Financing the green and just transition: towards further partnerships between Europe and Latin America and the Caribbean

Despite several socioeconomic gaps persisting in Latin America and the Caribbean (LAC) compared to European Union (EU) countries, some common trends arise among LAC and Europe. One key common socioeconomic and political factor concerns the green transition agenda. In particular, most LAC and EU citizens share common values on the need to adopt a green development agenda, and most of their governments in both regions have committed to the fight against climate change.

To respond to the green and just transition, both LAC and EU countries need to find the conditions to finance these policies. The fiscal space is still limited or decreasing in some cases, and therefore improvements to a better management of public resources, combined with a more effective taxation system that contributes to enhance competitiveness and reduce inequalities should contribute to this equation. The combination of these factors infers that LAC and the EU look much more alike today than in the past.

However, tax revenues in LAC are currently insufficient to meet its development objectives. In 2022, LAC’s tax revenues amounted to just 21.5% of GDP, ranging from 10.6% in Guyana to 33.3% of GDP in Brazil, below the OECD and EU averages of around 34% and 40%, respectively (OECD et al., 2024a). The region’s tax structure does little to mitigate inequality, as it remains heavily dependent on indirect taxes, which accounted for 48% of total taxes in 2022 (32% in the OECD), with value-added tax being a prominent proportion of this. Personal income tax and social security contributions accounted for only 26.7% of LAC’s total tax revenues in 2022, compared to 48.4% in OECD countries. Conversely, corporate income tax contributed more in LAC (16% of total taxes) than in OECD countries (12%).

Considering the experience of some European countries and adapting them to the particularities of LAC countries, the region has an array of tax policy options that would help increase revenues and positively impact development agendas. Expanding recurrent taxes on immovable property, which averaged 0.4% of LAC’s GDP in 2022 compared to 1% in OECD countries, can raise revenues and promote wealth redistribution. Simplifying the tax process, ensuring efficient administration and promoting fairness are crucial for improving tax collection and progressivity. Environmentally related taxes in LAC, averaging 0.9% of GDP compared to 1.8% in OECD countries, rely heavily on fuel taxes and energy subsidies. While protecting the most vulnerable populations should be addressed, in some countries there is room to expand carbon taxes, carbon emissions trading systems and carbon credits. Additionally, reassessing high effective corporate tax rates and optimising incentives to pay taxes can help support investment and entrepreneurship. Currently, the effective average tax rate for a given investment project is 23.9%, compared to 21.9% in OECD countries and 17.1% in 25 emerging economies. Further cooperation and partnerships between LAC and EU on these aspects should contribute to improving the tax structure of LAC countries.

Green, social, sustainability and sustainability-linked (GSSS) bonds continue to be an attractive financing mechanism, and international cooperation between the EU and LAC will be key in scaling up such debt securities for financing the sustainable development agenda. GSSS bonds increased from 9.3% of total LAC bond issuance in international markets in 2020 to almost 35% in 2023 (OECD et al., 2024b). To scale up GSSS bonds in the region and overcome barriers hindering market development, international financial cooperation is crucial. This includes the establishment of harmonised frameworks and reliable monitoring and supervision mechanisms to prevent greenwashing and SDG washing.

Development cooperation can help reduce barriers to international financial flows as well as perceived risks. It can allow access to ‘derisking instruments’, which aim to share risks among multilateral, public and private actors, such as blended finance or guarantees offered at concessional or competitive terms to unlock private finance. LAC development partners such as the EU are pursuing initiatives that drive the mobilisation of financing through the use of such tools. With the Global Gateway Strategy, the EU has put forward a holistic approach to international partnerships with integrated financing structures that bring together investment, trade and cooperation actors. The EU-LAC Global Gateway Investment Agenda promotes a 360-degree approach, mobilising quality investments that create local added value and promote growth, jobs and social cohesion.

The views expressed in this #CriticalThinking article reflect those of the author(s) and not of Friends of Europe.