By Vedant Monger and Priyadarshini Alok
The much-celebrated joint statement released during PM Narendra Modi’s state visit to the US briefly touched upon a commitment to decarbonise the transportation sector. Yet, a few weeks back, the Union government decided to substantially cut the purchase subsidy for electric two-wheelers. India must chart an optimal path for itself to drive the EV transition. Against this background, we critically examine here the purchase subsidy under the Faster Adoption and Manufacturing of Electric Vehicles (FAME) scheme from the lens of elementary public economics. We further propose a carefully designed carbon tax to simultaneously tackle vehicular pollution and promote the adoption of Evs.
Government intervention in a market must be adjudged on two grounds: the existence and the extent of a market failure, and the efficacy of the instrument it employs towards that end. The FAME subsidies are contestable on both counts.
Certain economic activities have spill-over effects on society, called ‘externalities,’ that are not reflected in their prices. Fossil fuel vehicles, for instance, impose social costs—the cost of premature deaths due to pollution, release of carbon emissions, etc. On the other hand, externalities are, at times, positive. These benefits tend to be under-priced in markets, which justifies a case for subsidising them. Knowledge spillovers from R&D are a classic example.
Contrary to the general (mis)conception, EVs do not create positive externalities—adoption of EVs avoids social costs but does not create spill-over benefits. The key for the electric mobility transition lies in addressing the negative externalities created by fossil fuel vehicles.
Subsidies are incompatible with limited fiscal resources—they entail an enormous fiscal burden upon the exchequer and the economy. The Union government alone spent Rs 5,200 crore in the EV subsidies apart from the states. States such as Delhi have offered subsidies worth Rs 100 crore. Subsidy competition among states leads to a zero-sum outcome at the cost of crucial welfare spending.
Unwarranted subsidies impose severe opportunity costs captured in the marginal cost of public funds (MCPF). The rationale is that had this spending been left untaxed, it would be better spent by other actors in the economy. In India, this figure is estimated to be about 3—every rupee spent by the government costs the economy three rupees. Based on this, the cost of Union subsidies alone would amount to about Rs 15,600 crore.
Moreover, the government has already employed a host of other measures to induce EV demand—income and corporate tax deductions besides the 5% GST rate on EVs against 28% of ICE vehicles. The EV subsidies perhaps make little difference to a consumer’s decision. Evidently, the share of EV’s was a minuscule 0.5% of total vehicle sales in 2021. Lastly, subsidies must have a reasonable redistribution objective—subsidies that were earlier devolved to lower-income households were slashed while car subsidies toward relatively well-off households continue.
The biggest negative effect, however, will be the creation of an uncertain policy environment. Automakers had earlier petitioned the Parliamentary Committee on Industry to examine withheld subsidy payments amounting to Rs 1,200 crore.
When subsidies cannot be doled out indefinitely, they are discontinued. A discontinuity in policy distorts market signals, especially when the government seeks to influence the price, for the price is the most fundamental information signal to market participants.
Clear policy signalling, on the other hand, anchors policy expectations, thus, allowing private actors to make calculated investment (supply-side) and purchasing (demand) decisions. For long-term decarbonisation specially, it is paramount that the government maintains a constant signal reflecting its intention to achieve the Net Zero target for 2070.
The development of the EV market would benefit from the imposition of a reasonable tax on the carbon content of fossil fuels. A carbon tax directly addresses the negative externality arising from vehicular fossil fuel combustion in addition to an inflow of revenues—a study by IMF estimated that a $70 carbon tax in India would generate revenues equal to about 3.5% of GDP while lowering emissions by about 42%.
As a market signal, a carbon tax conveys a clear signal to both EV and fossil fuel vehicle markets. It disincentivises the purchase of fossil fuel vehicles while portending a rise in prospective demand for EV manufacturers. However, as Edmund Burke remarked, “to tax and to please, no more than to love and be wise, is not given to men.”
Burke’s (read, political) concern can be addressed through intelligent tax design. An additional carbon tax would certainly impose burden on fossil-fuel consumers, though, it must be noted that the fossil fuel excise (about $15) already acts as an implicit carbon tax. The trick would be to convert the fossil fuel excise into a carbon tax such that revenue neutrality is maintained in the initial phase of the tax. By doing this, neither does the government forego revenues nor do consumers face additional burden.
To have an effect on emissions reduction, the government must go one step further by clearly indicating that the carbon tax would be gradually raised by a certain percentage/amount every year—it could be as minuscule as Rs 2 per year. Canada, for instance, implemented a law that would raise its carbon price by $15 annually. Alternatively, the government could reverse-engineer a pathway for the carbon tax based on a target price.
A glide pathway can be traced using modelling studies, already widely adopted by the NITI Aayog. Regardless of the mechanics, the key idea is to give a clear signal to markets—a gradual tightening of the tax would also avert the need to impose extreme and sudden measures such as bans.
The equitable nature of the tax must be adjudged on how the government distributes the tax. Toward that end, it could employ the proceeds toward supporting the transition of heavy-duty vehicles to adopt cleaner models (perhaps a subsidy makes more sense here), and toward creation of large-scale charging infrastructure. Studies have estimated that expenditure on charging station subsidies are twice effective as purchasing subsidies.
Alternatively, proceeds could be directed at lowering supply-side constraints for manufacturing. With a carbon tax and efficient spending directed at improving charging infrastructure and manufacturing issues, the government would effectively support markets to drive the electric mobility transition.
Authors are with Shakti Sustainable Energy Foundation
Views are personal