By Renu Kohli, Deepthi Swamy & Varun Agarwal
Climate change has pushed the global economy to a turning point. The world’s energy supply, industry and transportation systems, still largely dependent on fossil fuels, will undergo a massive transformation over the next three decades as countries strive to reduce greenhouse gas emissions to combat climate change. In November 2021, India also announced its goal of achieving net zero emissions by 2070 at the 26th Conference of Parties (COP-26). The required low-carbon development trajectory to achieve this goal implies profound structural change in the economy, according to our analysis. For example, by 2050 at least three quarters of India’s electricity should be generated from fossil-free sources, compared to less than a quarter now. The share of electricity and green hydrogen in the Indian industry’s fuel mix should now increase by more than 50%, from less than a sixth. In transport, all two- and three-wheelers, three quarters of the total number of buses and cars and at least half of the total trucks sold, should be powered by electricity or hydrogen by 2050, compared to today’s one fortieth of total vehicle sales.
Undoubtedly, the transition from fossil fuels offers opportunities and benefits, including a significant reduction in oil import dependency, better human health through reduced particulate matter pollution, and an economy-wide cost savings of as much as Rs 60 trillion ($877). billion) by 2050 compared to a business-as-usual transition rate. At the same time, it also poses challenges, one potentially crucial one being fiscal. In the dynamics of the energy transition, this may have received less policy attention than the exceptional and high government revenue dependence of fossil fuel taxes indicates. A gradual decline in fuel revenues over time, however gradual, could be a serious drag on public finances during the transition.
Fossil fuels, primarily petroleum products, are well-known and prominent contributors to both central and state government revenues. The Prayas Energy Group estimates the share of energy taxes in central government revenues at about 25% in FY20, rising to an astonishing 35% in FY21; taxes on petroleum products collected more than three quarters of energy revenues. The transition away from fossil fuels, mainly driven by substitution in the transport sector that could lead to almost two-thirds reductions in projected consumption of petroleum products by 2050, thus implies significant losses in government revenues. Our analysis, based on the current tax structure and assuming a decarbonisation trajectory in line with our climate goals, shows a reduction in fuel revenues of 16 trillion ($234 billion) by 2050 (relative to business-as-usual), or 1, 8% of projected GDP in that year.
In addition to these projected losses, fuel revenues are also subject to numerous uncertainties; in particular, the pace of transition in the private sector (which is not under government control and wholly driven by market forces), and relative price changes, among other competitiveness reasons. Companies, especially those with heavy reliance on fossil fuels and external exposure, are more likely to respond to the pressure than delay energy and technology transitions; The mobility and transport choices of households will also be determined by the evolution of technology and purchasing costs. Innovation shocks and unexpected surprises in both directions cannot be ruled out in a context of global turn to solve climate-related problems.
Public finance management is therefore likely to face multiple challenges. It is exacerbated by the timing of the energy transition, which has coincided with an exceptionally weakened financial position that predates the pandemic and its exacerbation. A wider budget deficit and increased government debt have tightened the government bond belt. Then, in addition to the expected losses in fuel revenues, there is the increasing need for transition-related government spending; this would exceed the usual budgetary demands of education, health care and social security. Such spending includes public investment in low-carbon technologies, supporting infrastructure, research and transfers to protect the most vulnerable households from the effects of the transition.
Financial constraints will not only weigh down productive spending that exerts a strong multiplier on labor and capital, but potentially slow or hinder the climate transition. Both outcomes are undesirable. Our analysis identifies a critical role for government spending multipliers, which, when combined with growth in green sectors such as clean electricity and hydrogen production, outweigh the shrinkage in the brown or carbon-intensive sectors and result in net increases in GDP and employment compared to a corporate sector. as usual scenario.
All of these forces underscore the need to explore alternative income options. Carbon pricing plays a central role in every country’s climate mitigation plans. It is no different in India and the current fuel taxes are a good starting point. It’s good to think of some of this as carbon taxes. Tax planning can adjust and refine it over time and in different scenarios to maintain or increase revenue; a dynamic mix can also be designed that encompasses all emission-causing fossil fuel applications to drive a gradual shift. Electricity taxes can be tapped as a long-term gradual replacement – demand for electricity is expected to exceed conventional rises in living standards due to greater electrification in industry and transportation. On the direct tax side, the increase in personal and/or corporate income tax rates is determined by both structural and cyclical factors. Potentially higher economic growth (compared to business as usual) resulting from the transition to a low-carbon economy could improve direct tax revenues in the long run.
These examples are limited to illustrate that, under different transition scenarios, fiscal planning should start at least at the beginning, taking into account expected and unexpected shocks. It is also necessary to ensure that the potential regressive effects of indirect taxes, for example the impact on energy prices for the poor, are avoided through careful evaluation and design. Analyzing all these challenges and available options, quantifying them under different scenarios, and putting them up for public debate for further enrichment are useful steps forward.
(Kohli is an economist who has previously worked with the IMF & RBI. Swamy & Agarwal are lead and senior project officer respectively, Climate Program, World Resources Institute, India. Opinions are personal.)
