The Indian Economy Blog

March 30, 2007

The Case For A Carbon Tax

Filed under: Business — Kiran @ 12:55 am

An idea that is getting very popular among environmentalists is a Carbon Tax. While Europe is seriously considering one for all EU states, it is a very touchy issue in the US (despite one-offs like this). But is this the right time for such a tax in India, and what would be the implications?

What is it?

The Carbon Tax is a tax on energy sources that release pollution, primarily in the form of carbon dioxide into the atmosphere. Like taxes on alcohol and cigarettes, the carbon tax would be a Pigovian tax which is meant to discourage what is termed a negative externality – a tax on something “bad”.

How would the tax work?

A carbon tax can work at many levels because there are so many different emittors of CO2. The most obvious target would be power stations. When new power plants come up, they would have to provide a clear estimate of how much CO2 they would release and they will have to pay tax in that proportion for every unit of power they sell. So a gas-based power plant will pay very little when compared to a coal-based power plant. But a wind, hydro or solar plant will pay no tax at all. And neither will biogas- or biofuel-based plants, since they are also considered carbon neutral.

In the next stage, we could target manufacturing plants. This is not just to target industries that use kilns and furnaces and release a lot of smoke. We must also ensure that the clean energy sources remain clean through-out their lifecycle. For instance the manufacturing process that goes into making wind turbines or solar panels does cause CO2 pollution.

In the last stage, we could target automobiles, starting with commercial vehicles and moving on to individual vehicles. A tax at this level could be implemented by taxing fossil-based fuels at the point of sale. This would benefit more fuel efficient vehicles, which also tend to be less polluting. Electric vehicles would not pay any tax at all.

Using the tax

Using the tax revenues is the most critical aspect. The obvious answer would be to use this revenue to balance the subsidies given to wind and solar power projects. Ideally cigarette and liquor tax revenues must solely be used to promote healthcare in the country. This does not happen, and we must ensure that a carbon tax also does not go the same way.

The carbon tax must also not be seen as an alternative to direct taxes like income tax. In effect, the govt must work on the assumption that this tax is a punitive tax and must at some stage be phased out – along with the sources of pollution. Thus it should be used for the specific purpose of promoting the alternate energy industry till the time that the industry is cost competitive with fossil-based fuels.

How the incentives would change industry

The next time say Lanco or REL offer to set up a coal-based power plant, they might seriously consider clean-coal technologies if the post-tax cost works out the same.

If tax revenues should be channeled into the renewable energy sector, we will see a whole new industry blooming. A part of the money should flow into R&D, but we must realize that there is cutting-edge research being done in this field all over the world and it would make more sense at this stage to tie up with foreign companies to manufacture in India for local consumption (and export).

It might be prudent to not subsidize the power producers, and instead provide time-based subsidies to the manufacturers in a way that there are incentives for capacity addition to continuously produce more efficient and cheaper power generation products. For instance a manufacturer could get subsidies on a solar cell of 20% efficiency for maybe 3 years. Beyond that the subsidy will be available only if they move to an efficiency of say 25% – or if the product is better is some other way. The subsidy structure should encourage the industry to move towards competing with conventional energy sources without subsidy – the subsidy should aim to phase itself out.
Solar photovoltaics are already competing with electronics for complexity in the semi-conductor manufacturing space. If done well this would give India an opportunity to build a world-class capability in a cutting-edge industry. Of course along the way we could also meet the more mundane goals of energy independence and a clean environment.


  1. “Ideally cigarette and liquor tax revenues must solely be used to promote healthcare in the country.”

    Just an academic doubt: who decides the level of compartmentalization for tax revenue neutrality.

    As in why just “healthcare”, and why not “healthcare + education”

    Thanks for the nice post, btw

    Comment by Harsh Gupta — March 30, 2007 @ 4:05 am

  2. I think this ia a very good idea. But just the idea on a blog will not work. Is there any way to help propose this and take it forward to the appropriate people in India. But it has to make a significant difference as people have to feel the pinch of paying those taxes. For eg. if it is a very small amount then individual owners and commercial vehicle owners will not be concerned about dishing out a small extra amount.

    Comment by Natarajan Sridharan — March 30, 2007 @ 9:40 am

  3. Isn’t this great! The west pollutes the air for more than 150 years and we have to pay tax to combat the effect? Apparently we are told we get impacted the most – so pay up or else. Very nice.

    Why don’t we cap our per capita energy usage at, say, 2007 (or is it 2000?) levels. Most Indians villages don’t have power anyway so they can continue to live in dark and, probably, use oil lamps occasionally. And I am sure they can afford to pay additional taxes too – after paying for already heavily taxed petrol for their mopeds.

    One more national priority set by someone else.

    Comment by Chandra — March 30, 2007 @ 10:06 am

  4. why leave hydro power?. Recent studies reveal that the large natural vegetation submerged in the reservoirs of huge hydel power projects in tropical countries are being subjected to bacterial decay and large amount of greenhouse gases are emitted into the atmosphere. In some cases as in brazil the emission is much more greater than that emitted by a coal based or gas based power plant of similar scale.

    Comment by karikalan — March 30, 2007 @ 11:53 am

  5. “Isn’t this great! The west pollutes the air for more than 150 years and we have to pay tax to combat the effect? Apparently we are told we get impacted the most – so pay up or else. Very nice.”

    Apparently this was one of the comment made (not sure who made) at the Davos World Economic forum about Global warming. The West (developed countries) has enjoyed the growth and in the process been a main cause for pollution and effects shown in form of global warming. Now the effect of global warming is taking on developing countries.

    Interesting thoughts Kiran.

    Such a regulation will certainly bring down the pollution on the domestic front. In addition, countries should form a entity which governs pollution and its effects. There should be a index which indicates how much each country is contributing to Global warming. Highly contributing countries to the global warming should be taxed.

    Comment by Harish Babu — March 30, 2007 @ 12:10 pm

  6. Great post I must say. Written by an accomplished academician, it seems. But the other readers have raised very valid points, chief among them being the hesitation displayed by Western countries in the drive against pollution. The fact is they have been polluting heavily for the last 150 years and now when they realize that other countries are catching up, they come up with environmental mumbo-jumbo. Agreed that pollution is a major problem common to all nations and should be minimized through mutual cooperation. Look at US, they still refuse to sign the Kyoto Treaty when in fact they are moving away from manufacturing and coal-based power plants. Another one of those examples where rational economic thinking becomes extremely blurred when combined with political thinking…Insightful article though.

    Comment by Deependra — March 30, 2007 @ 3:03 pm

  7. “Just an academic doubt: who decides the level of compartmentalization for tax revenue neutrality”

    Good question. I did not so much mean to comment on the means (spend on health care) as on the ends (the elimination of a “vice”). More importantly as the Govt becomes more and more dependent on the revenues from this tax, it gets seen more as a “necessary evil”, without any real incentive to phase out these “vices”. (Vices in the govt’s view, not mine!). Spend on health care was merely a philosophical justification for a tax that is punitive on health grounds.

    If the carbon tax takes the same route we will see the fossil fuel addition becoming a necessary evil.

    “Thanks for the nice post, btw” – Thanks for the compliment!

    Comment by Kiran — March 30, 2007 @ 5:14 pm

  8. Thanks to all who have commented above. There are concerns raised here which have probably not been addressed in my post adequately (understandable since this is a topic that could occupy an entire chapter in a book). I think these are worthy of a separate post, which I will work on.

    Comment by Kiran — March 30, 2007 @ 5:25 pm

  9. As said in the previous post, the Europeans have been polluting for the last 150 years. Now that their economies have shifted to services they can afford to do things like this. I would say we impose carbon tax after our percapita energy consumption has become atleast half of the european levels.
    There is another CO2 reduction effort called carbon emissions trading. It is another way of taxing polluters and is getting popular in EU and US.

    Comment by muttan — March 30, 2007 @ 9:51 pm

  10. Cribbing that West has been polluting for around 1.5 centuries and we are to bear the consequences is not the solution. Yes it may have happened, but we cannot do anything about what West did. But we can do everything about what we can do. I live in Pune, I know what it is to live in a polluted environment. Auto rickshaws, old cars, PMT buses, trucks all cough out lots of CO2. It is rare to breathe fresh air when one is central parts of Pune.

    It not so easy to bring carbon tax onto ppl. Europe may be able to successfully implement it because most of the folks there are educated and realize the consequences of global warming. But in India, where a major chunk of ppl dont even know about these things, will only protest from the perspective that Govt has been levying taxes incessantly. We are diverse set of cultures/principles/ppl(I dont know whether that is a good thing or not), and we do everything to resist something from happening. (For e.g. the recent protests of staying OBC quota implementation and earlier the protests of announcing the same by the HRD ministry is an example. We simply never come to a consensus on a any thing because very few use “reason”)

    Comment by mike — March 31, 2007 @ 9:22 am

  11. Muttan/Mike

    I understand that your basic objection to a carbon tax is that it will hurt the common man in India. That does not have to be the case. For example, since petrol is already heavily taxed, it might make sense to simply convert some of those taxes into the carbon tax.

    The point is we can implement a carbon tax without hurting consumers. For example, in the link I have provided above, the implementation of a carbon tax in the state of Colorado in the US, saw consumers’ bills rise by an average of 2-3%.

    The objective is to merely create a focussed fund to develop alternate energy sources, to secure our energy future. Whether this fund will come at the cost of the man on the street or not is largely up to the govt.

    Comment by Kiran — March 31, 2007 @ 6:05 pm

  12. [...] What is it? How would it work? Does India need it? Read Kiran’s thoughtful posts here and here. [...]

    Pingback by DesiPundit » Archives » Carbon tax — April 1, 2007 @ 8:34 pm

  13. Hello,

    I think a tax is the false signal. The tax is the burden of of power consumer. Industry will give at the end costs in form of taxes to the people. Prices will rising and people get angry.
    A better strategy in my view is to give incentives to the polluting industries to force the development of alternative energy or alternative production processes.
    To limit their todays pollution I would implement a certificate of emission, which means, a firm blast 100 tons of Co2 in the enviroment, managers have to buy certificates for each ton ( cost/certifacte increases by buying more rights for emmission) , so incentive to bring down their pollution and search for alternative strategies are given.

    Nice to see that world is changing their responsibility for our planet.

    Have a nice day.

    Comment by Mehra, Robin — April 1, 2007 @ 8:58 pm

  14. Here are some thoughts to consider:

    1) CO2 – carbon dioxide is plant food, not a pollutant;

    2) Human activity creates less than 5% of atmospheric CO2;

    3) H2O – water vapor, is the major “greenhouse gas”;

    4) Foreseeable Global Warming is likely to be beneficial;

    5) The Global Warming uproar is a political game.

    Lee Welter
    SACRAMENTO California

    Comment by Lee Welter — April 1, 2007 @ 11:56 pm

  15. [...] But, now, it’s not just the intellectuals, in their high chairs separated from normal Indian life, but everyone is lining up. Seeing gowns worn by Hindi movie stars to award shows while they imitate their Hollywood counterparts in mannerisms (absurdity of the utter artificiality of imitation is laughable), or reading about one’s perception of what enjoying life is all about, or reading an argument for national priorities based on social needs and capabilities of other societies makes me wonder will we be ever able to keep, nurture, grow, and advance our own culture or is our culture on the path to extinction taken over by the utterly monotonously boring largely western culture. [...]

    Pingback by INI Signal - » Four Facets of Bharatiya Intellectuals — April 2, 2007 @ 5:19 am

  16. @Lee Welter
    >>Foreseeable Global Warming is likely to be beneficial
    Who are the beneficieries? Probably the energy producers, wealthy farmers and those stooge scientists who put their bogus claims from wealthy funds of these sponsors.

    Did you ever consider about the loss of polar habitats endangering the rare species like Penguins and polar bears? Did you consider the loss of lives of millions of people and flora/fauna living in the submerging of low lying regions like Bangladesh, Mauritius, etc who have no part in this game? Did you consider the effect of climatic change on the livelihoods of millions of farmers in tropical countries? What about the weather impacts like record making floods we are seeing across the world the last couple of years?

    The West has a moral responsbility in answering this question to the rest of the world. Just as it complains the poor nations for export of terrorism, it should hold it accountable for export of natural disasters. Unless the consumption levels in countries like US comes down to a more sustainable world average, we lurking into far greater problems of which global warming with CO2 is only a part.

    Comment by Balaji Viswanathan — April 2, 2007 @ 12:44 pm

  17. @Robin – Yes, that is an alternate mechanism that might work too.

    @Lee – Thanks for the stats. I will not debate them, so let us agree to disagree here. :)
    @Balaji – Apparently global warming should warm up huge areas in Canada and Russia and open them up for more comfortable habitation and agriculture. This would be another category of folks who would \”benefit\” from global warming. (Of course this is still hotly debated by scientists.)
    General Clarification:

    Hover since the cause and effect of global warming is outside the purview of my post, I will not compare our pollution levels with that of the west.

    My point was that emissions are polluting our cities and villages, even leading to smog in some places. Where cleaner technologies have worked (natural gas, which is cleaner than petrol/diesel) they have shown great results, environmentally and economically. Thus it makes great sense for India to move in that direction, and to use economic mechanisms to accelerate the movement in that direction.

    As the govt tries to electrify remote and poor villages, it is increasingly looking to alternate sources of energy like biomass/biogas for instance. So funding for these technologies would help these poor – also since they will be powered by clean energy sources, they will pay no carbon tax. As the technology matures, even villages that have (poor) electric supply would get such power units to complement their supply. This would decrease the highly polluting smoke from their wood stoves, as well as all the methane from biomass that would now be converted to biogas and fertilizer.

    Comment by Kiran — April 2, 2007 @ 3:36 pm

  18. @Kiran
    I believe the researches that show the warming will make Polar regions more habitable is mostly ingenuous and mostly dont appreciate the non-linearity of the complex systems. The warming is like in the range 1-2 degrees, and -50C and -51C are not much different if we are standing in those regions, in terms of hospitality. But, the kind of change that could be brought out by the 1-2C in climatic patterns could be disastrous.

    A lot of complex systems including economic, ecological & biological systems have a range of non-linear dynamics with complex tipping points that turn can turn a stable region into a nightmare by just altering a few variables. And this is why I feel a lot of carbon tax systems are so stupid. If you destroy 10 hectares of Amazon forest, you cannot replace it by planting 10 hectares of some trees elsewhere, the same way as you cannot replace the loss of 10 white tigers by growing 10 pet cats. With all the advanced mechanisms we still dont have a lot of understanding into the working of these complex systems, and we dont want any body to feel too comfortable and moral in polluting the environment by paying some lousy carbon credits.

    And regarding support for alternative fuels, a lot of mechanisms exist already. There are generous loan and grant schemes for biogas, solar panels etc in villages and there are punitive taxation methods for disastrous fuels like Gasoline and less so for a more benign Diesel. And the government still pursues controversial Hydroelectric system along with subsidized wind power utilities. But, there is no way Hydroelectric and windpower support the growing needs of India and I feel it is like giving a staw of grass for an hungry elephant.

    To reach Western level of development, India needs to increase per-capita energy use by alteast 10 times the current levels, and even if 1X of the component is from hydro/wind, we are all screwed with disastrous environmental calamities. The only way is Thorium based nuclear development to achieve that kind of development, along with exploration for better solar energy.

    Comment by Balaji Viswanathan — April 3, 2007 @ 6:18 am

  19. Balaji

    Firstly, the taxes on automotive fuel are not punitive taxes. If they were then diesel which is far more polluting than petrol would face a higher tax, not lower.

    Secondly the current subsidies on solar power are not working. Most of the 100 MW of solar panels built in India are exported. Most new capacity that is coming up aims solely for the export market. The only ones sold in India are those that qualify for the 50% govt subsidy, which is for a fixed number of installations annually. Once that number is exceeded, there is no market.

    I find it curious that you state that wind and hydro are more disastrous to the environment than coal-powered plants. That does go against conventional belief, but I guess you have your reasons and I will respect those.

    Comment by Kiran — April 4, 2007 @ 11:42 pm

  20. @kiran
    Diesel is much lesser polluting than gasoline. It is just a popular myth that diesel is more polluting from its black fumes. Diesel produces 31% less greenhouse gases than gasoline per-km (due to higher fuel efficiency), and its use is in more of public transportation that makes its emission/mile-person of a factor of upto ten times less than gasoline and wins hands down. This makes a case for subsidizing Diesel and punishing petrol.

    In hydro electric case, collosal damage to forests are not taken into account. Each square mile of a tropical forest (in which we have the dams) can absorb thousands of tons of carbon every year, and destroying them will cause their emission (much more than a coal plant), apart from the loss of pricelss flora and fauna that run the ecological system. Then consider the losses in seepage from the dams leeching the soil, the huge mounds of cement needed to house the water, the erosion effects, the increase in evaporation (releasing another greenhouse gas H2O), the loss of fish life leading to losses of jobs…. Hydro electricity is the worst mistake of mankind. Fortunately its not economical everywhere, saving the world from another disaster.

    Wind power is not as bad, if they are setup in places without clearing coastline forests and dont lead to a change in local weather patterns including rainfall. But, considering its very low potential with these conditions, from a macro perspective it is not interesting at all, though from a micro perspective it can help in rural power generation at remote locations and help a lot of communities to come to power-grid.

    I’ll need to spend more time in researching why solar subsidies dont work, but my gut feeling is that with proper structural adjustments and more generous monetary support, the tipping point might not be far.

    In short, as mentioned in the other thread, we need a comprehensive environmental tax in which CO2 emission is just one part. Otherwise, we will be keeping on having knee-jerk reactions with today’s global warming worries replaced by tomorrow’s other environmental worries. We need a considerable rethink in any technology, practice or business that affect environmentally sensitive forests (mangrove, tropical rain forests, etc) and restructure taxation principles based on that.

    Comment by Balaji Viswanathan — April 7, 2007 @ 6:30 am

  21. Coming back to popular myths, it is just fashionable to shun fossil fuels world-wide. But, just because something doesnt emit anything doesnt necessarily mean it is eco-friendly. We need a more wholistic picture that takes a full product chain into observation from its source to its recycle, and note down the overall environmental index, and in the long run the world would have to move to such an index.

    In that index, cycling might become the best transportation of the future :). Already in my campus at Redmond, you could see so many people switching to the next-generation lifestyle – cycling, walking, keeping windows open, avoiding ACs, wearing sweaters during winter :).

    Comment by Balaji Viswanathan — April 7, 2007 @ 6:38 am

  22. Kiran-

    A technical point- a Pigouvian tax is not a tax on “something bad.” Its a tax on activity that imposed costs on those not involved. So though chanting loudly while praying is a wholesome activity, it is fit candidate for a Pigouvian tax, while drinking yourself silly in you own home (a terrible activity) is not.

    Comment by Nimish Adhia — April 8, 2007 @ 10:00 am

  23. [...] Several times I have heard people being worried about vehicular pollution because their cars spew huge amounts of CO2. This comment about Pune being polluted because vehicles emit CO2 is just one of the several examples I have encountered. No! If CO2, H2O and N2 were the only pollutants from a vehicle exhaust, the air would be as fresh to breath as that in a forest, miles away from civilization. The real problem in vehicular emissions are particulates, unburnt hydrocarbons, carbon monoxide and nitrous oxides (in roughly that order; also ozone). Heard about a catalytic convertor… its job is to ensure that the pollutants from a vehicular exhaust are CO2, H2O and N2, as far as possible. [...]

    Pingback by Una verdad simulada » Blog Archive » An Inconvenient Side-Effect — April 13, 2007 @ 2:50 am

  24. [...] In the posts on a case for a carbon tax we saw a deliberate exclusion of existing power plants from the ambit of a “cleanup”. This made sense for a few reasons. Primarily since the plants are already up and running, it would be economically and politically more difficult to get them to cleanup. Since new power capacity is expected to rapidly overtake the currently existing capacity, even targeting only the new capacity would make a significant difference. Moreover, since power from existing plants would remain cheap, the cost to consumer would see a more gradual rise. [...]

    Pingback by The Indian Economy Blog » Would A Cap-And-Trade Mechanism Work In India? — April 23, 2007 @ 12:42 am

  25. The West has done a great job in the last few hundred years. If people want now the west to take the full responsibility for the Co2 pollution people should as well not use modern science and tech. And this will lead to much bigger environmental problems than just climate change. Humanity has never lived sustainable in the sense, that all future generations could have the same use of nature as the one at that time. Most times this were local environmental probelems, however.
    Anyhow only a the Co2 emission was even during industrialisation low compared with today. So in few decades Asia will have emitted the same as e.g. Europe integrated over time.

    I think we need a global pollution trade, because otherwise those who try to protect the environment subsidy making of pullution in the other countries. Then nobody wants to be the best environmental protector for the costs of the local economy.
    Therefore it is not enough to give some help for technological developement or something like this. It is a need for international contract, where countries, which are not staying inside the limits the promise to hold, are punished in some way.

    The argument that goods are made in one country and than consumed in another country is as well a bad argument. Europeans want nothing more, but that the costs of pollution in Asia are in the price of the goods. Then western economy becomes more competitive, as the environmental laws tend to be more strict in the west.
    This would lower unemployment in the west, which is a much more severe problem, than a bit lower prices for clothes and toys. Anyhow there is a huge difference in what consumers pay to the retailer and what the enterprises pay to Asian producers, sometimes more than a factor of ten.

    Comment by mheck — August 7, 2007 @ 8:14 pm

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