Fossil Taxes Funding India’s Decarbonisation: An Impact Analysis

Executive Summary

Context and Objectives

India faces a dual challenge: sustaining economic growth while meeting ambitious climate goals. With updated Nationally Determined Contributions (NDCs) and a 2070 Net-Zero pledge, the country must mobilise significant domestic climate finance. Fossil fuel taxation may emerge as an important policy tool.

The fossil taxes contribute approximately one-third to the indirect tax revenue collections in India. Given the significant amount of revenues generated by taxes/duties on fossil fuels, and India’s massive need for climate finance, some of these revenues may emerge as an important source of domestic climate finance.

This study asks: What if India redirected some part of fossil fuel taxes back into decarbonisation investments? Specifically, it examines funding energy-efficiency technologies in hard-to-abate (HTA) sectors, i.e., cement, iron and steel, aluminium, and building renewable energy (RE) transmission systems to meet the 500 gigawatt (GW) non-fossil-fuel-based energy target by 2030.

Objectives of the study:

1. Estimate the investment requirements for industrial decarbonisation and renewable power infrastructure.
2. Assess economic, environmental, and social impacts of redirecting fossil fuel-based tax revenues into green uses.

Methodology

The study uses an Environmentally-extended Social Accounting Matrix (ESAM) for 2019–2020, covering 45 economic sectors (including HTA industries, thermal power, and renewables) and 318 labour categories. This model captures how investments in one area ripple through the economy, affecting production, emissions, and household incomes.

Three scenarios are modelled:

• Scenario 1 (S1)—Energy Efficiency (EE): All funds invested in EE technologies in HTA sectors.
• Scenario 2 (S2)—RE: All funds invested in RE transmission systems.
• Scenario 3 (S3)—Combined: Funds split between EE and RE transmission.

Impacts on Gross Value Added (GVA), Gross Domestic Product (GDP), emissions intensity, and household income distribution are compared with baseline outcomes.

Revenues and Investment Requirements

Revenue Availability:

• To finance both EE technologies in the HTA sectors and the RE transmission system, around ₹75,166 crore annually is required.
• In light of the recent Goods and Services Tax (GST) 2.0 reforms (September 2025), which discontinued the Compensation Cess, the excess revenue collection from the increased GST rate on coal is estimated at ₹16,949 crore (based on Financial Year (FY) 2023–2024 figures).
• Finance from oil and gas taxes: approximately ₹58,217 crore (8.7% of collections).

Investment Needs:

• EE in HTA sectors: As per existing studies, approximately ₹1.32 lakh crore of cumulative capital expenditure (Capex) is required (Iron and steel: ₹76,479 crore; Aluminium: ₹32,499 crore; Cement: ₹22,650 crore). [1]
• Renewable transmission system: As per Central Electricity Authority (CEA) (2022) Capex of around ₹2.44 lakh crore [2] by 2030.

Observation: The redirected funds could finance a substantial portion of HTA efficiency upgrades or accelerate renewable grid expansion, but fall short of total requirements.

Results

Economic Impacts

• All scenarios boost GDP, GVA, and output by stimulating demand for machinery, construction, and services.
• S2 (RE investments) delivers the highest GDP growth, followed by S3 and then S1.
• This is driven by the high spillover effects in S2, followed by S3 and S1 in sectors like construction, machinery, agriculture, food and beverages, and services (accounting for around 60% of production activity).
• Using existing taxes (rather than new levies or debt) makes this a fiscally neutral green growth strategy.

Environmental Impacts

• S2 yields the largest decline in emissions intensity, which is largely because almost 40% of emissions in the country are from electricity production and redirecting funds could reduce the grid’s emissions factor.
• S1 reduces emissions in the HTA sectors through lower energy use, but with narrower system-wide benefits.
• S3 balances both approaches, with a decline in emission intensity lower than S2, but higher than in S1.

Social and Distributional Impacts

• Household incomes rise in all scenarios due to job creation and higher factor demand.
• S2 is the most equitable for:
  • Rural households: Lower-income quintiles gain relatively more, showing a progressive impact.
  • Urban households: Only S2 shows progressive results; S1 and S3 display mild regressivity (benefits tilt toward higher-income groups).
• In summary, S2 achieves a “triple dividend”: growth, emissions reduction, and social equity.

Conclusion

Redirecting some fossil fuel taxes represents a strategic opportunity for India, as these funds could:

• Finance green investments in HTA sectors and RE infrastructure.
• Boost GDP and employment, creating a green growth trajectory.
• Cut emissions intensity, advancing India toward its NDC and Net-Zero targets.
• Improve social equity, particularly in rural households, when invested in RE systems.

The study demonstrates that this reallocation can generate a triple dividend, i.e., economic, environmental, and social, aligning fiscal policy with the nation’s climate commitments and sustainable development goals.

Policy Recommendations

• Leverage fossil fuel tax revenues:
  • Allocate additional GST collected from replacing the GST compensation cess on coal with an increased GST rate toward financing the decarbonisation measures
  • Allocate part of Special Additional Excise Duty (SAED) and Road & Infrastructure Cess (on petrol and diesel) toward climate finance.
  • These levies already generate large revenues; earmarking a small share avoids introducing new taxes.
• Prioritise RE infrastructure:
  • Evidence from S2 shows grid investment yields the highest economic, environmental, and social returns.
  • Building RE transmission enables scaling up to 500 GW of non-fossil energy capacity by 2030.
• Ensure transparency and accountability:
  • Revive or establish a dedicated Clean Energy Fund with strict reporting on collections, disbursements, and project outcomes.
  • Prevent underutilisation of funds, which plagued the original Clean Environment Cess (CEC), where over 60% of collections remained unused.

Qualification and Future Research

• Static Analysis: ESAM framework provides a comparative static analysis, capturing immediate structural dependencies and not dynamic adjustment paths.
• Future Research: Incorporate dynamic modelling and expand beyond fossil fuel tax revenue reallocation to explore broader fiscal mechanisms for decarbonisation.