Compensating for the Fiscal Loss in India’s Energy Transition
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The global shift from fossil fuels to renewable energy sources is transforming energy production and consumption worldwide. As countries intensify their efforts to combat climate change and reduce greenhouse gas emissions, the transition to clean energy is gaining momentum. India has committed to ambitious targets, aiming to achieve net-zero emissions by 2070, aligning itself with this global shift. However, this transition away from fossil fuels presents significant fiscal and institutional challenges that warrant careful examination.
This study primarily explores the dynamics of tax revenues and the fiscal implications of India’s transition. As fossil fuel consumption declines over time, government revenues generated from fossil fuels are also expected to decrease relative to GDP. This scenario demands a sense of urgency due to India’s ongoing efforts to reduce its reliance on fossil fuels.
The research examines the institutional challenges related to enhancing existing tax systems and considers the viability of implementing a carbon tax as an alternative revenue source to replace fossil fuel taxes. The study assesses various tax revenue options, evaluating their effectiveness in revenue generation, longterm sustainability, required institutional changes, and the preservation of state autonomy. Allocating revenue between the Union and individual States can be intricate, given that States have limited revenue sources that provide them with substantial autonomy.
The study highlights the potential of carbon taxes as a valuable medium-term solution to address revenue loss. However, it also underscores the challenges associated with their implementation, including institutional barriers and political-economic complexities, particularly within India’s fiscal-federal structure. Active engagement from institutions like the Finance Commission and the GST Council is emphasised, recognising their critical roles in managing this transition and mitigating its impact on state-level fiscal autonomy.
The study argues for the need to consider multiple factors, including efficiency, equity, sustainability, institutional considerations, and the possibility of reducing expenditures on non-essential goods. This recognition underscores the importance of further research in this area, as India navigates the intricate landscape of fiscal and environmental policy changes.
Q&A with the authors
What is the core message conveyed in your paper?
Energy transition will play a pivotal role in achieving the Net Zero target laid by India which is to be achieved by 2070. This transition will lead to a considerable decline in government revenues which will present a significant fiscal challenge for both the Union and the State governments. This paper primarily assesses various taxation options that India may explore to compensate for the potential loss in revenues from fossils while examining the institutional challenges related to the existing tax systems and the viability of implementing such alternative taxes. Carbon taxes can be considered as a medium-term solution to this problem and thus, various tax bases for this fiscal tool have been explored in this study. Further, the need to examine multiple factors for assessing taxation options such as effectiveness in revenue generation, long-term sustainability, and requirement of institutional changes while preserving the State’s autonomy have also been discussed.
What presents the biggest opportunity?
The study finds that certain tax options have the potential to address the fiscal challenge posed by energy transition, but also have the associated implementation and institutional challenges which need due consideration. Carbon pricing instruments such as emissions taxes and carbon credit trading mechanisms can be considered as an opportunity for restructuring the existing tax system which was fossils driven to an emissions-based system. This will have a dual impact on revenue generation and emissions reduction, thus furthering the goal of energy transition. Innovative options such as distance-based taxes, and electricity duties could provide interesting possibilities, albeit presenting some institutional challenges.
What is the biggest challenge?
One major challenge is institutional barriers and political-economic complexities, particularly within India’s fiscal-federal structure in introducing new taxes or amending the existing ones. Despite the existence of various direct and indirect taxes, there are limited avenues for rapidly increasing revenues from direct taxes, and they are unlikely to yield the desired results. Considering India’s federal nature of taxation and related mechanisms in the case of indirect taxes, the likelihood of rationalising Goods and Services Tax (GST) rates or inclusion of additional items while preserving States’ autonomy, does not appear likely either in the near term. The identification and assessment of various taxation options along with their institutional challenges in this study can be used by policymakers to address the potential fiscal challenge of transitioning away from fossil fuels.
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The Centre for Social and Economic Progress (CSEP) is an independent, public policy think tank with a mandate to conduct research and analysis on critical issues facing India and the world and help shape policies that advance sustainable growth and development.