The São Paulo State (Brazil) Ecological Fiscal Transfer: Distributive and environmental effects

Abstract

To restore 12 million hectares of native vegetation in Brazil by 2030, aligning environmental policies with incentive measures is crucial. The Ecological Fiscal Transfer (known as Ecological ICMS in Brazil) allows states to redistribute the ICMS tax (similar to the Value Added Tax) revenue based on environmental criteria, likely motivating municipalities to take environmental action. São Paulo recently modified its ecological ICMS legislation, increasing the ICMS revenue distributed according to environmental criteria and introducing a new criterion for native vegetation cover. We assessed the impact of these changes on tax redistribution, considering three scenarios: the former rules (2021), the new rules (2025), and the new rules with 1.5 million hectares of vegetation restored (2042). While the pattern of ICMS distribution remained mostly unchanged, there were distributional effects. Some municipalities lost up to 5% of their initial revenue, while others with high socio-environmental importance doubled their revenues. Existing environmental criteria still lack incentives for local environmental policies. However, the new criterion for native vegetation cover could, with practical limitations, boost municipal revenue after restoring 1.5 million hectares. São Paulo's initiative to incorporate native vegetation cover into an Ecological Fiscal Transfer policy holds the potential to inspire similar tax-based environmental incentives worldwide. However, it must be adapted to motivate local governments to embrace restoration actions rather than serving primarily as a compensatory measure.