68417 Ukraine Financing the Environment: Ukraine’s Road to Effective Environmental Management A Public Environmental Expenditure Review February 2003 Environment and Socially Sustainable Development Unit Europe and Central Asia Region ACKNOWLEDGEMENTS This study of Ukraine’s Public Environmental Expenditure is based on a background report prepared by external and local consultants and findings from Bank missions to Ukraine between February 2001 and May 2002. The team wishes to thank the government of Ukraine for the cooperation received from senior officials, managers, oblast officials, environmental authorities in Donetsk, NGOs, and representatives of the private sector for their collaboration with the joint Bank-Fondazione Eni Enrico Mattei (FEEM) Italy consultant team. The team wishes to thank Serhiy I.Kurykin, Minister of Environment and Natural Resources, Mikola Pylypchuk, Director of the National Environmental Fund, Lydmila Lukash, Head of the Department of Agriculture and Environmental Finance in the Ministry of Finance and V. Kurulenko, Head of the Donetsk Oblast State Department of Environment for their substantive support and collaboration with the team during the preparation of this study. The team wishes to express its gratitude to the management of Joint Stock Company “Nord” and Krivorozskaya Metallurgical Plant for their cooperation and contribution to the team’s work. The tem wishes to express its special thanks to Mr. Vasyl Shevchuk, Minister of Environment and Natural Resources for his and his collaborators’ support in conducting a Round Table for reviewing and discussing the recommendations of the Public Environmental Expenditure Review in February 2003 in Kiyv. Throughout preparation the team benefited from collaboration with NGOs such as the Ukrainian Society for Sustainable Development, the Institute of Economy, the National Academy of Sciences of Ukraine, the public advocacy group EcoPravo Kiev, and other groups and independent experts who provided feedback during all stages of public consultations. This input helped the team greatly improve its understanding of the system of public finances for environmental protection. The study was undertaken by a Bank team comprising Adriana Damianova, Task Team Leader and Senior Environmental Specialist, Anil Markandya, Lead Economist, (ECSSD), Alexei Slenzak, Operation Officer (ECCUA). Jean-Jacques Dethier, Senior Economist (DECVP) and principal author of the Ukraine Public and Institutional Expenditure Review, provided substantial input to the team and final report. The team is grateful for the help of Marialuisa Tamborra, FEEM Consultant Team Task Team Coordinator, Polina Averianova, Junior Researcher, Professor Massimo Bordignon, the Catholic University of Milan, and Professor Alistair Hunt, University of Bath, UK. The Italian team was supported by Olga Dragan, Irina Maliarchuk, and Natalia Malisheva, Ukrainian experts on public finance and taxation. The study benefited from the work in progress to review the Ukraine forest sector, being prepared by Christian Albert Peter (ENV) and V. Popkov, Ukrainian Forest Economist, which includes an overview of forest sector finances. The study greatly benefited from valuable comments and guidance from Jane Holt, Sector Manager for Environment, under whose direction the effort was managed, and Luca Barbone, Country Director (ECC011), Lilia Burunciuk, Country Officer, and Marjory-Anne Bromhead, Sector Manager, Natural Resources. Valuable comments and suggestions were provided by peer reviewers Debora Wetzel, Sector Manager (ECSPE) and Peter Dewees, Principle Natural Resources Economist (ECSSD). Special thanks go to: Eugenia Marinova (AFCZA), Grazia Atanasio, Emanuele Santi (EXTCD), and Vadim Diukanov for their support in organizing and conducting public consultations on the draft report; Kimberly Heuckroth for editorial support, Irene Bomani (ECSSD) and Vlasta Sposobna (ECCUA)for continuous administrative support.. The team wishes to express its gratitude to the other agencies, private enterprises, and local authorities who spent time with the Bank and consultant teams in open and constructive discussions. ii CURRENCY EQUIVALENTS (Exchange Rate Effective June 19, 2002) Currency Unit = Hrivnya 1 Hrivnya = US$0.18 US$1 = 5.54 Ukraine Hryvnia FISCAL YEAR July 1 -- June 30 ABBREVIATIONS AND ACRONYMS CEE Central and Eastern Europe PPP Polluter Pays Principle DECV Vice President Development Economics & SEEA International System of Environmental P Chief Economist Accounting DPSIR Driving Forces, Pressure, State, Impact, UAH Ukraine Hrivnya Response ECSS Environmentally and Socially Sustainable USAID United States Agency for International D Development Development EF Environmental Funds USSR Soviet Union ENV Environment WHO World Health Organization EPR Environmental Performance Review EU European Union Ci/sq. km Curie per square kilometer FEEM Fondazione Eni Enrico Mattei, Italy EC European Community GDP Gross Domestic Product CO2 Carbon Dioxide IPPC Integrated Pollution Prevention Control CO Carbon Monoxide MAC Maximum Allowable Concentrations NOx Nitrogen Oxide MENR Ministry of Environment and Natural Resources SO2 Sulfur Dioxide MOF Ministry of Finance PM Particulate Matter NIS Newly Independent States US$ United States Dollar OECD Organization for Economic Cooperation and VOCs Volatile Organic Compounds Development OED Oblast Environmental Department NMVOC Non-methane Volatile Organic Compounds PAC Pollution Abatement Control GBq Giga Becquerel PEER Public Environmental Expenditure Review NPP Nuclear Power Plant Vice President: Johannes Linn Country Director: Luca Barbone Sector Director: Laura Tuck Task Team Leader: Adriana Damianova iii CONTENTS ACKNOWLEDGEMENTS ................................................................................................ II CURRENCY EQUIVALENTS ..................................................................................................III ABBREVIATIONS AND ACRONYMS ...................................................................................III EXECUTIVE SUMMARY ......................................................................................................... VI I. INTRODUCTION ................................................................................................................ 1 II. ENVIRONMENTAL EXPENDITURE IN UKRAINE: AN OVERVIEW ..................... 3 2.1 INTRODUCTION ...................................................................................................... 3 2.2 DEFINITIONS AND DATA COLLECTED ...................................................................... 3 2.3 SOURCES OF FINANCING FOR ENVIRONMENTAL MEASURES ..................................... 4 2.4 ENVIRONMENTAL EXPENDITURE DATA: 1996 - 2000 ............................................... 5 2.5 INTERNATIONAL COMPARISON OF ENVIRONMENTAL EXPENDITURE.......................... 6 2.6 ENVIRONMENTAL TAXATION: TAXES ON USE OF NATURAL RESOURCES AND POLLUTION CHARGES .................................................................................................... 10 III. ENVIRONMENT AND NATURAL RESOURCES IN UKRAINE .......................... 14 3.1 INTRODUCTION .................................................................................................... 14 3.2 AIR ..................................................................................................................... 14 3.3 WATER RESOURCES ............................................................................................. 15 3.4 SOLID WASTE...................................................................................................... 16 3.5 PRESSURES ON NATURAL RESOURCES AND BIODIVERSITY ..................................... 18 IV. POLICY, LEGAL AND INSTITUTIONAL FRAMEWORK FOR ENVIRONMENTAL PROTECTION....................................................................................... 20 4.1 INTRODUCTION .................................................................................................... 20 4.2 INTRODUCING NEW ENVIRONMENTAL POLICIES AND LAW ENFORCEMENT IN UKRAINE 20 4.3 THE INSTITUTIONAL FRAMEWORK FOR ENVIRONMENTAL REGULATION ........... 21 5.1 ENVIRONMENTAL EXPENDITURE ....................................................................... 23 5.2 SOURCES OF REVENUE FOR PUBLIC EXPENDITURES .......................................... 28 5.3 REGIONAL INDICATORS...................................................................................... 34 5.4 COMPARING REGIONAL EXPENDITURES WITH REGIONAL REVENUES ................ 36 5.5 CONCLUDING REMARKS....................................................................................... 38 VI. REGIONAL CONTEXT OF ENVIRONMENTAL EXPENDITURE: DONETSK CASE STUDY.............................................................................................................................. 40 6.1 INTRODUCTION .................................................................................................... 40 6.2 INSTITUTIONAL STRUCTURE OF ENVIRONMENT MANAGEMENT IN DONETSK ........... 40 6.3 OBLAST REVENUES.............................................................................................. 41 6.4 OBLAST EXPENDITURES ....................................................................................... 45 6.5 OVERALL CONCLUSIONS BASED ON DONETSK CASE .............................................. 53 REFERENCES ............................................................................................................................ 57 iv LIST OF TABLES Table 2.1a: Actual Environmental Expenditure in Real Terms – 2000............................. 8 Table 2.1b: Public and Private Environmental Expenditures in Constant Dollars ............ 8 Table 2.2: Investment Expenditure on Environment in 1999 ............................................ 9 Table 2.3: PAC Expenditure as Percentage of GDP in OECD Countries ......................... 9 Table 2.4: Breakdown of Environmental Expenditures in Selected Countries ............... 10 Table 2.5: Planned Revenues of State Budget from Use of Natural Resources in Real Terms ........................................................................................................................ 12 Table 2.6: Number of Environmental Protection Funds in 2000..................................... 13 Table 2.7: Distribution of Pollution Charges Among National, Regional and Local Environmental Funds ................................................................................................ 13 Table 2.8: Average Ratio of Expenditure and Revenue of the Environmental Fund System....................................................................................................................... 13 Table 3.1: Toxic Waste Produced and Accumulated at Enterprises During 1996-2000, and Expenditures for Disposal of Waste in Organized Landfills in 2000 ................ 17 Table 5.1: Breakdown by Media of Actual Environmental Expenditure from State Budget in Real Terms, 2000 (‘000)UAH.................................................................. 24 Table 5.2: Breakdown by Media of Actual Environmental Expenditure from National Environmental Fund in Real Terms 2000 ................................................................. 25 Table 5.3: Current Environmental Expenditures in Nominal Terms............................... 26 Table 5.4: Current Environmental Expenditures in Real Terms...................................... 26 Table 5.5: Current Environmental Expenditures by Sources of Financing in Real Terms ................................................................................................................................... 26 Table 5.6: Environmental Investments ............................................................................ 27 Table 5.7: Budget Financing of Environmental Activities in Real Terms ...................... 29 Table 5.8: Expenditures by Environmental Media as a Share of Total Expenditures (*) 29 Table 5.9: Environmental Expenditures by regions in 2000............................................ 30 Table 5.10: Charges and Fines for Environmental Pollution in Real Terms ................... 32 Table 5.11: Compliance Rates by Environmental Media ................................................ 33 Table 5.12: Environmental Pollution Charges Paid by Legal Entities in 2000 (‘000 UAH) ................................................................................................................................... 35 Table 5.13: Environmental Funds Expenditures by Regions (‘000 UAH) in 2000......... 38 Table 6.1: Pollution Charge Payments, Declared and Actual, and by Media.................. 42 in Donetsk Oblast, 1998-2000 .......................................................................................... 42 Table 6.2: Pollution Charge Contributions to Oblast and Local Environmental Funds .. 43 Table 6.4: Payments for Natural Resources Utilization in Donetsk Region.................... 47 Table 6.5: Planned Public Environmental Expenditures in Donetsk for 2002 ................ 48 Table 6.6: Capital Investments in Environmental Protection of Donetsk Region........... 49 Table 6.7: Capital and Operational Costs on Existing Assets, 1998 -2000 ..................... 50 Table 6.8: Allocation and use of Environmental Funds (‘000 UAH).............................. 51 Table 6.9: Environmental Fund (EF) Revenue, Expenditure and Utilization Rates in Donetsk Oblast, 2000................................................................................................ 52 Table 6.10: Detailed EF Expenditures in Donetsk, 1997 - 2000 (000 UAHs.) ............... 53 Table 6.11: Efficiency of Environmental Expenditures in Donetsk Oblast..................... 55 v EXECUTIVE SUMMARY i. This study presents a detailed analysis of the system of environmental expenditure in Ukraine with a particular focus on public expenditures. It examines the extent to which the present system meets national environmental objectives and identifies ways in which it can be improved and made more cost-effective. Since environmental spending is closely tied to sources of environmental revenues (partly a result of earmarking and partly because of the regulatory role that pollution charges and fines play), this review also covers revenue issues. ii. The study is based on international systems of environmental accounting established by OECD Pollution Abatement and Control (PAC) studies in other transition countries, on Eurostat’s SERIEE system and on the revised UN SEEA.1 The scope of the analysis does not include expenditures related to the Chernobyl nuclear accident because most of these expenditures are better categorized as social than as environmental. iii. The key findings from the analyses of environmental expenditure are as follows: • In aggregate terms, environmental expenditures have fallen from about a billion dollars in 1996 to about $600 million in 2000. Total expenditure on the environment as a percentage of GDP is, on average, higher in the CEE countries than in OECD countries. Ukraine data for 2000 are similar to those of to CEE countries. Where Ukraine differs from countries in this group is with respect to investment expenditure as a percentage of the total. In the OECD group, this averages about 27 percent, but most countries are well above that and the "Cohesion Group" countries, Ireland and Portugal, which are still undertaking programs to catch up with the EC acquis, have investment shares of 43 and 47 percent respectively. In Ukraine this percentage is around 22 percent. • Most of the environmental expenditure is from non-budgetary sources, principally “enterprise” funds, i.e. the “private sector.” This financing source dropped more than any other in the period 1996-2000. In 2000, non-budgetary expenditure accounted for 94 percent of all environment expenditure. The greatest share of total expenditure is private current expenditure, which accounted for 77 percent of the total in 2000. The other notable difference is the share of total investment in the environment made by private sector. In the OECD group, this averages 43 percent, ranging from 27 percent (Austria) to 54 percent (Portugal). In Poland it is higher, 67 percent, and in Ukraine even higher, 82 percent. This means that the "public good" type of investments undertaken by the public sector is particularly scarce in Ukraine. • By contrast, the contribution from budgetary sources, $35 million in 2000, increased slightly over the period 1996-2000. In terms of total expenditure (capital and current), the role of the public sector is even smaller. Total expenditure as a share of GDP is about 2 percent, broadly in line with the level in other countries although it has fallen substantially since 1996. Of the total, only 6 percent is public. In the OECD group the average is 55 percent, and in Poland, 32 percent. iv. The conclusions and recommendations from the study are best presented as answers to four key questions: • Is the pattern of environmental expenditure consistent with national priorities and objectives? 1 The United Nations Statistical Office and Eurostat have developed the System of Integrated Environmental and Economic Accounting (SEEA), and Eurostat has developed the European System for the Collection of Economic Data on the Environment (SERIEE). vi • How efficiently are environmental expenditures allocated and what actions can be taken to make use of resources more efficient? • Is the overall level of expenditure on environmental protection adequate? Is division of responsibility for environmental protection between the public and private sectors appropriate? • Are the sources of finance for environmental protection efficient from a public finance perspective? What actions can be taken to increase the efficiency with which such funds are mobilized? What are the main environmental objectives in Ukraine, and is the pattern of environmental expenditure consistent with these objectives? iv. National environmental policy has not been formulated in terms of specific environmental targets against which one can measure achievement. Policy statements are mostly declarative in nature and do not provide priorities among the broad goals. Some specific goals related to environmental policy have been specified, articulated in national and regional “Environmental Programs,” each of which targets a particular environmental problem and details the actions needed to address that problem. Two such programs, prominent nationally were the program to upgrade meteorological and pollution monitoring and the program for environmental enhancement of Dnieper river basin and improvement of quality of drinking water. No determination has been indicated, however, of the relative priority of these programs. As well, the role of private versus public sector should be clearly delineated. This report discusses the Donetsk environmental program (at the regional level), which gives greatest priority to the management of solid waste and radiation – allocating 60 percent of its budget to this item – followed by natural resource management and flood protection at 18 percent. v. However, as discussed in more detail in Chapter 3, expenditures do seem to be concentrated on Ukraine’s highest priority problem. According to empirical data, water pollution is a highly serious problem in Ukraine: 24 percent of discharged water is insufficiently treated and 12 percent of water bodies fail to meet sanitary conditions. Moreover, water supply restrictions still apply in some cities. By contrast, atmospheric emissions have declined and the intensity of air emissions is below the average for OECD countries. Thus, it is understandable that a large percentage of environmental expenditures are spent on water treatment and related projects. Ukraine’s environmental needs should also be assessed from the viewpoint of private versus local and regional responsibilities. Data from 2000 shows that: • The largest share of expenditures is in the water sector (in 2000 the sector accounted for 33 percent of the state budget and 53 percent of the National Environmental Fund). • Air protection is entirely delegated to the National Environmental Fund and to enterprises because it mainly involves end-of-pipe measures (e.g. scrubbers). However, this expenditure has been extremely limited and has increased only recently (in 2000). Nevertheless it is still only about 7 percent of the National Environmental Fund expenditures and 1 percent of aggregated expenditures from both sources. This low figure contrasts with the fact that air pollution charges are the largest share of environmental charges as a whole. • The National Environmental Fund is also the only funder of activities in the area of waste. • Expenditures on “green” issues, such as afforestation and nature reserves, takes up about one-fifth of expenditures of both the state budget and the National Environmental Fund. vii • Other items funded by the National Environmental Fund include development of management programs, research and development, awareness raising programs, conduct of Environmental Impact Assessments and some other minor items. Together these account for about 12 percent of the National Environmental Fund expenditures. vi. The biggest problem with all these programs, however, is under-funding. Programs contain much more than can be funded, and the percentages actually implemented can be very low – well below 10 percent. There has been some improvement in this respect in some programs in 2000 (e.g., of the Dneiper River Basin program referred to above, 19 percent of the plan was funded) but there is still a long way to go. Furthermore, there is no way of knowing whether the programs actually implemented are indeed the ones of highest priority. There is a tendency to start a large number of projects and programs, and then argue in subsequent years for funds to complete them (a practice common to the days of the Soviet Union). vii. A weaker test of consistency is to see if actual levels of expenditure by broad category match policy goals. As noted in Chapter 2, the bulk of state spending on the environment is on "water resources protection," especially repair and rehabilitation of water supply and wastewater systems. This is broadly consistent with national priorities – water-related problems were identified as the critical issue in the NEAP and their priority makes sense given the need to ensure clean water for human populations and aqueous ecosystems. RECOMMENDATIONS viii. The links between expenditures and priorities need to be strengthened. Specifically, the following actions should be taken: • Link priorities with specific environmental goals and outcomes: Effectiveness can be enhanced if procedures are adopted that enable different levels of the administration to set priorities based on specific goals and outcomes (such as levels of pollution reduction to be achieved) that are, in turn, linked to environmental monitoring of results. This would enable expenditures to be more closely linked to environmental performance. • Link expenditures to priorities: Public environmental expenditure should be linked to policy priorities, which in turn should be linked to outcomes that affect public health/safety, reduce poverty or protect natural resources. Decisions on public spending for environmental goals should be driven by solid analysis of the environmental and economic effectiveness of public investments. In addition, enhanced enforcement of administrative and economic pollution-management instruments and compliance requirements will encourage businesses to address their environmental problems by investing in eco-efficient technologies, as well as free public resources for investment in environmental public goods. How efficiently are the environmental expenditures allocated and what actions can be taken to make the use of resources more efficient? ix. The Report highlights ample evidence that the expenditures made to protect the environment are not efficient in the sense of selecting the programs and projects with the highest net benefits, or obtaining the maximum improvement in a physical indicator per dollar spent. Assessing efficiency in this sense for environmental investments is not easy; estimated benefits, especially from better protection of natural resources, are difficult to quantify. Likewise, the use of cost-effectiveness criteria, which are well established for investments in sectors such as health and education, are less so for the environment. Nevertheless, tools and techniques for such assessments are increasingly available and should be used in Ukraine at the program and project level. viii x. The issue of efficiency is of course wider than the use of cost-benefit and cost- effectiveness analysis. More generally, one can ask the following questions that pertain to the effectiveness of environmental expenditures in meeting national priorities. (a) Does the method of allocation prioritize items within a program, so that, when funds are inadequate, the highest priority items are included? It does not. There are more than 1,600 environmental funds at the local and regional level that “spend” pollution charges for various purposes. These are too numerous to be efficient, and too much discretion is given to the funds to set their own agenda. In some cases, the funds support gaps in local budgets. Funds spent from the national budget adhere more closely to environmental priorities. (b) Is it easy to track expenditures by category and know when a spending unit has not delivered or has overrun the cost of a project? The monitoring of environmental expenditures is quite weak. Accountability, especially at the local level, needs to be strengthened. (c) Are policies based on proper consultation? In large measure Ukraine has a reasonable system of consultation in deciding its environmental programs, but it can be improved. (See Recommendations.) RECOMMENDATIONS xi. The following recommendations are intended to enhance the effectiveness of environmental expenditures: • Increase transparency and public disclosure: Public resources for the environment belong to the system of public finances and, as such, should be managed in accordance with principles of sound public-finance management. Transparency and accountability should be enhanced in many areas, especially for decisions concerning exemption from paying pollution charges. A system should be put in place to assess the environmental effectiveness of expenditures undertaken at all levels, especially at the local level. Transparency and public disclosure should be introduced. Public awareness and participatory decision-making should be extended in accordance with the Åarhus “Environment for Europe” Ministerial Conference as well as the Convention on Access of Information, Public Participation in Decision Making, and Access to Justice in Environmental Matters Conventions that Ukraine ratified in 1999. • Consider introducing international expenditure standards, to better monitor environmental expenditures: The environmental-expenditure system can be better managed by making Ukraine’s classification system consistent with international practice and standards. Ukraine should adopt an environmental expenditure-classification system such as SEEA, SERIEE, or the OECD PAC system. • Enhance accountability: Accountability of spending units should be increased. At present, it is difficult to trace back environmental expenditure borne by public bodies other than the MENR. The new budgeting system, which introduces a program classification, should help in this regard. • Introduce economic appraisal techniques for environmental projects and programs: Formal environmental project and program economic appraisal appears to be limited to those companies that seek financing from sources outside Ukraine. We recommend that such appraisal techniques be introduced at all levels of government in order to increase the efficiency of expenditures. At present, this appraisal process is limited to companies receiving money from the public sector, in particular those participating in the Economic ix Experiment. However, this appraisal seems to address financial and administrative aspects rather than environmental ones (see Chapter 5). Is the overall level of expenditure on environmental protection adequate? Is division of responsibility for environmental protection between the public and private sectors appropriate? xii. Although this question is often asked, it does not have a simple answer. One must distinguish between current and capital expenditure and between public and private expenditure, and determine whether each of these is adequate for the purposes for which it is intended. The data show that, while the total level of expenditure on the environment is in line with that in other countries in a similar position, there is, comparatively, too little investment expenditure and too much current expenditure. Of the total, only 22 percent is investment expenditure, compared to 27 percent in selected OECD countries and 59 percent in Poland. Moreover, the share of total expenditure that is public expenditure is too low in Ukraine; at only 6 percent, it is much lower than for OECD countries and much lower than in a transition country such as Poland (where it is about 38 percent). xiii. The composition of environmental expenditure has important implications. The low share of investment as a proportion of total expenditure means that not enough is being put into replenishing the environmental capital, and the low share of public expenditure means that not enough is being spent on the kinds of things that the public sector is responsible for. In all countries, the state undertakes "public good" expenditures. This includes items such as monitoring of environmental quality, protection of watersheds and sensitive land areas, and protection of nature reserves and forests. xiv. In transition countries, the state also supports investment in water supply and sewage, in other key areas of infrastructure, and in key industrial enterprises, on the grounds that those responsible for these entities have insufficient resources to maintain them and that their collapse would have serious consequences for public health, the natural environment and possibly employment. Over time, of course, this reason will become less important, and one would expect to see public spending decline on this count and pick up on the more conventional "public good" component. xv. The evidence from this review is that public spending on the environment, especially on the monitoring side and on key infrastructure protection, is probably insufficient. This is notwithstanding the fact that there are inefficiencies in what is spent; increasing efficiency will take time and there are urgent programs that need immediate action. RECOMMENDATIONS xvi. The following recommendations are made with regard to the level and composition of spending. • Maintain financing: In the next few years, public environmental expenditure should be sustained at its current level in real terms, complemented if necessary by international sources, to enhance environmental monitoring at all levels and to build institutional capacity in analytical methods (such as cost-effectiveness and cost-benefit analysis) that are critical to evaluating public investment programs. Ideally, funds for public expenditure such as monitoring of environmental compliance should be financed directly from the budget. x • Reduce discretion in allocating funds: Discretion in allocating and re-allocating resources should be reduced, especially for environmental funds. One way to achieve this would be to define broad shares of allocation for different categories. These measures would make decision-making and priority-setting more efficient. Consultations with Ukrainian stakeholders have confirmed the need for an Action Plan on Environmental Protection drawn up in a democratic and transparent way. Are the sources of finance for environmental protection efficient from a public finance perspective? What actions can be taken to increase the efficiency with which such funds are mobilized? xvii. Ukraine’s principal sources of public environmental expenditure are state and local budgets and special earmarked environmental funds linked to revenue from pollution charges. The funds support a wide range of environmental activities by contributing (in order of magnitude) to: (i) investments in environmental improvements, particularly water-related, then air- and waste-related; (ii) protection of protected areas and forest resources; (iii) monitoring and training; and (iv) research and development. Expenditures financed from the state budget under the aegis of the Ministry of Environment and Natural Resources (MENR) are roughly equivalent to those financed by all the environmental funds together, and give highest priority to water resources, followed by protection of nature reserves, afforestation, mineral resources protection and land protection. The contributions from the environmental funds can be in the form of direct investments or of grants on a matching basis. xviii. Too Many Funds. The system of environmental funds is extensive and includes over 1,600 regional and local funds. The sheer number of these funds is clearly inefficient because each uses resources to finance administrative costs, leaving relatively small amounts per fund, limiting the nature of projects that can be funded. On the other hand, local government control is valuable because decisions about how to spend resources can be made closer to where environmental problems exist. xix. Pollution Charges. The income of the funds comes primarily from pollution charges, which are imposed on enterprise emissions to air, water and waste in accordance with rates determined by national level legislation. The highest revenues collected have been for air pollution while the largest expenditures have been on mitigating water pollution. Data disaggregated by region show that compliance rates with charges and fines are lower in the regions where pollution is higher; and in these same regions, fines are less likely to be imposed on firms. In the case of some regions, this may be an indication that where charges become too high, firms have more problems paying. Most likely, however, lack of payment is a result of corruption in the system, or at least willingness to treat large polluting firms more generously on broad economic grounds. The empirical analysis is at least consistent with a picture where large firms lobby successfully for exemption, while smaller firms bribe tax officials or simply do not pay the charges. xx. Pollution Charges Seen More As Revenue- Generating Instruments Than As Instruments For Pollution Prevention. Largely, pollution charges in Ukraine are not to reduce pollution; given their low levels, the pollution charges are unlikely to provide incentives to enterprises to invest in environmental improvement to avoid the charges. Rather, the charges are to raise revenue for environmental protection. Over the last five years or so, these charges, fixed in nominal terms, have had their real value eroded. Since there is a continuing need to maintain environmental expenditures, unless the expenditures are financed by the budget some restitution of value of the pollution charges is justified. Such an increase would also provide an incentive to reduce emission and invest in environment mitigation. xi xxi. National Environmental Fund. More generally, one has to ask whether the system of pollution charges to generate revenue for subsequent allocation among environmental funds is the best way of financing public environmental expenditures. In the longer term, the answer is no. The system is inefficient at changing polluters’ behavior, does not match cost with benefits, and has led to a proliferation of highly inefficient local funds; therefore, in the medium term, it should be phased out. Still, immediate action should be undertaken to make the system more efficient in the near term, and maintaining it is justified because there is no alternative means to ensure a minimum level of funding for the environment that can be put in place immediately. As well, the present system has some features that recommend it. The National Environmental Fund does operate relatively effectively; projects are rigorously processed there, and the Fund is open to adopting better methods of appraisal. Improvements can be made to the way it operates; some suggestions are offered below. At the same time, there is a need to overhaul the system of local funds (there are too many of them) and to change the system of subsidy across regions (see Recommendations). In the longer term, the program of comprehensive public finance reform that ends all earmarking and subjects all revenue to integration into the public finance system will lead to phase-out of the environmental funds. RECOMMENDATIONS xxii. The following recommendations are made with respect to the financing of environmental protection. • Refine the institutional and legal structure for environmental funds: The National Environmental Fund suffers from an excess of discretion. The law that defines the task of the Fund is too generic, and allows for the financing of unproductive projects. Accordingly, the law defining allowed uses of the Fund should be streamlined and clarified. The role of the center in managing the resources of the Fund should be strictly confined to general monitoring and research activities and to co-financing projects that clearly affect more than one region. Lastly, the center should be charged with preparing a more detailed annual report to the public and the Government as to how the funds have been used. • Reduce the number of funds: The number of environmental funds should be reduced. The environmental fund system suffers from fragmentation that prevents economies of scale. At the same time, environmental expenditure is divided into thousands of small local funds, leaving local bodies with insufficient resources to tackle environmental problems. What the system seems to lack most at present is a definition of the "right" level of government to manage the resources of the National Environmental Fund. This level of government should be "low" enough (that is, close enough to where pollution takes place) to discourage diversion of resources to unproductive uses and ensure accountability. On the other hand, the level of government should be "high" enough so that sufficient resources are available and a general overview of the fund system is maintained. The Oblast level represents a compromise between these two conflicting aims. Hence, our final recommendation would be to reinforce the role of the regional level of government in determining the allocation and use of Fund resources. • Spend resources close to where they are collected1: Reforms should stress strict adherence to the “revenue-benefit principal” that resources should be spent as closely as 1 At present, the regions that contribute the largest revenue, such as Donetsk and Zaporyhyhzia, receive little money back from the center. Expenditures for different sources of pollution are also distorted: revenues from air pollution charges are much higher than those from water pollution, which draws considerably more abatement resources. One way of achieving balance would be to introduce an Integrated Pollution Prevention Control system similar to the EU IPPC Directive. xii possible to where they are raised. This would reduce political discretion and increase effectiveness, because revenue from pollution charges is highest where pollution is highest. Assuming the government fully adopts the revenue-benefit principle and focuses on providing services that have the characteristics of public goods, earmarking funds for environmental protection may be a way to improve the quality and efficiency of the present system of financing. • Introduce more rigorous guidelines for use of environmental funds: The Government may also wish to reassess the wisdom of permitting localities to keep a portion of pollution charges, since the localities are so free in how to spend these funds that this revenue is not unlike general budgetary funds. It is quite likely that a large percentage of these funds are used to pay local salaries and support a variety of municipal needs. • Phase out environmental funds in the long run: From a public-finance perspective, earmarking budget revenues can result in inefficient and non-transparent use of public resources. In the short run, Ukraine’s environmental funds could be a useful instrument for implementing specific environmental programs, but only if they are better managed. In the longer run, the earmarking system should be dropped, as has already occurred in other NIS countries. However, the idea of immediately dropping earmarking could be a challenge. Environmental protection is seldom a political priority, particularly in times of financial stress, and moving pollution charges into the general revenue stream might well lead to a sharp drop in environmental expenditures. xxiii. The following recommendations are made with respect to pollution charges: • Adjust pollution charges to make up for value lost due to inflation: The loss of real value has resulted in a decline in public environmental expenditure. This should be reversed if the level of such expenditure is not to continue to fall, with consequent neglect of important environmental programs. • Eliminate exemptions: Exemptions and barter should be substantially limited, or eliminated. The present system seems to depend heavily on lobbying for exemptions by the largest companies, which is inherently inefficient. Much of the business sector, especially heavy industry, is still owned by the state. Many of these firms do not make profits, but, considered strategic for the Ukrainian economy, are subsidized2 and allowed not to pay taxes or to pay them through barter (Chapter 6). The proposed policy is inconsistent with experiments currently under way in some sectors of the economy that exempt firms from paying pollution charges in exchange for a promise to increase investment in environmentally friendly technologies. Given the difficulties of assessing compliance with the bargain, it is most likely that the latter scheme will simply result in a way of avoiding environmental taxation altogether. • Streamline pollution tax structure: A smoother and more efficient pollution tax schedule should be introduced. Looking at the system of environmental charges as a pure tax structure, two marginal tax rates exist, with a sharp kink at the level of the predetermined limits of pollution. The marginal tax rate above the set polluting standards is five times larger than the marginal tax rate below the standards, and is in practice even higher if one considers that charges above the limits are not deductible from the corporate income tax base and that firms in this category also run the risk of being subsequently fined by the judicial system. A system with such a heavy jump in the marginal tax rate is very unlikely to be optimal. It is even less so considering that charges above the limits are largely evaded, proving that this system is unsustainable unless the Government is 2 Most coal mining is unprofitable. The state continues to subsidize current expenditures of about 180 coal mines rather than restructure the industry. State support for coal industry (almost UAH 1 billion a year) is focused on preventing social problems associated with the large-scale closedown of mines and pits. Nevertheless, mine closures continue: in 1998, twelve mines were closed, and 20 each in 1999 and 2000. xiii willing to push firms into bankruptcy if they do not pay, or to remove their license to operate. The abruptness of the jump in charges may, however, make such tough stances politically difficult. In view of this the tax schedule should also be smoother, marginally increasing in relation to the pollutant emissions. This would provide more incentive to firms that could curb pollution at relatively low costs to actually do so, while more heavily punishing polluting firms. Furthermore, compliance levels could improve, especially of those firms that are just above the fixed standard levels. • Strengthen oversight to reduce corruption: Although enforcement of tax payments has increased significantly since 1999, when the duty of collecting pollution charges was shifted from the MENR to the Tax Authority, stronger oversight and control on the part of the MENR is recommended in those regions where compliance rates are significantly lower. Inspections of inspectors should be more rigorous to curb corruption. • Reduce changes in case of financial inability to pay: In many cases, low compliance rates reflect the financial inability of firms to pay the charges. Where this is a generic problem throughout a region, it may be better to reduce the overall environmental charges than to allow some firms to escape the charges without being fined. Such a decision would avoid further undermining the credibility of the legal enforcement system. • Promote greater feedback on compliance to ensure appropriate pollution charge levels are set: The standards for computing admissible levels of pollution are based on an assessment of the technical characteristics of the firms and the danger and potential effects of different pollutants on the environment and human health. While this sounds reasonable, our empirical analysis suggests that in at least some cases this methodology does not work as well as it should. For example, in the case of water pollutants, the level of emissions charges above the fixed limits is basically the same as the level of charges for emissions within limits. Given the marginal tax rates for the two types of emissions, this means that Ukrainian firms on average pollute at a level that is at least 20 percent higher than the fixed standard. The policy implication is that there should be continuous feedback between actual compliance of firms and the standards they must meet. Such a feedback system would help to raise compliance rates because it would identify unrealistic standards, which are harder to enforce since they promote avoidance and lead to corruption. • Simplify pollution tax procedures: Although compliance has improved with the shift of responsibility for collecting pollution charges to the Tax Authority, the system can be further improved by simplifying the system, the number of pollutants taxed and the procedures for payment. This would also reduce the burden companies face in computing pollution charges and the opportunity for corruption by inspectors. xiv I. INTRODUCTION 1. This report analyses environmental financing in Ukraine. It focuses on expenditure, examining the extent to which the present system meets national environmental objectives, and identifies ways in which it can be improved and made more effective. Strengthening the system of public finances is itself a theme in the public sector reform program supported by the Bank’s 2002-2003 Programmatic Adjustment Loan. 2. The report also aims to engage the government of Ukraine in a constructive dialogue on integrating environmental economic instruments into development policies. The study is an important step in demonstrating to the government that having a strategy for environmental financing that builds on sound budgeting decisions and public expenditure management principles translates into sustainable development. This review also covers revenue issues because Ukraine’s environmental expenditure is closely tied to earmarking of funds and the regulatory role that charges and fines can play. 3. Public environment expenditure must be seen in the broader context of other measures to meet Ukraine’s environmental goals. Growing environmental deterioration over the last decade calls for radical policy and institutional reform to address the many environmental problems facing the country. At the same time, Ukraine’s highly constrained public finances makes it increasingly difficult to meet the cost of provision of environmental public goods without integrating financing for environmental protection into the public finance system. Thus, the development of more effective institutional arrangements for managing public environmental expenditures remains a challenge for central authorities. 4. The review provides guidance on policy options for better environmental management and preferred alternatives for strengthening the revenue base to allow budget planning to be linked to environmental performance results. It constitutes a first step in undertaking an environmental analysis of the government budget and suggesting improvements to the budget process through effective revenue-raising mechanisms and consensus building on priorities for environmental financing. The government also aims to use this analysis to determine alternative ways in which foreign financial assistance can be effectively channeled to environmental projects. While foreign assistance is critical to protecting national and global public goods, donors have had difficulties linking their assistance to the existing system of public support, as there are few mechanisms for providing complementary local public and private funds. 5. The scope of the analysis does not include expenditures relating to the Chernobyl nuclear accident as these expenditures are better categorized as social rather than environmental. In addition, most expenditures aimed at addressing the impacts of the Chernobyl accident on the environment have been limited to international sources of financing. 6. The study goes beyond central government environmental performance to look at sub-national expenditures for environmental protection through a case study of the Donetsk Oblast, where severe environmental problems jeopardize future development. The study illustrates the increasing devolution of environmental expenditure assignments to Oblast governments, and the need to improve the structure and management of sub-national environmental expenditures to provide quality public services and equitable distribution of environmental public benefits. Company-based case studies were also undertaken to draw out lessons on the effectiveness and efficiency of environmental expenditures in the industrial sector. 7. The study is primarily targeted at Ukrainian decision-makers at all government levels, including the Ministries of Finance, Economy, and Environment and Natural Resources. The objective is to facilitate informed decision-making. The government has recognized the need to change its current policies to ensure increased environmental compliance and to improve budgeting by better identifying issues and priorities and effective expenditure planning on activities that yield the highest environmental returns. 8. The study is also intended for Ukrainian civil society groups, who play an important role in vocalizing the public’s concerns about the economic and social consequences of deteriorating environmental conditions in 1 Ukraine and proposing actions to address those concerns. The study aims to transmit knowledge and analysis to experts and managers challenged to make institutional and expenditure management decisions in a macroeconomic context. Finally, it aims to increase public awareness of the mechanisms for allocating and spending public funds for environmental protection and stimulate public support for the initiation of long- awaited policy and regulatory reforms. 9. The preparation of this study involved several ministries, particularly the Ministry of Environment and Natural Resources (MENR), the Ministry of Finance (MOF), and the State Committee on Statistics. Our hope of presenting a comprehensive picture of environmental expenditure by government ministries and bodies other than MENR proved impossible, as information was scattered and missing. Most data used in the analysis were taken from bulletins of the State Committee on Statistics, which proved to be a comprehensive source of information on revenues obtained from pollution charges and current expenditures and investments by enterprises. 10. The report has six chapters and five annexes. Chapter 2 is central and provides an overview of the environmental expenditure in Ukraine. A summary of the anthropogenic pressures on the environment in Chapter 3 provides a context of the environmental problems in Ukraine. It identifies the main trends in environmental pollution, and sources of data, classifications and methods of assessment used in Ukraine. Chapter 4 examines the institutional framework for environmental protection in Ukraine, including mechanisms for financing environmental expenditure, and compares it with expenditure levels in selected OECD countries. Chapter 5 presents a thorough analysis of the revenue and the expenditure sides of environmental financing. Finally, Chapter 6 provides an overview of the sub-national institutional setup, including case studies of the Donetsk region and selected companies. 2 II. ENVIRONMENTAL EXPENDITURE IN UKRAINE: AN OVERVIEW 2.1 INTRODUCTION 11. This Chapter provides an overview of the environmental expenditure for the period 1996 –2000. It aims to describe public expenditure for pollution abatement and control in relation to budget revenue flows based on the OECD definitions of environmental expenditure. It looks into the sources of earmarked funding from the State budget, expenditure structure by spending units (public and private) and allocation. Further, the chapter provides an overview of environmental taxes: viewed from fiscal revenue perspective and from their effectiveness as an economic instrument to manage pollution and regulate use of natural resources. This is followed by a comparison of the levels of environmental expenditures in selected CEE and OECD countries from which interesting findings derive: • The degree of consistency of Ukrainian budget classification with international environmental expenditure definition is partial; some agencies do not follow international norms. • Ukraine’s level of environmental expenditure is comparable with that of CEE countries, and even higher than some OECD countries. What separates Ukraine from these countries is that investment expenditure, as a percentage of total, is significantly low and the share of expenditure by the state is also very low. • The share of total investments spent on environment made by the public sector in Ukraine is particularly low, which means that the "public good" type of investments, undertaken by the public sector, are particularly in short supply in Ukraine. The body of the chapter presents more data in support to these conclusions. Chapter 5 provides more details on expenditures and on the structure of finances. 2.2 DEFINITIONS AND DATA COLLECTED 12. The most important reference document for the purposes of this study is the OECD methodology for the calculation of Pollution Abatement and Control Expenditure (PAC expenditure). This provides an internationally acceptable procedure of estimating such expenditures. According to the OECD, pollution abatement and control (PAC) activities are defined as: “purposeful activities aimed directly at the prevention, reduction and elimination of pollution or nuisances arising as a residual of production processes or consumption of goods and services.” 13. This approach only includes those expenditures that are directly aimed at environmental protection and in practice, a strict interpretation of this definition is taken by most OECD countries. Nevertheless, there are definitional issues as to what part of an outlay constitutes an environmental expenditure and the extent to which an integrated process investment is motivated by environmental considerations. Through extensive application of the OECD methodology, certain ‘rules of thumb’ have evolved, which, while remaining somewhat arbitrary, at least ensure consistency nationally in the application of the methodology3. For example, in all countries, household expenditures are excluded. In spite of these efforts, however, the degree of consistency of definition internationally is still limited, making international comparisons difficult. 14. While the PAC is defined in terms of ‘elimination of pollution’, this is somewhat misleading as in practice it is now being interpreted to include, for example, spending on “collection and purification of 3 For example, the United States routinely attributes 70% of expenditure for collection of municipal waste to PAC, the rest being assumed not to be attributable to addressing an environmental problem in the sense defined above. 3 wastewater, combating of pollution in the marine environment, abatement of groundwater and soil pollution, combating of pollution of inland surface waters and expenditures related to the management of natural resources.” Thus the definition is wide enough to include most ‘green’ items (see Chapter 5 for details). 15. There are also two sub-categories under the PAC methodology: the ‘abater’ and ‘financing’ principle. Under the ‘abater’ principle, the expenditures are recorded at the point at which the expenditure is undertaken, while under the financing principle they are recorded at the point at which the funds are made available. Reconciling the two requires knowledge about subsidies, fees and charges. The main issue is to use a consistent principle across all agents so that there is no double counting. 16. In Ukraine, data from the Ministry of Environment are classified under the PAC methodology, using both the ‘abater’ and ‘financing’ principles. This Ministry is the most important administrative spending unit for environmental protection by the public sector at the national level and its main sources of finance, as explained in detail in the following sections, are the State budget and the National Environmental Protection Fund. Many other spending units4 were considered for the purpose of this analysis but data obtained from them was inconsistent and sparse. Consequently, the main sources of information for this analysis remain aggregated data from the Ministry of Finance (which provides a consolidation of expenditures by all Ministries) and the Ministry of Environment and Natural Resources. This is unfortunate as it excludes details of expenditures by municipality-operated facilities, water and wastewater treatment, solid waste landfills and district heating. Enterprises in these all fall under the jurisdiction of the Committee of Construction, Architecture and Housing Policy. 2.3 SOURCES OF FINANCING FOR ENVIRONMENTAL MEASURES 17. The law “On Environmental Protection” recognizes the following as major sources of financing of environmental activities: a. The State Budget of Ukraine, the Budget of the Autonomous Republic of the Crimea, local budgets; b. Funds of businesses, institutions and organizations; c. Environmental protections funds; and d. Voluntary contributions and other funds (ecological insurance funds, bank loans). Categories a) and c) constitute the principal sources of public environmental protection, whereas category b) pertains to the private environmental expenditure. Category d is not considered in this report as no voluntary contributions have been received from Ukraine to date. In the annex further details are provided on the first three categories. 18. The Law “On Environmental Protection” identifies budget funds and environmental funds (extra- budgetary funds) as two separate sources of financing for environmental programs and projects. Over the years this law has been amended. One of the modifications introduced by the Law “On Environmental Protection” of 5th March 1998 related to the consolidation of environmental protection funds into the budget. This measure was aimed at strengthening control over the use of environmental extra-budgetary funds, as it appeared that these earmarked funds had been misused or channeled to uses other than environmental protection. 19. Figure 2.1 shows the main sources of revenues for the public sector related to the environment and consequently how is environmental expenditure financed. This diagrammatic representation shows the sources 4 The following Ministries were contacted: Ministry of Finance, Ministry of Environment, Ministry of Economy, Ministry of Emergency situations and Chernobyl, Ministry of Industrial Policy, Ministry of Transport, Ministry of Education, Ministry of Energy, Ministry of Agriculture, Committee on Construction, Architecture and Housing Policy, State Committee on Water Management, State Committee on Forestry, State Committee on Land Resources, State Committee on Statistics. 4 of revenues of the State budget, including pollution charges that go to the State budget’s special earmarked fund and the taxes on the use of natural resources that, like other taxes, are channeled to the General State budget. Arrows indicating the flows of money represent the relative magnitudes of the actual flows. Thus one can see that taxes on natural resource use are much more important than those on emissions of pollutants (of air, water and waste). There is a legal basis for earmarking part of the taxes on natural resources for use by the environmental protection funds but this law has never been implemented, since these taxes are seen as an important source of revenue for the Ukrainian State Budget. An additional source of revenue is from fines applied in cases of infringement of environmental legislation. These money-flows are, on average, divided into general and special funds on a fifty-fifty basis. In principle, the law also envisages payment of compensation for damages to be equally divided between special and general fund. In practice, these cost are never computed. 20. Public environmental expenditure for programs at the national level is undertaken predominantly by the Ministry of Environment, other Ministries however undertake a small part. Local Departments of Environment have little independence and can only spend funds for environmental protection from local earmarked environmental funds. Environmental expenditure is only minimally financed by the State budget. According to official statistics, the share of current environmental expenditure paid by the business sector has significantly increased over time, passing from 61% in 1998 to 98% in 2000. Investments are scarce but also mainly undertaken by the business sector, much of which is, of course, still owned by the state receives considerable subsidies. All transfers to the state enterprises from the budget count, or course, as public expenditures and the same applies to environmental expenditures5. 2.4 ENVIRONMENTAL EXPENDITURE DATA: 1996 - 2000 21. Table 2.1a, reports expenditures on the environment in Ukraine. Figures are given in local currency in constant prices and, for ease of comparison converted in constant US dollars in Table 2.1b. The main points to note from the table are: • In aggregate terms environmental expenditures have fallen, from around a billion dollars in 1996 to $600 million in 2000. • Most of the environmental expenditure is from non-budgetary sources, principally enterprises’ funds, i.e. the private sector. This financing fell the most in the period 1996-2000. By contrast budgetary sources, which amounted to $35 million in 2000, have actually increased slightly over the period. In 2000 non-budgetary expenditure accounted for 94% of all expenditure. • The greatest share of total expenditure is non-budgetary private current expenditure, which accounted for 77% of the total in 2000. Total expenditure as a share of GDP is about 2%, which is broadly in line with that in other countries although it has fallen substantially since 1996. 22. The data have some important gaps. First, not all public expenditure is included, because some Ministries do not record the data in a way that allows it to be included in the PAC measure. It is unlikely, however, that major investments for environmental protection have been left out for this reason. Second, not all relevant enterprise expenditure has been recorded, and the PAC method has not been used in all cases. These aspects make a comparative analysis of the data difficult, but important information can nevertheless be obtained. 23. Table 2.1a and b do not show what the funds have been spent on. Detailed information for the State Budget and the National Environment Fund is provided further in this chapter. The biggest item is ‘water resources protection’ which includes repair and rehabilitation of water supply and wastewater systems. This 5 Transfers for current environmental expenditures by enterprises are relatively small (1.3 –2.4% of all spending). For enterprise investment it is even smaller (less than 1%). 5 accounts for about 43% of the total. The extent of the environmental problems in the water sector justifies such large allocations of expenditure, but not necessarily from the public sector. Other large amounts go to afforestation and forest protection, nature reserves and mineral resource protection. The allocation to air protection and waste management are relatively small (about 1% of the total). 2.5 INTERNATIONAL COMPARISON OF ENVIRONMENTAL EXPENDITURE 24. Interesting information could be obtained by comparing Ukraine’s environmental spending with two of its neighbours -- Belarus and Poland. Table 2.2 reports the investment component of environmental expenditures in 1999 for all three countries. A comparison of all environmental expenditures is not possible, as Poland does not report current environmental expenditures. Total PAC environmental investment in Poland in 1999 was around 2.2 billion, compared with $124 million in Ukraine and $53 million in Belarus. This is much more striking a difference than would appear if one looked at total environmental expenditures in Ukraine, which are closer to the $600 million. The other notable difference is that in both Belarus* and Poland a much greater share comes from the budget – about half as opposed to one-fifth in Ukraine. 25. Comparison of environmental expenditure levels in Ukraine with those in other countries may allow further insight into the effective use of such funds. The OECD has compiled some recent data on environmental expenditures as part of their country Environmental Performance Reviews (EPRs). The EPRs present PAC expenditures as a percentage of GDP. Estimates for OECD countries for 2000-2001 are shown in Table 4.3. According to the same source, the equivalent value for environmental expenditure in the Ukraine for the year, 2000, was 1,95%, whilst for Russia in 1999 it was 1.9%. 26. Table 2.3 shows that as a percentage of GDP environmental expenditures in Ukraine are in fact higher than for any of the selected OECD countries6. There are however, problems in interpreting this data, as reporting is incomplete and the issue of how much integrated process investment to include has not been fully resolved. Nevertheless one should note that a considerable level of effort has been made to ensure that data is combined as consistently as possible and that the numbers are useful as guides of relative performance. 27. More detailed look at international data is given in Table 2.4. The table provides information for selected countries from the latest year available (1998). It was made available by the OECD environment directorate and is not at present published. The data looks at environmental expenditure in the public and business sectors and by current and capital expenditure. It reveals some interesting findings: (a) Total expenditure on the environment as a percentage of GDP is on average higher in the CEE countries than in OECD countries. Ukraine data for 2000 are of a similar value to the CEE countries. (b) Where Ukraine differs from countries in this group is with respect to investment expenditure as a percentage of the total. In the OECD group this averages about 27 but in fact most countries are well above that and the ‘Cohesion Group’ countries, Ireland and Portugal, which are still undertaking programs to catch up with the EC acquis, have investment shares of 43 and 47% respectively. In Ukraine this percentage is around 22%. (c) The other notable difference is the share of total investment on the environment made by the private sector. In the OECD group this averages 43%, ranging from 27% (Austria) to 54% (Portugal). In Poland it is as high as 67% and in Ukraine it is even higher, at 82%. This means that the ‘public good’ type on investments, undertaken by the public sector, are particularly in short supply in Ukraine. (d) In terms of total expenditure (capital and current) the role of the public sector is even smaller. Of the total, only 6% is public. In the OECD group the average is 55% and in Poland it is as high as 32%. * One reason might be the lower share of private sector in Belarus , and the operation of two environmental funds until recently in Poland. 6 This assumes that the environmental expenditures identified for the Ukraine are equivalent to the OECD PAC categorisation. 6 Figure 2.1: Flow Diagram of Environmental Expenditure Financing INDUSTRY HOUSEHOLDS (Private & State-owned) “PRIVATE” ENVIRONMENTAL EXPENDITURE Taxes Pollution on Nat. Share of Res. Taxes Nat. Charges Res. Use fines (& Use compens. Other taxes damages) Special (earmarked) funds of the General Budget Funds budget (Env. Prot. Funds) OBLASTS’ & LOCAL DEPART. OF MINISTRY OF ENVIRONMENT ENVIRONMENT OTHER MINISTRIES, OBLASTS’ & LOCAL DEPART. PUBLIC ENVIRONMENTAL EXPENDITURE INTERNATIONAL COOPERATION 7 Table 2.1a: Actual Environmental Expenditure in Real Terms – 2000 (“000 UAH) Public Environmental Non-budgetary Private Total Public Total Expenditure Environmental Expenditure Environmental Env. Env Exp Estimated Expend Total Current Capital Total Expenditure Exp. as as % of Expend all general Expend Invest- % of GDP funds budget ments GDP 1996 53,300 52,809 106,109 4,258,294 1,025,969 5,284,262 5,390,371 0.07% 3.34% 1997 97,500 71,504 169,004 2,860,838 690,992 3,551,831 3,720,835 0.10% 2.21% 1998 42,000 55,537 97,537 2,606,722 572,722 3,179,444 3,276,981 0.06% 2.13% 1999 68,200 67,987 136,187 2,778,142 536,309 3,314,451 3,450,638 0.08% 2.10% 2000 96,200 95,347 191,547 2,583,414 600,657 3,184,071 3,375,618 0.11% 1.95% Source: Elaboration of State Budget, Ministry of Environment and Bulletin of Statistics Table 2.1b: Public and Private Environmental Expenditures in Constant Dollars Year ‘000 UAH in 2000 Prices Converted to Million US$ at 2000 Exchange Rate PERCENTAGES Private Environmental Public Environmental Expenditure Expenditure Total Public as Total as % of Env. Funds Budget Total Current Capital Total Expenditure % of GDP GDP 1996 9.8 9.7 19.5 782.8 188.6 971.4 990.9 0.07% 3.34% 1997 17.9 13.1 31.1 525.9 127.0 652.9 684.0 0.10% 2.21% 1998 7.7 10.2 17.9 479.2 105.3 584.5 602.4 0.06% 2.13% 1999 12.5 12.5 25.0 510.7 98.6 609.3 634.3 0.08% 2.10% 2000 17.7 17.5 35.2 474.9 110.4 585.3 620.5 0.11% 1.95% 8 Table 2.2: Investment Expenditure on Environment in 1999 Some Country Comparisons (US$Million) Total as Budget of which Non-budget Total % of Env. Funds GDP BELARUS 24.8 16.6 28.1 52.9 0.4% POLAND 1163.4 532.0 999.0 2162.4 1.4% UKRAINE 25.0 12.5 98.6 123.6 0.4% Source: World Bank: Various Studies Table 2.3: PAC Expenditure as Percentage of GDP in OECD Countries Country % of GDP Country % of GDP Country % of GDP Canada 1.1 Denmark 0.9 Norway 1.2 Mexico 0.8 Finland 1.1 Portugal 0.9 USA 1.6 France 1.4 Spain 0.8 Japan 1.6 Germany 1.5 Sweden 1.2 Korea 1.7 Greece 0.8 UK 1.0 Australia 0.8 Hungary 0.7 Netherlands 1.8 Austria 1.7 Ireland 0.6 Czech Rep 2.0 Belgium 0.9 Italy 0.9 Data on Poland has been excluded, as it did not include current expenditures. Source:http://www.oecd.org/oecd/pages/home/displaygeneral/0,3380,EN-documents-476-14-no-1-no-476,00.html 28. Effectiveness of Expenditure – Process of Prioritization. The analysis above, whilst useful in identifying possible features of the size and type of environmental expenditure, does not indicate how effective the expenditure actually are or shed any light on what the optimal levels of expenditure should be. Thus, whilst the comparisons may be broadly indicative of allocative expenditure changes that should be made, the actual levels of expenditure need to be determined through a politically transparent domestic assessment based on the actual need to address specific environmental problems and on cost efficiency criteria. 29. The Ministry of Environment establishes priorities for the allocation of money in consultation with the Oblast Environmental Departments of Ministry of Environment at the local level. The Cabinet of Ministers then approves these priorities. However, the process of allocating money does not correspond in practice to priorities and needs. Rather, the tendency is to approve a large number of projects and programs irrespective of whether money is available. This poses a problem in terms of the effectiveness of environmental programs, as they are therefore usually under-funded and, therefore, seldom completed. The new budgeting system – now in force - and explained in Annex II is likely to help public bodies better manage and increase control over their financial resources. 30. A gap still remains however, in the appraisal of proposed projects. To date, modern methods of appraisal, using cost effectiveness and cost benefit analysis are rarely applied. This is discussed further in Chapter 6 where an in-depth study of the Donetsk Region is undertaken. 9 Table 2.4: Breakdown of Environmental Expenditures in Selected Countries MILLION DOLLARS, 1998 Capital Total Private Total expenditure Current expenditure Total Total as invest/ invest/ public/ Total Total COUNTRY Business Public Business Public % of GDP expend. Total invest. expend. OECD AUSTRIA 361 998 873 2,282 4,514 2.14% 30.1% 26.6% 72.7% FINLAND 217 218 390 507 1,332 1.03% 32.7% 49.9% 54.4% FRANCE 2,655 3,114 8,487 8,547 22,803 1.57% 25.3% 46.0% 51.1% IRELAND 121 163 72 306 663 1.56% 42.9% 42.5% 70.8% PORTUGAL 194 163 106 306 770 0.72% 46.5% 54.3% 61.0% ALL ABOVE 3,549 4,657 9,928 11,948 30,082 1.55% 27.3% 43.2% 55.2% CEE CZECH R. 755 337 N.A N.A 1,092 1.92% N.A 69.1% N.A HUNGARY 149 253 N.A N.A 402 0.85% N.A 37.0% N.A POLAND 1,799 883 1,322 574 4,579 2.87% 58.6% 67.1% 31.8% UKRAINE 110.4 25 474.9 10.2 621 1.95% 21.8% 81.5% 5.7% Note: Data are for 1998 except for Ukraine, which is for 2000. Sources: OECD and Ukraine Government 2.6 ENVIRONMENTAL TAXATION: TAXES ON USE OF NATURAL RESOURCES AND POLLUTION CHARGES 31. As mentioned above, existing revenue generating fiscal instruments related to the environment are divided into two main categories: taxes for the special use of natural resources7 and charges on pollution. Figure 2.2 illustrates the level of tax revenues from these sources that are channelled to the general or to special (earmarked) funds of the State Budget. Earmarked funds used to be extra-budgetary, but since 2000 have been consolidated into the budget8. As a general rule, taxes on the use of natural resources are channelled to general funds, although in theory the law foresees the possibility of channelling them to the special Fund for Environmental Protection. Pollution charges are the main source of revenues for the environmental funds. Allocation of these funds to the different level of the administration is explained in the following paragraphs. Tax rates are discussed in detail in Annex II. This overview of rates highlights that these taxes are too low and unlikely to provide an incentive to enterprises to invest in environmentally friendly innovation rather then have to pay taxes. In addition, the amount of pollution taxes collected is in practice even lower than it should be since many companies cannot afford to pay taxes and receive exemptions (see Annex II). This is particularly the case if the companies are well connected in the political system and lobby for tax exemptions. However, enforcement in tax payment has improved after a reform was introduced in 1999 that transferred the duty of collecting taxes from Oblast Department of the Ministry of Environment to the Tax Authority. Table 2.5 provides an estimate of 7 Special use of natural resources – fee-based placing natural resources at the disposal, possession, use or leasing of citizens, enterprises, institutions and organizations on the grounds of special environmental permit for realization of production activity or other activities. 8 As mentioned by the recent PEIR (paragraph 1.11), all the extra budgetary funds at the central level have either been incorporated into the budget or been completely eliminated except for the social insurance funds in 2000. There are, however, some earmarked expenditure items in the budget that are outside the MOF control. These are mainly Chernobyl-related expenditures that include various environmental, social, health programs. Other programs are run by the Ministry of Emergencies and Consequences of Chernobyl. The MOF has no authority to make any adjustments to these expenditure items even if the government falls short of revenues. There is little information about how these funds are spent. The effectiveness of these programs remains to be assessed 10 planned revenues from the use of natural resources in real terms that are channelled to the State budget. For the years 1998-2000 the different ratios of actual versus planned expenditure are also reported and show a great variability of ratios across years. The most important source of revenues comes from land tax, which, at the same time, is also heavily exempted. Moreover, it is worth noting that in the late 1990’s this type of revenue has increased significantly. 32. The system of taxation for both natural resource use and emissions appears very burdensome for companies exceeding their emission permit limits, essentially for two reasons: a) Taxes on emissions above the limits are charged at 5 times the rates of emissions within the limits; b) Taxes within the established limits are considered as production costs in the accounting system, while tax payments for exceeding the established limit are paid for from the enterprise profit. Limits for natural resource use are established in an order defined by the Supreme Council of the Autonomous Republic of the Crimea, by regions, and by City Radas of Kyiv and Sevastopol with the exception of cases where natural resources are deemed to be of national importance (the list of such resources appears there in Article 39 of the Law on Environmental Protection). Limits for natural resource use of national importance are established in the order defined by the Cabinet of Ministers of Ukraine. 33. Environment Fund System. The Environmental Fund System is composed of more than 1600 funds at different levels of the government, as illustrated in Table 2.6. The Ministry of Environment is the manager of these funds. Supervision of the Fund programs is carried out by the Economic Department of the Ministry, which is also in charge of controlling the Fund expenditure. 34. Table 2.7 illustrates the allocation of revenues to the different environmental funds at different levels of government. Funds collected as environment pollution fee are distributed among local (rural, village, municipal), regional (Oblast), the Autonomous Republic of the Crimea and the National Environmental Protection funds. The general rule establishes that 30% of the revenues should be distributed at the national level, 20% to the regional and, finally, 50% at the local level. Special rules apply for the charges paid in the cities of Kyiv and Sevastopol and by enterprises of the mining & metallurgic sector participating in the environment- economic experiment (July1999–December 2001). These enterprises are exempted from paying 70% of charges provided this money is instead used to finance environmental protection activities by the firm. 35. This partition of funds allows most local communities to have their own environmental funds. However, this allocation does not seem to be very effective, as local administrations do not generally have sufficient resources to undertake any significant environmental measures. In addition, it is common that local funds for the environment are often used as a substitute for local budget gaps. 36. Figure 2.3 illustrates total revenues for the system of Environmental Funds, both in nominal and real terms (2000 UAH). Table 2.8 shows the average ratio between estimated expenditures and revenues of all funds that in principle should be equal to 1 at least as an average over the years. In practice this is not the case, although, apart from 1998, it is not far from an average ratio that corresponds to 0.86. Enforcement has improved in recent years, but the number of exemptions has also increased in parallel. Fines due have decreased significantly, though it is questionable as to whether this is the result of a better compliance with environmental legislation. 11 Figure 2.2: Revenues of Consolidated Budget Allocated to General and Special Funds GENERAL FUNDS State budget STATE BUDGET Taxes on the (special) use of water, land, mineral resources, forests and fauna. Budget of the LOCAL BUDGETS ARC*, Cities Part (usually 50%) of of Kiev and fines and sanctions for Sevastopol breaching environmental law Budget of villages, Part (usually 50%) of settlements damage compensation and cities as a consequence of SPECIAL FUNDS (earmarked) law infringement State budget STATE ENVRONMENTAL Charges on air PROTECTION FUND emissions (stationary & mobile), waste and Budget of the LOCAL water discharges. ARC*, Cities ENVIRONMENTAL of Kiev and PROTECTION FUNDS Part (usually 50%) of Sevastopol fines and sanctions for breaching Budget of environmental law villages, Part (usually 50%) of settlements damage compensation and cities as a consequence of law infringement ARC = Autonomous Republic of Crimea Table 2.5: Planned Revenues of State Budget from Use of Natural Resources in Real Terms Real/ Planned Revenues 1996 1997 1998 1999 2000 (2000 UAH) (‘000) (‘000) (‘000) Actual/ (‘000) Actual/ (‘000) Actual/ UAH UAH UAH Plan. UAH Plan. UAH Plan. Total taxes for use of 153,600 1,227,300 2,527,800 0.88 2,304,400 2.01 1,665,900 2.74 natural resources Forest resources 3,400 56,700 57,800 1.15 84,700 3.81 47,200 8.57 Water resources 14,200 517,400 314,900 0.65 300,500 0.00 170,000 0.00 Mineral resources 6,900 46,800 97,800 0.59 55,000 5.86 38,700 10.44 Geological prospecting 71,100 606,400 535,300 0.43 480,400 2.26 200,000 5.88 Land 58,000 no data 1,522,000 1.10 1,383,800 0.02 1,210,000 0.02 Source: Elaboration of data of the Ministry of Finance 12 Table 2.6: Number of Environmental Protection Funds in 2000 Total State Autonomous Regional Local City, Republic funds, Kyiv & community Crimea Sevastopol and village 1623 1 1 26 346 1249 Source: Ministry of Environment and Natural Resources, informal meetings Table 2.7: Distribution of Pollution Charges Among National, Regional and Local Environmental Funds Charges paid Share of charges distributed to: In Ukraine (except In the cities of By enterprises of mining the following Kyiv and & metallurgic sector cases) Sevastopol participating in the “economic” experiment National Environmental Fund 30% 30% 10% Local Environmental funds 20% / 10% Regional Environmental Funds* 50% / 10% Kyiv & Sevastopol Env. Funds / 70% / Enterprises Environmental Funds / / 70% * Regional Environmental Funds are funds allotted to the budget of Oblasts and the Autonomous Republic of Crimea9 Figure 2.3: Revenue of the Environmental Fund System Table 2.8: Average Ratio of Expenditure and Revenue of the Environmental Fund System Year Expenditure/Revenue 140000 Ratio. 120000 1996 1.02 Thousand UAH 100000 Rev. all 1997 0.98 80000 funds (nominal) 1998 0.57 60000 Rev. all 1999 0.95 40000 funds (real - 2000 UAH) 2000 0.77 20000 0 1996 1997 1998 1999 2000 year Source: Ministry of Environment 9 The Law “On Amendment of the Law of Ukraine “On Environmental Protection”, ratified March 5, 1998, establishes this scheme of allocation funds of charges. Before its entry into force the ratio was 70%, 20%, 10% respectively. The reason for its adjustment is the fact that pollution sources mainly affect the state of the environment of neighboring areas. 13 III. ENVIRONMENT AND NATURAL RESOURCES IN UKRAINE 37. Chapter 3 provides an overview of the status of environment in Ukraine. It outlines major environmental pollution and natural resource problems and recent trends, as a basis for the analysis of environmental expenditures presented in Chapters 5. The main conclusions which set the stage for the analysis of the effectiveness of current policies and regulations, and related financial means to address the most pressing environmental issues, are as follows: • Economic decline led to reduction of atmospheric emissions by 7%, effluent discharges by 36%, and toxic waste generation by 16%. • The intensity of air emissions (tones/1000 dollars of GDP) is below the average of OECD countries and below some transition countries. • Ambient air quality does not meet national air quality standards in most populated and industrialized cities although national standards are stricter than those of WHO. • Water pollution is one of the most serious problems in Ukraine with 24 % of discharged water insufficiently treated and about 12% of water bodies failing to meet sanitary conditions. • Industrial waste generation per comparable production unit (kg/$1000 GDP) is higher than most OECD countries • Land contamination is a serious problem with 20% of the land contaminated from pesticides, heavy metals and radionuclides. 3.1 INTRODUCTION 38. Ukraine measures 603,700 km2, and is divided into 24 oblasts (provinces) and the Autonomous Republic of Crimea. About 65% of its population of 50 million people lives in urban areas; its population has been falling 0.8% a year since 1994. Ukraine has five cities with populations over one million, led by Kyiv with a population density of 3286,5 people/km2, and Sevastopol 434 p/km2. Population density averages 82 people/km2 and varies considerably across the country. The most populated regions are the heavily industrialized zones of Donetsk (186 persons/km2), Dnipropetrivsk (116 p/km2), Chernivtsy (115 p/km2), Ivano-Frankivsk (105 p/km2), Luhansk (98 p/km2) and Lviv (125 p/km2). All these regions are critical areas with respect to industrial pollution. A case study on the Donetsk region is presented in Chapter 6. 39. Ukraine has established objectives for reducing environmental pollution in the atmosphere, water bodies and from waste disposal. Since 1996 atmospheric emissions have been reduced by 7%, contaminated water discharges by 36% and toxic waste production by 16%. This progress, however, is more related to economic decline than improved environmental management or to introduction of clean environmental technologies, goods, and services. 3.2 AIR 40. Since 1996 Ukraine has reduced emissions of a number of air pollutants: SOx emissions have dropped 24%, NOx, emissions 6%, and non methane VOCs 1%. However, emissions of CO have risen almost 10% after dropping three times since 1991, but still below 1991 level. While industrial emissions of all these pollutants declined significantly, mainly as a consequence of the fall in economic output, emissions from road transport recorded a rapid increase of 23% over 1996-2000. 41. The intensity of SOx, NOx, and CO2 emissions (emissions/ GDP) in Ukraine is below average levels for OECD countries and some countries in transition, such as Hungary and Poland. Ukraine’s emission intensity is one fourth for SOx and CO2 and a half of corresponding Polish indicators (Figure 2.1). Air pollutant emissions 14 are equally low: In 1998 Ukraine emitted 20 kg of SOx per capita, 9 kg of NOx, and 7 tons of CO2; the OECD average was 40 kg of SOx per capita, 41 kg of NOx, and 11 tons of CO2. Figure 3.1 Intensity of Air Pollutant Emissions, SOx and NOx (kg/$1,000 GDP), and CO2 (tonnes/$1,000) 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Ukraine Canada Poland Hungary Germany OECD SOx NOx CO2 Source: Ministry of Environment, Ukraine; OECD Environmental Data 42. The stationary sources that contribute most to air pollution are manufacturing, energy and heat generation, and extractive industry and are concentrated in the most heavily industrialized regions, Donetsk and Dnipropetrivsk—which together account for about 60% of emissions from stationary sources—Luhansk, and Zaporizhya. 43. In 2000 the transport sector generated 27% of NOx emissions, 56% of COx emissions and 37% of non- methane VOCs of anthropogenic origin. Motor vehicles represent 33% of total pollution emission in Ukraine and are a significant cause of poor urban air quality. The sector has a strong increasing growth trend, while further endangers future air quality. On the other hand engine quality and fuel efficiency is improving with a gradual replacement of old Soviet built vehicle with EU standards 44. Ambient air pollution exceeds national air quality standards in the most populated and industrialized Ukrainian cities. Even though Ukraine’s ambient air quality standards are even stricter than the standards recommended by the WHO Air Quality Guidelines for Europe, the WHO standards for specific pollutants are exceeded in almost all big Ukrainian cities. Annex I provides data on atmospheric concentrations of PM, NOx, CO and SO2.. 3.3 WATER RESOURCES 45. Discharges of effluent water decreased sharply over 1997-99, then turned upward in 2000. In 2000 water discharges of 10,517 million m3 were almost the same as in 1998. Moreover, Ukrainian water resources are continually polluted by discharges of contaminated water that is insufficiently—or not at all—treated. Although the treatment process seems to have improved during the last three years, as the volume of insufficiently treated polluted water has decreased by 26% and the volume of polluted and untreated water by 7%. Nevertheless, the level of treatment of water discharge remains low, with 24% of discharged water insufficiently treated, and 7% untreated. The industrial sector discharges the largest volume of wastewater (37%), including a considerable part of contaminated water. Residences are the second largest contributor to water pollution with 45% of total water discharges. 15 46. The greatest volume of contaminated water was discharged in the Donetsk-Prydniprovya region: Donetsk (25% of total contaminated water discharge) Dnipropetrivsk (18%), Luhansk (10%) and Zaporizhya (8%). Kyiv and Odesa discharge respectively 13% and 8% of Ukraine’s contaminated water (Figure 2.2). The greatest amount of pollutants was discharged into rivers Dnipro (26% of total discharge), Siversky Donets (16%) and Azov Sea (4%). Figure 3.2 Contaminated Wastewater Discharges in Selected Cities, 1999, (million m3) 1800 1500 1200 900 600 300 0 Dnipropetrovsk Donetsk Zaporizhya Kyiv Luhansk Odesa clean w ater insuff.treated non treated Source: Bulletin on Statistics, Committee of Statistics 47. A number of cities impose water supply restrictions during certain periods of the day. Those restrictions, and periodic shutdowns have contributed greatly to the bacteriological pollution of drinking water. Drinking water increasingly fails to meet state standards for cleanliness, breaching chemical, bacteriological, and sanitary standards. A 2000 water survey found that 11.9% of water bodies do not meet sanitary- hygienic standards or microbiological standards, and others contain pathogenic organisms and virus hepatitis. Hygiene standards were not met in 6% of district, 10% of communal and 5% of municipal water supply pipelines because of the poor quality of water supply sources, the poor condition of the sewage systems, frequent accidents, malfunctioning treatment installations, and lack of disinfect ion. The water supply network—built during the 1960-70s using inadequate supply standards—also has insufficient capacity to meet current demand. 3.4 SOLID WASTE 48. Solid waste accumulated in upper landfills totals more than 25 billion tons, or 40,000 tons per km.2 This is about 400 tons of waste per capita. There is about 4.5 billion tons of toxic waste on Ukraine’s territory— about 87 tons per capita. Toxic waste is increasing at 8 to 10 million tons per year. Since the beginning of the 1990s, industrial toxic waste generation has slackened, with an average annual reduction of 7% over the last three years. This fall is modest and not proportional to the drop in industrial production. This can be explained mainly by inadequate infrastructures and increasing reliance on low-grade industrial raw material. 49. Ukraine recognizes four classes of industrial waste, grouped according to hazardous properties and physical, chemical, and biological characteristics. The first, second, and third classes—considered most harmful—represent 3% of annual generation of waste, or 1% of waste accumulation. The fourth class is considered less harmful and, in practice, represents total accumulation of toxic waste in Ukraine. Table 2.1 shows accumulated toxic wastes at “organized” (i.e., set up according to legal requirements) storage sites in Ukraine over 1996-2000. 16 Table 3.1: Toxic Waste Produced and Accumulated at Enterprises During 1996-2000, and Expenditures for Disposal of Waste in Organized Landfills in 2000 (thousand tons) Expenditures Expenditure /Accumulated UAH (‘000) UAH/1000 tons TONS (‘000) 1996 1997 1998 1999 2000 Hazard Class I 30 29 19 20 14 6,670 44,732 Hazard Class II 606 924 183 184 176 4,194 2,489 Hazard Class III 2,516 2,209 2,252 2,616 2,424 17,6662 7,237 Hazard Class IV 132,008 99,814 81,579 85,655 78,762 6,0975 21 Total production 135,159 102,975 84,033 88,476 81,375 24,85045 Total accumulated 4,063,971 4,158,637 4,312,288 4,366,206 4,447,581 Source: Ministry of Environment, 1998- 2000 report, official documents 50. The major sources of waste generation in Ukraine are the mining, chemical and metallurgical, machine building, energy, wood pulp and paper, and agriculture sectors. Large accumulations of toxic wastes increase the risks of ecological accidents from disposed heavy metals, oil products, pesticides, and other materials.10 In 2000 about 81,000 thousand tons of hazardous waste was generated, of which 33% was recycled, 2% was treated and 61% was disposed to organized landfills. Waste treatment is still rare and in 2000 covered 73% of 1st class toxic waste generated, 11.9% of 2nd class, 2.6% of 3rd class and only 2.4% of 4th class—98% of toxic waste. It is also not clear that enterprises always classify waste correctly. 10 In 1999 20,397,6 tons of 1st class industrial toxic waste were produced, including 4,568,3 tons of benzo(a)piren, 2,700,6 tons of lead, 145.8 tons of nickel (mainly from coal mining sector), 122.8 tons of galvanic waste, 96.9 tons of pesticides (mainly from agriculture), and others. Obsolete pesticides and other toxic agricultural chemicals are a special category of highly toxic waste of 1st class. Although special landfills had not been built in advance, pesticide were disposed of on inadequate opened disposal lots, without treatment. 17 Figure 3.3 Industrial Waste Generation, kg/$1,000 GDP11 Hungary Poland France Austria Czech Rep. Ukraine 0 50 100 150 200 250 300 Source: Ministry of Environment, Ukraine and OECD Environmental Data 51. While industrial waste generation is difficult to compare with that of OECD countries because of a lack of clear definitions and homogeneous reporting requirements, a rough comparison on a GDP basis shows that Ukrainian industrial waste generation per comparable production unit (GDP unit at PPP) is much higher than most OECD countries except that of Czech Republic (see Fig. 3.3). 3.5 PRESSURES ON NATURAL RESOURCES AND BIODIVERSITY 52. The state owns 50% of Ukraine’s land area of 603,700 km2, of which 71.3% is agricultural, and 17% forests and other forested area. Biodiversity. Ukraine has diverse biodiversity. The distribution of vegetation is irregular, with the greatest variety in the Carpathian and Crimean mountains. About 179 million km2 (about 30%) of natural vegetation has been affected by human activity. Forest. Ukraine’s timber stock is estimated at 1,736 million m.3 Because of the reduction in industrial production and construction, forest use is decreasing. However, this annual forest cut is not enough to meet domestic demand and a large quantity of wood is imported from Belarus and Russia. Reforestation in Ukraine is very poor and it is principally determined by estimated wood cut area. Intensification of forestation is generally not possible due to lack of funds. Almost the entire forest stock is located within zones where industrial air emissions exert a severe impact that diminishes the forest’s natural resistance and self-regulation abilities. Moderate and heavy defoliation show that forest contamination is increasing rapidly indicated, and protection from pests and tree diseases that represent a critical problem to forest areas is minimal. The forest sector in Ukraine is basically “unreformed” which affects the forest resource base. Mineral Resources. Ukraine is one of the largest producers of iron, manganese, coal, titanium, graphite and kaolin. The regions with the most large-scale development of mining works are Donbas, Kryvbas, Peredkarpattya, and Naddnipryanshchyna. Large mines exploiting Ukraine’s significant reserves of mineral resources pose a variety of environmental problems. Long-term exploitation of coal has led to subsidence problems. Vast areas of fertile land are covered with waste rock and tailings dumps. Mine waters contaminate surface and ground waters while dust, refuse dump combustion products, methane, 11 Industrial waste production per comparable production unit ( 2000 GDP unit at purchasing power parity) measured in kg/ thousand dollars. Ukraine waste generation is ~ 160 kg per thousand dollars which is more than three times what EU members states ( 46 kg per thousand dollars) produce. 18 and other substances cause heavy air pollution. Serious environmental problems occur with mine closures because of flooding. A 1999 study12 on the environment and people’s health by the mining sector shows that in many mining regions people’s “integral health” is “catastrophic” or “critical” and the environmental situation was classified as “unsatisfactory” and “catastrophic.” Land Resources. About 20% of Ukraine’s land is highly fertile and contains extraordinarily rich black soils (chernozems) that represent some of the best arable land in Europe. However, pollution from agriculture, industry, and the Chernobyl nuclear catastrophe has affected a large part of the country's land resources. About 20% of Ukrainian land is polluted, with the most dangerous soil pollutants being radionuclides, metals, and pesticides. The Chernobyl nuclear accident had a large effect on land resources. The total area of agricultural lands contaminated with radionuclides is 6.7 million ha; of them 5.6 million ha are contaminated to a level of 1 Ci/km2, 1 million ha to 1-5 Ci/km2, 100 thousand ha to 5- 15 Ci/km2, 27 thousand ha to over 15 Ci/km2. The exclusion zone occupies, in aggregate, 58,000 ha. The most contaminated zone is Polissya. However, radiological monitoring data show a recent stabilization and reduction in levels of radiation contamination of soils. Chernobyl’s long-term impact on soil has not been fully studied and may justify a separate effort to bring deeper understanding on pollution mitigation and containment costs. “Hot spots.” Industrial plants have created heavily polluted "hot spots." The concentration of metals (copper, cobalt and iron) in soils near cities, roads and industrial zones is very high. Environmental problems caused by agricultural erosion and water runoff that contributes silt and plant nutrients to water bodies—although falling mineral fertilizer and pesticide application in recent years has reduced the toxic impact on the soil in recent years. However, serious safety problems may also arise from storage and inadequate disposal of pesticides. 12 The study was conducted by the Institute of Natural Resources and Environment of Ukraine’s National Academy of Science, in with the National Mining Academy of Ukraine in a number of mining areas in the Dniepropetrovsk, Donetsk, and Lvov regions. 19 IV. POLICY, LEGAL AND INSTITUTIONAL FRAMEWORK FOR ENVIRONMENTAL PROTECTION 4.1 INTRODUCTION 53. This chapter provides an overview of the policies and environmental legislation, and their implementation and enforcement in Ukraine, and sets the scene for the empirical analysis undertaken in the subsequent chapters. Section 4.2 introduces the legislative framework for the environment and discusses enforcement of regulation. Section 4.3 highlights the institutional framework of environmental regulation and introduces the system for financing environmental protection. The main conclusions emerging from this chapter are as follows: • The movement to a market economy calls for changing the role of Government to one of regulator and protector of the environment, removing subsidies and distortions that actually hurt the environment in the past and introducing market-based incentives to promote environmental protection. • A significant effort is required to apply the polluter pays principle (PPP) consistently and effectively. • Ukraine lacks a realistic and long-term strategy defining national environmental priorities and linking them to financial planning. 4.2 INTRODUCING NEW ENVIRONMENTAL POLICIES AND LAW ENFORCEMENT IN UKRAINE 54. Ukraine’s transition to a market economy led to a rethinking of the government’s role in setting and enforcing national environmental objectives. It attempted to reduce interventions that distort the economy and subsidize environmental degradation by recasting itself as a regulator and developing policies to finance sustainable development while paying significant attention to budget distortions and constrained public resources. Environmental Legacies from the Soviet Era 55. Ukraine’s large industrial and energy base, long sheltered from competitive pressures and price incentives and often starved of the capital necessary to modernize, is the source of many serious environmental problems. These were exacerbated during the Soviet era by ineffective environmental laws. 56. Even before independence in 1990, the Ukrainian SSR was a party to 18 multilateral environmental agreements, in addition to the international commitments and multilateral agreements undertaken by the Soviet Union. Since then it has signed some 20 multilateral environmental conventions, making it party to more than 40 multilateral legal acts on issues of environmental protection. It has also adopted a significant number of bilateral and regional environmental agreements in the last decade, including pacts on the Carpathian region, the Black Sea, and the Danube Basin. However, almost none of these are fully implemented. Legal Framework 57. Building the legal basis for the implementation of market-oriented policies started with the Supreme Rada of Ukraine’s passage of the Law «On Succession of Ukraine» when Ukraine gained independence. This Law stated that the new nation was the legal successor to those rights and obligations with respect to the international treaties of the USSR that were not contradictory to Ukraine’s Constitution or its national interests. 20 58. Ukraine largely adopted the philosophy of the Polluter Pays Principle (PPP), which imposes charges on polluters based on the level of pollutants they generate and eliminates subsidies. The basic principles of the PPP are enshrined in Ukraine’s environmental laws and follow the principles of environmental protection and regulation of enterprises in a manner similar to OECD countries. Their scope however, is too broad and ill defined to be enforced in practice. Enforcement has been uneven and significant effort is still required to establish an incentive structure that promotes compliance and sustainable growth. Moreover the provision of grant or subsidized financing of investments in polluting enterprises and utilities is against the PPP. Over time Ukraine should move to a more consistent application of the PPP, eliminating such support and ensuring that polluters indeed bear the full costs of mitigating their pollution and of the damages that it causes. Need for Strategic Environmental Planning 59. Existing strategic documents13 are more of a declarative nature than a basis for implementing cost- effective investments to address priority environmental problems. Strategic planning based on realistic assumptions of capital investments, operating and maintenance costs, combined with consideration of affordability is key to financing more effective environmental programs and policies. Ukraine lacks a realistic and long-term strategy defining national environmental priorities and linking them with financial planning. 60. The government’s tendency to be declarative is further illustrated by the implementation of the Aarhus Convention on “Access to Information, Public Participation in Decision-Making and Access to Justice in Environmental Matters” (Aarhus, 1998) was signed in June 1998 and ratified in July 1999. Its emphasis on environmental decision-making is also rooted in the Constitution. However, in practice public participation in decision-making regarding the environment, and access to information remain limited. 4.3 THE INSTITUTIONAL FRAMEWORK FOR ENVIRONMENTAL REGULATION 61. As already pointed out by the Environmental Protection and Natural Resources Management Report 13 laws define few clear commands or enforcement mechanisms and do not empower the MENR to undertake the necessary steps to implement the law. In addition, the MENR and its regional departments are understaffed, especially in terms of environmental inspectors. 62. A serious problem continues with respect to enforcing court rulings and decisions of authorities regarding the collection of penalties. In 1999, administrative jurisdiction authorities (except for courts) imposed penalties on individuals for environmental misconduct equal to almost 6.4 million UAH, while only 3.9 million UAH were collected, corresponding to slightly more than a half of the total due. In the same period, authorities calculated the amount due for liability caused by environmental misconduct as equal to almost 26 million UAH, with only 7.8 million UAH, or less than one-third actually collected. 63. Economic incentives for promoting environmental compliance are weak and do not send a strong enough signal to the polluter to modify his behavior. Economic instruments regulating environmental and natural resource protection are not very effective, although improvements have been made recently. The core problem with applying economic instruments in an unstable macroeconomic environment relates to pricing. Economic analyses show the neglect of price mechanisms as one of the basic causes for environmental degradation (de Moor, 1996). Present economic incentives in Ukraine are not well suited to changing polluters’ behaviors, as they fail to send the right market signals, which results in inefficiencies and sub- optimal resource allocation. 13 Ukraine. Suggested Priorities for Environmental Protection and Natural Resources Management, Report No. 12238-UA, World Bank 1994 21 64. Institutional and administrative imperfections are exacerbated by a failure to remove subsidies that underpin “dirty production.” Apart from being a major drawback from the Polluter Pays principle, in the long run, under-pricing of environmental damage will undermine the international competitiveness of Ukrainian producers when countries start acting uniformly under international free trade agreements. 65. Another problem of environmental regulation in Ukraine is its weak enforcement. Many businesses avoid paying charges and fees or do not pay them in full. One reason stated by private businesses for this lies in the complexity of the regulations and reporting system. Not all the rules for deductions are clearly defined in the laws and the mechanisms for calculating environmental pollution payments are rather complicated, as are those for financing environmental programs and projects. Failure of law enforcement is due to weak institutional capacity. Accepting continuous non-compliance with laws and regulations has a political dimension at a national level, which requires serious effort on the part of the Government to make changes. 66. As a regulator, MNER issues permits for environmental emissions, monitors compliance and carries out “ecological expertise reviews” of new investments. It is empowered to initiate legal actions against polluters and indemnify the public for damages resulting from infringements of environmental laws. The MNER has the authority to provide grants and other benefits to businesses, institutions, organizations and individuals for their greening efforts, such as investing in waste reduction facilities, energy - and resource- saving technologies, alternative energy and other environmentally friendly initiatives. 67. Mechanisms for financing environmental activities are regulated by environmental legislation as well as by financial, administrative, business and tax laws. The Law of Ukraine on Taxation (February 18, 1997)14 provides the full list of taxes and fees applicable in Ukraine. Its includes clauses stipulating payments for land and for the special use of natural resources, as well as charges for environmental pollution. Issues directly relating to budget revenues and expenditures are regulated by the finance law “On the Budget System of Ukraine” (June 29, 1995)15, the annual law “On the State Budget of Ukraine”, as well as by other regulations16. 68. Ukraine’s environmental laws define few clear enforcement mechanisms and do not empower MENR to undertake the rulemaking needed for implementation. In addition, MENR and its regional departments are clearly understaffed, especially in terms of environmental inspectors, and have significant problems in enforcing court rulings and administrative decisions, and in collecting penalties.17 69. A lack of institutional capacity and weak enforcement has undercut Ukraine’s environmental regulations. Many businesses avoid paying pollution charges and fees or do not pay them in full. Many firms take advantage of the complexity of the rules and mechanisms for calculation of pollution payments and avoid payment. Accepting continuous non-compliance with laws and regulations has a political dimension at the national level, which requires serious effort on the part of the government to make changes. 14 Vidomosty of the Supreme Rada of Ukraine. - 1997. – No. 16. - p. 119 15 Vidomosty of the Supreme Rada of Ukraine. – 1995. – No. 26. - p. 195. 16 In 1999 administrative authorities imposed environmental misconduct penalties of almost UHA6.4 million, but collected only UHA3.9 million. The authorities calculated the amount due for liability caused by environmental misconduct as almost UHA26 million, of which much less than one third was collected. 17 In 1999 administrative authorities imposed environmental misconduct penalties of almost UHA6.4 million, but collected only UHA3.9 million. The authorities calculated the amount due for liability caused by environmental misconduct as almost UHA26 million, of which much less than one third was collected. 22 V. ANALYSIS OF ENVIRONMENTAL REVENUE AND EXPENDITURE IN UKRAINE 70. The aim of this chapter is to complement the institutional and more general analysis of the previous chapters with more detailed analysis of the main sources and uses of environmental expenditure and revenue in Ukraine. Section 5.1 looks at the structure of environmental public expenditure. Section 5.2 provides a review of the sources of revenue. Section 5.3 illustrates regional variances of pollution levels and enforcement of environmental taxation. Finally, section 5.4 provides a comparison of the regional expenditure and revenues. The concluding Section 5.5 offers conclusions and also outlines the policy recommendations. To save space and keep the discussion to the essential points, only selected key evidence is reported in the main text. 71. The analysis in this chapter highlights several inefficiencies in the way environmental policy is presently organized in Ukraine, which calls for a reform in the way in which pollution charges are organized and in the way in which environmental revenue is distributed across the different levels of government. • On the whole, both current and capital environmental expenditure appear to be declining in real terms. Most environmental expenditure is made up by businesses and the role of the national budget is falling. • On the expenditure side, the shrinking revenues raised by pollution charges are often used inefficiently. Investments in many projects remain uncompleted for lack of funding. Expenditure redistribution principles by regions and by environmental media also appear in contrast with the benefit nature of the environmental fund. • The analysis of the environmental fund system confirms that it does not pass the test for efficient financial instrument for delivering public goods. • The system of pollution charges appears to be less effective where it is most needed, in the heavily polluted industrial regions. • Revenue from environmental charges had been shrinking, overall compliance rates have been falling (except in the very last year), exemption has increased and it has become more concentrated in the largest and more heavily polluting firms. 5.1 ENVIRONMENTAL EXPENDITURE Public Environmental Expenditure 72. As mentioned in the previous chapter, the share of environmental expenditure in the State Budget allocated to the MENR is very small (about 0.33% in the last few years) and is comparable to that allocated to the environment from the system of environmental funds. The trend of public environmental expenditure however, is upward. This section looks at that disaggregated data on that trend. 73. Unfortunately the disaggregated data are incomplete. In particular, disaggregated data by environmental media are only available for the State Budget and the National Environmental Fund (for three years out of the period considered). Furthermore classifications used in the two cases are similar but not completely consistent. Data from both sources are shown below in Table 5.1 for the State Budget and in Table 5.2 for the National Environmental Fund. 23 74. These tables and data from the previous chapter show that: 18 a) The largest share of expenditures is in the water sector (in 2000 the sector accounted for 33% of the State Budget and 53% of the National Environment Fund). b) Air protection is entirely delegated to the National Environmental Fund and to enterprises and mainly involves end-of-pipe measures (e.g. scrubbers). However this expenditure has been extremely limited and has increased only recently, in 2000. Nevertheless it is still only about 7% of Fund expenditures and 1 % of aggregated expenditures from both sources. This low figure contrasts with the fact that air pollution charges are the largest share of environmental charges as a whole. c) The National Environmental Fund also exclusively covers activities in the area of waste. d) Expenditures on ‘Green’ issues, such as afforestation and nature reserves take up about one-fifth of expenditures of both the State Budget and the National Environmental Fund. e) ‘Other items in the National Environment Fund’ are made up of development of management programs, research and development, awareness raising programs, conducting Environmental Impact Assessment and some other minor items. Together they account for about 12% of fund expenditures. f) Total public expenditure on the environment has increased quite sharply in 2000 but, as was noted in the previous chapter, as a shore of total spending on the environment it is very low; a disproportionate share is from enterprises. g) The share of investment expenditure in total is also very low, with most spending being of a non- capital nature. Table 5.1: Breakdown by Media of Actual Environmental Expenditure from State Budget in Real Terms, 2000 (‘000)UAH 1996 1997 1998 1999 2000 Environmental Protection and Nuclear 52,809 71,504 55,537 67,988 119,310 Safety Total Water resources protection 30,001 19,132 17,110 23,282 39,933 Land protection 2,314 9,892 305 5,731 3,752 Afforestation and forest shelter-belt 2,516 10,572 5,705 11,335 8,970 Mineral resources protection 1,839 6,359 3,725 1,984 5,630 Local environmental authorities 10,786 13,138 12,708 11,760 40,831 Natural reserves 4,408 9,721 9,381 9,346 14,509 Other environmental activities 53 1,709 0 252 224 Nuclear safety organizations and other 892 982 6,604 4,298 5,463 nuclear safety management expenditures Source: Ministry of Finance 18 There is a some inconsistency between these data, which are from the Ministry of Finance, and those further in Chapter 5, which were from the Ministry of Environment. In broad terms, however, they both point to similar trends. It should also be noted that General Chernobyl Related Expenditures are not included in Tables 5.1 and 5.2. Special nuclear safety programs, however are included and accounted for about 4% of total spending from these two sources. 24 Table 5.2: Breakdown by Media of Actual Environmental Expenditure from National Environmental Fund in Real Terms 2000 (‘000)UAH) 1998 1999 2000 Total 2,748 11,288 23,706 Air protection 0 265 1,766 Water resources protection 341 2,599 12,463 Forest resources protection NA NA 1,142 Preservation of protected areas 676 2,746 3,308 Waste 333 964 1,400 Soil 25 NA NA Nuclear and radiation safety NA 752 635 Others 1,374 3,962 2,994 Source: Annual Report of the National Environmental Fund for 1998, 1999 and 2000, Ministry of Environment Environmental Expenditure by the Business Sector 75. Environmental expenditure channelled through the Environmental Funds constitutes only a small part of total environmental expenditure in Ukraine. Instead, most environmental expenditure is made directly by firms, often still owned by the State, and only partly co-financed by transfers from the general budget. An assessment of environmental expenditure in Ukraine would then not be complete without some further analysis of this expenditure as well. The Bulletin of Statistics offers this information, collecting it directly at the level of the single company. Although not exhaustive, it provides an additional and potentially interesting source of information on environmental expenditure in Ukraine. Current Expenditure by the Business Sector 76. National level data allow us to discriminate between current and capital expenditure on environmental matters, as well as to discriminate between the sources of funds and their use. Table 5.3 presents the data in nominal terms for the last five years, providing a breakdown of current expenditure by media. In nominal terms, current expenditure appears to be increasing over the period, although at a very slow rate. In 2000 total expenditure was only 20% higher than in 1996, reaching two and half billion UAH or around $480 million. 77. Composition of Environment Expenditure. The composition of expenditure across media varies considerably over the period. Most of the expenditure is concentrated on improving quality of water supply and the trend is consistently upwards over the period. In 2000, 66% of total expenditure went towards improving water quality, compared to 54% in 1996. Against this, expenditure on improving air conditions fell from 20% of total expenditure in 1996 to 13% in 2000. Expenditure on waste disposal remained approximately constant during this period. % 78. Table 5.4 presents the same data as Table 5.3, but in real 2000 terms. As one would have expected, this shows a sharp fall in environmental expenditure. From 1996 to 2000, total current expenditure fell by almost 40% in real terms. 79. Table 5.5 shows the distribution of current expenditure in the period by source of funds. The table shows that almost all expenditure was consistently financed with firms' own resources. Transfers from the National Budget and local governments comprise on average about 2% of total expenditure. The ratio of local to national government transfers appear negligible and approximately constant in the period, at around 20%, with the exception of 1998, which is thought to be due to an error in the data set. 25 Table 5.3: Current Environmental Expenditures in Nominal Terms Year Total Water Air Land Mineral Waste Water/ Air / Land Mineral/ Waste/ resources Total Total /Total Total Total 1996 2,177,866 1,166,104 437,608 32,506 57,041 462,740 0.54 0.2 0.01 0.03 0.21 1997 1,628,412 1,035,499 263,363 31,067 86,956 180,639 0.64 0.16 0.02 0.05 0.11 1998 1,774,548 1,109,601 288,124 43,361 109,620 193,691 0.63 0.16 0.02 0.06 0.11 1999 2,248,733 1,420,085 280,489 48,475 218,988 246,058 0.63 0.12 0.02 0.1 0.11 2000 2,618,375 , 350,417 66,876 162,866 279,211 0.66 0.13 0.03 0.06 0.11 1715,327 Source: Bulletin of Statistics Table 5.4: Current Environmental Expenditures in Real Terms Year Total Water Air Land Mineral Waste resources 1996 4,314,759 2,310,271 866,984 64,401 113,009 916,775 1997 2,930,235 1,863,321 473,906 55,903 156,472 325,050 1998 2,660,999 1,663,886 432,053 65,021 164,379 290,447 1999 2,828,906 1,786,467 352,855 60,982 275,487 309,541 2000 2,618,375 1,715,327 350,417 66,876 162,866 279,211 Source: Bulletin of Statistics Table 5.5: Current Environmental Expenditures by Sources of Financing in Real Terms Year Total From From From National local enterprise's Budget budgets resources a b c d e=b/a f=c/a g=d/a 1996 4,314,759 56,466 10,015 4,242,386 0.013 0.002 0.983 1997 2,930,235 69,397 13,478 2,842,515 0.024 0.005 0.970 1998 2,660,999 54,277 176,643 2,411,435 0.020 0.066 0.906 1999 2,828,906 50,765 11,144 2,750,129 0.018 0.004 0.972 2000 2,618,375 34,961 6,917 2,563,270 0.013 0.003 0.979 Source: Bulletin of Statistics 80. Chapter 6 provides further data about the composition of expenditure for industrial sector in the Donetsk region. Manufacturing and Mining absorb more than 70% of total expenditure and the ratios of expenditure in the different sectors appear remarkably constant along the period. There is, however, a modification in the source of funds. Regarding total expenditure, the ratio of the resources derived from the National Budget appear approximately constant over the period, but an increasing part of it appears to be concentrated in the mining sector, reducing transfers to the energy sector. 26 Capital Expenditure by the Business Sector 81. To compute gross capital expenditure on the environment by enterprises the two different data series were summed: a series on capital investment, which approximates to net investment, and a series of capital expenditure for major repairs, which is interpreted as investment to rebuild depleted capital stock. The Bulletin of Statistics also offers a distinction between planned and actual capital expenditure. Accordingly in Table 5.6 the ratio between the two is also reported. Gross capital expenditure on the environment varies in nominal terms between UAH 470 million and 620 million (planned) and between UAH 380 million and 606 million (actual)19. In real terms, however, there has been a sharp reduction. In 2000 real capital expenditure was approximately half that in 1996. However, there appears to be an increase in real terms since 1998, as well as of the ratio of planned investment to actual; this ratio between the two increased from 84 % in 1996 to almost 98 % in 2000. Firms apparently are beginning to make more realistic plans and sticking to them. Table 5.6: Environmental Investments19 Year Nominal Real Planned Actual Planned Actual % To planned 1996 618,544 520,563 1,225,452 1,031,333 84.2 1997 466,361 385,510 839,190 693,703 82.7 1998 483,266 383,175 724,675 574,585 79.3 1999 480,033 426,555 603,882 536,607 88.9 2000 621,604 605,922 621,604 605,922 97.5 *Environmental Investments = Net Capital Investments + Major Repair Total Business Expenditure 82. Total expenditure on the environment by source of finance was reported in Chapter 2, Table 2.1. In Table 5.7 a more detailed breakdown is given -- by current and capital expenditure and source of finance. Overall total environmental expenditure in 2000, as recorded by the Bulletin, turns out to be equal to about UAH 3 billion (US$620 million), or approximately 2% of GDP. However, investment expenditure is only about 20% of total expenditure, and most of it is absorbed to maintain deteriorating capital stock. Furthermore, total expenditure in 2000 is in real terms only 60% of total expenditure in 1996 and the trend appears overall to be downward over the period, with no apparent difference between current and capital expenditure. 83. In looking at the data by source of funds, only resources coming from the National Budget including the National Environmental Fund have been included, as funds from local governments have always been negligible with respect to capital expenditure. It turns out that the share of environmental expenditure by firms financed through transfers from the budget has been between 1-2% of total expenditure and appears to be declining during the period, both in absolute real terms and in percentage terms of total expenditure. However, the table also highlights an interesting phenomenon; although declining, environmental expenditure mediated by the national budget appears to be increasingly concentrated on capital expenditure. The percentage of expenditure financed by the National Budget rises from 0.53% in 1996 to 0.87% in 2000, and is in real terms almost the same in 2000 as is in 1996. 19 There is a slight discrepancy between these figures and those in Table 5.1 but the differences are minor and probably the result of different methods of assessing capital repair expenditures. 27 84. Table 5.8 summarizes the situation by environmental media with respect to the use of funds. The table confirms what has been noted already, that the larger concentration of environmental expenditure is in air and water. It also shows that the ratio of capital to current expenditures is lowest for water, followed by air, minerals and waste. For the last two years the division among capital and current is approximately equal. Expenditure by Region 85. Table 5.9 illustrates the distribution of expenditure by capital and current at the regional level. The ratio of current to total expenditure varies considerably – from a low of 32% in Odessa to a high of 95% in Ternipol. It has not be possible to investigate the reasons for these differences in this study but, given the importance of maintaining capital expenditures, further work in this area is justified. 5.2 SOURCES OF REVENUE FOR PUBLIC EXPENDITURES 86. Revenues for public environmental expenditure come from general taxation, via the state budget, and from pollution charges and fines, via the Environment Funds. In this section a more detailed analysis of the revenues of the Environment Funds is provided. As this is a report on expenditure it does not go into all aspects of revenue, but revenues for the Environmental Funds are an exception, because the level and structure of expenditure is very much determined by the revenues and their distribution between the funds. Earmarked Environmental Funds and the Benefit Principle 87. One of the principal characteristics of the current context in which Ukraine environmental policy is set is the existence of earmarked funds for environmental expenditure. Revenue is collected by imposing user charges on firms on the basis of permits issued by officials from the Ministry of Environment and Natural Resources. The proceeds are then shared among the State and the local governments according to a pre-determined formula and can only be spent on environmental policies and activities, according to a law defining the allowed characteristics of this expenditure. 88. There is no real equivalent to the Environmental Funds in OECD countries. Where similar institutions exist, they are sector-specific, with targeted mandates (e.g. the French or Dutch Water Agencies or the Superfund in the United States). Moreover, they are also set up for a limited period of time. In the Ukraine, as in most NIS/CEE countries, the funds have no such time limit and the mandate is very wide, covering a range of activities and beneficiaries. 89. Earmarked funds for environmental expenditures are rarely used in OECD countries. This is because it is generally felt that earmarking unduly reduces budget flexibility without guaranteeing sufficient resources to finance expenditure. Furthermore, earmarking may not set sufficient limitations to prevent diversion of the money to other purposes by the fund managers. Though Ukraine has recently initiated reforms in the public sector accounting and the Budget Code (budgetary procedures), including eliminating extra budgetary funds (see PEIR, report 23356-UA, March 2002), the practice of earmarking funds for the environment is still in use. 90. Thus the first question at hand is: Are there valid arguments to maintain the practice of earmarking resources for environmental purposes? If so: Are the existing arrangements optimal for the system of Environmental Funds on both the revenue and expenditure sides? 91. Normative public finance theory is specific in identifying the conditions that would justify the existence of earmarked funds. There has to be a clear relationship between the two sides of the budget, so that revenue sources for the earmarked Fund are clearly connected with the expenditure financed by the Fund itself. This is known as the benefit principle. In the case of Ukraine, resources are derived from pollution charges and are used, at least in part, to curb pollution. The issue then is, whether resources stemming from the existing pollution tax system are sufficient to achieve any of the stated purposes. 28 Table 5.7: Budget Financing of Environmental Activities in Real Terms Year Current Expenditures Capital Investments Total Expenditures Total From % Of total Total From % Of total Total From % Of total National National National Budget Budget Budget 1996 4,314,759 56,466 1.31 1,031,333 5,364 0.52 5,346,092 61,830 1.16 1997 2,930,235 69,397 2.37 693,703 2,711 0.39 3,623,938 72,108 1.99 1998 2,660,999 54,277 2.04 574,585 1,863 0.32 3,235,584 56,140 1.74 1999 2,828,906 50,765 1.79 536,607 297 0.06 3,365,513 51,062 1.52 2000 2,618,375 34,961 1.34 605,922 5,265 0.87 3,224,297 40,226 1.25 Source: Bulletin of Statistics* Table 5.8: Expenditures by Environmental Media as a Share of Total Expenditures (*) Year Capital Investments Current Expenditures Water Air Waste Mineral Water Air Waste Mineral 1996 0.1 0.04 0.01 0.01 0.43 0.16 0.01 0.02 1997 0.1 0.05 0.01 0.02 0.51 0.13 0.02 0.04 1998 0.1 0.04 0.02 0.01 0.51 0.13 0.02 0.05 1999 0.08 0.03 0.02 0.02 0.53 0.1 0.02 0.08 2000 0.1 0.03 0.02 0.03 0.53 0.11 0.02 0.05 (*) The numbers should be added horizontally. They do not add up to one because some items of expenditure are excluded. Source: Bulletin of Statistics 92. Given the amount of environmental problems, which Ukraine has to solve, resources fall short of what is needed to combat pollution. The total amount raised by the National Environmental Fund in 2000 was only 84 million UAH, or 0.0017% of General Government revenue, a negligible amount. Of course, the Fund does not cover all expenditure relating to the environment in Ukraine. One cannot help but wonder if it makes sense to maintain such a complex system to raise such a limited amount of money. Possibly, environmental funds could finance expenditure on some key items -- e.g. monitoring, compliance, protecting bio-diversity etc. -- which, because of their public good nature, could only been guaranteed by public money. But then the resources raised must be adequate to meet these needs. It may make more sense to finance these directly from the budget. Taxing pollution has merits of its own, if it is so structured to induce polluters to cure pollution beyond that of financing environmental expenditure. But then one should ask if the existing system is the right one in which to provide firms with the correct incentives to curb pollution. The analysis of Chapter 5 raises several doubts in this regard as well. 93. The evidence shows that in Ukraine, revenue from environmental charges has been shrinking, and overall compliance rates have fallen (except in 2001). Indeed, exemptions have increased and become more concentrated in the largest and more heavily polluting firms. In other words, environmental taxation is less effective where it is most needed, i.e., in the heavily polluted industrial regions. On the expenditure side, the evidence shows that only a fraction of the revenue raised are actually spent. Moreover many projects are initiated but remain uncompleted for lack of funding. The collection and redistribution to different regions and environmental media also contrast with the benefit aspect of the environmental fund. In summary, the available evidence indicates that the benefit principle does not apply in practice and calls for a reform in the 29 way in which pollution charges are levied and in which environmental revenue is distributed across levels of government, and for a reform of the system of earmarked funds that are ineffective. Table 5.9: Environmental Expenditures by regions in 2000 Region From Total Current From Enterprise From Current National Exp. National Investmen National Exp./Total Budget Budget t Budget a b c d e f g=c/a Ukraine 2,321,249 63,270 1,715,327 15,425 605,922 47,845 0.74 Autonomous Rep. 46,837 648 36,063 75 10,774 574 0.77 Crimea Vinnytsya region 20,483 191 18,145 191 2,338 0 0.89 Volyn region 9,642 465 7,436 40 2,206 425 0.77 Dnipropetrovsk 611,141 6,397 440,782 205 170,359 6,192 0.72 region Donetsk region 365,476 3,969 286,756 1,109 78,721 2,860 0.78 Zhytomyr region 33,850 453 32,602 292 1,248 161 0.96 Zakarpattya region 8,018 169 4,832 1 3,186 168 0.6 Zaporizhzhya 164,691 821 123,888 93 40,803 728 0.75 region Ivano-Frankivsk 41,948 1,285 32,041 13 9,907 1,272 0.76 region Kyiv region 47,018 9,861 36,572 8,444 10,446 1,417 0.78 Kirovohrad region 15,065 346 12,935 0 2,130 346 0.86 Luhansk region 147,877 339 136,514 339 11,362 0 0.92 Lviv region 45,439 4,650 37,666 3,754 7,773 896 0.83 Mykolayiv region 134,218 473 119,814 173 14,404 300 0.89 Odessa region 101,878 6,779 32,464 0 69,414 6,779 0.32 Poltava region 90,438 139 58,947 12 31,491 127 0.65 Rivne region 55,713 89 32,988 60 22,725 29 0.59 Sumy region 34,128 30 23,324 0 10,804 30 0.68 Ternopil region 11,312 303 10,723 0 589 303 0.95 Kharkiv region 102,105 1,217 82,230 237 19,876 980 0.81 Kherson region 18,686 785 14,705 54 3,981 732 0.79 Khmelnytsk 11,652 783 9,439 101 2,213 682 0.81 region Cherkasy region 18,633 440 14,826 118 3,807 322 0.8 Chernivtsi region 7,911 1,892 5,777 0 2,135 1,892 0.73 Сhernihiv region 28,783 2,306 20,320 92 8,463 2,215 0.71 The city of Kyiv 133,495 17,482 73,814 23 59,681 17,459 0.55 The city of 14,816 956 9,728 0 5,088 956 0.66 Sevastopol Source: Bulletin of Statistics 94. As noted, the main economic rationale for the existence of the National Environmental Fund is the benefit principle; it follows that the same rationale would require this principle to be respected as close as possible on the expenditure side of the Fund. In other words, there should be correspondence between the source of the money and its use. For example, in terms of repartition by media, there should be a balance 30 between media taxed and media for which expenditures are made. Assuming that the tax charges are selected optimally in the first place, expenditure to curb pollution should be aligned with those sub-sectors where the highest environmental charges are higher. Again, in terms of the territorial distribution of Fund expenditure, regions where pollution is higher and where therefore environmental charge revenue is also higher should get a larger amount of Fund expenditure. Pollution Charges 95. Pollution charges are levied at two levels: a base rate for emission up to a certain level and a rate 5 times higher for emissions above that level. The higher the rate carries an additional penalty as the system is so designed to penalize polluters. Firms are not allowed to deduct these extra charges from their corporate income tax base. Finally, firms that pollute above the limits might also be fined, following the proceedings of the judicial system, and have to pay further charges. 96. Level of Charges. The data reveal an increase in the number of firms with declared charges at the higher rate over the last five years; the number of such firms20went up from approximately 10% in 1996 to 30% in 2000. At the same time the percentage of firms above the limits who were subsequently fined dropped from 36% to 10%. At the same time, the number of exemptions is also increasing, particularly for the heaviest polluters. 97. Compliance also shows that Firms do not always pay their charges. Over the period 1996-2000, compliance rates for charges within lower limits are fairly high as 75-80%, but for charges above limits the rate falls to 40-65%. Compliance rates for fines however have been higher, at around 70-80%, possibly as a result of the legal consequences from not paying a fine decided by the judicial system. The data also show that compliance rates improved substantially in the study period. In particular, compliance rates for both within and above the limit increased by almost 20 points in 2000 with respect to 1999. This is probably due to an important institutional change that occurred in calendar 2000. In this year the responsibility to enforce the charges moved from officials belonging to the Ministry of Environment to officials belonging to the tax authority, who are more effective at collecting taxes. This clearly highlights the problem of the inefficient enforcement system for pollution taxes that had existed, but also points to a positive development in effectiveness. . 98. Emphasis. Increasing levels of pollution and low compliance rates are not the only problems with the existing system. The increasing levels of emissions, which are simply exempted from taxation, represent another problem. The firms that were exempted from the payment of pollutant charges in at least one dimension have always been a negligible percentage of the total number of firms. In 1996 only 81 out of 10,000 firms were given exemptions and, in 2000, only 65 from more than 12 thousand firms. Yet, the amount of charges due, that, because of exemption escaped taxation, increased by almost 600% in the period, from UAH 6,842 million in 1996 to UAH 38,712 million in 2000. In percentage terms, while the ratio of exempted charges over total charges due (including fines) amounted to only 0.02% in 1996, it was 14% in 2000. 99. The increase implies a fundamental change in the nature of the firms who were given an exemption during the 1996 to 2000 period. The 65 firms exempt in 2000 avoided taxation to a degree 6 times larger than the amount avoided by the 81 exempted firms in 1996. This becomes even more dramatic if one takes into account the nominal reduction in pollution charges over the period. While average charges due for both within and above limits firms dropped from UAH 35,000 in 1996 to UAH 17,000 in 2000; the average exempted charges per firm increased from UAH 85,000 to almost UAH 600,000 in 2000. Clearly, therefore, 20 "Total" firms are identified with "within" limits firms, according to the argument stressed by our Ukrainian contacts at the Ministry of the Environment, that it is extremely unlikely that a firm may violate the limits along all dimensions at once. Hence, generally all firms are within limit firms, at least according to some dimension. 31 the largest and the most heavily polluting firms are also the ones that have been increasingly exempt from pollution charges. The evidence suggests that the exemption procedures have been used to the advantage of the largest and the most powerful firms, possibly a Ukrainian variation of the "too big to fail" argument, which emphasizes the higher leverage and influence that big firms often have in many countries. 100. The data also show a fall in real revenues from pollution charges (Table 5.10), as expensed in constant UAH 2000 prices. In real terms, due charges in 2000 for “within-limits” firms were only a fourth of those in 1996. Due charges for “above limits” firms remained roughly unchanged, while fines were only a fifth of those in 1996. For actually paid charges, the fall was less impressive, thanks to the improvement in enforcement in 2000, but still remarkable. In 2000 total charges and fines paid amounted to UAH 84 million, while in 2000 real prices terms they were UAH 128 million in 1996. 101. Given that Ukraine’s real GDP fell by almost 60% from 1990 to 1999 in real terms, it is not surprising that tax revenue, including pollution revenue, did not keep up with inflation nor with more general budget revenue trends (details in Annex III), which compared total due and paid charges and fines with total tax revenue of the general budget. The comparison confirms that the environmental tax revenue fell in real terms and also in respect to tax revenue as a whole. The fall in the levels of environmental charges stems from the fact that charges are not indexed to inflation, combined with falling compliance rates and lower fines. Table 5.10: Charges and Fines for Environmental Pollution in Real Terms (‘000 UAH, 2000 prices) Year Due Charges and Fines Paid Charges and Fines Within Above the Fines Exemptions Total* Within the Above the Fines Total* establishe established established establishe d limits limits limits d limits a b c d a b c 1996 631,399 38,599 25,127 13,557 699,665 117,228 4,707 3,949 127,669 1997 254,222 67,161 6,525 30,807 331,558 96,397 4,687 1,942 104,559 1998 301,627 44,376 20,641 13,210 368,318 78,305 2,557 2,033 83,676 1999 239,171 50,065 10,550 21,843 314,079 53,409 3,336 1,384 64,997 2000 178,383 37,939 5,631 38,712 234,385 66,838 6,603 1,369 84,130 Source: Bulletin of Statistics (*) Total due payments are computed as the summation of a+b+c+air pollution by mobile sources Pollution Charges by Environmental Media 102. Thus so far, data on total payments of environmental charges have been discussed without reference as to the source of these charges. A more disaggregated analysis would be useful on several grounds. First, by comparing the environmental charges data with the data on the distribution of pollutants presented in Chapter 3 and in Annex I, one can better assess the effectiveness of environmental taxation in curbing pollution. Second, given the widespread diffusion of both legal and illegal avoidance of environmental taxation, one may ask if these features are generalized or specific to particular media. 103. Data on revenues for water, air and land were investigated for “within limits” and “above limits” charges and for charges due and charges paid. For charges due “within limits” air pollution is the main source of revenue across all the periods, although its share is declining. In 1996, due charges for air pollution within the limits covered 80% of total due charges; by 2000 this figure had dropped to 57%. Charges due for 32 water pollution remained roughly constant through the period at about 9 %, while charges due for waste disposal increased dramatically in the period, from 12% to 34% of total due charges. In absolute (nominal) terms, charges due for waste disposal increased by 50% in the period, from UAH 40 million to 60 million; in contrast, the other two sources appear to be declining in absolute terms over the study period. 104. For “above limits” due charges the situation appears to be reversed. Due charges for air pollution above limits are only 28% of the total for the year 2000. Due charges for water pollution “above the limits” are 37% of the total, roughly the same percentage as due charges for waste disposal. Furthermore, for water pollution charges for emissions “above limits” are, in any year, almost the same as charges for emissions “below the limits”, whilst the same ratio is far below unity for the other two media. Hence, there would seem to be greater difficulty for the system of environmental taxation to keep water pollution under limits, than the other two forms of pollution. 105. The situation is somewhat different when one looks at actual charges paid. Here the share of actual payments for water pollution has always been considerably higher for both below and above limits emissions than the corresponding share for due charges. In other words, compliance rates for water pollutants appear to be higher than for the other two media. In particular, compliance rates for Waste disposal appear to be considerably lower than for the other two media. 106. Table 5.11 provides the data in terms of compliance rates for all media, for all years and for both “within” and “above limits” emissions. The evidence is clear: “within limits” compliance rates are highest for water pollutants (around 60% in the final year of the sample). They are twice as high as compliance rates for waste disposal, and much higher than the compliance rates for air pollutants. For “above limits” emissions, water compliance ratios are on average along the period the largest, although in the final year air compliance ratios appear to be higher. The higher compliance rates for water pollution may be related to a greater acceptance that such pollution is really harmful to people and livestock. Table 5.11: Compliance Rates by Environmental Media Year “Within limits” “Above limits” Water Air Waste Water Air Waste disposal disposal 1996 0.53 0.14 0.26 0.20 0.09 0.09 1997 1.15 0.15 0.10 0.12 0.04 0.03 1998 0.51 0.25 0.20 0.03 0.07 0.08 1999 0.48 0.21 0.18 0.07 0.04 0.09 2000 0.62 0.38 0.31 0.18 0.25 0.11 Source: Bulletin of Statistics 107. Summing up, the results on pollution charges by media indicate • Due charges for air pollution represent the largest share of charges for emissions “within limits.” • For emissions “above limits”, water pollution charges now represent the biggest share. • Due charges for waste disposal show the highest rate of growth in the period • Compliance ratios for water pollutant charges are higher for both “below” and “above limits” emissions than for air or waste. • Compliance rates for waste disposal are the lowest for both above and “below limits” emissions 108. It is hard to assess these phenomena on economic grounds. The general impression is that this evidence points to inefficiencies in the way standards are set and enforced. For example, if firms consistently go beyond the established limits for water pollutants, in spite of the fact that charges and fines are largely 33 enforced for this medium, it could mean that either the limits are set at a level which is too low for firms to be able to respect them, or that the charges are too low to provide a sufficient monetary incentive for firms to respect the limit. More likely it is the latter that is the key factor. Similarly, the fact that due charges for waste disposal increase so much without the tax enforcement mechanism being able to enforce them raises suspicions about the efficiency of the environmental charge system. On the other hand, these pessimistic conclusions are somehow weakened by the trends of the compliance rates for the different media to converge in 2000. Assuming that standards and charges for the different media are optimally set in the first place, one would expect that the enforcement rate for each environmental medium should be approximately the same. This is exactly what is observed as the trend over the period. 109. One can also ask whether these charges have had any impact on emissions? The data show that all environmental indices have improved in the second half of the 1990's. Water pollutants fell by 36% in the period 1996-2000; waste disposal fell by 16% and air pollution by 7%. This is due in major part to the decline in output and economic activity, but the most substantial fall in water pollution also seems to square with taxation on water pollution being more effective than for the other media. If this correlation is genuine, one should then expect in the future, following the recovery in compliance rates for the other two media, a sharper reduction of pollution for these media as well. 5.3 REGIONAL INDICATORS 110. The empirical evidence discussed so far has referred to Ukraine as a whole. The data discussed thus far has been averaged across regions which in fact, are characterized by very different environmental conditions, as was noted in Chapter. It is thus interesting also to analyze the conditions at the level of the single region. To this end, these average figures have been broken down into their regional components for the year 2000. Table 5.12 presents the figures for total amount of pollution charges paid by each region, and broken down by “within” and “above limit” charges and fines. The coefficient of variation (last row fifth from left) suggests that the different regions do not differ that much in terms of the percentage of “within limits” charges on total charges paid; instead they differ enormously in the percentage of paid charges “above limits” compared to charges “within limits” and for the percentage of fines raised over “above limits” charges. This suggests that there is a large variance across regions not only in terms of pollution, but also in terms of the enforcement of environmental taxation. 111. The evidence collected in Annex III supports this proposition. First, there is evidence of a high level of concentration of pollution in Ukraine. The two industrial regions of Dnipropetrovsk and Donetsk together are responsible for almost 40% of the total payment of charges for “within limits” firms, and for almost half of the total payment for “above limits” firms. For example, average payments per within limit firm in the Dnipropetrovsk region are UAH 28 ,000 or five times the national average, and sixty times the lowest regional average payment. Regions with a high presence of large firms, producing in the traditional mining and extractive industry, cause a more than proportional increase in pollutant emissions. 34 Table 5.12: Environmental Pollution Charges Paid by Legal Entities in 2000 (‘000 UAH) Region Total Within Above Fines amount established established limits limits a b c d e=b/a f=c/a g=d/a h=c/b I=d/c Ukraine, total 84,130 66,838 6,603 1,369 0.79 0.08 0.02 0.10 0.21 Autonomous 1,755 1,482 795 2 0.84 0.04 0.00 0.05 0.03 Republic Crimea Vinnytsya region 1,041 502 83 7 0.48 0.08 0.01 0.17 0.09 Volyn region 280 157 12 4 0.56 0.04 0.01 0.08 0.29 Dnipropetrovsk 13,042 10,567 1,364 163 0.81 0.10 0.01 0.13 0.12 region Donetsk region 18,974 16,536 1,234 407 0.87 0.07 0.02 0.07 0.33 Zhytomyr region 934 583 145 0 0.62 0.15 0.00 0.25 0.00 Zakarpattya region 399 288 5.0 0 0.72 0.01 0.00 0.02 0.04 Zaporizhzhya region 9,987 8,881 425 144 0.89 0.04 0.01 0.05 0.34 Ivano-Frankivsk 821 560 49 74 0.68 0.06 0.09 0.09 1.51 region Kyiv region 1,036 708 118 25 0.68 0.11 0.02 0.17 0.21 Kirovohrad region 2,416 2,204 21 25 0.91 0.01 0.01 0.01 1.21 Luhansk region 4,352 3,077 699 100 0.71 0.16 0.02 0.23 0.14 Lviv region 2,090 1,684 48 28 0.81 0.02 0.01 0.03 0.58 Mykolayiv region 2,243 1,922 43 0.86 0.02 0.00 0.02 0.00 Odessa region 1,947 1,198 104 4 0.61 0.05 0.00 0.09 0.04 Poltava region 2,765 1,840 107 158 0.67 0.04 0.06 0.06 1.48 Rivne region 1,599 1,442 16 0.90 0.01 0.00 0.01 0.00 Sumy region 1,213 991 16 0.82 0.01 0.00 0.02 0.00 Ternopil region 330 143 52 6 0.43 0.16 0.02 0.36 0.11 Kharkiv region 4,690 3,899 45 15 0.83 0.01 0.00 0.01 0.32 Kherson region 1,233 925 21 84 0.75 0.02 0.07 0.02 4.08 Khmelnytsk region 757 570 10 15 0.75 0.01 0.02 0.02 1.43 Cherkasy region 2,017 1,547 129 2 0.77 0.06 0.00 0.08 0.02 Chernivtsi region 227 97 2 2 0.43 0.01 0.01 0.02 1.20 Сhernihiv region 1,173 762 93 7 0.65 0.08 0.01 0.12 0.07 The city of Kyiv 4,606 3,732 85 95 0.81 0.02 0.02 0.02 1.12 The city of 2,203 542 1,600 2 0.25 0.73 0.00 2.95 0.00 Sevastopol Coefficient of 0.23 1.70 1.34 2.88 1.58 variation Source: Bulletin of Statistics 112. Compliance Rates. As would be expected, evidence reported in the Annex also shows that pollution is far more regionally concentrated if one uses due charges instead of paid charges as an indicator of pollution, since compliance rates vary across regions. For instance, due charges in the two industrial regions of Dnipropetrivsk and Donetsk summed together are about 60% of the total due charges for both within and above limits firms in Ukraine, whereas paid charges are only 45% of the total. Average compliance rates for both “within” and “above limit” firms in the Dnipropetrivsk and Donetsk regions are also consistently lower 35 than their counterparts at the national level. For “within limits” firms, for instance, compliance rates are 24% and 30% respectively in the Dnipropetrivsk and Donetsk regions, against a national average of 37%. For “above limits” firms, the corresponding figures are 16% and 7%, against a national average of 17%22 113. Exemptions. In general, one would also expect to find more exempt firms in the heavily polluted regions, a prediction supported by the data. For instance, in the Dnipropetrivsk region, a third of the due environmental charges are actually legally exempted by taxation, the highest figure in the sample. In the same region, the percentage of firms, which are exempted over the total number of resident firms, is 8 times larger than the national average. 114. Summing up, the regional empirical evidence yields rather pessimistic conclusions about the current status of environmental taxation in Ukraine. Where, if these charges are to be successfully applied to act as a disincentive, the result is less successful in the most heavily polluted industrial regions. Both legal and illegal avoidance of environmental taxation are higher in these regions. This raises issues about the effectiveness of tax enforcement but also about the political and social framework, which surrounds tax enforcement. These issues are returned to in the conclusions. 5.4 COMPARING REGIONAL EXPENDITURES WITH REGIONAL REVENUES 115. Unfortunately, descriptions of projects financed by the environmental funds, especially at the regional and local level are too generic to allow for a meaningful assessment by media; often projects are often not completed, compounding any such effort. It has been possible, however, to carry out an analysis by region, using the data from the Bulletin of Statistics and from the National Fund, of all expenditures from the environment funds. The relevant data are given in Table 5.13. 116. The distribution of the total money raised by the environmental charges between the Regions and the Center reflects the appropriation formula described in Table 2.7. The expenditure of the money accruing to the National Fund, however, is the result of an autonomous decision by the Center itself. The first column in Table 5.13 reports the effect of these decisions, by providing a break down at the regional level of the Center’s financing choices. The second column presents the expenditure at regional level by Regions and local governments. This has been computed by using regional revenue from the environmental charges and the appropriation formula itself. Hence, their summation in the third column provides the total Fund expenditure made by any level of governments in each region. Finally, the fourth column presents the paid charges for regions. 117. Cross Subsidization. The data reported in Table 5.13 provide interesting findings on environmental expenditures in different regions and nationally. First, not all money raised by the environmental charges is actually spent. Out of the UAH 84 million that according to our estimates were collected by the National Environmental Fund in 2000, only UAH 80 million was spent (data of the Bulletin of Statistics)23. This inability to spend the money collected has been a structural characteristic of environmental expenditure in Ukraine but has improved significantly over the years. Second, the re-distributive role played by the center is very significant. The ratio of National Fund expenditure over paid charges at the regional level is anywhere 22 The situation in these two regions is however probably worse than these figures would seem to suggest. This is so because the two regions constitute a large part of due and paid environmental charges in Ukraine. The national average itself is thus largely influenced by the situation in these regions. Hence, a simple comparison with the national average provides a biased and more optimistic picture of the situation than occurs in reality. A simple rank indicator is probably more enlightening in this respect. To this end, note for example that the Donetsk region, which is the first in Ukraine in terms of due charges for both within and above limits firms, is also the one with the third lowest compliance rate for both type of firms 23 There is a discrepancy in the data here. Table 5.1 reports all expenditures from the funds in 2000 as 119 million UAH. The difference must be accounted for by special expenditures at the regional local level that are not reported in Table 5.13. This difference of 16% is big enough to cause concern and is being studied.. 36 between 0% and 200%. Third, the ratio of environmental tax expenditure over environmental tax revenue at the regional level varies widely across the sample. To emphasize this point, the last column of the Table computes the ratio of total expenditure to total revenue at the national level and for each region24. The results of this exercise are instructive. With respect to the unitary national standard, regional levels of expenditure can be as high as 2.8 or as low as 0.2. In the heavily polluted regions of Dnipropetrovsk and Donetsk, for example, the ratio are, respectively, 0.8 and 0.4, meaning that percentage of environmental revenue of the two regions which is effectively spent in these regions is far smaller than the national average. In other words, through the money accruing to the National Fund, the highly polluted industrial regions heavily support environmental expenditures in the other regions. 118. Redistribution Conflicts with “Benefit Principle”. It is hard to reconcile this evidence with the benefit principle commented on above. Generally speaking, the centre plays a re-distributive as well as an insurance role with respect to local governments. Richer regions implicitly support, through the transfers made by the national budget, poorer regions. However, what is being evaluated here is not general taxation but “benefit taxation” or effectiveness of pollution charges, where the proceeds should be spent as close as possible to the sources. It is not clear then what could justify such a heavy re-distributive role of the centre. In the present context, the rationale for having some of the money collected locally being channelled to the centre can be as follows: • First, it might serve to finance general research, monitoring and administrative functions which are more efficiently done at selected locations because of the presence of increasing returns to scale. • Second, there may be a problem due to the residence principle of taxation. Firms pay taxes, including environmental charges, according to the region where they have their legal residence. However, the productive unit, which is responsible for the environmental pollution, may well be situated in another region. It follows that there may be a discrepancy between the region who receives the proceedings from environmental taxation and the region which suffers the damage. Allocating resources to the centre and then redistributing them across regions may be a way to overcome this problem. • Third, there may be projects that affect several regions at once. It may then be advisable that the centre directly administers these projects, as the latter may be better suited to solve free-riding problems and reach timely decisions. 119. There is not enough information to assess the extent to which these explanations are presently valid in the context of the Ukrainian Environmental Fund. But we can note the following. The first reason may require some money to be channeled to the Center, but certainly cannot justify such a large share as the one which appears from these computations. The second reason could be better handled by an ad hoc correction in a formula to redistribute charge revenues across regions. For example, the charge money could be redistributed according to indicators of a firm's productive activities in a given region (i.e. local employment). As for regional projects those with national interest could be easily identified and treated separately from the rest. In other words, the evidence collected in Table 5.13 seems to call for less money and less discretion in the use of the Fund being given to the centre. 24 To get revenues and expenditures to add up to the same total, each ratio is scaled by the ratio of total revenues to charges. Hence, by construction, ‘total expenditure’ is now equal to ‘total revenue’ at the national level, and all regional levels of expenditure can be directly compared with this unitary standard. 37 5.5 CONCLUDING REMARKS 120. This chapter has looked at the level and composition of environmental expenditure in as much detail as is possible. The data reveal a picture where, overall, both capital and current expenditure have been falling. This is because enterprise spending has been falling and although public spending has actually gone up in 2000, the latter is still a very small share of total spending. Moreover, the bulk of the spending is on current and not capital items. Table 5.13: Environmental Funds Expenditures by Regions (‘000 UAH) in 2000 Region National Regional Total Charges Fund Funds Expenditures Expenditure * s** a b c d e=a/d f=c/d (*) Ukraine, total 23,706 56,613 80,319 84,130 0.3 1.0 Autonomous Rep. Crimea 295 943 1,238 1,755 0.2 0.7 Vinnytsya region 10,325 300 1,331 1041 1.0 1.3 Volyn region 385 160 545 280 1.4 1.9 Dnipropetrovsk region 3,881 6,080 9,961 13,042 0.3 0.8 Donetsk region 1,761 5,068 6,828 18,974 0.1 0.4 Zhytomyr region 780 502 1,282 934 0.8 1.4 Zakarpattya region 753 205 958 399 1.9 2.4 Zaporizhzhya region 700 3,499 4,199 9,987 0.1 0.4 Ivano-Frankivsk region 440 425 865 821 0.5 1.1 Kyiv region 980 1,128 2,108 1,036 0.9 2.0 Kirovohrad region 228 220 448 2,416 0.1 0.2 Luhansk region 243 817 1,060 4,352 0.1 0.2 Lviv region 1,071 149 1,220 2,090 0.5 0.6 Mykolayiv region 1,423 682 2,105 2,243 0.6 0.9 Odessa region 510 4,888 5,398 1,947 0.3 2.8 Poltava region 607 1,355 1,962 2,765 0.2 0.7 Rivne region 470 648 1,118 1,599 0.3 0.7 Sumy region 381 813 1,194 1,213 0.3 1.0 Ternopil region 770 153 923 330 2.3 2.8 Kharkiv region 245 1,206 1,451 4,690 0.1 0.3 Kherson region 405 545 950 1,233 0.3 0.8 Khmelnytsk region 392 214 606 757 0.5 0.8 Cherkasy region 740 1,137 1,877 2,017 0.4 0.9 Chernivtsi region 260 138 398 227 1.1 1.8 Сhernihiv region 400 895 1,295 1,173 0.3 1.1 The city of Kyiv 257 3,717 3,974 4,606 0.1 0.9 The city of Sevastopol 0 1,751 1,751 2,203 0.0 0.8 (*) The ratio ‘f’ is multiplied by a scaling factor to ensure that the ratio is equal to one for Ukraine as a whole. Source: Bulletin of Statistics & Annual Report of National Environmental Fund 121. This picture has important implications. The low share of investment in total expenditure means that not enough is being put into replenishing the environmental capital and the low share of public expenditure 38 means that not enough is being spent on the kinds of things that the public sector is responsible for. In all countries the State undertakes the ‘public good’ type of expenditure. This includes items such as monitoring of environmental quality, protection of watersheds and sensitive land areas, and protection of nature reserves and forests. In all transition countries, the State also supports investment in water supply and sewage, industrial enterprises, and in other key areas of infrastructure, on the grounds that those responsible for these entities have insufficient resources to maintain them, and a collapse would have serious consequences for public health, the natural environment and possibly employment. Over time, of course, this reason will become less important and one would expect to see public spending decline on this count and pick up on the more conventional ‘public good’ component. In the short term, however, this role is important and needs to be sustained. 122. The analysis in this chapter also highlights several inefficiencies in the way environmental policy is presently organized in Ukraine. On the revenue side, revenue from environmental charges have been shrinking, overall compliance rates have been falling (except in the very last year), exemption has increased and it has become more concentrated in the largest and more heavily polluting firms. Environmental taxation appears to be less effective where it is most needed, in the heavily polluted industrial regions. On the expenditure side, the shrinking revenues raised by pollution charges are often wasted. Only a part of the resources raised are actually spent, while many projects remain uncompleted because of lack of funding. The way in which the money that is collected is redistributed by regions and by environmental media also appears in contrast with the benefit nature of the environmental fund. Clearly, this evidence calls for a reform in the way in which pollution charges are organized and in the way in which environmental revenue is distributed across the different levels of government. 39 VI. REGIONAL CONTEXT OF ENVIRONMENTAL EXPENDITURE: DONETSK CASE STUDY 6.1 INTRODUCTION 123. The regional case study of Donetsk Oblast presented in this chapter comprises a review of public environmental expenditures and the revenues and the expenditures of two commercial enterprises located in the City of Donetsk 26. The commercial enterprises are: a refrigerator manufacturer, Nord, and Krivorozskaya Metallurgical Plant. The first, Nord, is included as an enterprise case study. This chapter aims to complement the analysis in earlier chapters. 124. The Donetsk case study is an important in the context of the review because it is a region in which heavy industry is concentrated and, as noted in Chapter 3, pollution is very high impacting negatively on the environment. At the same time, the region's mineral resources remain a potential source of future economic growth. The analysis leads to the conclusion that, in order to exploit these resources in a manner that will maximize regional welfare and conform to international environmental standards, improvements in environmental management are needed. Thus, the region's importance in part derives from the fact that its environmental problems are severe, but also from the fact that environmental management is critical both for local and national welfare. A number of other industrialized regions with high industrial development scores27 have sizable environmental problems and face similar challenges. The last section of this chapter offers useful recommendations for potential reforms. 125. The Chapter concludes with the following key points: • Economic and environmental efficiency losses result from the low levels of pollution charges – they provide little incentive to enterprises to invest in pollution control equipment; paying the charge is much cheaper. • The effectiveness of environmental expenditures is undermined as a result of excessive dispersion of resources between 116 local environmental funds. Amalgamating funds at the regional level will increase the economies of scale of investments. • Eliminating excessive discretion by local administrators of environmental funds should be considered since often the funds are used to fund general budget deficits. Improving transparency in allocation of resources at lower levels of government will help increase the predictability and transparency of revenue and expenditure planning. • Introducing economic appraisal techniques for project evaluation should increase the efficiency of expenditures. 6.2 INSTITUTIONAL STRUCTURE OF ENVIRONMENT MANAGEMENT IN DONETSK 126. The principal public authority responsible for environmental management in the region is the State Agency of Ecology and Natural Resources in Donetsk Oblast, part of the Ministry of Environment and Natural Resources of Ukraine. This authority co-ordinates the process by which regional environmental 26 Prices throughout are expressed in the national currency, hryvna (UAH), and are given in constant prices for the year, 2000. 27 According to Helsi’s Standardized Scores for Regional Development Indices (Scale 1.00 (Low)-25.00(High), Dontesk Oblast has the highest Industrial developmnet score of 25.00; Dnipropetrovska oblast 20.88; Kyivska 15.16, Lvivska 13.75 and Luhanska 12.62. (Kravchuk, The Quest for Balance) 40 priorities are determined through consultation with other oblast state departments as well as with local and city authorities in the region. The Ministry then presents the priorities, are determined and associated expenditure requirements to the Cabinet of Ministers, for ultimate approval by the Supreme Court of Ukraine. Revenues that the oblast administration receives for spending on priority areas are, however, constrained by the receipts from enterprises relating to pollution charges, which are allocated among national, oblast and local authorities on the basis of a formula pre-determined at the national level, as described in previous chapters. At the time of this study the total number of environmental funds in the oblast is 116, an increase of 6 from 1999. In addition to the regional fund, there are understood to be 49 city funds, 7 district funds, 26 village funds and 34 town funds. 6.3 OBLAST REVENUES 127. This section reviews the current pattern of revenues intended to support environmental protection in Donetsk Oblast. It identifies the sources of these revenues, reports on their utilization rates, and concludes with an assessment of the efficiency with which these revenues are obtained. 6.3.1 SOURCES OF REVENUES i) Pollution Charges 128. Pollution charges are imposed on enterprise commensurate with the level of emissions to air, water and waste, in accordance with the rates determined by national level legislation. Annual limits for enterprises are not determined according to the amount of environmental damage they cause. Rather, it appears that they are defined by federal legislation on a relatively crude basis whereby enterprises are allocated a quota of the regional emission limits, according to a function of their specific emission coefficient and projected production over the time period. Given the low level of the charges enterprises have little incentive to make investments to reduce pollution rather than pay these charges. 129. The method of revenue collection has recently changed. Prior to 1999, the Oblast Environmental Department (OED) was responsible for both the imposition and collection of the charges. However, since 1999, the Tax Administration rather than the environmental authorities has collected the charges. Tax officials visit enterprises at the same time as environmental inspectors from OED. They have the power to impose automatic fines on non-payment or for emission levels higher than the pre-agreed limit for the enterprise. All data that is collected by the environmental inspectors is then submitted to the OED. Table 6.1 shows that tax collection rates of payments due for pollution within the prescribed enterprise limits have increased from 17.2% in 1998 to 26% in 2000. The pattern is the same for collection rates of payments due for pollution above the prescribed enterprise limits, which have increased from 2.8% to 13.2% for the same time period. 130. In principle, the money collected is then held by a commercial bank on behalf of the Administration, before being distributed to these environmental Funds at the national, regional and local levels. The revenues from these charges collected in Donetsk Oblast are distributed accordingly: 20% to national level, 50% to oblast, and 30% to local funds. In practice, as is illustrated below, a significant proportion of this money is re-directed towards non-environmental expenditure. . 131. Table 6.1 shows the revenues that were due (declared), and actually collected from enterprises over the period, 1998-2000, for which records are available. The table disaggregates the revenue on the basis of whether it came from taxes paid at the rates applicable for emissions “within limits” or from the enterprise, those paid at the rates that apply “above these limits”. 41 Table 6.1: Pollution Charge Payments, Declared and Actual, and by Media in Donetsk Oblast, 1998-2000 1998 1999 2000 Within Above Within Above Within Above Stationary sources Air emissions - Declared 37,093 3,470 38,253 4,566 36,869 6,570 - Actual 7,761 75 7,167 75 11,075 581 % actual of declared 20.9 2.2 18.7 1.6 30.0 8.8 Water discharges - Declared 2,647 2,815 3,596 2,936 3,720 4,186 - Actual 1,678 105 1,424 288 1,987 382 % actual of declared 63.4 3.7 39.6 9.8 53.4 9.1 Waste disposal - Declared 15,199 1,935 16,503 4,614 13,797 5,899 - Actual 2,537 30 2,548 300 3,474 271 % actual of declared 16.7 1.6 15.4 6.5 25.2 4.6 Other - Declared 18,814 10,594 15,209 3,093 18,464 1,809 - Actual 520 310 1511 848 2438 1,204 % actual of declared 2.8 2.9 9.9 27.4 13.2 66.6 TOTAL - Declared 73,753 18,814 73,561 15,209 72,850 18,464 - Actual 12,496 520 12,650 1,511 18,974 2,438 % actual of declared 16.9 2.8 17.2 9.9 26.0 13.2 Source: Donetsk Environment Report, 2000, Ministry of Environment 132. Table 6.1 shows a general pattern of under-payment of the taxes that are owed by enterprises. Actual payment rates vary by media, with payments from waste being the lowest and payments for water being the highest. A pattern of payment rates across the three years for which there is data - of falling between 1998 and 1999 before rising again in 2000 is common across air, water and waste. This reflects the particularly difficult economic conditions prevailing in Ukraine in 1999 combined with the Tax Administration taking over responsibility of collection of these charges in the middle of this year. The largest contributor to revenues, in terms of media, is payments from air emissions, (53% of the total in the year 2000). In 2000, total revenues were UAH 21.4 million, equivalent to approximately $3.5 million. 133. The revenues collected are low in absolute amounts and, as a major source of public finance in the oblast, provide limited potential capital to Environmental Funds for pollution prevention. One reason is that the pollution charge rates appear to be set at very low levels, making it impossible for substantial revenues to result. It is likely that the charges do not approach the levels that would equate to environmental damage costs - the environmental efficiency of the policy instrument is low. 134. In addition, tax exemptions are often granted to enterprises that argue that they cannot afford it. Indeed, enterprises that have significant debts for pollution charges are understood to make non-monetary barters with other sectors - such that 10% of total payments are made with cash, whilst 90% are made on a barter basis. The affordability argument is undoubtedly strong in this region, as throughout Ukraine. However, it would seem desirable from an efficiency perspective that the system of barter-based offsets be converted to transparent monetary flows and be spent by the environmental funds according to the environmental priorities. 42 135. The actual collection rate of these charges is, however, gradually increasing. Including payments made in kind (barter) to the authorities, over 50% of enterprises having due charges paid in 2000, following a steady increase from 12% in 1996. The greatest increase in the number of contributing companies has been recorded in the cities of Donetsk, Avdeevka, Yenakievo, Kramatorsk, Makeevka, Khartsizsk, Amvrosiyevskiy and Starobeshevskiy areas (primarily by identifying the owners of moving sources and legal entities who dispose domestic wastes). This increasing trend is the result of the new role of the Tax Administration as enforcer of tax collection, with greater statutory powers and greater personnel resources than the predecessor, the OED. 136. Whilst this is a positive development, the fact that there are two authorities now involved in the levying and collection of charges, has had other detrimental consequences, including the fact that the environment department now does not know which enterprises have paid or not. It is clear that the information flow between the tax and environment departments is less than perfect. Revenues are also lost as a result of the fact that pollution payments are due to be made in the region where the enterprise is registered. In many cases this appears to be in Kyiv, where the head office is located, though the (polluting) operation occurs in Donetsk. As a consequence, less revenue is received at the oblast level than appears appropriate, given that the need for environmental expenditure tends to be where the operation is itself located. 137. Table 6.2 shows the contributions to oblast and local Environmental Funds made from different types of pollution charge payments. The local funds are able to secure revenues from fines and debt payments in addition to 30% from pollution charges due as a standard payment. Table 6.2: Pollution Charge Contributions to Oblast and Local Environmental Funds Sources of Revenue Pollution Fines for Fines for Debt Others All Revenues Charges Violation Late Payments Payments Oblast 6716.2 0 0 0 0 6716.2 Local 6087.5 243.5 177.2 158.6 331.8 6998.6 Total 12803.7 243.5 177.2 158.6 331.8 13714.8 Source: Donetsk Environment Report, 2000, Ministry Of Environment 138. Table 6.3 gives a more detailed picture of the flow of payments from enterprises to the Environmental Funds. It shows that the local funds are able to secure a significantly higher percentage of payments (51.2% in 2000) that are due than the regional oblast fund (24.6% in 2000). Thus, instead of the oblast level funds being greater than the total local funds, in actual fact it is the local funds that have more resources at their disposal. This pattern appears to be due to the money collected and being set aside at the national and oblast level being diverted for other (non-environmental) purposes. 139. The percentage of payments that are actually made - as opposed to being due - increased significantly between 1999 and 2000 from 19.8% to 35.9% overall. The increase was most substantial in the payments to the national fund, which increased eight-fold. It is not certain why this pattern has occurred though it is likely to be related to the fact that the tax administration is most effective at the national level . 43 Table 6.3: Calculated Charges and Actual Payments to Environmental Funds 1999-2000 Year Calculated charges (‘000) UAH Actual payments (‘000) UAH Total National Local Total National Oblast Local RETAINE OBLA Fund Funds Fund Fund Funds D BY ST ENTERP FUND RISE 1999 76,474 5,361 21,402 35,217 14,492 14,065 1,022 5,550 7,493 19.8%∗ 4.8%* 18.4%* 51.7%* 2000 69,751 10,965 18,095 27,222 13,468 21,100 7,485 6,707 6,999 35.9%* 41.4%* 24.6%* 51.3%* Source: Donetsk Environment Report, 2000, Ministry of Environment ∗ Percentage of actual payments made by polluters ii) Natural Resource Charges 140. The revenues from natural resource charges should also in principle be allocated to the earmarked fund by law (the law of Ukraine “On Environmental Protection”). Table 6.4, below, shows that the total revenues from these charges amount to over ten times those from pollution charges – UAH 254 million from natural resource charges in 2000, compared to UAH 21million from pollution charges. However, it is a cause of considerable dissent within the oblast MoE that in practice these revenues are simply allocated to the general public budget and are not earmarked for environmental management. The rate of collection, at close to 100% of the planned amounts, appears to have been enabled by much higher manpower being allocated to this task than for the collection of pollution charges. This pattern of seemingly very high collection rates does, however, mask the fact that actual utilization rates of the natural resources, and hence charges due, turned out to be higher than those planned at the beginning of the year in question. The real collection rate is not, therefore, transparent. 141. Table 6.4 shows that the main revenue contributor to the national general budget is the revenue accruing from the charges from consumption of water resources. Actual payments have risen from UAH 10.2 million in 1998 to UAH 35.9 million in 2000 and comprise 73% and 89% of the total revenue from Donetsk natural resource charges to the national budget respectively. These make up approximately 90% of the totals and are shown to be increasing over the five year time period, from UAH 88.8 million in 1996 to UAH 198.3 million in 2000. The pattern of revenues from water and mineral extraction over time is less clear. Water resource revenues rise from 1996 to 1998 before declining to the year 2000. Mineral extraction charges peak in 1999 at UAH 7.1 million but have a mean level of UAH 6.5 million. The totals for the region as a whole, increase over the time period, from UAH 126.6 million in 1996, to UAH 254.1 million in 2000, principally reflect better enforcement practices, higher charge rates and a slight improvement in the level of economic activity in 2000. Payments to the local - including regional, municipal and district - budgets are dominated by those from rents paid on land use. This pattern of revenues - of those from water going to the national budget, whilst those from land go to local budgets - appears to reflect a formal historical delineation agreement between local and national authorities. 142. It is not clear what the underlying explanations are for these various trends, especially because it is not evident what the parallel trends are in offset barters. However, over a period of economic deterioration in the region, the upward trend in total revenues suggests that public financial authorities regard these flows as important enough to invest in enforcement resources. It is likely that charges for resource use appear more easily defined, measured and collected than pollution charges. In other words, they are regarded as a more efficient revenue vehicle. Perhaps it is a consequence of these facts that this revenue is diverted away from environmental uses and towards the general public purse. Whatever the explanation, the legitimacy of these flows needs to be clarified and agreed upon. 44 6.3.2 CONCLUSIONS ON REVENUE 143. There is a newly established mechanism with which pollution and natural resource charges are collected. This mechanism results in lower rates of collection to the extent that barter offset or exemptions are allowed, and higher rates of collection when the tax authorities are directly responsible for the collection. Fortunately recent changes (since 2000) have all been in the latter direction, resulting in higher revenues from pollution charges. The subsequent utilization of these revenues is constrained by the fact that a portion of the revenue from pollution charges and all of the revenue from natural resource charges is, at present, diverted away from the financing of environmental management activities and towards other (non-environmental) actions that are perceived to be higher priorities. 144. For natural resource charges, the revenues are much higher and reflect higher collection rates by the tax authorities. However, whilst by law these revenues are earmarked, in practice these are not assigned for environmental expenditures, but simply contribute to the general national and oblast budgets. 6.4 OBLAST EXPENDITURES 145. Section 6.4 reports on the nature and effectiveness of environmental expenditures within Donetsk Oblast. The process of priority setting in the determination of environmental expenditures is reviewed before a discussion of historical expenditure patterns is presented. The emphasis in these sub-sections is on the identification of improvements that could be made to increase the efficiency of environmental expenditures. The discussion examines public and private sector expenditures in similar depth reflecting the fact that the distinction between the two sectors remains blurred, and that private sector expenditures are almost always approved directly by the OED. It should be noted that this section does not review expenditures made by other ministries. 6.4.1 PRIORITY SETTING 146. There is an established legal process of environmental expenditure prioritisation in Donetsk region. In 1997, with the purpose of achieving further improvement in environmental management and environmental safety in the region, the "Environmental Program for Donetsk Region 1998-2000” was developed. The principal components of the program were integrated within “The Program of Social and Economic Development of Donetsk Region in 1998-2000”. This program was approved on 21st November 1997 at the session of regions Rada (Parliament) and confirmed by the Ministry for Environmental Safety of Ukraine on 2nd December 1997. It was approved by the Resolution issued by the Cabinet of Ministers of Ukraine on 15th December 1997 – No.1398, “Implementing the Program of Social and Economic Development of Donetsk Region for 1998-2000”. 147. The details of the environmental program are initially drawn up by the OED before being submitted to the Ministry of Environment and Natural Resources. The program establishes sub-program regarding enterprises, cities and rayons and Donetsk Oblast as a whole. Also those program initiated by the OED are considered where Donetsk is involved with other Oblasts (i.e. Azov Sea). The priorities are then adjusted according to what the national administration judges to be the key issues from a national perspective. In principle, local environmental priorities are dictated by preferences expressed at oblast level, though there is some scope for differential patterns of priorities if the local fund presents a good case. In practice, the scope for differential priorities at local level appears to be substantial since oblast officials who have a duty to police the expenditures made at this level, have insufficient resources to do so. 45 Table 6.4: Payments for Natural Resources Utilization in Donetsk Region (UAHs million.) Year and National Budget Local Budgets Total Payments - Plan and Actual Type of Resource Plan Actual Actual as Plan Actual Actual Plan Actual Actual as % of Plan as % of % of Plan Plan 1996 total, incl.: - - - 118.7 101.8 85.8 - 101.8 - - land rents 0 0 0 107.8 88.8 82.4 107.8 88.8 82.4 - water resources - - - 3.3 6.6 200.0 3.3 6.6 200 - mineral extraction - - - 7.6 6.4 84.2 7.6 6.4 84.2 1997 total, incl.: - 15.3 - 154.9 171.4 110.7 - 186.7 - - land rents 0 0 0 136.9 148.9 108.8 136.9 148.9 108.8 - water resources - 11.0 - 11.3 16.0 141.6 - 27.0 - - mineral extraction - 4.3 - 6.7 6.5 97.2 - 10.8 - 1998 total, incl.: 34.5 13.9 40.3 182.1 195.3 107.3 216.6 209.2 96.6 - land rents 0 0 0 163.7 172.3 105.3 163.7 172.3 105.2 - water resources 26.3 10.2 38.8 11.5 16.9 147.0 37.8 27.1 71.7 - mineral extraction 8.2 3.7 45.1 6.9 6.1 88.4 15.1 9.8 64.9 1999 total, incl.: 22.8 24.0 105.3 204.4 204.4 94.8 227.2 228.4 100.0 - land rents 0 0 0 177.8 177.6 99.9 177.8 177.6 99.9 - water resources 19.2 21.7 113.0 8.8 8.98 102.1 28.0 30.68 109.6 - mineral extraction 3.6 2.3 63.9 17.8 7.1 39.9 21.4 9.4 43.9 2000 total, incl.: 38.6 40.2 104.2 216.4 213.8 98.8 255.0 254.1 99.6 - land rents 0 0 0 202.5 198.3 97.9 202.5 198.3 97.9 - water resources 34.6 35.9 103.8 7.2 8.7 120.8 41.8 44.6 106.7 - mineral extraction 4.0 4.3 107.5 6.7 6.8 101.5 10.7 11.2 104.7 2001 - 6 months, incl.: 27.93 109.86 307.44 137.79 44.8 - land rents 0 108.8 231.84 108.8 46.9 - water resources 23.0 1.0 61.68 24.0 38.9 - mineral extraction 4.93 0.06 13.92 4.99 35.8 Source: Donetsk Environment Report, 2000, Ministry of Environment 47 148. The program for the 1998-2000 period had a planned budget of UAH 651.8 million. The actual expenditure that occurred in this period was UAH 126.7 million, 19% of that intended. Reasons for this discrepancy are discussed below. In the 2001 program, a total of 334 action measures to be undertaken are planned, for a total sum of UAH 196.7 million. This is to be funded using enterprise resources (119 Million UAH), the national budget (UAH 30 million, and local budgets (including regional, municipal and local budgets totalling UAH 33 million). It is also assumed that the equivalent of USD 1.6 Million (approximately UAH 8 million) of foreign investment will also be available, based on existing international commitments. 149. The program of public expenditure for the year 2002 in Donetsk is outlined in Table 6.5, and detailed further in Annex IV. The largest component, at 59%, is expenditure on "miscellaneous pollution”: waste and radiation, comprising UAH 374 million. Two-thirds of this sum is, in fact allocated to the decommissioning of the Chernobyl nuclear plant, and the Chernobyl social rehabilitation program. The prioritisation process may be broadly characterized as "top-down" where broad priorities are determined and funds allocated after consultations. However, as the table in Annex IV shows, specific local projects with adjudged environmental benefits have been identified. The consultation process appears to substitute for a more rigorous project appraisal process that would result in a bottom-up fund allocation. It would seem possible to introduce a more formal evaluation procedure as part of the existing process as long as a greater onus was placed on those making project suggestions to demonstrate the fulfilling of criteria including cost effectiveness etc. 150. The table below shows that of a total expenditure on the environment in Donetsk by public authorities of UAH 672.4 million, Environmental Funds plan to make only 13% financed by pollution charges. This reflects the fact that the oblast OED expect that the expected revenues from pollution charges will not be sufficient to finance the planned expenditures. The split also represents a bargaining strategy by the OED to the oblast and federal level government. The split also implicitly suggests that the revenues at present flowing from natural resource charges to the General Fund should be used for environmental purposes. The totals are also set at what the OED regards as optimal levels and represent a position from which it will have to accept reductions made by the regional and federal governments. As the experience of previous years suggest, it is highly unlikely that these expenditure plans will be fulfilled. Table 6.5: Planned Public Environmental Expenditures in Donetsk for 2002 Expenditure Year 2002 (planned) (‘000) UAH General Environmental Total % of Total Public Funds Funds Natural resource management, flood 89,387 29,422 118,809 17.7 protection Waste utilisation 28,250 9,628 37,878 5.6 Miscellaneous pollution 374,678 26,932 401,609 59.7 Protected areas conservation 21,457 4,177 25,634 3.8 Research and development in environmental 26,558 1,197 27,755 4.1 protection Miscellaneous activities, including 42,309 18,371 60,680 9.0 international co-operation, education TOTAL 582,639 89,725 672,365 Source: Donetsk Environment Report, 2000, Ministry of Environment 48 151. Expenditure programs are now planned by the OED on an annual basis within 5, 10 and 20 year time horizons - which is good practice in allowing the mapping of realistic cost burdens over time. However, annual estimates are contingent on revenue, that is, itself, contingent on the effectiveness of collection. Moreover, the procedure of making annual submissions regarding expenditure priorities to the national government makes expenditure planning difficult. There is therefore likely to be a bias towards small, short term, projects that have immediate benefits but which do not necessarily allow for the maximization of net benefits over time. 6.4.2 HISTORICAL PATTERNS OF ENVIRONMENTAL EXPENDITURES IN DONETSK 152. Tables 6.6 and 6.7 below give an overview of the pattern of environmental expenditures in Donetsk Oblast. Table 6.6 shows the pattern of investment in new capital equipment over the period, 1996 - 2000, whilst Table 6.7 shows capital and operational expenditures relating to existing capital over the period, 1998 - 2000 - the years for which data is available. There is a general trend over these years of increased environmental expenditures. New capital investment has increased by 36% between 1996- 2000, whilst replacement capital investment and running costs have increased by 20% and 85% respectively. Enterprise level investment dominates as the major source of environmental expenditure in the oblast, contributing 80% of the total in 2000. Oblast and local Environmental Funds comprise 15% of the total, dwarfing the contribution made by the national Fund (2.7%). 153. Table 6.6 does not disaggregate the expenditure of the environmental funds in Donetsk in terms of environmental media. However, assuming that their expenditure on new investments has a similar pattern to that on replacement capital, water pollution prevention emerges as the largest single category of environmental expenditure. It comprises 62% of total environmental expenditure, excluding that by Environmental Funds on new capital investments, reflecting the preference expressed by OED officials that water was a priority sector. Water quality is widely perceived to be a priority and investments in the sector require large amounts of capital. Table 6.6: Capital Investments in Environmental Protection of Donetsk Region (‘000 UAH) Source of investment 1996 1997 1998 1999 2000 Enterprise Capital investment, including: 42,737 43,183 35,194 34,033 49,316 Water resources pollution reduction 18,563 22,875 22,856 18,407 26,246 Air pollution reduction 17,313 19,506 9,759 11,220 15,304 Waste disposal 6,861 802 2,579 4,406 5,787 Utilization of local environmental funds 2,448 9,764 14,743 10,646 10,533 (generated from environmental payments) Investments of National environmental 0 0 128 162 1,720 fund Investments of payments for natural 0 0 0 0 0 resources utilization TOTAL 45,185 52,947 50,065 44,841 61,569 Source: Donetsk Environment Report, 2000, Ministry of Environment 154. The discussion above suggests that capital expenditures are determined in part by the ease with which they can be administered i.e. that fewer, large scale investments made by enterprises are easier for the OED to monitor than a larger number of smaller scale investments. There is little evidence to suggest that more formal procedures of evaluation such as cost benefit, or cost effectiveness, analysis are used as investment criteria. However, there is wide recognition within the OED that these procedures and measures may provide a powerful means with which to convince enterprises of effective courses of actions across media. 49 Table 6.7: Capital and Operational Costs on Existing Assets, 1998 -2000 ('000 UAH.) 1998 1999 2000 Totals Capital Operational Capital Operational Capital Operational State 30 1,306 0 1,063 161 1,716 Local 2,542 3,265 596 2,178 2,380 2,874 Enterprises 21,814 236,446 24,869 346,491 26,720 441,182 Other 31 114 0 53 143 1,030 ALL 24,417 241,131 25,465 349,785 29,404 446,802 Source: Donetsk Environment Report, 2000, Ministry of Environment 155. Table 6.7 shows that operational expenditures dwarf total (maintenance, and new, shown in Table 6.7) capital investment. For example, for wastewater total capital investment by enterprises is UAH 39.6 million in 2000, (13.381 + 26.246), whilst operational expenditure is UAH 284 million. This can be seen as encouraging since it suggests that there is no pattern of capital investments being made but not being used subsequently. However, there may be a risk that new capital investments are not being made regularly enough to take advantage of improved process and environmental technologies. 6.4.3 ENTERPRISE LEVEL EXPENDITURES 156. Tables 6.6 and 6.7 above demonstrate that enterprises are responsible for the majority of environmental expenditures. The impetus behind this pattern lies in resolution No.656 issued by the regional administration on 4 November 1993, entitled, “Strengthening of environmental activities at enterprises – primary contributors to environmental pollution of the region”. This general legislation demands that each enterprise introduce a program to reduce its environmental impact by a specified amount. Prioritisation of expenditures is made on the basis that the enterprise is bound to submit a proposed program to the OED. This allows the OED to check that the programs conform to the oblast environmental program. The enterprises are then inspected and - dependent on this inspection - the programs are approved or rejected. The outcome is then published in the local media and is open to public consultation. On the basis of this, the scheme or measure may be modified. 157. By 31st December 2000, the region’s state environmental department had received 72 enterprise- developed environmental programs out of 79 planned. Out of these, 46 programs have been approved and 26 programs have been returned for revisions. It is not clear what criteria are used by the OED in evaluating enterprise environmental improvement programs. An additional comment, with regard to the efficiency of this expenditure, is that efficiency might be expected to be considerably greater if the system of pollution charges were upwardly adjusted so that they acted as an incentive to make expenditures on pollution prevention. This would be possible if the level of the pollution charges better reflected the real damage costs associated with the pollution. An adjustment of this type would also reduce the administrative cost associated with the evaluation of each enterprise program, currently borne by the OED. 158. A specific program that has been introduced in order to promote direct enterprise level expenditure is known as the "Economic experiment at the enterprises of the mining and metallurgical sector of Ukraine". According to the law of Ukraine “On the implementation of economic experiment at the enterprises of the mining and metallurgical sector of Ukraine” and decree No.1820 issued by the Cabinet of Ministers on 1 October 1999 a group of 23 participating companies was selected. The state department issued order No.117 of 18 November 1999, which stipulates the measures for monitoring the implementation of the economic experiment at the enterprises of the mining and metallurgical sector, the main industries in the Oblast. Article 5 allows for 70% of the money that would otherwise be collected as a result of pollution charges to be retained by the enterprise. The remaining 30% is paid and allocated equally between the national, oblast and local environmental funds. 159. The scheme is innovative in the Ukraine in that it links the pollution-charging regime directly and formally with investment in pollution prevention measures at the enterprise level. Here, the money 50 retained by the enterprise is earmarked as having to be spent on environmental improvements. The enterprise is free to prioritise this expenditure between alternative uses, though approval for the uses ultimately has to be sought from Ministry of Environment at the oblast level. Once approval has been given, quarterly expenditure reports are submitted to OED, and subsequent inspections are undertaken. The total value of the scheme has been estimated at UAH 34.8 million, whilst one enterprise alone accounts for UAH 14 million of this total. 160. Published data on the environmental improvements achieved to date is not yet available. However, Ministry of Environment officials are not hopeful. Much of the money appears to have been diverted from its original purpose of pollution prevention to simply up-dating existing production technologies. This has been justified on economic grounds i.e. that the technology is required to remain competitive in the market and, ultimately, to prevent job losses. Only two enterprises out of the twenty- three participants are understood - from interviews with OED staff - not to have generated higher air and water emissions compared to those at the beginning of the project. It is not yet clear whether this general pattern of increase is due to non-investment in pollution prevention equipment or an expansion in output, though given the recent economic performance of the region it is believed to be the former. 161. The success story from this scheme is the Avdiivka Coke and Chemical Plant. This is believed to have reduced emissions of SO2 by 10,000 tons per year - a 99% reduction. In this case, the project received additional support from the Dutch national government, which are contributing the technological equipment. It is likely that the stringent evaluation procedures imposed by the Dutch Government on the loan are partly responsible for this success. If so, it demonstrates the potential for international assistance with the adoption of more rigorous and objective evaluation criteria than appear currently to exist. 6.4.4 ENVIRONMENTAL EXPENDITURES BY ENVIRONMENTAL FUNDS IN DONETSK 162. The aggregate revenues and expenditures of the funds are reported in Table 6.8 for 1997-2000. Whilst local environmental fund expenditures have been erratic, peaking in 1998, oblast fund expenditures show a steady increase over this period so that they are now approximate to the local fund levels. Total revenues and expenditures, however, are also erratic in their availability over time and it is disconcerting to see that oblast revenues and expenditures have fallen in both 1999 and 2000. It is clear that the availability of revenues is the binding constraint on these expenditure patterns. As is highlighted in Table 6.9, there is significant diversion of funds away from environmental purposes. Table 6.8: Allocation and use of Environmental Funds (‘000 UAH) 1997 1998 1999 2000 Revenues of Env. Funds Oblast 1,692 3,845 5,550 6,707 Local 8,675 11,633 7,535 7,144 Total 10,367 15,478 13,085 13,851 Expenditures of Env. Funds Oblast 1,692 3,624 4,193 5,050 Local 8,072 11,120 6,543 5,778 Total 9,764 14,743 10,736 10,829 Source: Donetsk Environment Report, 2000. Ministry of Environment 163. Table 6.9 gives more details of the utilization rates of the different level funds. The utilization rate at the national level is just 23%, reflecting the fact that these funds are often diverted to other expenditure priorities, away from environment. 51 Table 6.9: Environmental Fund (EF) Revenue, Expenditure and Utilization Rates in Donetsk Oblast, 2000 Environment Funds Actual allocations to Actual expenditures Percentage of EFs, (UAH '000) from EFs, (UAH '000) utilization National fund 7,485 1,720* 23.0%* Regional fund 6,716 5,068 75.5% Local fund 6,899 5,494 79.6% TOTAL 21,100 12,282 58.2% *-In the western areas of Donetsk region Source: Donetsk Environment Report, 2000. Ministry of Environment 164. The funds received from the National Environmental Fund, which in 2000 amounted to UAH 1,720 million, was allocated to the implementation of the following environmental actions: • Construction of sewer pumping station No.5a, the city of Mariupil; • Construction of the regional laboratory and information center for environmental protection; • Development of a scheme for perspective utilization of natural resources in the coastal neighborhood of the Sea of Azov in Donetsk region; • Measures as to liquidation of radioactive wastes within the territory of former army base 03321 in the Artemovsk area. 165. The program relating to the Sea of Azov is one of several significant trans-boundary issues that affect Donetsk Oblast, and that need co-ordination between oblast administrations and the involvement of the national government. At present, there is some co-operation between different oblast environmental funds. However, the legal requirement is for contributions to the wastewater treatment operation to be pooled from local, regional and national funds on a fixed percentage basis. The number of environmental funds that need to be coordinated is therefore substantial and likely to result in significant transaction costs that could perhaps be avoided were environmental expenditure issues of this nature to be rationalized and made by a single fund. 166. Expenditure by the regional and local Funds are presented in Table 6.10 It should be noted that the expenditure amounts do not match the totals given in Table 6.9 above for the year, 2000. No explanation is given for this discrepancy in the Donetsk Environmental Report, 2000. The categories are not helpful in understanding the efficiency of these expenditures since they are not generally broken down by environmental media - though the largest spending category in 2000 appears to be land reclamation. Otherwise, health treatment from environmental pollution damage and development/implementation of national and regional programs is the largest expenditure component. 167. Emphasis is therefore on so-called "soft" expenditure types (rather than "hard" capital investments in equipment), reflecting the limited size of funds available. In a sense, this can be seen as a reasonable functional split between the business sector, which make the capital and operational expenditures associated with pollution prevention, and the public sector, which focuses increasingly on policy formulation with public consultation. As a possible consequence of this re-focusing the number of environmental NGOs is rising and public awareness campaigns (notably the public participation strategy, supported by the UK Government) appear to be becoming more effective in raising environmental issues as a policy priority amongst the wider public. 168. The level of utilization of financial resources allocated to the regional and local funds shown in Table 6.9 suggests that there is an under-spend. This appears to be a problem at the point of disbursement of monies to the environmental funds from the commercial banks. This has resulted, as with the allocation from the national fund, because of a shift of funds to other priority policy areas apart from the environment. 52 Table 6.10: Detailed EF Expenditures in Donetsk, 1997 - 2000 (000 UAHs.) 1997 1998 1999 2000 Expenditure categories Development & Implementation of 345 7,606 5,587 1,910 Environmental Programs Conferences, seminars etc for 138 0 3 263 environmental awareness & education Documentation 271 18 2 9 Emergencies & accidents 521 104 240 15 Health care related to environment 5,471 5,825 3,061 2,728 pollution Environmental monitoring & assembly 265 17 11 46 of databases Equipment purchase 126 116 33 734 Environmental training 23 21 1 0 Reclamation 4,535 Miscellaneous 2,604 1,036 1,798 588 TOTAL 9,764 14,743 10,736 10,828 Source: Donetsk Environment Report, 2000. Ministry of Environment 6.4.5 CONCLUSIONS ON EXPENDITURE 169. There appears to be an elaborate system within which environmental management actions are prioritised at the oblast level over one, five, ten and even twenty-year time horizons. It appears that this prioritisation process is slowly but surely more influenced by the concerns of the wider public. The conclusions regarding efficiency are summarized in Table 6.11 below. 170. Actual expenditures on environmental improvements at the enterprise level are determined by the ability of the OED to dictate and subsequently check on the nature of the expenditure. Whilst enterprise expenditures are approved by the OED before being made, there appears to be severe resource constraints that limit the authorities from verifying that the agreed expenditures have actually been made. The very low demand conditions affecting much of the industry in the region is a significant reason for enterprises not making these expenditures. Limited success has been made in some enterprises where formal investment appraisal techniques have been used. These techniques tend to be associated with the involvement of an international donor. 171. Expenditures by environmental funds, themselves contingent on the receipt of pollution charge revenues from enterprises, amount to approximately 10% of expenditures made by enterprises. Planning of these expenditures is continually thwarted by the low collection rates of the charges. It is often the case that the enterprise is exempted or able to pay on a barter basis, thereby reducing the efficiency of the prioritisation planning undertaken by the environmental funds. Much of this expenditure is on so-called "soft" programs such as health care provision and environmental monitoring. 6.5 OVERALL CONCLUSIONS BASED ON DONETSK CASE 172. There remains a significant problem of air, water and waste pollution in Donetsk as a consequence of the heavily industrialized and non-modernized structure of the economy in the region. As a consequence, there is a need for enterprise investment in environmentally improved technologies in much of the heavy industry in the area. 1) The system of prioritization of environmental expenditures appears to be well developed, thanks in part to the commitment of a number of key officials in the OED. The model of short, medium and long term planning, combined with consultation, could profitably be adopted in other oblasts within 53 the Ukraine. The realization of those plans in Donetsk is contingent on the capacity of OED to having greater monitoring and enforcement powers and associated manpower resources. 2) In general, the new budgetary system introduced by the Budget Code in 2001 has had positive effects for oblasts and lower level governments (see Public and Institutional Expenditure Review Chapter 5). First, budgeting has become more realistic and planning more predictable for local governments since the amount of transfers received is known. Second, local governments have more freedom since they can now choose how they will allocate their revenue resources among competing expenditure demands. Third, transparency of the allocation of resources to lower levels of government has improved considerably. However, there has not been an increase in predictability and transparency when it comes to revenues from pollution charges. 3) Revenues from pollution charges together with natural resource taxes would provide a potential source of finance for these environmental improvements, channeled through environmental funds at the national, oblast and local level. However, these funds, in particular those collected from the use of natural resources are raided on a regular basis by regional and national authorities who wish to use the revenues for other priority purposes. This practice means firstly that the total sums available to the funds are too small to finance significant investments, and secondly that the annual amount to invest is uncertain, mitigating against long-term investment schedules. Finally, the pollution charges are set too low to provide an incentive to enterprises to invest in pollution control equipment rather than having to pay the charge. Both economic and environmental efficiency are lost in these ways. We recommend therefore that these mechanisms, along with charge payment enforcement mechanisms, be reviewed - paralleling the recommendations at the national level. 4) The effectiveness of environmental expenditures that can be gained through large-scale investments is further limited by the fact that the funds available to the region are dispersed between 116 local environmental funds. Thus economies of scale in purchasing are difficult to exploit for the benefit of the region as a whole. We recommend that the system of local funds be reviewed with the view to amalgamating funds at the regional level. 5) Efficient administration of the revenues from pollution charges is hampered by the fact that two agencies, the Tax Administration and the oblast environmental authority are involved. Again, this reflects the situation at the national level. Assuming that consolidation of the administration into one agency -- is not likely to be functionally effective, we recommend that a formal and effective system of information exchange be introduced at the earliest opportunity. 6) Enterprise level environmental expenditure is promoted within the oblast environmental program. The most specific scheme of this type is known as the Economic Experiment in the Mining Sector and Metallurgy and it allows enterprises to withhold 70% of their due pollution charges in exchange for embarking on an environmental investment program. The experiment is part way through but it is expected that it will not be successful in achieving its environmental objectives. It appears that the revenue is being diverted into other expenditures and away from those agreed at the experiment's outset. We recommend that more resources are made available to better police the scheme though we recognize that the poor economic situation can prove a strong argument against effective intervention. 7) Evidence of formal environmental project and program appraisal is limited to those companies that seek finance from sources outside Ukraine. We recommend that such appraisal techniques be introduced to the OED in order to increase the efficiency of their expenditures. 54 Table 6.11: Efficiency of Environmental Expenditures in Donetsk Oblast Source of Expenditure Main Area of Expenditure Efficiency Issues Enterprise Air, Water, Waste Appraisal is rare; Re-allocation to non- environmental expenditures occurs and is hard to prevent National Fund Cross-boundary issues; Public good role where individual waste-water oblast authorities cannot agree division of expenditure. 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