Can a carbon tax drive decarbonization and sustainability agenda?

We examine if carbon taxes are the right option for India to limit climate change impact.

The rise in global temperatures and the resultant climate change are now at the center stage of public policy debates. Governments, businesses and communities are pledging to take action to reduce emissions. At the recent G20 Finance Ministers’ meet on 9-10 July, 2021, all participants concurred that tackling climate change remains an urgent priority compared to other threats to growth and prosperity. The tools suggested for the effective policy mix for sustainable development included green investments in sustainable infrastructure, innovative technologies that promote decarbonization and carbon pricing to support clean energy sources.

There are many features that make carbon taxes an attractive potential public policy instrument in India. It is possible to cover all sources of emissions through a well-designed carbon tax i.e., upto 100% of the emissions. In contrast, command and control type of regulations (e.g. green building code) apply only to a part of the emissions i.e., only the sectors for which the scheme has been designed.  The implementation of command and control regulations/ schemes have their own challenges.

As per the International Monetary Fund IMF, depending upon their level of ambition, energy mixes, and different starting points, reaching the emissions abatement objectives defined in NDCs requires measures equivalent to carbon price increases of US$25-75/tCO2 or more by 2030 in many G20 countries. For India, a carbon price of US$25 per tonne of CO2 in 2030 will help reduce emissions by about 25%.  For achieving its commitment of reducing emissions intensity of GDP by 33-35% by 2030 over 2005 levels, a higher carbon price may be needed.

Carbon taxes could also be a significant source of revenues for governments seeking to increase the tax to GDP ratio. Assuming annual emissions of 2.0 billion metric tonnes of carbon dioxide per annum, a carbon tax of Rs 1000/ tonne of CO2 (approx. US$15 per tonne) could help the government raise potentially Rs 200,000 crores of taxes annually.  This could be attractive, particularly when considering the impact of COVID on public finances.

The decision to impose explicit carbon taxes can have challenges too since governments need to balance economic progress and provide higher standards of living for their citizens, with ensuring lower emissions. Economic growth entails increased usage of energy. There is a trade-off between ensuring reduced emissions through carbon taxes and increased economic activity through availability of cheap and abundant energy. There is an element of the tax being regressive as it is passed on to the consumer through the supply chain. For this reason, there have been instances where carbon taxes were unpopular, as was the case in Australia^[2]. At the same time, countries like Finland^[3] have been successful in implementing a carbon tax. Thus, the right carbon tax design is important for achieving the balance between effective carbon pricing and growth. 

It may be noted that no country can solve the problem of emissions unilaterally. The current approach has been for countries that are signatories to the Paris accord to develop their individual plans for reducing emissions. The effects of carbon emissions in any one country would be felt all over the world, and disproportionately higher in more vulnerable countries.  Thus, imposition of a carbon tax by just one country could end up hurting the economy of that country, if the rest of the world does not follow suit. 

EU has proposed a new Carbon Border Tax by way of an additional levy on imports of steel, aluminium, cement, electricity and fertiliser, if carbon prices equivalent to that paid by manufacturers in EU are not paid in the country of origin. This proposal indicates that application of carbon prices and taxation could start impacting trade and put pressure on countries to have their own carbon pricing mechanisms.