Morocco’s Minister of Environment, Dr. Hakima El Haite, asked the World Bank to explore options for carbon pricing and investigate its social and political feasibility in her country in mid-2016. Morocco imports approximately 90 percent of its energy needs and had only recently phased out subsidies for liquid fuels, embarking on an ambitious renewable energy development program. This was also the year that the country was preparing to host the annual Conference of Parties of the United Nations Convention on Climate Change (COP22), cementing its status as a champion of sustainability in the developing world.
The work initially focused on traditional carbon pricing options such as emission trading systems (ETS) and carbon taxes. But the concentrated structure of the power market, the dominant role of the state-owned power utility, and the presence of only a few large industrial emitters, would make it hard for an ETS to deliver its cost-saving potential and manage monopoly risk.
Fiscal instruments offered more promising alternatives. An Inter-Ministerial Advisory Group, which included representatives of the Ministry of Economy and Finance and the Ministry of Energy, was formed to guide the work. Preliminary analysis focused on identifying opportunities to align environmental, fiscal and sectoral policy objectives through tax-subsidy-expenditure adjustments, known as “environmental fiscal reform”.
The analysis found some areas of potential policy misalignment, for instance:
- While the standard Value Added Tax (VAT) rate in Morocco was 20 percent, fossil fuels enjoyed a preferential VAT rate of 10 percent. This was less than the 14 percent VAT rate for solar and wind plant equipment;
- Fossil fuels (including coal) used for power generation were exempt from excise consumption taxes (taxes intérieures de consummation), while for industry, coal was taxed less than heavy fuel oil;
- Diesel used in transport was taxed 36% less than gasoline, notwithstanding its larger contribution to the health cost of local air pollution;
- Bottled butane gas, used primarily in households, benefited from the last remaining large, explicit fiscal fossil fuel subsidy in Morocco, kept partly for social reasons, and partly to stop rural households from burning biomass at home.
Adjusting these misalignments could deliver a range of impacts, for instance:
First, environmental fiscal reform could contribute to achieving the broader goals of fiscal and economic policy of Morocco, even before considering climate and pollution benefits. For example:
- It could reduce the size of the informal economy, especially if part of the revenues were used to lower income taxes; which, unlike energy taxes, can be avoided by escaping to the informal sector.
- It could improve the efficiency of the tax system if revenues were used to offset income taxes because upstream energy taxes are easier and cheaper to collect, more difficult to evade and less subject to fraud.
- It would boost VAT revenues, which are imposed on the value of energy products after excise duties.
- It would send price signals to encourage structural transformation towards innovative, knowledge-intensive (as opposed to fuel-intensive) economic activities.
- It could stimulate the clean energy transition and boost the domestic production of clean energy technologies, such as solar water heaters.
- It could reduce Morocco’s budget deficit, even after a portion of fiscal revenues were to be funneled as targeted transfers to compensate for the income loss by vulnerable households.
Second, reducing tax expenditures on fuels would help achieve some objectives of Morocco’s energy policy, but challenge others.
- It would encourage more efficient use of energy in power generation and industry,
- It would increase the competitiveness of renewable energy sources to achieve the government target of 52 percent share of renewable energy in the total installed capacity by 2030.
- However, environmental fiscal reform would likely have a negative impact on the profit margins of coal power plants and energy-intensive industries. In 2017, thermal plants produced 84 percent of Morocco’s electricity, including 55 percent fired by coal, of which a majority (about 2.4 Gigawatt) was through new, recently commissioned units.
- Moreover, these plants were built under long-term (usually 30 years) power purchase agreements (PPAs). A deeper analysis of the commercial structures of these agreements would be needed to determine the final incidence of changes in fuel tax rates and the impact this would have on consumers, particularly the poorest, with appropriate strategies put in place to manage these impacts.
Third, the phased removal of the butane subsidy could deliver fiscal and economic benefits, but social and environmental impacts would need to be managed. The total subsidy - 10.3 Billion Dirhams in 2017 or about 4 percent of total government spending - was poorly targeted with the richest 20 percent of the population receiving 2.5 times more subsidy than the poorest quintile. The availability of subsidized butane also dampens innovations and opportunities in alternative, cleaner solutions: households have fewer incentives to install building-integrated solar water heating systems, which means reduced demand for scaling-up domestic manufacturing and servicing of this equipment, and lower job creation in the sector.
The fiscal savings from butane subsidy reduction would be more than enough to compensate poor and vulnerable households for any social impact of increased energy prices, through social tariffs or targeted financial transfers. However, these kinds of transfers are often complicated to do in practice and the process must be carefully managed to ensure that the adverse impacts on the poorest are fully mitigated. Care must also be taken to ensure that as butane subsidies are phased out, the poorest, rural households do not revert to wood and charcoal for cooking purposes, as this would deteriorate indoor air quality and put pressure on fragile forests. Instead, clean and convenient substitutes, such as solar water heaters or electric cooking, must be made available.
The Inter-Ministerial Advisory Group provided critical feedback and “reality-checks” that helped guide these findings. An initial formal stress-testing of these qualitative findings with an economic model was conducted with the Department of Forecasting in the Ministry of Finance using the computable general equilibrium model of the Moroccan economy, developed with World Bank support. The model is still a work in progress with simulation results¾ encouraging though they are ¾ still considered initial findings that require further testing with an improved model and better data.
Environmental fiscal reforms may have multiple benefits, but they also entail significant socioeconomic risks and need to be carefully prepared. When the time is ripe for Morocco, the World Bank will be there ready to support the government with design and implementation.