A Roadmap Toward More Efficient and Sustainable Fiscal Policies: Lessons from Chile, Colombia, and Mexico

Chile, Colombia, and Mexico offer valuable examples for Latin America and the Caribbean on how to design and implement environmentally aligned fiscal instruments that are both effective and deliver tangible impact. A new study, led by member countries of the MEF Climate Change Platform with support from the IDB, distills lessons drawn directly from the Ministries of Finance that have led the implementation of these tools.

Evidence from the three countries shows that fiscal instruments—carbon taxes in this case—are not alone sufficient to drive the technological changes required by a sustainable development model. The study identifies multiple barriers that limit their effectiveness, including regulatory constraints, lack of infrastructure and information, and limited technical and technological capacities.

As a result, the objectives of these instruments must be realistic and aligned with their actual effectiveness. They should be understood as part of a broader set of economic policies. For example, in some cases it will be necessary to increase financing to advance toward a more sustainable economic model, while in others it may be necessary to adjust sectoral regulations.

Before implementing carbon pricing, it is essential to review subsidies and tax exemptions to avoid generating market distortions. Certain energy-related subsidies, for example, can represent a significant share of the effective carbon price and often have the opposite effect of what is intended. Sequencing reforms—first addressing existing distortions and then introducing carbon pricing—can enable more responsible fiscal management and a more efficient allocation of resources.

The three countries studied converge on an innovative mechanism: allowing compliance with the tax through the purchase of carbon credits.

• Chile allows stationary sources to offset up to the full amount of their taxable emissions using offsets from domestic projects
• Colombia allows taxpayers to settle the tax directly with offsets, creating artificial demand that has already helped stimulate projects with positive environmental impacts
• Mexico, during its pilot phase, explored the accreditation of tax payments through emission reduction certificates

This mechanism mobilizes financing without violating the principle of non-earmarking of fiscal revenues, while also helping improve political and social acceptance by offering flexible compliance options. In addition, it facilitates a more gradual transition for sectors facing higher abatement costs.

However, the study also highlights key institutional challenges: administering and overseeing these mechanisms, preventing double counting of credits, and ensuring additionality and permanence of emissions reductions. Addressing these challenges will require Ministries of Finance to strengthen capacities and work closely with Ministries of Environment and sectoral authorities.

Political and social support for implementing carbon taxes at sufficiently high rates is not guaranteed; therefore, public acceptance must be central to their design. The three countries provide examples of effective strategies to support feasibility, including:

• Narrowing initial coverage through exemptions for certain fuels, sectors, or uses, and applying impact thresholds.
• Starting with low rates and establishing pre-defined, regular increases to provide certainty.
• Designing communication campaigns that explain the benefits of the instrument and address public concerns.
• Respecting the principle of non-earmarking and integrating revenues into general government funds.

The balance is delicate: while concessions can reduce socio-economic impacts and improve acceptance, they may also weaken effectiveness. The key lies in viewing a limited initial implementation as part of a gradual, long-term pathway—an approach demonstrated by Chile and Colombia through successive reforms.

For these instruments to be effective, it is essential to strengthen institutional capacities so that Ministries of Finance can assess impacts ex ante and, during implementation, manage complex mechanisms and coordinate with multiple sectoral ministries. Strengthening these capacities makes the difference between an instrument that drives economic transformation and one that becomes a fiscal distortion with limited real impact.

The experiences of Chile, Colombia, and Mexico show that implementing sustainable fiscal policies requires coherence, robust technical capacities, and sustained commitment. Adopting a systemic approach with comprehensive policy packages, avoiding unnecessary distortions, strengthening institutional capacities, and actively managing social acceptance are all fundamental. This roadmap offers countries in the region a practical guide to harnessing the potential of these instruments in support of fiscal efficiency and economic stability.

Download the study: Effective Carbon Tax Design: Key Considerations from Latin America and the Caribbean (available in Spanish).