Carbon tax to meet climate concerns

India can display bold leadership by imposing a carbon tax on all fossil fuels in proportion to carbon dioxide emissions

Oil prices have plummeted since June 2014 by almost 60 per cent. This has obviously proved to be a bonanza for oil-importing countries like India just as it has seriously hurt oil-producing nations like Russia and Iran. The fall has been unexpected and what has added to the mystery is the behaviour of Saudi Arabia, the traditional “swing producer” in OPEC which has chosen not to cut production in order to boost prices.

The main reason now being adduced for the oil price decline is the re-emergence of the U.S. as a major hydrocarbon producer because of exploitation of its substantial shale deposits. Lower than anticipated demand, especially from countries like China, and anaemic economic growth in Europe have added to the pressure. As to the response of Saudi Arabia, the best guess is that it does not want to lose market share like it did the last time when it cut output to keep prices up. There are, of course, the usual conspiracy theories — that the Americans have put pressure on major OPEC oil producers not to cut output so that Russia could get hurt from falling prices. Another Byzantine view is that Saudi Arabia is not too unhappy with these prices since its arch-rival Iran is getting hurt and because over the medium-term it would discourage the development of new sources of supply that would threaten the Saudi position.

Revisiting an old idea

Whatever be its backdrop, the current oil price scenario offers the right moment for the international community as well as for major carbon emitter nations to revisit an old idea that has been around for quite some time as a way of dealing with the challenge of climate change — and this is a carbon tax. Economists mostly agree that such a carbon tax is the way to go, but it has faced tremendous political resistance, especially in the U.S. A couple of days ago, however, the influential economist Larry Summers, who has been a close adviser to both President Barack Obama and former President Bill Clinton, came out publicly in its favour, pointing out that a tax of $25 per tonne of carbon would add just 25 cents to the price of gasoline. There have been other intellectually weighty voices in the past who have advocated a carbon tax, William Nordhaus being perhaps the most prominent amongst them.

It is the political resistance to any form of taxation (what the late Sukhamoy Chakravarty, the distinguished Indian planner, had called the emerging fiscal sociology) that has led to systems of cap-and-trade being adopted to deal with the emissions problem. The EU has such a system, the Chinese have seven pilots and have announced a national initiative beginning next year, and the Americans too are putting it in place for carbon emissions from power plants. A cap-and-trade system puts a cap on the quantity of emissions (which is flexible) and the “rights” to emit are then traded for a price among classes of consumers. It has considerable appeal since it is “market-based” and it has actually been used very effectively to deal with the consequences of sulphur dioxide emissions from power plants in the U.S. (the “acid rain” problem as it is usually called). The cap-and-trade system does provide incentives for emission levels to decline. On the other hand, a carbon tax is much simpler and straightforward to design and administer since it does not involve fixing emission “quotas” for each emitting industry, which is technically very cumbersome.

“A carbon tax is simple to administer since it does not involve fixing emission 'quotas' for each emitting industry, which is technically very cumbersome”

William Nordhaus himself in his classic “The Climate Casino,” after an elaborate analysis of the two approaches, writes: “If I were put on the rack and forced to choose, I would admit that the economic arguments for carbon taxation are compelling, particularly those relating to revenues, volatility, transparency and predictability. So if a country is genuinely unsure, I would recommend it use the carbon tax approach.” Dale Jorgenson, one of the pre-eminent economists of our times, has taken the Nordhaus approach and asked the question: how to make it politically acceptable? In “Double Dividend: Environmental Taxes and Fiscal Reforms in the United States,” Mr. Jorgenson and his colleagues make out a persuasive case for a carbon tax in the U.S., but with a twist: that the revenues be used for a capital tax reduction with other countries free to recycle revenues in the matter they deem fit.

Actually, India has a carbon tax of sorts. It is not called as such but the United Progressive Alliance government’s budget of 2010-11 introduced a cess of Rs. 50 per tonne of both domestically produced and imported coal. Last year, this was doubled. However, the idea of this cess, it must be admitted, was less to curb carbon emissions but more to raise revenues for the National Clean Energy Fund. Of course, the Fund itself could well support carbon mitigation initiatives but its take-off has been slow so far since Finance Ministers see it as a source of mitigating not carbon but the fiscal deficit. The Fund has close to Rs. 15,000 crore already accumulated in it and this will grow rapidly as coal consumption increases. But the important point is that India already has an important half-step, even though its version of a carbon tax is not economy-wide and it is far below the levels that are generally accepted as being desirable (around $20-25 per tonne of carbon).

Mr. Summers’ plea comes with a catch: he wants the U.S. to impose a carbon tax on its own as well as a tax on the carbon tax on its imports, in order to goad other countries to adopt the carbon tax route. Perhaps he has China in mind since it has been estimated that at least a fifth of China’s emissions are because of its export sector. He seems to think that this will be World Trade Organization-compatible. But it will pose a huge threat to the world trading system which has produced tangible benefits for those who have harnessed its potential — like China and India — if it were to be used to meet climate policy objectives.

Requiring a different response

Some years ago, drawing inspiration from no less a person than Lord Keynes himself, the Nobel Laureate James Tobin proposed a tax on short-term currency transactions. This was later expanded to cover all short-term financial transactions and is widely known as the Tobin Tax. But it remains on paper as to which periodic obeisance is paid. The carbon tax is a similar development deity but it is an idea whose time has undoubtedly come given the current and expected oil price situation. In the past, oil prices have declined as they have in recent months; the commitment of countries to make the transition away from fossil fuels has perceptibly wavered. This time around, however, given the climate change imperative, our response has to be dramatically different. A carbon tax imposed on all fossil fuels in proportion to carbon dioxide emissions would signal that transformed thinking. It would generate the needed resources for low-carbon investments in a manner that does not add to the fiscal deficit and provide the impetus to a meaningful global agreement in Paris later this year in December. This could well be India’s moment of bold leadership