By Rajnish Gupta & Shalini Mathur
The rise in global temperatures and the resultant climate change are now at the centre stage of public policy debate. Governments, businesses, and communities are pledging to take action to reduce emissions. Broadly, there are two types of instruments available to policymakers for bringing about changes in consumption and production practices in an economy.
First are the traditional regulatory approaches (sometimes referred to as command-and-control approaches) that set specific standards across polluters or mandate the usage of cleaner fuels. Mandatory purchase of renewable energy, mandatory usage of CNG vehicles, or setting emission standards are examples of these. The Indian government, so far, has primarily followed this approach.
The second option is around deploying economic incentives or fiscal tools that rely on market forces to incentivise changes in production and consumption behaviour. From an economic standpoint, emissions are a “negative externality” i.e. costs from generating emissions are not reflected in the costs incurred by the producers of goods or paid for by the buyers. The impact is felt outside the markets and within the society at large. A carbon price applied directly or implicitly to carbon emissions ensures that the negative externality gets reflected in the costs and prices of goods using inputs with a high emission footprint. Businesses that seek to maximise profits respond to high input prices by finding ways of limiting the use of such inputs and reducing the production of products causing greenhouse gas emissions.
Explicit price of carbon emissions can be achieved both through carbon trading schemes and carbon taxes. In a carbon trading scheme, the government sets a cap for the level of permissible emissions and then gives emission allowances to entities where the total allowances equal the cap. Entities can buy and sell these allowances based on their needs and the secondary market reveals the cost of emissions. Therefore, like carbon taxes, carbon trading schemes also provide a transparent and tangible cost of carbon emissions. However, prices for carbon trading can often be volatile as they are driven by forces of supply and demand. In contrast, carbon taxes provide greater certainty to businesses regarding the price that must be paid for emissions. Certainty in pricing helps players make better decisions about technology and usage choices.
Globally, countries are employing a variety of fiscal tools to incentivise reduction in emissions. According to the EY Green Tax Tracker there are more than 1,800 global sustainability incentives, 80 carbon pricing initiatives, and 2,600 environmental taxes in effect in 45 of the largest jurisdictions. In India, in addition to command and control policies, incentives have been deployed as a policy tool to drive change. Extra FSI being provided under GRIHA scheme, demand subsidies on EVs, waiving of certain charges for transmission of green energy PLIs for advanced chemistry cell battery storage and solar panels, etc are all examples of usage of fiscal incentives.
However, there is no emission trading scheme or an explicit carbon tax in India, in contrast to the EU. The coal cess of `400/tonne and a high level of taxation on petrol and diesel are examples of an implicit carbon tax. Currently, effective tax on petrol and diesel is in excess of 100%, in contrast to the general 18% tax on most fuels subject to GST. However, India does not have an explicit carbon tax. Also, clean fuels like natural gas continue to be outside the ambit of GST, thereby impacting its competitiveness as a fuel and India’s ability to reduce emissions. Thus, even though some of the levies are in the nature of a carbon tax, the overall taxation structure in India is not designed to provide incentives to reduce emissions.
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 CO2 emissions in any one country would be felt all over the world and disproportionately higher in more vulnerable countries.
Thus, imposition of a carbon price by just one country could end up hurting its economy if the rest of the world does not follow suit.
The recent EU Carbon Border Adjustment Mechanism (CBAM) has been designed in this context.It proposes that imports of certain products such as steel, aluminium, cement, fertiliser etc will attract an additional levy if carbon prices equivalent to that paid by manufacturers in EU are not paid in the country of origin. The levy would be computed based on the emission generated for producing the product and the prevailing carbon price in EU. Once implemented, application of carbon prices and taxation could start impacting trade and put pressure on countries to have their own carbon pricing mechanisms.
The decision to impose carbon price has challenges, as governments need to balance economic progress and provide higher standards of living for their citizens, while ensuring lower emissions. Economic growth entails increased usage of energy. There is a trade-off between ensuring reduced emissions through carbon pricing and increased economic activity through availability of cheap and abundant energy. In case of carbon tax, there is also an issue of them being regressive as it is passed on to the consumer through the supply chain. Thus, there have been instances where carbon taxes were unpopular, as was the case in Australia. At the same time, countries like Finland have been successful in implementing a carbon tax.
Carbon pricing is assuming greater significance and some of the Indian businesses conscious of climate impact are already applying internal carbon pricing in their decision making. A proper and a clear long-term policy on how carbon emissions would be priced will provide greater guidance on reducing emissions.
(The authors are respectively, associate partner and director, tax and economic policy group, EY India)