By Janak Raj, Valbha Shakya, & Kritima Bhapta

India needs large financing to meet the climate goals set out in its nationally determined contributions document. Various estimates for India have placed climate finance requirements at $160-288 billion (Rs 12.6-22.63 trillion) per year till 2030. India would need to raise a large part of it on its own. India received less than $8 billion in 2023 for climate finance from official external sources (largely multilateral development banks).

The governments (Centre and states) will have a key role to play in providing climate finance. However, there is hardly any fiscal space at the general government level with the debt-GDP ratio soaring from 70.4% in 2018-19 to 82% in 2023-24 (due to the large pandemic related expenditure). The government tax-GDP ratio has not shown any significant improvement, ranging in a narrow range between 16%and 17.5% in last 12 years. So there is a need to explore all other options to raise resources.

One possible source of revenue could be carbon pricing (carbon taxes and emission trading system or ETS), which has been gaining traction in many other countries. It has become all the more necessary due to the European Union’s (EU) cross-border tax mechanism (CBAM) that will become effective from January 1, 2026.

The EU-CBAM is ostensibly a tool designed to mitigate the risk of carbon leakage (relocation of production facilities in countries with less stringent carbon emission norms) by imposing a carbon price on six products (cement, iron and steel, aluminium, fertilisers, electricity, and hydrogen) entering EU markets based on their embedded emissions. In India, the impact will be felt largely on its exports of iron and steel (28.3% of its total steel exports go to the EU) and aluminium (27.2%) for their carbon emissions as they largely rely on coal-fired power plants for energy requirements.

In the absence of a carbon pricing mechanism at home, carbon tariffs will be required to be paid to the EU, estimated at over €1 billion (for direct emissions) a year. What is worrying is that a similar mechanism is being considered by other countries such as the US, the UK, Japan, Canada, and Australia.

What is the potential revenue that the government could raise, should it decide to introduce carbon pricing? Let’s first focus on select fossil fuels which are already taxed. Average taxes (based on Delhi, Mumbai, Kolkata, and Chennai) constituted 70% of the base price on motor spirit (MS) and 54% on high-speed diesel (HSD) in 2023. These taxes are a significant source of revenue (15.1% of the central government in the form of excise duties in 2022-23 and 7.8% of state governments in the form of VAT).

MS and HSD contribute 16% of carbon emissions in India. Fuel taxes, when converted into effective carbon taxes, are estimated at around Rs 18,000/tCO2 (total carbon dioxide) for MS in 2023 and Rs 12,000/tCO2 for HSD. Effective carbon taxes on MS in India in euro terms work out to €216/tCO2, close to/higher than taxes levied on MS in Spain (€223/tCO2), Austria (€213/tCO2), New Zealand (€207t/CO2) and Norway (€189/tCO2). Effective carbon taxes on HSD in India work to €143/tCO2, higher than in Switzerland (€142/tCO2), South Korea (€139/tCO2) and France (€133/tCO2). These countries have much higher level of per capita income than India.

Of other fossil fuels, coal alone accounts for 70% of India’s carbon emissions. However, India taxes coal very little at `400 per tonne (by way of GST compensation cess). Other carbon-emitting products are: light diesel, fuel oil, naphtha domestic LPG, kerosene, aviation turbine fuel (ATF) and natural gas (with a share of 16% in carbon emissions). All these products are under the GST regime, other than ATF and natural gas, which attract excise duty and VAT.

A key consideration for introducing carbon pricing would be the effective carbon rates which will help raise revenue and also achieve carbon neutrality. The EU has estimated that €120 per tonne of CO2 will decarbonise the economy by mid-century. Such estimates are not available for India. But effective carbon taxes in the EU could still be an important guide, though €120/tCO2 would appear to be on the higher side, especially because India has committed to achieve carbon neutrality by 2070. Assuming carbon taxes equivalent to €90/tCO2 on coal alone, India could generate around Rs 8 trillion (4.2% of GDP). An additional revenue of over Rs 1.5 trillion (0.8% of GDP) could be generated from petroleum products, other than MS and HSD that are heavily taxed.

Carbon pricing on LPG and kerosene may hurt vulnerable sections. However, they are better protected by direct benefit transfers. Carbon pricing could also impinge on the competitiveness of Indian industry. However, with the introduction of EU-CBAM and similar taxes by other countries expected, there will be no escaping from carbon pricing in India.

Carbon pricing can be an effective tool not only for raising resources over the medium term for mitigation and adaptation, but also for decarbonising the Indian economy in a relatively more predictable manner.

Janak Raj, Valbha Shakya, & Kritima Bhapta, Respectively, senior fellow, research associate, and research analyst, Centre for Social and Economic Progress, New Delhi.

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