The complexity of green transition

Inaction on generating new revenue as fossil fuel taxes dry up will harm India's economic prospects

As climate change plays out and India prepares to transition towards lower carbon emissions and a greener economy, a range of challenges needs to be addressed. One such area is the impact on government revenues. An inordinately high proportion of state and central government revenues, which according to one estimate, account for above 3 per cent of India’s gross domestic product (GDP), emanate from fossil fuels. To illustrate, tax and non-tax revenues from fossil fuels are greater than India’s entire defence Budget and also exceed what the central government spends on education and health. 

But it is not just the quantum but the complexity of change that will be India’s biggest challenge.  Multiple sources of funds will dry up as we consume less fossil fuel, revenues from public sector enterprises (PSEs) involved in fossil fuels will fall, and those requiring subsidies, such as for renewable energy, will require more. The dependence on revenues also differs from state to state.  Some states, such as Odisha, have higher royalty revenues due to coal mining, while others such as Maharashtra rely more on tax revenues. 

The problem, therefore, is not merely of generating additional government revenues from non-fossil sources, but also about sharing these revenues in a manner that is satisfactory for the many stakeholders. Take, for instance, the issue of state autonomy over tax generation. One of the key reasons why petroleum products could not be included in the goods and services tax (GST) was that the current value added tax (VAT) regime enables state governments to decide on the level of taxation autonomously. GST, for all its benefits, does not score high on state autonomy considerations. Any movement away from VAT will rightly be a cause for concern to states interested in maintaining some autonomy over their revenues.

There is another challenge related to the high levels of subsidies being given to the electric vehicle (EV) sector. Policy rightly focuses on steadily reducing the share of petroleum-driven vehicles and increasing that of EVs. However, the challenge is that the EV solution requires significant subsidies, whereas fossil fuel vehicles are revenue generators for the government. Reducing EV subsidies will slow down the transition, but maintaining high subsidy levels will impose a growing burden on government revenues. What makes this challenge more complex is that the EV rollout and fossil fuel reduction have different stakeholders within the government.

Yet another class of issues are related to reducing the damage that transition will cause. Take, for instance, the coal mining jobs that will be eliminated over the next few decades as dependence on coal reduces. There are two categories of jobs that will be lost. The first category includes those who are directly employed in coal mining. These are easier to deal with for two reasons. First, those directly employed in coal mining are fewer in number, and second, their numbers will fall over the next few years due to technological changes in the mining sector and natural attrition. But the key challenge is for those who are indirectly employed due to coal mining — these are the many providers who are servicing mines and miners.  They are far greater in number and typically there are few economic alternatives in the vicinity of coal mines. Another example is related to stranded assets in the thermal power sector, or the capital that will become redundant as India shifts away from thermal power towards renewable energy.

In other words, we can broadly classify the revenue needs of the transition to include those required to (a) cover falling revenues, (b) enable rapid transition, (c) correct the economic destruction that will accompany the transition, and (d) identify appropriate allocation principles that will not disempower the states. Taken individually, each of these is a tough challenge to address, but taken together, they seem insurmountable.

The rational approach in such circumstances may appear to be delaying efforts at finding the right solutions. The 2070 Net Zero target is some decades away, new technologies are emerging rapidly, and the Indian economy is undergoing a deep structural change. It might, therefore, seem that a wait-and-watch approach is the right path ahead.

And that is precisely what India cannot afford.  The transition process has already started and is irreversible. Renewable energy capacity and generation are growing rapidly, and so are EVs. The latter are also part of a (silent) strategy to use the depth of domestic markets to leverage scale economies for tapping into global markets. At the same time, the costs of transition will rise going forward, and the bulk of these will need to be borne by the government.  Therefore, doing nothing on the revenue front will lead to a situation where growth in government revenues is steadily curtailed, which will impact the fiscal situation quite significantly over the next decade or two, with obvious adverse implications for growth.

There are some solutions to the problem, but each has different characteristics and India will need to identify what works best for it. Increasing direct tax rates, for instance, is unlikely to work given experience with implementation and leakages. Carbon taxes will hasten the transition and may reduce the immediate revenue challenge but will not solve the long-term fiscal problem. Rationalising GST may work but will require significant negotiation between the Centre and the states. New forms of taxes, such as distance or road use taxes, may be easier to implement but may not address the state autonomy objective. Reducing non-productive expenditure or welfare expenditure is always easier to call for than to implement.  Moreover, it would be difficult to reduce welfare expenses in an era where trickle-down effects are operating slowly.   Some solutions, such as carbon taxes, may even require constitutional amendments, which are possible but will take time and much coordination.

An important feature of this problem is that most key stakeholders are a part of the government, namely, Central and state governments and PSEs. And here, actions within the government have already shown the path ahead. By allowing fossil fuel PSEs to enter the renewable energy space, the government has to some extent aligned the interests of the fossil fuel PSEs with that of the transition. 

An alignment between the central and state governments on transition and associated action on revenue generation may be a more difficult exercise, but it is critical. Many of the costs, whether changing expenditure profiles, stranded assets, or employment impacts, will be borne by the states, which are not ready for them. India, therefore, requires the creation of a formal mechanism that maps state-level transition requirements against revenues, identifies emerging gaps, and explores various alternatives ahead. Most importantly, it will need to identify possible revenue sources where state governments have some autonomy.

The writer heads CSEP Research