit-refund system. The tax is waived for importers and producers who verify a percentage of their packages are being returned and reused. Apparently the tax had an incentive effect since recovery of packages developed rapidly in 1997, the first year of the excise tax collection, and revenues were much lower than expected. The Ministry of Environment has set ambitious short term goals for packaging waste recycling and reuse and intends to further develop the excise tax and deposit refund accordingly. It has also been politically viable to gradually increase pollution charge rates which have led to increased revenues in recent years, a large portion of these administered by the State Environmental Fund. Payment collection efficiency has been reported as positive. This may have been partially influenced by existing strict enforcement sanctions (daily interest rate of 0.2 percent applied to late charge payment). A CO2 emission charge is planned to be incorporated into the existing air pollution charge system in 2000 which will further contribute to domestic policy goals and be a step toward possible harmonization with international trends and help create a market for carbon trading.

Compared to other CEECs, a rather high degree of evaluation of economic instruments has also been carried out in Estonia. Weaknesses have been identified in the permit system and in the levels of charge rates. It is assumed that permitted emission levels have initially been established too high and charges set too low to realize full pollution abatement potential. Given the high payment collection efficiency, the reevaluation of permitted emission threshold levels and increasing charges rates may further improve the environmental effectiveness of charges in the air and water sectors. Identifying how charge allowances may be more effective in stimulating pollution abatement measures is also being reviewed.

7. Hungary

The Hungarian model for using economic instruments has focused on product charges rather than a system of emission charges. Environmental charges levied on products such as fuel, packaging, tires, refrigerators, etc. have played a central role in generating funds earmarked for state support to environmental investment. In 1997, product charges accounted for 78 percent of the Central Environmental Protection Fund's USD 93 million total revenues. A successful innovation to the charge system, in 1997, has been the role of tax inspectorates in the charge collection process.

An extensive environmentally relevant incentive system also exists through non-earmarked fuel taxes, excise taxes, VAT, and road charges. Additional tax differentiation in the transport sector is applied to vehicles based on age and other environmental considerations. The combination of earmarked product charges and non-earmarked taxes have resulted in the highest gasoline prices in the CEE.

Non-compliance fines have been used to enforce standards regarding air emissions from fixed sources and water effluents, but these have not been very effective as revenue raisers or incentives for abatement. The fine levels have remained too low to encourage enterprises to change operating procedures. Difficulties in implementing non-compliance fines have been reported, i.e. inflation decreasing real charge rates, weak monitoring, and lack of uniform enforcement. Financing waste collection and treatment is also a growing concern. While promoting recycling has been a major goal of some product charges, continued efforts in this area are still are required.

As long as no further instruments are introduced and product charges are used to provide environmental subsidies across other sectors, the Polluters Pays Principle is only partially implemented. Hungary has not implemented a charge system to directly influence emissions within permitted levels. New legislation which would introduce air, water, and soil pollution charges has been prepared. The air load charge is proposed with the intention to set charge rates high enough to result in decreases of targeted pollutants, including SO2 and dust emissions.

8. Latvia

The use of economic instruments in Latvian environmental policy is based on the Law on Natural Resources Tax (1995) which established a mixed policy approach with an accent on economic instruments to both efficiently achieve established goals and raise revenues for environmental spending. Referred to domestically as taxes, the resulting system contains a permit/charge/non-compliance fee system in the air, water, waste, and natural resource extraction sectors. Graduated penalty rates and charge waivers for environmental investment are also intended to generate further incentive effects. Charge waivers act as an interest free loan for pollution control projects which are co-financed to some degree by the enterprise. If project implementation is successful and sustainable pollution reduction is achieved, the loan can be converted into a direct grant.

In addition to a rather comprehensive pollution charge system, product charges are in place. The product charges on packaging materials, tires and batteries are designed with refund rates to encourage reusing and recycling of goods and products. Legislation is also in place which foresees the introduction of tradeable licenses for entrepreneurial activities with potentially harmful environmental impacts, but the market is not yet developed.

Limited analysis has been carried out on the effectiveness of natural resource tax system. Existing cost-benefit analysis and comparison with similar rates in Western countries indicate that charge rates are well below levels which would reflect true environmental costs. Further analysis suggests that the effectiveness of economic instruments have been limited by: uncertainty regarding pollution abatement costs and value of environmental benefits; underdeveloped environmental monitoring capacities; political context/public opinion unprepared to accept increased tax pressures; and the simultaneous revision of the complete Latvian tax system. These pressures are fairly representative of the region.

As is true throughout the Baltic States, the transport and energy sectors have been identified as priority problem areas. The use of economic instruments are limited in these sectors. The following proposals have been discussed by policy makers: taxation of energy consumption with charge rates based on carbon content of fuels; additional charge rates to target high sulfur-content fuels; tax differentiation between leaded and unleaded gasoline; and road taxes with subsidies offered to cars with catalytic converters. Under current political conditions and perceived public willingness to pay, only the introduction of tax differentiation between leaded and unleaded gasoline has been accepted, and enacted in 1997. As experience is accrued in other countries with carbon-based and other taxes, the remaining proposals could be reconsidered in order to support the implementation of policy integration envisioned under the Environmental Protection Policy Plan for Latvia.

9. Lithuania

The current system of partially earmarked pollution charges and unearmarked taxes on natural resources in Lithuania was developed in 1991. The state budget generally receives 30 percent of charges on pollution and 100 percent of taxes on nature resources. The remaining revenue from pollution charges is administered by Municipal Nature Protection Funds in the local area where charges are levied. The State Nature Protection Fund receives revenues from non-compliance fees only (USD 0.5-1.5 mln in recent years). Total revenues from economic instruments (USD 30 million in 1997) represented 1.4 percent of state budgetary revenue in 1997. Further analysis of both the fiscal component of pollution charges and the effectiveness of local administration vis a vis national funds may yield interesting results.

The natural resource extraction charges, including charges on water, peat, oil, amber, and soil have been administered successfully, and contribute substantial revenues directly to the central budget. These charges have been collected by the State Tax Inspectorate and are easy to calculate and control. Penalty rates for extracting quantities over permitted levels also encourage more responsible and efficient exploitation of natural resources.

Problems implementing some charges and non-compliance fines in the area of air and water pollution have been attributed to methodological inadequacies and complexity of the original law. The 1991 law elaborated 151 distinct charge rates for pollutants in air and water and defined pollution permit limits that proved difficult to monitor and administer. The effect of the charge system on the behaviour of enterprises has been characterized as low. Reasons cited are: delay in indexing charge rates to inflation; methodological inaccuracies; lack of knowledge of abatement costs; and lack of political consensus regarding environmental goals. Although collection efficiency is weak for non-compliance fees, air emission and water effluent charges demonstrate collection efficiencies close to 100 percent, raise revenues, fulfill an environmental education role, and help implement the PPP.

Legislation is currently being revised based on the experiences gained over the years. The number of charge rates will be reduced and communicated more clearly to polluters, charges rates will reflect the actual level of emissions, and straight-forward incentive effects are being built into the charge structure. It will also be interesting to follow current efforts to design a marketable permit system in the water sector in a determined region of Lithuania. While it is still too early to comment about the possible implementation of it, the work done so far allows for positive expectations.

10. Poland

The recent growth in environmental expenditures in Poland, the region's largest economy, has relied heavily on the rapid increase of revenue from pollution fees and non-compliance fines which have been earmarked for environmental investment via local, regional, and national environmental funds. In a period of high competition among sectors for public investment spending, the revenue generated from pollution charges has co-financed or leveraged environmental investments from domestic sources with quite limited direct involvement of the state budget. Spending from the National Fund of Environmental Protection alone (representing 26 percent of total national environmental expenditure) amounted to USD 491 million in 1996. Experience continues to be gained regarding the development of modern financing mechanisms.

The Polish charge system has generally become regarded as a model in the region for successfully implementing economic instruments for raising earmarked investment funds. The EI current system is applied to air emissions, water extraction, waste water discharge, solid waste disposal, and cutting trees and bushes. Some of the current charge rates are ranked among the highest in the world. Emission charges on sulfur dioxide alone generated USD 127 million in 1996, while actual emissions continue to decrease indicating an environmental incentive effect. Charge rates are revised annually to maintain their real values and were linked to inflation much earlier than in other countries. Recently, more rigorous means were introduced to maintain the real level of charge rates. This was achieved by adjustments accounting for projected inflation for the following year.

Future environmental policy goals in Poland focus on: further accenting the incentive effect of instruments; modifying pricing systems in the water and waste sector; simplifying the charge system, i.e. reducing the number of pollutants covered; introducing specific product charges; and harmonizing environmental spending with EU policies. Research and an experimental project have been completed regarding the possibility for tradable emission permits for SO2 emissions. It is feasible that such a system of tradable permits would function in conjunction with the existing system of charges and non-compliance fines.

11. Romania

A second wave of severe economic depression and comparatively less progress toward creating a market economy have provided an unfavorable context for implementing economic policy measures for environmental goals in Romania. Inflation remained high throughout the decade, and the purchasing power of the population's income has been dramatically reduced. For political and social reasons, price controls continue in the energy and water sectors. The use and effectiveness of economic instruments, under such circumstances, has been rather limited. Among many factors contributing to this, poor monitoring and enforcement, low social acceptance and/or understanding of economic and environmental policy integration, insufficient institutional capacity, and lack of political will to set efficient charge rates have been cited as principle causes. Charges in the air sector have not been expanded beyond standard enforcing non-compliance fines. Fine rates are low and are not directly linked with the actual level of emissions. Total revenue from air pollution non-compliance fines in 1996 was approximately USD 0.98 million, a low amount for a nation with 22.5 million inhabitants. Collection efficiency varies and remains a serious problem in most sectors.

The water sector in Romania is under particular pressure. The water supply authority is limited by relevant legislation to price levels necessary for operating and maintenance costs only. Metering of water consumption is not consistent. According to legislation, investments would be financed through the state budget, but current budgetary conditions do not allow for necessary large scale infrastructure development. While water effluent charges have appeared to trigger pollution reduction to some extent in the short-term, there is a possibility that the recipient of these charges, the water authority, may become dependent on the revenue flows and not aggressively promote abatement measures. On the conceptual level, it appears that economic instruments are viewed as a central element of environmental management and financing policies, and numerous ideas for modern economic instruments have been proposed. Current indicators, however, suggest that Romania still needs a more stable economic context, a complete and effective regulatory framework, and the political will necessary to fully reap the potential benefits of economic instruments for environmental policy.

12. Slovakia

Environmental charges in Slovakia, in their current form, were introduced in 1992. Charges for pollution in air and water are based on the actual level of pollution, and aim to serve both revenue-raising and incentive roles. The system is rather extensive and has generated sustained revenues between USD 50-75 million per annum between 1994-97. In some cases, however, the charge system does not perform efficiently enough. A primary cause cited for this was inconsistent monitoring of emission sources. Charge rates have been phased in and allow certain allowances/delayed payments, but given difficult charge payment administration, the rising rates provide additional incentives to find loopholes and evade charges. The Clean Air Act (1998) has attempted to address certain inconsistencies in the air sector by mandating continuous monitoring.

A success story in Slovakia has been the successful phasing-out of leaded gasoline. This achievement was the result of a mix of policy measures including tax differentiation between leaded and unleaded gasoline and discounted road tax charges for cars equipped with catalytic converters. Also noteworthy are land-use conversion charges for agricultural and forest lands, a 10 percent surcharge on electricity generated by nuclear power facilities, and a beverage container deposit-refund system with some rates as high as 35 percent of product price. Non-returnable bottles, however, mainly imports, are increasing their market share.

Much of the framework for an efficient system of economic instruments is in place in Slovakia. With planned improvements in supporting legislation, monitoring, and enforcement much potential exists for economic instruments to play an effective role in environmental policies.

13. Slovenia

Slovenia has designed several economic instruments in recent years, along the line of eco-taxes being introduced in many Western European countries. These instruments are, in theory, regarded by economists as more efficient in the long run, as the absence of earmarking avoids the potential for inefficient and distortionary allocation of resources. Moreover, once a stable revenue flow and desired pollution targets are achieved, the full implication of eco-taxes is to reduce other taxes, generally taxes on labor. However, environmental policy makers often would rather earmark the revenues from such charges, if only in the short-term, to catalyze and leverage environmental investments. The latter path has been the preferred option in other countries of the region, as stimulating environmental financing has been perceived to be a major challenge.

In Slovenia, both the waste water charge (1995) and CO2 Tax (1997) generate unearmarked funds for the central budget. Beyond the direct incentive effect of the charge itself, the estimation of the full environmental effectiveness of these charges requires an evaluation of both the magnitude of revenues generated and the state budget environmental spending program. Spending from the state budget in the environmental sector has been fairly low considering Slovenian regionally high per capita GDP. For this reason, environmental policy makers are somewhat reserved about accepting eco-taxes as the dominant policy tool at the current stage of policy development. Nevertheless, the current intention is to raise the water effluent charge rates to provide significant incentives for polluters to invest in water treatment measures and to extend the CO2 Tax to cover not only liquid fuels but also coal used for electricity production in 2004. Analysis should be initiated to report on developments through the next few years.

A levy on electricity generated from the Krsko nuclear power plant has also been introduced. Similar to the Slovak strategy, the revenue from the charge is earmarked for a fund which seeks to internalize all costs involved in the operation, eventual shut-down, and waste disposal procedures over the lifetime of the plant. Charges in the transport sector are largely earmarked for road construction and maintenance. Several new charges are also being planned for the waste management sector, fertilizers and pesticides, and in the area of nature protection.

14. Yugoslavia

Implementing economic policies, in general, and for environmental goals, in particular, will be difficult in Yugoslavia over the next few years due to social, political, and economic factors. The following conditions in particular have been cited: high foreign debt, low technological development of industry, shortage of working capital to finance investments, and unstable political and market conditions. Pressures on environmental protection have been exacerbated by the suspension of international cooperation and therefore both technical and financial assistance in the environmental sector. The transition to a market economy is decidedly slower in Yugoslavia, and the state continues to play a large role in key economic sectors. It is not expected that domestic sources will provide the needed funds for environmental spending in the near future. The reasons for this are: low willingness to pay, limited and shrinking tax revenues, inadequate banking system, low enforcement capacities, and lack of clear environmental financing policy. Despite extremely difficult circumstances, a number of economic instruments have been introduced in recent years. There are non-compliance fees in force for violation of air, water, waste and nature protection laws. Encouraging is the recent introduction of air and water pollution charges in the Republic of Montenegro. Positive experiences in Montenegro may lead to the introduction of similar charges at the federal level and in the Republic of Serbia. However, very limited information is available to allow for a reasonable judgement on the performance of these instruments, an issue which should urgently be addressed by policy makers. Increased regional and international experience exchange would be very useful for Yugoslavia. Although this seems to be difficult under current political circumstances one should hope that the future will allow for more possibilities and flexibility.
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