This article is written by Krithajnya Raghunathan, pursuing Certificate Course in Advanced Corporate Taxation from LawSikho. The article has been edited by Zigishu Singh (Associate, LawSikho) and Ruchika Mohapatra (Associate, LawSikho).
Climate change is a cause for global concern and could have devastating effects on the planet if serious mitigation efforts are not undertaken. Forecasts have determined that if the planet becomes warmer by a mere 2°C, there could be unprecedented heat waves, intense storms and widespread food shortages. To avoid reaching this threshold, it is essential that there are zero net carbon emissions by the end of the century; carbon taxes are one of the mechanisms for achieving this target.
In simple words, a carbon tax is a tax on carbon emission. The purpose of a carbon tax is to reduce carbon emissions by sending a price signal to emitters to incentivize them to eschew carbon-intensive production and consumption. The revenue collected by governments as carbon tax can then be used to further reduce emissions by channelising such funds to invest in green technology, renewable energy sources, research on emission reduction, etc.
An important feature of carbon taxes is that they place the external costs of carbon emissions—such as loss of land due to rising sea levels, the damage to crops caused by changing rainfall patterns and the healthcare costs associated with heatwaves and droughts—on the polluter and not on the public. Carbon taxes hence serve to capture the costs associated with negative externalities of carbon emissions within their ambit. Carbon taxes need not necessarily be levied only on carbon emissions; they could also take the form of taxes on the use of fossil fuels such as petroleum and coal. This article aims to examine the impacts of carbon taxes on India.
A brief analysis of carbon tax in the world
Several countries around the globe have implemented various types of carbon pricing mechanisms (carbon pricing mechanisms are mechanisms that place a price on carbon emission). According to the United Nations, 23 of these countries have implemented carbon taxes, primarily at the national level. Countries began adopting carbon taxes in the early 1990s—Finland introduced a carbon tax in 1990; Norway and Sweden in 1991; and Denmark in 1992. Over the decades, carbon taxes were introduced not just in developed economies, but also in emerging economies (for example, Chile and South Africa have introduced carbon taxes). Carbon taxes vary in their mechanism and rates in every country and are increasingly being adopted by countries not only in pursuance of mitigating the effects of climate change but also as a means to avoid being penalised by the international community.
The carbon tax regime in India
According to the Global Climate Risk Index 2021, India is among the 10 countries most affected by extreme weather caused by climate change. As a developing country, it is of paramount importance that carbon emissions are brought to the lowest level possible. While India is one of the few countries on track to achieve its targets for emission reduction under the Paris Agreement, it is essential that further efforts are taken to bolster it against climate change.
Currently, India does not have a uniform system of carbon taxation across the country; however, state governments have imposed their own taxes to capture the costs of negative externalities—such as the Green Cess implemented in Goa and the Eco Tax on vehicles entering Mussoorie. Further, while the Government of India (GOI) has not implemented an explicit carbon tax, it has in the past introduced measures to capture the costs of negative externalities.
One measure introduced by the GOI in 2010 was the Clean Energy Cess which aimed to incentivize the use of clean fuels by increasing the cost of consuming coal and using a portion of the revenue collected to fund research and clean energy projects. However, with the introduction of Goods and Services Tax (GST) in 2017, the Clean Energy Cess was abolished; in its place, a Compensation Cess on coal production at Rs.400 per tonne was introduced.
The Compensation Cess introduced is to have force until 2022. However, it taxes only the usage of coal and not the quantum of carbon emission from the usage of coal. This creates a two-fold problem:
1. It does not serve to reduce the amount of coal used and therefore the amount of carbon emitted, and
2. It penalizes taxpayers even if they choose to use cleaner variants of coal.
The system of carbon taxation in India is currently rudimentary at best. Further, it is not a progressive system of taxation. Not only does this have an impact on the economy of the country in terms of the external costs of carbon not being adequately captured, but it has the potential to affect India’s international trade.
The European Union (EU) announced that it plans to introduce a “Carbon Border Adjusted Mechanism” (CBAM) which would tax carbon-emitting goods which enter the EU at the borders. At present, it is cheaper to import certain goods from outside the EU than use domestically manufactured goods; the CBAM hence aims to resolve this issue by bridging the gap between the prices of imported and domestic goods. As a part of the rollout strategy for the CBAM, a reporting system is to apply from 2023 and importers would need to start paying financial adjustments by 2026. The CBAM would be detrimental to India’s interests and India has been vocal about its displeasure.
From an international trade perspective, India would not have enough bargaining power to combat policies such as the CBAM which would be injurious to its interests as it does not have a domestic carbon pricing mechanism in place. With the dangers of climate change looming over the planet, it can be expected that many more countries would implement such mechanisms. Mechanisms such as adopting a carbon tax would not only portray to the international community that India is serious about its emission reduction targets but also gradually help reduce carbon emissions and thereby reduce the impact of measures such as the CBAM on its exports.
Utility of carbon taxes
Carbon taxes have several utilities as laid down below:
- Carbon taxes discourage the consumption of highly emissive materials/sources of energy and incentivize the use of renewable sources of energy. By making highly emissive inputs more expensive, such taxes would provide an impetus to firms to search for greener inputs.
- Carbon taxes place the external costs of carbon emission on the polluter and not on the public. This forces polluters to use means of production which are less emissive and more environmentally friendly. Further, they also enable the government to collect revenue which can then be used to mitigate any potential disasters caused by climate change.
- If a maximum limit of emissions is set, beyond which such emissions would be taxable, carbon taxes could be a progressive system of taxation. Further, by taxing emissions and not the use of fossil fuels which are essential to economically disadvantaged persons, a carbon tax system would benefit the country without harming the very individuals it seeks to protect.
- From an international trade perspective, India would protect itself from being ostracised or penalised for not imposing a carbon tax. Further, India would be able to bolster itself from any adverse impacts on its exports.
Disadvantages of carbon taxes
While carbon taxes have many utilities, they also have several disadvantages:
- Carbon tax systems could have an adverse impact on the economy if they are not tailor-made for it. If the system is not suited to the needs of the economy, it could result in harsh burdens upon economically disadvantaged persons. A strategy for implementing such a mechanism hence needs to be carefully considered and meticulously implemented.
- The production of many essential commodities results in carbon emissions. If a carbon tax is imposed on emissions, it could make such essential commodities more expensive and thereby ultimately burden consumers. This is extremely problematic for a country like India where large sections of the population cannot afford to pay an increased price for such commodities.
- To avoid paying carbon taxes, firms could hide their true levels of carbon emissions which would mask the extent of the issue. If governments were not to rely on voluntary disclosure and were to instead inspect the emissions of firms, it would require manpower and infrastructure which could be time-consuming and expensive to establish.
Carbon taxes are a useful mechanism for reducing carbon emissions and fighting against climate change. It is becoming increasingly important from an international perspective for countries to introduce carbon pricing mechanisms. Carbon taxes not only capture the costs of negative externalities but would also incentivise and encourage firms to switch to cleaner and greener means of production which would be beneficial to both the environment and the economy. Hence, it would be advantageous if such a tax were introduced in India. However, it must be kept in mind that such a system must be established after considering the specific needs of the Indian economy.
- Eckstein, D., Kunzel, V., & Schafer, L. (2021). Global Climate Risk Index: Who Suffers Most From Extreme Weather? GERMANWATCH. Retrieved October 11, 2021, from https://germanwatch.org/sites/default/files/Global%20Climate%20Risk%20Index%202021_2.pdf
- Ojha, V. P., & Pohit, S. (2020, September 4). Controlling emissions: Explicit carbon taxation is needed, indirect taxation doesn’t help. Financial Express. Retrieved October 16, 2021, from https://www.financialexpress.com/opinion/controlling-emissions-explicit-carbon-taxation-needed-indirect-taxation-doesnt-help/2074347/
- Sawhney, A. (2021, July 15). Carbon Tax – An Indian Perspective. Vidhi Centre for Legal Policy. Retrieved July 18, 2021, from https://vidhilegalpolicy.in/blog/carbon-tax-an-indian-perspective/
- The World Bank. (n.d.). Pricing Carbon. Retrieved October 19, 2021, from https://www.worldbank.org/en/programs/pricing-carbon#WhyCarbonPricing
- United Nations Climate Change. (n.d.). About Carbon Pricing. Retrieved October 10, 2021, from https://unfccc.int/about-us/regional-collaboration-centres/the-ci-aca-initiative/about-carbon-pricing#eq-7
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