The Nexus between fiscal policy and sustainable development: Insights for developing countries from the case of Chile

Abstract

This paper hypothesizes that fiscal policy is one important factor determining whether or not environmentally and socially sustainable economic growth is possible. We postulate that tax policies affect the incentives to make the economy more or less dependent on natural resources and the environment as factors of production. So-called pro-growth tax policies consisting on a low tax burden, low direct taxes but high indirect ones, affect the composition of factor endowment, often inducing over investment in physical capital and under investment in human capital including education and health. These policies in part explain a structure of production heavily dependent on natural resource-based and environmentally-dirty industries. Also, these tax policies induce high levels of inequality that ultimately may render economic growth socially and politically unsustainable. This analysis has important implications for Chile and other developing countries especially in Latin America which are highly dependent on natural resources and have unequal income distribution.