As electric buses continue to become cost competitive with diesel in India, procurement in smaller cities such as Pune could boost domestic manufacturing of EVs and batteries | Photo: Pune Mirror/ Rahul Deshmukh

India must use economic recovery to redirect fuel taxes towards sustainable transport

In the first part of a two-part series, Carbon Copy explored how India’s population bears the burden of India’s high tax rates and how it translates to future-oriented clean and inclusive system of transportation. This second part will look at how India’s fuel taxes can be reimagined into elements of a sustainable and inclusive transport policy.

It is often suggested that carbon pricing should be a key component of climate policy (some ill-informed commentators, or overly ideological economists, even suggest that carbon pricing should be the only climate policy). How much do India’s fuel taxes translate to in terms of implicit carbon prices? By implicit, we mean these taxes are not specifically labelled as carbon taxes, they have the same effect as explicit carbon taxes: namely, raising the consumer cost of carbon intensive fuels.

Burning one litre of petrol emits about 2.3 kg of CO2. In India, the tax wedge on that litre was about ₹51. This works out to ₹23 per kg of CO2 emitted; or a whopping – ₹22,500 per tonne of CO2 emitted. Expressed in nominal US dollars, this equates to a tax rate per tonne of carbon emitted of about US$300. The calculation for diesel is similar: about ₹19,000 per ton of CO2 emitted, or US$255 per ton.

These taxes are not labelled as carbon taxes per se, but the effect is the same: they raise the consumer cost of emitting carbon. Thus, about 13% of India’s energy consumption is subject to an ‘effective carbon’ tax of more than US$250 per tonne. Expressed in purchasing power parity, the effective carbon tax rate works out to more than US$900 per tonne. This is the rate at which the fuel tax would have to be set in the US in order to cost consumers their same in ‘purchasing power’ as it does to consumers in India.

We can derive two conclusions from this fact. Firstly, calls for countries to adopt carbon taxes or emissions trading schemes under the global climate negotiations are misplaced. India already has relatively high energy prices, and high levels of energy taxation, i.e. de facto carbon taxation. Certainly, there is a need to reform and rationalise energy taxation in India, including introducing an explicit carbon component. But, and this is the second point, the very fact that a substantial share of India’s energy consumption is already highly taxed clearly shows: carbon pricing is not a panacea against climate change. Complementary measures are clearly needed.

Why is a carbon tax of around ₹20,000 per tonne not sufficient to drive energy transition in the transport sector? In economic terms, raising the price of one good (petrol or diesel based private transport) raises demand for substitute goods (public transport, electric vehicles, walking, etc). But if the supply is not there for these clean substitutes, then consumers cannot switch and they will be forced to pay the higher price or not travel at all. If India’s public transport is ‘undersupplied’, i.e. overcrowded, of poor quality, and inconvenient, then even very high diesel and petrol taxes will not drive a transition to public transport. Likewise, if there is no charging infrastructure, or affordable and convenient models, then consumers will not switch to electric vehicles.

Part of the fiscal rationale for high fuel price taxes is to discourage social bads like local congestion, air pollution, and CO2 emissions. But the above discussion shows that demand-side measures like high fuel taxes are not enough. There also needs to be a supply-side push to provide consumers with alternatives that are affordable, viable and convenient.

What then are the elements of a sustainable strategy for India? Firstly, and this lies well out of the scope of energy and climate policy, India needs to raise its tax share in GDP and in particular its direct tax share in GDP (i.e. taxes on wages, capital gains, etc). The share of indirect taxes on goods and services in GDP has been relatively constant over the past four decades at about 8-9% of GDP. The share of direct taxes is around 5.5%. Given that indirect taxes are difficult to target in a progressive way, this is not the way to build a progressive fiscal system. The formalisation of the Indian economy is key to achieving a higher share of direct taxes.

India’s tax share in GDP is about the level of European countries just before the first World War, an astonishingly low level and completely inadequate for supplying the basic public goods required of government: health, education, domestic and external security, and infrastructure.  Faster growth, formalisation, and modernisation of tax infrastructure are essential.

Secondly, high fuel taxes can be maintained as a necessary, but not sufficient strategy to provide sustainable mobility. They need to be combined with much larger investments in enhancing the supply of clean mobility, in particular the development of public transport infrastructure. Given that poorer households spend more on conveyance as a share of total household expenditure, investing in improving public transport infrastructure would be progressive. Hypothecating a share of fuel taxes to clean transport investment could be considered. 

What kind of investments would make sense? In large cities, an expansion of metro rail is essential in the mid to long term, given the very high population densities, and the challenge of providing required levels of mobility from road transport only. But building metros takes time and lots of money, and only provides net benefits on decadal time scales. Thus, borrowing from capital markets is an appropriate avenue to fund such investments, although the ability of the government of India to service additional debt can only be secured by raising growth and tax revenues.

In addition to massive long-term investments in metro-rail, a COVID stimulus package should include public investments in expanding the urban bus fleet, and sourcing exclusively electric buses. Electric buses are already cost competitive with diesel in India, although upfront costs are higher. Public investment to defray this investment cost can allow fiscally stretched states to reap the operational cost benefits of electric buses. Electric buses can also be rolled out to India’s tier 2 and 3 cities, reducing the pressure on tier 1 cities as India urbanises. A huge procurement of electric buses could also be used to boost domestic manufacturing of electric vehicles and batteries.

Finally, India’s electric vehicle policy is in need of a boost. Additional investments in charging infrastructure are required to support public adoption of electric vehicles. But this is probably the wrong place to start. A better idea would be to combine bans on new sales of fossil fuel-based commercial vehicles (taxes, ride-hailing, and company fleets), with tax breaks for commercial investment in fast-charging infrastructure. This would place the responsibility of coordinating infrastructure development with commercial fleet operators, who best know the characteristics of charging demand. The government could thus consider banning new sales of fossil-fuelled vehicles for commercial use by 2030, and commit to spending a certain share of fuel tax revenues to facilitate transition.

Thirdly, India should look at introducing a small, explicit, cross-sectoral carbon price for all fuels. This would not necessarily drive the energy transition, but it would raise additional revenue to fund it. Certain fuels would remain much more highly taxed through existing taxes, because of the greater paying capacity of the consumers of these fuels. But there would be an across-the-board carbon price at a relatively low level, that can be used to signal to the international sphere India’s commitment to climate action, but more importantly to raise substantial revenues.

This series has been written under the “Climate Transparency” project, a global partnership with a shared mission to stimulate a “race to the top” in climate action in G20 countries through enhanced transparency. Climate Transparency publishes a set annual reports on the state of climate action in G20 countries, as well as sector-specific policy papers on sectoral climate policies in G20 countries.

About The Author