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Reason Foundation

The Mint

Can Carbon Taxes Work in India?

More than half of India's economy is fueled by "dirty" fuels like coal and wood

Shikha Dalmia
April 30, 2007

India should be prepared for an earful of eco-haranguing by the West now that the Intergovernmental Panel on Climate Change has declared that global warming will have the worst consequences for poor, agro-based tropical economies least able to defend themselves. The haranguing will go: "India should act now to contain its carbon dioxide emissions – if not to save the planet then to save itself."

Yet even if one accepts this call for action, the question is, is there any proposed cure for global warming that in fact won't hurt the Indian economy more than the disease?

The West's latest hot idea for cooling the earth is a global carbon tax. No less than Fareed Zakaria, Newsweek's Indian international editor, has written glowingly about it. This panacea has become especially popular as Europe's one-year-old experiment with "cap-and-trade" is fizzling out. Under this experiment, every European signatory to the Kyoto treaty got a fixed quota for carbon dioxide emissions that it then divvied up among its utilities, manufacturing plants and other greenhouse-gas-spewing industries. Companies that exceeded their allotment had to buy off-setting credits from those with a surplus. The hope was that this type of trading would allow carbon cuts to happen where they are the cheapest.

But the scheme has not substantially cut carbon dioxide emissions because countries, loath to burden their industries with excessive mitigation costs, obtained rather generous allotments in the first round of horse trading. Even if they subsequently accept tighter limits, the technology to capture carbon emissions is exceedingly expensive, something that will inevitably invite their industries to cheat.

A carbon tax would be more enforceable. But that's not the only reason for its growing appeal. The environmentally-minded like it because it will make conventional fossil fuel sources – petrol, diesel and coal – more expensive and create an incentive for research into cleaner-burning alternative fuels. But even many free-market advocates for whom any talk of taxes is usually anathema are warming up to a carbon tax – especially if it means replacing a portion of income taxes. Far better to tax "bads" like pollutants and internalize their costs to the polluters than "goods" like income, they reckon.

So is a carbon tax the way for India to go? Actually, the reverse in the case: India already has a carbon tax of sorts that it needs to slash – both for the sake of its economy and environment.

Taxes constitute 52 percent of the price of petrol and 32 percent of the price of diesel in India. By contrast, they constitute 18 percent of the price of both petrol and diesel in the United States; and 45 and 33 percent respectively in Japan. Even consumers in greener-than-thou Europe pay much less than Indians in such fuel taxes.

Notwithstanding fuel subsidies to the poor, the net effect of these taxes has been to raise fuel prices and depress energy consumption in India. Indeed, per capita energy consumption in India is not just low by the standards of developed countries but also developing countries: It is 17 times less than United States, eight times less than Denmark and England, nine times less than Japan and about two-and-a-half times less than China and Brazil. Indian households pay the highest rate for energy in the world in purchasing power parity terms. Furthermore, because petrol and diesel are so exorbitant, this energy consumption is heavily skewed toward even dirtier fuels like coal and wood that power more than half of India's economy.

If calls for a global carbon tax escalate, India will face immense pressure to extend its petrol and diesel taxes to coal as well. But putting one of the few affordable sources of energy off-limits would be tantamount to administering hemlock to the Indian economy.

The far better option would be for India to cut taxes on petrol and diesel. Counter intuitive though this might sound to Western ears, this will be good for the global environment because it will diminish India's need for coal-fired plants and automatically cut down on its green-house gas emissions. Furthermore, to the extent that increased oil consumption by a growing economy like India will raise its prices for the rest of the world, it will help the very search for alternative fuels that a carbon tax is supposed to trigger. A ready supply of diverse energy sources will also allow India to maintain its stellar economic growth, something that will put it in a far better position to deal with the ill effects of global climate change that the IPCC is so concerned about.

In short, India can't help the environment without first helping its economy. And for that it needs an energy policy that puts cheap – not more expensive -- fuel at the disposal of every Indian. Ironically, the only Indian politician who has consistently made slashing India's stratospheric fuel taxes a top-order priority is Communist Party of India General Secretary Prakash Karat. India would do well to block out Western sages like Zakaria and listen to him on this one.


Shikha Dalmia is Senior Analyst


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