India’s Fiscal Transition Goals Through The Lens Of Union Budget 2024 And Beyond
A roadmap for realizing energy transition goals by examining the need for restructuring fossil taxes and subsidies in the present and subsequent Union Government budgets.
Energy transition, a term that has a long history, has gathered momentum in the past decade or so, and in the Indian context it has further accelerated post the Conference of Parties 26ᵗʰ (COP26) meeting held in Glasgow in 2021.
Prime Minister Narendra Modi laid down the Panchamrit action plan for India, to be achieved by 2030 and to pave the way for attaining a Net-Zero emissions target by 2070. Achieving energy transition goals will require investments in efficient and less polluting sources of energy, however, and as India shifts away from fossil taxes, revenue equivalent to 3.2% of India’s GDP in 2019-20 will be lost. This is about one-third of the total indirect tax revenue collections for India.
There is need to compensate for potential revenue losses and support a sustainable transition to a low-carbon economy. To achieve this, India must explore a mix of taxation and subsidy strategies including restructuring existing fossil taxes and subsidies. This article attempts to examine alternatives such as user taxes, a carbon tax to balance economic stability with environmental goals, and channelling fossil subsidies towards renewables - primarily Solar and Wind, among others.
Energy Transition and Budgetary Allocations
India's commitment to green growth and energy transition, as outlined in the "Amrit Kaal" budget in 2023-24, is evident in its policies and financial allocations. These efforts aim to reduce the economy's carbon intensity and create extensive green job opportunities. The National Green Hydrogen Mission launched in 2022, with a budget of Rs 19,744 crore ($2.47 billion), aims to contribute in the transition to low carbon intensity and reduce dependence on fossil fuel imports. Additionally, the Budget allocates Rs 35,000 crore ($4.23 billion) for priority capital investments towards energy transition, net-zero objectives, and energy security through the Ministry of Petroleum & Natural Gas.
The Union Budget's emphasis on green growth is further evident from the expenditure data, which highlights a gradual pivot from conventional to renewable energy sources. For instance, budgetary allocations for ministries associated with traditional energy, like coal and petroleum and natural gas, have seen a decline from 0.034% in 2017-18 to 0.004% of total expenditure in 2024-25 for coal, and from 1.55% to 0.62% for petroleum and natural gas over the same period.
In contrast, the Ministry of New and Renewable Energy's budget has risen from 0.17% to 0.27%, with the majority of funds directed towards Solar and Wind power, comprising 56.4% and 18.6% of the ministry's total expenditure respectively. Despite this upward trend, the current investment levels in renewables remain insufficient compared to the traditional energy sectors, underscoring the urgent need for increased funding to realise India's energy transition goals.
Source- Author’s Analysis using various union budget expenditure reports
Need for Fiscal Transition
The energy transition process has a two-fold impact on India's revenue collections. First, there will be a loss of a significant amount of tax revenue which is 3.2% of the GDP, translating into around 62% and 38% loss for the Union and State governments correspondingly (Bhandari and Dwivedi, 2022).
Second, there could be a contractionary impact on the economy resulting in a 2.12% reduction in nominal GDP if fossil taxes are removed, along with a reduction in the government expenditure by the same amount, without introducing any alternative mechanism (Verma and Bhandari, forthcoming). This is due to the decreased aggregate demand emanating from the government, as it will have reduced capacity to spend. Thus, the cost of inaction could be substantial, and the Government of India needs to find alternative sources of taxation.
To compensate for the revenue losses which could have helped in India’s economic growth, energy transition goals and other commitments of the Amrit Kaal budget, the government needs to find alternative methods of mobilising revenue, which necessitates a fiscal transition. Potential solutions include climate financing from developed countries or restructuring fossil taxes and subsidies in India. However, one cannot rely only on the former as financing by the developed world has been bleak.
Analysing the Fiscal Transition Mechanisms
This section delves into the distributional implications of replacing the fossil tax structure with other forms of taxes on economic efficiency, emissions intensity and equity in India, and the insights here are from the forthcoming publication at CSEP (Verma and Bhandari).
The possibility of restructuring the subsidies from disincentivising the fossils to incentivising the greener alternatives has also been examined. The following results are based on simulation exercises utilising an Environmentally-extended Social Accounting Matrix (E-SAM) developed at CSEP for 2019-20. E-SAM is an accounting database that combines information on the flow of inputs and outputs across various sectors of the economy and households along with its interaction with emissions from these sectors.
a. Restructuring Taxes
Considering various taxation instruments in India, which include direct and indirect taxes, potential revenue losses can be compensated by imposing new taxes or altering the existing ones. For direct taxes, revenue can be increased by raising tax rates, lowering minimum thresholds, or taxing currently non-taxable income sources like agricultural income.
However, the first two options may not generate sufficient revenue, and taxing agricultural income would require a constitutional amendment and further, is a sensitive area to target (Bhandari et al., 2023). Furthermore, the share of direct taxes in GDP for India has historically been low and stagnant, currently around 6% of GDP, up from 2% between 1950 and 1990.
Therefore, exploring other taxation options is necessary. One option is to expand the Goods and Services Tax (GST) base by including items such as electricity, liquor, petroleum, and services like agricultural services, education, and banking. While this could generate significant revenues, it requires institutional changes and may divert substantial revenue sources from states, making implementation unlikely. Additionally, one can simply propose a proportionate increase in GST which has mild impacts on equity (0.05% and 0.06% increase in tax burdens on the lowest quantile in Rural and Urban areas respectively) and a marginal decline in real GDP by 0.18%.
Another option is to impose user taxes, a tax combination levied on electricity consumption and distance travelled. These taxes have the potential to generate significant revenues as electricity consumption and transportation are expected to rise with increasing incomes. User taxes may be difficult to levy institutionally, but are mild to strongly progressive across quintiles of rural and urban households. However, they are likely to decrease the real GDP by 0.83% coupled with a minor increase in emissions intensity by 0.19%. Furthermore, this will only increase the relative prices of the electricity sector by around 1.3% on average.
The third option is levying a carbon tax that can generate significant revenues and address negative externalities by putting a price on emissions. A carbon tax on coal emissions positively impacts real GDP and simultaneously reduces emissions. However, it is regressive. A carbon tax on coal would only hasten the transition process but would not address the long-term fiscal challenge, because its revenues would decline eventually as emissions decrease to meet NetZero targets, hence it can offer a medium-term solution.
Further, implementing a carbon tax involves challenges such as monitoring emissions and mapping them to notional values (if subsumed under GST). Despite these challenges, a carbon tax is pragmatic and politically feasible, especially given the global push for carbon pricing (Verma & Bhandari, forthcoming).
All three options represent intrinsic trade-offs between economic efficiency, equity, and emissions, and hence these require careful consideration.
While country circumstances vary widely, lessons can be drawn from the Nordic experiences which are relevant to India and other developing countries seeking to recover fiscal space while addressing emissions. Iceland in 2010 levied a carbon tax on all fossil fuels and CO2-based vehicle taxes. Norway has used economic instruments like CO2 electricity taxes since the early 1990s, adding compensatory measures in 2001. Similar examples can also be found in Sweden and Denmark. GHG emissions per dollar of GDP have declined for Denmark, Finland, and Sweden relative to the OECD average from the early 1990s when carbon taxes were introduced. These Nordic countries are now among the lowest GHG emitters, highlighting the dual success of their tax restructuring strategies. India can leverage these insights to develop its fossil tax restructuring strategy, facilitating a smoother energy transition process.
b. Restructuring Fossil Subsidies
The gradual reduction and subsequent elimination of fossil fuel subsidies is required because they distort the market by incentivising environmentally unfriendly products and further contribute negatively to the fiscal deficit. In FY23, oil and gas subsidies in India rose by 63% through direct budgetary transfers to state-owned oil marketing companies, despite a 3% contraction in revenue receipts.
Coal has been subject to a low GST rate of 5% plus a Rs 400 Compensation cess. Further, subsidies for coal have increased from 13.16% in total share of energy subsidies in FY 2017 to 15.80% in FY 2023, reflecting the dependence on coal for producing 77% of India's energy needs (MOSPI).
Petroleum subsidies have remained stable between FY17 and FY23, except for a dip to 15.53% in FY22. Renewable energy subsidies have increased by 8% over FY22; however, they remain modest in comparison to fossil fuel subsidies, accounting for only 12% of overall fossil fuel subsidies. This highlights the urgent need for the government to address this divergence of subsidy amount between the renewables and fossils to achieve its energy transition targets.
The graph below illustrates that renewable energy constitutes only 5% of the total energy subsidies in FY23 allocated to energy sources. Therefore, reallocating subsidies from conventional energy sources to solar, wind, and other non-conventional sources will be crucial for achieving NetZero goals and mitigating the impact of falling revenues from fossil fuels.
Source: Author’s analysis using subsidy data from the International Institute for Sustainable Development (IISD)
Note: FY 2023 represents the period from 1st April 2022 to 31st March 2023.
Denmark was the first European country to introduce a large subsidy scheme for wind power in 1993. This scheme, which combined price guarantees and tax reductions, led to rapid growth in wind power capacity in the second half of the 1990s (IRENA, 2013). The support scheme has continued, with adjustments over time, and over 25 years (1990-2015), the share of wind power in Danish power production increased from 3% to 42%, mainly replacing coal.
Finland assessed a total of 400 subsidy measures, categorising them into three categories: 'Good', 'Bad', and 'Ugly'. 'Good' subsidies were targeted for their positive environmental impacts, while 'Bad' subsidies were considered a possible waste of money, and 'Ugly' subsidies had potential negative environmental impacts. The harmful subsidies were concentrated in the energy, transport, and agriculture sectors, with the energy sector alone accounting for EUR 800 million in harmful subsidies annually.
To begin with, India can apply Finland's approach by comprehensively assessing its subsidies, and identifying and categorising them based on environmental impact. By targeting the elimination of "bad" and "ugly" subsidies, India could redirect funds towards more sustainable and environmentally beneficial initiatives, such as solar and wind power.
Roadmap for Fiscal Transition
a. Immediate to Medium-Term Solution
Implementation of a Carbon Tax on emissions of coal and lignite can serve as a medium-term solution, as replacing fossil taxes with this can increase the real GDP and also reduce emissions intensity significantly (Verma & Bhandari, forthcoming). This is because the Coal and Lignite sector is not only one of the most carbon-intensive sectors, but is also a major input to the hard-to-abate sectors in India such as thermal electricity, Cement, Iron and Steel, Aluminium, etc.
A carbon tax results in an increase in the cost of production for these sectors which results in a decline in their production, thus reducing overall emissions level. Carbon taxes on coal’s emissions can generate substantial revenues, though they may not be sustainable in the longer term as the emissions should come down gradually due to the adoption of greener production methods. While these taxes might impact the state governments’ autonomy, they deserve careful consideration due to the significant role fossil fuel emissions, especially coal emissions, play in overall greenhouse gas emissions in India.
India's reliance on petroleum and natural gas (6.8%) is considerably lower compared to coal (77%) for total energy generation, which will support the objective of energy transition. Hence, these subsidies cannot be reduced immediately as India relies heavily on thermal power plants. Instead, the focus should be on reallocating subsidies from oil and natural gas, which constituted 22.3% of total energy subsidies in FY 2023, to renewable energy which was 4.7% of total energy subsidies in FY 2023 such as solar and wind energy, which accounted for 71% of India’s power generation capacity addition in FY24.
b. Long-Term Solution
One option within User Taxes is a combination of a Distance Travelled Tax (DTT) and an Electricity Tax. Approximately 62% of the revenue can be generated from the DTT, which would be managed by the Union, while the remaining 38% can come from the Electricity Tax collected by the States. This 62:38 split aligns with the proportion of revenue loss from fossil fuels experienced by the respective governments. This can act as a panacea for autonomy concerns, as the electricity tax is already within the ambit of the States and the latter can be instituted under the Union by invoking Article 248 of the Constitution (Verma and Bhandari, forthcoming). Further, since the vehicle and electricity consumption for a developing country such as India will only rise, the erosion of the tax base is also not a major concern.
Challenges include the conflict of imposing additional taxes on that component of electricity which is subsidized, and inadequate metering infrastructure especially in rural areas, along with widespread non-payment of bills and electricity theft. Obstacles associated with DTT include privacy concerns related to private data-sharing with the government. It is important to address these issues for effective implementation and long-term sustainability of the solution. Smart meters can go a long way in solving some of these challenges.
As significant advancements in renewable technology have occurred and India’s energy transition has reached a pivotal point—with the country's reliance on renewable energy surpassing the 7.6% mark of FY 23—the government can strategically implement a gradual reduction in coal subsidies while increasing support for renewable energy over a decade or so. In FY23, a substantial portion of coal subsidies came from price support (31.2%) and government revenue forgone due to concessional GST rates on coal sales (38%). To generate revenue for our energy transition goals, it is imperative to gradually reduce price support and incrementally increase GST rates on coal sales.
Shifting away from fossil taxes and subsidies will enable us to reallocate funds towards enhancing renewable energy initiatives and closing the revenue gap, thereby aligning fiscal policy with our sustainable energy objectives.
The views expressed are the writer’s own and not those of CSEP.
The author is grateful for the research assistance by Arkoprovo Ghosh.
Notes:
² 2.9% from Fossil Tax Revenue and 0.3% from Non-Tax Revenue.
³ Verma, R. and Bhandari, L. (forthcoming). Implications of Taxation Alternatives in India’s Energy Transition: ESAM Analysis. CSEP.
⁴ A tax is called as progressive if relatively higher income households pay more than lower income households and is termed as regressive otherwise.
⁵ Autonomy concerns relate to the sovereign power of the State to levy taxes. With the advent of GST in 2017, most of this power was eroded as the Union and the States are required to jointly decide the tax rates.
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