The Multi-Level Fiscal Governance of Ecological Transition

Role of fiscal federalism in driving ecological transition

Ecological transition is defined as a ‘process towards a smarter social and economic model which better responds to green challenges.’ It aims for sustainability by preserving natural resources and reducing environmental impact. A recent OECD working paper explores how fiscal federalism influences ecological transition, a critical aspect of the UN’s Sustainable Development Goals. The study delves into the connection between fiscal federalism and ecological transition policies, with a focus on the roles of regional and local governments. Despite their commitment, these subnational governments face limitations in implementing comprehensive green plans due to local governments’ incentive schemes and capacity constraints.

The paper examines how fiscal federalism institutions like fiscal rules, transfers, and capacity-building programs that can aid ecological transition policies. It underscores the importance of involving regional and local governments in environmental efforts and emphasizes tailored multi-level fiscal governance for successful environment goals. By studying fiscal federalism’s potential in ecological transition, the paper offers insights for policymakers working on multi-level governance approaches to environmental challenges.

Some of the main findings of the report are as follows:

  • While the global green targets and environmental goals are set at international and national levels, subnational governments are responsible for managing crucial polices for the ecological transition. Results from the report show that local institutions are responsible for most of the public spending on environment protection. In the sample of 25 OECD countries, only four of their central governments execute more than 50% of the environmental public spending.
  • Spending on water waste and waste management are predominantly handled by local governments, while pollution control and efforts to protect biodiversity and landscapes are centralized. Although the environmental spending is carried out at the local level, the overall legal frameworks are established by central governments, sometimes with input from regional bodies.
  • Variations in environmental results are not necessarily linked to how decentralized policies are. There is significant cross-regional and cross-city heterogeneity regardless of whether decision-making is centralized or decentralized contexts.
  • The transversal nature of environment sustainability issues poses challenges in measuring how much funding is devoted to green programs. The OECD – EC subnational Climate Finance database addresses this question and shows that on average, across 33 OECD and EU Countries, subnational governments are responsible for 63% of climate significant spending overall and 69% of climate related public investment. Still, those figures only represent 1.1% and 0.4% of GDP, respectively.
  • Roughly 80% of the revenue generated from environmental taxes, encompassing energy, transportation, pollution, and natural resources, comes from the energy sector.  Charges on pollution and resources are found to be diverse but of limited revenue-raising capacity, whereas the few taxes on energy generate large revenues for the public sector. Taxes on tourism, waste disposal, or water use are often charged at the subnational level, whereas purely energy-related taxes are most of the time charged by national governments. Despite mainly centralized energy taxation, intergovernmental transfers in federal and quasi-federal counties often depend on energy tax revenues. As a result, the budgets of the subnational governments (SNGs) are affected due to short-term tax cuts implemented to address fluctuations in energy prices.
  • Although local governments increasingly report being aware and concerned about environmental issues, smartly designed incentives are needed to induce necessary behavioral change. Green contributions should be charged proportionately and according to, for instance, waste thrown, or kilometers driven.
  • Subnational governments are increasingly engaged in the ecological transition, but they recognize difficulties in complying with environmental targets. SNGs – particularly smaller ones – may lack the capacity or political willingness to align with international green agendas. Ecological Fiscal Transfers (EFTs) represent an example of how earmarked grants linked to environmental protection may be useful, despite general recommendations against conditional grants.
  • Local governments are well-positioned to ease the popular opposition against ecological transition policies. Yet, they have limited powers to deal with political resistance to distributional issues. In conclusion, institutions and frameworks are crucial for the success of the ecological transition. Results show that decentralization choices can help address allocative problems and equity concerns, benefiting net-zero objectives.

Dougherty, S. and A. Montes Nebreda (2023), “The multi-level fiscal governance of ecological transition”, OECD Working Papers on Fiscal Federalism, No. 44, OECD Publishing, Paris,

Photo credit: Wind farm, Lake Turkana, Kenya. Used under Creative Commons license (CC BY 2.0).