Designing fund transfers to local governments to incentivize ecosystem conservation and meet climate goals

Global biodiversity and climate goals are set collectively by national governments, but, in many countries, it is local governments that are responsible for environmental protection and the implementation of programs to meet targets. Similarly, the costs associated with conservation and climate action are often borne locally but with regional and global benefits. For example, as a part of the Paris Climate Agreement, India has committed to increase forest and tree cover to create an additional carbon sink of 2.5 to 3 billion tons of carbon dioxide equivalent. Meeting this commitment will require significant action by state governments, as forest management is largely under their jurisdiction.

One way to address this mismatch between costs and benefits is for federal governments to transfer funds to local governments to supplement costs associated with conservation and climate action. Transferring funds in proportion to the extent of natural ecosystems in a region can also provide an incentive to protect these ecosystems.

In India, states receive a portion of their budgets from the federal government based on criteria such as income, population, and geographical area. Recently, in 2015, the federal government added forest cover to this list. Under this new policy, states which have a high percentage of forest cover receive more funds.

It may be too soon to measure increases in forest cover, since forest recovery or restoration can take many years. To begin measuring success, researchers studied whether the new policy led to increased spending on conservation, since these changes can be measured in the short-run. Surprisingly, state governments did not allocate more funds for environmental protection in the years immediately following the new policy. According to the researchers, increasing awareness about the policy and making some changes to the policy design could incentivize higher environmental spending at the local level.

The design of ecological fiscal transfers

Ecological Fiscal Transfers (EFTs) are part of a larger system of fund transfers from the federal government to state governments in India. The federal government collects some taxes and shares them with states on the basis of rules which are reviewed every five years. Criteria such as income, population, and geographical area are used to decide how much of the total pool of funds each state is eligible to receive.

In 2015, forest cover was added as a criterion to this list, and 7.5 percent of the total pool of funds was recommended to be distributed among state governments on the basis of their forest cover. Areas with a canopy cover of more than 40 percent, categorized as ‘dense forests’, qualify for the transfer, and states receive an amount in proportion to their contribution to the country’s total dense forest cover. States are not, however, required to spend the funds they receive on conservation, and can use this amount for any purpose.

The experience with ecological fiscal transfers: 2015 - 2020

Between 2015 and 2018, approximately $7.4 billion was transferred each year to state governments on the basis of forest cover. States with a larger portion of country’s total dense forest cover received a higher amount. In a recent paper published in Environmental Research Communications, Jonah Busch, Avani Kapur, and Anit Mukherjee analyzed state budgets from 2013 to 2018 and found that in the years immediately following the new EFT, states did not allocate a higher proportion of the budget to the forestry sector. In fact, forestry budgets declined as a proportion of the total state budgets. While total state budgets increased by 42 percent between 2015 to 2018, forestry budgets only increased by 19 percent. Further, states which received the largest portion of EFT did not make a correspondingly higher allocation to their forestry budget. This implies that state governments did not immediately prioritize conservation, choosing to spend the additional amount that they received on the basis of their forest cover in other sectors.

Busch and his colleagues identified two key barriers which may explain why states did not increase budgetary allocations to the forestry sector even after the EFT. First, in 2015, the policy was based on the forest cover recorded in 2010/11, and local officials were not sure if subsequent transfers would reflect any increases in forest cover. This uncertainty was addressed in 2020, when the Finance Commission of India updated the transfer criterion to 2015/16 forest coverage, indicating that when a state increases its dense forest cover relative to other states, it qualifies for a higher amount of the transfer. Second, the researchers suggest that the amount of funding may have been insufficient to motivate states to prioritize forest conservation. This was also addressed to some extent in 2020, when the amount allocated for the EFT was increased from 7.5 percent to 10 percent of the total pool of funds.

Improving conservation outcomes

In a 2021 paper published in Climatic Change, Purnamita Dasgupta and Kavitha Srikanth argue that forest conservation outcomes might improve if funds were allocated to states on the basis of the ecological value of forests and not just on acres of dense forests protected. While there are several approaches to measuring the ecological value of an area, they suggest measuring the value of ecosystem services and products such as carbon sequestration, timber, and eco-tourism. Thus, unlike the current transfer mechanism which considers all dense forest area equal, Dasgupta and Srikanth recommend transferring larger amounts to areas with higher ecological value. This could create more incentives for ecological conservation and restoration.   

They also recommend making the transfer conditional on environmental spending by state governments. Currently, states can use the amount that is transferred to them for any purpose.

In fact, in 2009, when Surender Kumar and Shunsuke Managi first proposed an EFT for India in a paper in Environmental Economics, they suggested creating a mix of conditional and unconditional transfers. According to Kumar and Managi, conditional transfers, which are contingent on environmental spending, could be used to incentivize restorative or remedial action such as pollution abatement, while unconditional transfers, similar to the current EFT, could support preventative measures to keep ecosystems intact. 

Going forward, modifying the policy design to include a range of other socio-ecologically valuable ecosystems, home to unique and often understudied species, such as the Banni grasslands or the mangroves of the Sundarbans could be a more equitable way to reward conservation actions. States that don’t have the climatic conditions for high density forests could still create protected areas to preserve other types of ecosystems and should not be excluded from the EFT.

For example, in some regions of Brazil, where EFTs were initiated in 1991, similar transfers are made on the basis of protected areas rather than forest cover alone. In an evaluation of this policy published in Environmental Policy and Governance, Nils Droste, Guilherme Lima, Peter May, and Irene Ring found that the extent of protected areas increased after the introduction of the EFT, between 1991 and 2009. They also found that local governments with higher average incomes were more likely to have protected areas, suggesting that the environment becomes a local policy priority only once a certain level of economic growth has been achieved.

There is a similar tension between current development models and conservation objectives in India. Given the urgency of the global biodiversity and climate crises, the EFT could present a small but significant step towards valuing natural ecosystems for their role in supporting human well-being and creating incentives to conserve them. However, the EFT should not be reduced to a symbolic gesture. Funding should match the scale of the environmental challenges that state governments face, and transfers should be designed to create incentives for conservation, climate action, and local environmental goals while also ensuring fiscal accountability.