Taxation Alternatives for India’s Energy Transition – ESAM Analysis

Executive Summary

India has pledged to achieve net zero by 2070, which requires a reduction in CO₂ emissions and a shift towards clean energy. However, this shift will have fiscal implications, as revenue generated by fossil fuels (both tax and non-tax revenue in 2019–20) accounts for 3.2% of India’s GDP. This calls for the need to not only find alternative tax options to compensate for potential loss in revenues but also examine how these tax alternatives will impact economic efficiency, emissions intensity, and equity (E3). This study addresses the critical question of how the replacement of existing fossil fuel taxes with various indirect tax options will influence E3.

While previous research has explored the potential impacts of introducing new eco-taxes, this study introduces a novel perspective by evaluating the effects of replacing existing fossil fuel taxes with alternative taxation strategies, particularly within the unique context of India.

This paper uses the aggregated version of the Environmentally-extended Social Accounting Matrix (ESAM) for India 2019–20, where labour has been aggregated into 32 categories and households into 40 categories. The study has substantially altered the multiplier model and the price vector model. Using these methods, we estimate the potential impacts of replacing existing fossil fuel taxes with seven different tax options, which can be categorised under three sub-heads—Carbon Taxes (CT), User Taxes (UT), and Goods and Services Taxes (GST). These scenarios have been explained below.

The study finds that the restructuring of fossil fuel taxes will impact the welfare of households by marginally impacting their tax burden. The incidence is mildly regressive in almost all the scenarios, except in the case of the distance travelled tax and a combination of electricity and distance travelled tax. The macroeconomic and environmental impacts of these taxes vary across scenarios.

We find three key results. First, a carbon tax on coal emissions has positive impacts on real GDP and reduces emissions. However, it is regressive. Moreover, a carbon tax on coal would only hasten the transition process but not address the long-term fiscal challenge. Second, user taxes (scenarios 5 and 6) may be difficult to levy institutionally and are mild to strongly progressive. However, they are likely to have a strong adverse impact on real GDP and emissions. Third, a proportionate increase in GST results in a strong negative impact on emissions and mild impacts on equity and real GDP.

We can conclude there exists a trade-off in all these scenarios. In the medium term, fossil fuel taxes can be replaced with a carbon tax on emissions from coal; however, this will negatively impact equity. In the long run, replacing fossil fuel taxes with user taxes will negatively impact real GDP, whereas if a proportionate increase in the GST replaces fossil fuel taxes, then this will impact equity. The regressivity concerns can be addressed by providing revenue transfers from the State to the lowest quintiles and can be examined in future studies.

All these taxation alternatives will involve concerns related to institutionalising these in the Indian context, which often involves political economy concerns and addressing structural changes, which are dynamic challenges and hence will require further investigation. There will be intrinsic costs involved in choosing each of these alternatives, which is difficult to factor into the model simulations.

In the media:

Carbon tax best solution to make up for revenue loss from fossil fuel transition, says CSEP study