A study by the University of São Paulo (USP) in Brazil investigated a fiscal transfer mechanism whereby states transfer part of their sales tax revenue to municipalities in exchange for the creation of environmental conservation units. The mechanism is known as ICMS-E. ICMS is state-collected sales tax, and the “E” stands for ecological.
In an article published in the journal Ecological Economics, the researchers show that although the fiscal transfer mechanism has stimulated the creation of nature reserves in Atlantic Rainforest areas for some years now, it may be less effective than expected because most of the new reserves are classified as Environmental Protection Areas (APAs), a conservation unit category that entails relatively few restrictions on land use. In addition, the legislation on APAs calls for a lower fiscal transfer to municipalities. The effect of ICMS-E on the creation of APAs is almost seven times greater than on the creation of other types of reserve, such as those involving comprehensive protection.
The system is self-limiting, according to the researchers, in that the number of conservation units it incentivizes is unlikely to rise in future because fiscal transfers decrease as the number of protected areas increases. As a result, in the longer term the gains cannot cover the opportunity cost in a given area (the potential revenue from using the land for economic activities).
The authors also conclude that state and city governments respond differently to pro-nature incentives. States tend to focus on environmental benefits, while municipalities prioritize revenue growth. This also helps explain the rising number of APAs, as city governments gain from these units, which incur lower costs.
To quantify the impact of the mechanism on the creation of protected areas, the researchers used a dataset that combined information on their creation and ICMS-E implementation for the 1,467 municipalities in six Brazilian states containing Atlantic Rainforest fragments in the period 1987-2016. The article does not analyze specific cases in these municipalities.
“The study compared municipalities that did and did not receive fiscal transfers via ICMS-E, analyzing the differences between them before and after introduction of the incentive, in an experiment using observational data and a methodology whose relevance was acknowledged by the 2021 Nobel Prize for Economics,” said Jean Paul Metzger, a professor at USP’s Institute of Biosciences and last author of the article.
“One of the key findings is that subnational governments respond differently, and this makes sense. States don’t benefit financially because they transfer the funds. They benefit politically by advancing their environmental agenda. Municipalities clearly prefer to create less costly conservation units with fewer restrictions, such as APAs, because they don’t entail radical land use changes but generate revenue,” Patricia Ruggiero, a researcher at USP and first author of the article, told Agência FAPESP.
The study was conducted under the auspices of the FAPESP Research Program on Biodiversity Characterization, Conservation, Restoration and Sustainable Use (BIOTA-FAPESP) and led by Metzger, who is a member of the program’s steering committee.
It was supported by FAPESP via four projects (13/23457-6, 15/16587-6, 17/20245-9, and 14/11676-8). It was also supported by the National Council for Scientific and Technological Development (CNPq) and the Higher Education Research Council (CAPES), both of which are agencies of the Brazilian government, and by the US National Science Foundation (NSF).
For the researchers, the system drives a “rush” by municipalities to create APAs quickly because of their flexibility (compulsory purchase of land is not required, for example) and capacity to raise extra revenue. Political decisions influence the outcome of elections: the additional revenue from conservation units can be spent in the run-up to polling day wherever local government sees fit (healthcare, infrastructure, etc.), and does not have to be spent on environmental conservation.
In another article published earlier in Conservation Letters, Ruggiero and her group showed that destruction of the Atlantic Rainforest increases in election years.
According to this study, in the period 1991-2014 an additional 3,652 hectares of Atlantic Rainforest per year were cleared on average in federal and state election years compared with non-election years. The increase for municipal election years averaged 4,409 hectares.
The researchers correlated data from the Electoral High Court (TSE) and MapBiomas, the Brazilian Annual Land Use and Land Cover Mapping Project, for 2,253 municipalities in the South and Southeast regions.
How the incentive works
ICMS-E redistributes some of the tax collected by states to municipalities that contribute to the protection of biodiversity and the quality of the environment by establishing conservation units, in a manner similar to payment for ecosystem services. Its legal rationale is article 158 (IV) of the Federal Constitution, which empowers states to pass laws requiring compliance with certain criteria by municipalities in exchange for the transfer of sales tax revenue.
Brazil was the first country to implement an environmentally justified intergovernmental fiscal transfer system, beginning in 1991 in Paraná state. Similar systems have since been introduced in China, France, Portugal and India, which innovated by basing transfers on forest cover and extending the system to its entire territory. Germany and Poland are discussing proposals along these lines.
Funding from developed to developing countries to help pay for adaptation to climate change, and to compensate for loss and damage, was one of the most warmly debated topics at the 26th Conference of the Parties to the UN Framework Convention on Climate Change held in Glasgow, Scotland, in November.
São Paulo state passed adjustments to the legislation on ICMS-E in the first half of this year. Now Law 17,348 requires the state to transfer 2% of its total ICMS revenue to municipalities for this purpose, up from 1%. Analysts expect such transfers to amount to more than BRL 5 billion in the next ten years. Half of each transfer is supposed to go to conservation of protected areas and reservoirs for hydropower and water supply, with the other half going to waste management and biodiversity restoration.
“In conservation there’s no silver bullet, no single strategy to solve all problems. What’s needed is a combination of the available tools in pursuit of synergy and optimal results. ICMS-E is an important part of all this, but can’t do everything on its own,” Ruggiero said.