- Tax expenditure is the revenue the State forgoes through exemptions, deductions, and other preferential tax treatments. Today, around 17 Latin American and Caribbean countries estimate their tax expenditure, but they rarely measure what share of that expenditure has an environmental impact.
- Measuring and evaluating environmental tax expenditure is an opportunity for finance ministries to identify potential reforms that generate both budgetary and environmental benefits.
- Although there has been concrete progress in the region, few countries carry out this exercise. The IDB recently developed a methodology to help governments identify, classify, and evaluate these types of expenditure.
Each year, governments shape the allocation of public resources in two ways: what they spend and what they choose not to collect. The first is direct and more visible: the spending recorded in the budget, which is debated publicly and audited. The second is indirect and receives far less attention: the revenue the State forgoes through exemptions, deductions, credits, and other preferential treatments applied to certain sectors or economic activities.
This less visible dimension of public spending is known as tax expenditure (TE). According to the International Monetary Fund (IMF), it comprises special provisions of the tax system that reduce the tax burden of certain taxpayers relative to what would result from applying a benchmark tax system.
The IMF considers tax expenditure reporting a basic fiscal transparency practice, and today more than 17 Latin American and Caribbean (LAC) countries regularly publish estimates of its magnitude. However, these reports rarely reveal how much of that tax expenditure has an environmental impact: which fiscal incentives promote activities aligned with the country's climate or environmental commitments, and which, on the contrary, run counter to those objectives.
Identifying that dimension is precisely the purpose of environmental tax expenditure (ETE), a tool that allows finance ministries to strengthen evidence-based environmental fiscal policymaking. In this post we examine the importance of measuring it, a proposed methodology for estimating them, and the progress made across the region.
Measuring Environmental Tax Expenditure: A Different Reading of the Data
With tax expenditure, the State forgoes collecting revenue. Although its effect on public accounts is similar to that of direct spending, it tends to receive less scrutiny and systematic evaluation. This gap is even wider when it comes to its environmental dimension. While more countries estimate how much revenue they forgo through tax expenditure, few analyze whether those incentives contribute to climate and environmental objectives or, on the contrary, contradict them.
A TE can have an environmental impact when it has the potential to influence economic activities with effects, positive or negative, on the environment. ETE is not a new instrument, but rather a different way of interpreting existing data. Measuring it means identifying which part of the current fiscal incentives advances environmental objectives, which contradicts them, and which has no clear impact. Its importance lies in identifying reform opportunities that generate both budgetary and environmental benefits.
But how is this done in practice? After examining international best practices, the IDB recently developed a methodological framework (available in Spanish) to help countries in the region identify, classify, and evaluate their ETE.
Methodology for Measuring Environmental Tax Expenditure
The IDB methodology is inspired by the European Union's approach and incorporates the standards of Eurostat's Classification of Environmental Purposes (CEP) system.
It applies six benchmark environmental policy objectives: climate mitigation, adaptation, sustainable use of water, transition to a circular economy, pollution prevention, and protection of biodiversity. For an ETE to be considered to have a positive impact, it must contribute substantially to at least one of those objectives without causing significant harm to the others.
The process of identifying and classifying ETE is structured and adaptable to each country's institutional capacities. It operates in three phases:
Phase 1 – Collection: the inventory of fiscal incentives is built from their legal basis, technical characteristics, and estimated fiscal magnitude. This inventory is classified using the standards of the IMF Government Finance Statistics Manual and the CIAT Manual of Good Practices in Measuring Tax Expenditures, which facilitates international comparability.
Phase 2 – Identification and classification: each incentive's impact on the six benchmark environmental objectives is qualitatively assessed, distinguishing whether that impact is positive, negative, neutral, or indeterminate, and whether the incentive's purpose is primary or secondary.
Phase 3 – Quantification: based on the tax expenditure estimate available in the country, ETE is quantified according to its overall impact in local currency, dollars, percentage of GDP, or of total revenue. This step turns the qualitative diagnosis into actionable information for policy decisions.
The framework is flexible: a country can begin with phases 1 and 2 and move toward quantification as it strengthens its capacities. What matters is starting the process. ETE is not a static classification; it requires continuous monitoring, and that is a good reason for finance ministries to institutionalize it.
An Opportunity for Finance Ministries
Analyzing ETE is not only a technical exercise: it is an opportunity. By mapping which incentives have a positive, negative, or neutral environmental impact, finance ministries gain concrete evidence to:
- Improve the efficiency and effectiveness of tax expenditure: identify incentives that do not deliver the expected results, whether in economic or environmental terms, and prioritize them for review or elimination. In Latin America and the Caribbean, a significant share of fiscal incentives do not generate enough economic benefits to justify their cost (Armendáriz et al. 2025 and 2026); environmental analysis adds another dimension to that evaluation.
- Strengthen fiscal transparency: present to the legislature and the public a more complete account of forgone revenue, including its environmental dimension. France, Italy, and Costa Rica already do this: the results of their ETE analysis are published and presented to parliament.
- Facilitate the design of coherent reforms: detect contradictions between current incentives and the country's climate commitments, and create space for gradual, technically grounded reforms.
- Advance toward international comparability: the use of shared standards, such as the IMF Government Finance Statistics Manual and the classifiers of the System of Environmental-Economic Accounting of the United Nations, makes it possible to compare results across countries and learn from comparative experiences.
Most LAC countries already publish tax expenditure reports focused on quantifying revenue loss. The environmental analysis of ETE is a relatively accessible additional step once that inventory is in place, and it can turn that report into an input for sustainability policy.
Countries Are Moving Forward, And the Road Is Just Beginning
The regional picture shows some concrete progress, even though most countries in the region have not yet carried out this analysis:
- Costa Rica has spent several years applying an institutionalized ETE analysis and has managed to build historical series that gradually improve the quality of the information and its use for decision-making. The country's experience was one of the main references for developing the IDB's methodological guidelines, which were recently presented to officials from across the region during a workshop of the Finance Ministers Platform.
- Colombia has a detailed diagnosis that is already guiding public policy debates. The results show that a significant share of tax benefits with an environmental impact continues to favor activities with negative effects on the environment, while a considerably smaller fraction explicitly promotes environmental objectives. This type of finding can reveal inconsistencies between current fiscal incentives and national climate goals, providing evidence to drive more coherent reforms.
- Honduras incorporated the environmental analysis of tax expenditure in 2023, but it was only in the 2024 budget cycle that it updated the methodology and published this analysis for the first time in the draft general budget of revenues and expenditures of the Republic. The exercise showed that a significant share the incentives with an environmental impact is concentrated in activities linked to fossil fuels, providing, for the first time, systematic evidence to inform discussions on reform alternatives and better align fiscal policy with sustainability objectives.
ECLAC, in its analysis of international experiences, documents common traits shared by countries that have advanced the most in this exercise: a clear methodology, coordination between fiscal and environmental authorities, and periodic review mechanisms that keep the inventory up to date. France, Italy, and other countries outside the region have shown that ETE reporting can become a regular practice integrated into the annual budget cycle.
Four Steps to Move Forward
There is still much ground to be covered. The next step is not only to carry out these analyses, but to institutionalize them. This means integrating ETE analysis into the budget process, strengthening monitoring systems, moving toward impact measurement, and establishing periodic reviews that ensure the alignment of the tax system with environmental objectives.
These are the key conditions for ETE to move beyond an isolated exercise and become a permanent fiscal management tool. After all, it is hard to improve what is not measured.