CONTEXT OF THE ASSIGNMENT

Financing the green transition will require more effective public spending and alignment of fiscal policy with green objectives. Uzbekistan has sufficient scope for financial mobilization and can address costly energy subsidies and raise revenue through environmental taxation versus other tax measures. The country’s tax-to-GDP ratio sits at 14.8%, two points higher than middle-income country average. In 2022, about 5% of total tax revenues is made of tax with environmental relevance – mostly under the form of fuel and resource taxes. These revenue streams are not structured to support the GoU green economy strategy.

Overall, for the GoU the importance of considering and developing green taxation is being driven by three key forces:

·         State revenue generation for green economy reforms. In the context of the need for Uzbekistan to mobilize revenues equivalent to 8% of GDP to achieve the country’s SDG target by 2030 (FMI, 2021a), a comprehensive green tax package can not only accelerate the transition to green economy but also raise revenues in a more growth-friendly manner than alternative revenue-raising options such as an increase of VAT or corporate income tax (FMI and OECD, 2015 ; FMI, 2020).

·         Readiness for global carbon adjustment requirements. Uzbekistan's current carbon-intensive economic structure is exposed to the changing global policy environment and consumer preferences in a carbon-constrained future. This model faces transition risks, as the global policy environment rapidly shifts in favor of climate action. With the adoption of carbon border adjustment taxes, Uzbekistan's exports may face barriers in key markets. Additionally, the global low-carbon transition may sharply reduce the value of primary export commodities, affecting fiscal revenue and causing stranded assets for the financial sector.

·         Fast-tracking transition to green technologies for less pollution. The annual toll of premature deaths from ambient particulate matter pollution per million inhabitants in Uzbekistan is well above regional and global averages. The welfare cost of these deaths is estimated at over 10% of GDP as of 2019. Green taxation reforms, specifically focusing on taxing the worst pollutants across all sectors, could encourage incremental innovation and transition to green technologies.

The gradual introduction of instruments like vehicle tax based on motor efficiency, tax incentives for RES deployment, or a carbon tax could significantly address Uzbekistan's energy transition challenges. Uzbekistan began this process in 2022 by increasing the excise tax on carbon fuels (gasoline, diesel fuel, liquefied gas, compressed gas). As a further step, the Government of Uzbekistan intends to conduct a tax review to identify other areas ripe for green tax reform.

Introducing carbon pricing is a key ingredient for triggering the green transition. It can generate fiscal space for green investments, spur private investment needed to reach net-zero emissions, and create positive behavioral incentives for transition. Macroeconomic modelling suggests these policies can create additional fiscal space worth up to 5% of GDP over the transition period (WB, 2023).

The Ministry of Economy and Finance of Uzbekistan (MoEF) has started to review international experience on green taxation, notably during the green budgeting study tour organized by AFD in Paris in June 2022. Based on the following key issues of interest outlined by the MOEF, in 2022, a study was carried out to deepen its understanding of green tax instruments and identify potential application in Uzbekistan with a view to design and present a green tax package:

·         Tax measures to encourage environmental protection. To this date, Uzbekistan operates a system of pollution charge. Regulated industries have to pay a fee on the emissions of certain air and water pollutant as well as the generation of waste. The system covers over 250 pollutants but applies a very low charge rate on each of them. In 2020, it only generated $1.75 million or 0.01% of government revenues. In this regard, it should be created meaningful incentives for pollution abatement based on comparison with the corresponding abatement costs and the system is operated without reference to national environmental targets (SDG). This stands in contrast with international best practices which postulate that pollution charges tend to be effective when they are targeted at a few major pollutants and emitters. The MOEF and the Ministry of Ecology, Environmental Protection and Climate Change (MEEPCC) are aware of the shortcomings of the system and has implemented a tenfold rise in rates charges for certain pollutants in 2021. While this increase address some of the current problems, more analytics might be warranted to design a more profound reform of the system: focusing its scope on key pollutants, linking it to national green objectives or making it less burdensome to the private sector but more deterring to big polluters.

·         Tax measures to encourage water efficiency and conservation. In Uzbekistan, water abstraction from natural sources is subject to the payment of a water use tax. Payers are legal entities (including agricultural enterprises), individual entrepreneurs and dekhkan farms that use water from surface or underground sources for their economic activities. Tax rates per m3 of water depend on the type of water source, the economic activity and use purposes. Rates for the use of water resources are annually indexed by (adjusted to) the level of inflation, as they are set in absolute value. In general, revenues from the tax in 2021 amounted to 684.4 billion sums ($65 million). The share of water use tax in total budget revenues remains at the lowest level and is about 0.4%. These revenues are allocated to local budgets, but are not earmarked for water management and maintenance. The current system of taxation of water resources uses does not fulfill the stimulating role aimed at economical use of water resources, in this connection it is necessary to improve it considering foreign experience and ongoing reforms in the water sector.

·         Tax measures to encourage low-carbon economic development. Uzbekistan aims to gradually shift towards a low-carbon growth model, considering national constraints and the necessity to maintain growth and job-creation. Tax measures could be designed to support this agenda by (i) encouraging investment into low-carbon technologies through targeted tax expenditures, (ii) encouraging the adoption of energy efficient standards and (iii) directly taxing carbon emissions themselves. Currently, Uzbekistan’s tax framework has a series of excise and sale tax which target carbon fuels (petroleum products, natural gas, gasoline) and certain carbon-intensive products (cement). However, there is no direct levy on carbon (a carbon tax) and the pricing structure of current tax measures on key emitting sectors (transport, energy, construction) do not incentivize renewable energy deployment and energy efficiency. For instance, tax rates on the purchase of motor vehicles or motor fuels do not vary according to their energy efficiency or carbon-intensity.

The Study`s scope of the analysis is limited to three priority areas identified by the MOEF: namely, the taxation of pollutants, the taxation and pricing of carbon, and the taxation and pricing of water. While the Study is limited in its aims and scope, it is mindful of the larger context.

To this end, the MOEF has resolved to further examine green tax reform options.

TECHNICAL ASSISTANCE CONTEXT

To support the efforts of Uzbekistan on green transition, a wider green economy public policy loan program was designed and financed by the AFD. This five-year program (2022-26) consists in: (i) an in-depth policy dialogue on the formulation, implementation and evaluation of the Green Growth Strategic Framework (GGSF), (ii) a series of three concessional budget support loans disbursed upon completion of pre-agreed reform targets and (iii) a technical cooperation project funded by dedicated grants.

Thus, the Technical Assistance entrusted to Expertise France is implemented in the framework of the larger Green Economy Technical Assistance Program (GETAP) financed by the European Union that cover the remaining years of implementation of the Green Economy Public Policy Loan Program (2023-26) and will support national authorities in delivering on key milestones of the GGSF. In addition, it is a logical extension of a previous TA carried out by Expertise France and funded by AFD’s own resources. Expertise France’s part of the GETAP comprises the following components:

·                    Institutional support to the MoEF on GGSF operationalization and coordination, including support to the Centre for Green Economy Projects;

·                    Implementation of the MRV system;

·                    Green Public Investment;

·                    Green Budget;

·                    Fossil fuel subsidies phasing out;

·                    Environmental taxation;

·                    Sustainable Public Procurement;

·                    Sustainable governance of SOE.

In the previous phase of the TA, by the hired experts:

·         Provided capacity-building on the foundations of green taxation including the organization of a series of in-country workshops and training to present (i) the different objectives that green taxation can support (e.g. discourage emissions of pollutants, encourage investment in sustainable activities), (ii) the types of instruments that can be leveraged to deploy green taxation and meet the priorities outlined by the MOEF, (iii) international experiences in green taxation, (iv) how to develop and implement a coherent and fit-for-purpose green tax package and (v) develop with local stakeholders a list of potential tax measures to consider;

·         Conducted with the stakeholders (MOEF, MEEPCC, line ministries) a green tax review to identify options for green taxation in Uzbekistan. Based on the results of the workshops, developed a policy paper which (i) details the potential green tax measures, (ii) assesses their feasibility as well as their pros and cons, (iii) outlines steps for implementation (for the quick wins) or further research and design (for the longer-term reforms).

The scope of the Study is limited to three priority areas identified by the GoU: namely, the taxation of pollutants, the taxation and pricing of carbon, and the taxation and pricing of water. It (i) addresses related areas of taxation, such as taxes on transport fuels, and related environmental instruments, such as the regulation of pollutants, only insofar as these relate directly to the task of developing appropriate tax settings on pollutants, on carbon, and on water, as well (ii) identifies potential green tax instruments and sort them between quick-wins and more long-term reforms that will require further research and preparation.

The current assignment is a logical continuation of the work done previously.