As the Indian economy transitions from a fossil fuel-driven economy to that driven by cleaner energy, there will be a range of changes in economic activities that would span across individuals, households, communities, companies, and the governments.  Focusing on the last, namely governments, one element that is little understood is what would happen to governments’ budgets.  As is well known, state and central governments levy tax on fossil fuels differently.  Coal has a low goods and services tax (GST) imposed on it as well as a compensatory cess, whereas petroleum products such as petrol and diesel are taxed with customs duties and excise by the Union Government, whereas state governments impose a value-added tax (VAT).  In addition, many of the companies involved in fossil fuels are highly profitable and corporation tax also applies to them.  On the other hand, as of now, the bulk of the renewable energy economy requires extensive support from the government through both monetary (subsidies) and non-monetary (regulatory) means.   In other words, over time as fossil fuel dependence falls, governments will earn less and less revenues from the energy sector.  How will they deal with this loss? Indeed how much of a revenue gap will they face?  Would state governments be impacted more or less than the Union Government? What can they do about it?  These are only some of the questions that come up.

My colleagues at CSEP and myself have been studying these issues for some time.  In a sequence of studies, undertaken with Aasheerwad Dwivedi and Rajat Verma, I witnessed a range of issues associated with the fiscal transition that will need to accompany India’s energy transition. 

We found that as of 2019 tax and non-tax revenues, for both state and Union governments, from all fossil fuels including coal, petroleum products, and natural gas, were equivalent to 3.2% of India’s GDP.  Of this total, state governments’ revenues were 1.2% of India’s GDP and 2% for the Union or Central Government.  To give perspective, revenues from fossil fuels are greater than all of India’s defence expenditure, and also overwhelm all of the Indian government spending on health and education. Taking estimates of how fossil fuel use would change over the next 20 years we were also able to estimate how these revenues would change over time.

The numbers were quite unambiguous.  Over time though revenues would increase as would consumption due to economic growth, as a share of government budgets and also as a share of India’s economy they would fall. Why?  Because of growth, fossil fuel consumption would steadily decrease over the next 20 years.  But economic growth would be higher and consequently, over time in a relative sense, the dependence on fossil fuels would fall.  We estimated that overall from 3.2% in 2019, the overall figure would be closer to 1.8% of the GDP by 2030 and down to 1% of the GDP by 2040.

This led us to the question what would happen to the states, and we found that some states would be impacted far more, especially the states in the eastern parts of India.  States such as Jharkhand, Odisha, Chhattisgarh, and even Madhya Pradesh would be greatly affected in many ways, but the key challenge is related to revenues from coal.  As of now, these states obtain revenues from royalties and also the revenues that are associated with coal mining.  Moreover, many thermal power plants are also located closer to the head of the mines.  But as the use of coal stagnates, its share in their total tax and non-tax revenues would fall.  In other words, these states would be challenged more than the states such as Maharashtra and Tamil Nadu which have a larger more diversified economy and also lesser dependence on coal.The question that arises then is, what kind of revenue options do we have?  We looked at a range of tax options that could be imposed by both the Central and state governments. Options before India include increasing the tax rate, increasing the base of taxes, simplifying taxes, reducing government expenditures, and also imposing new types of taxes.  We find that while many possibilities exist, increasing tax rates is less feasible than increasing coverage or introducing new forms of taxes.

A carbon tax is one such possibility.  However, to institute carbon taxes the Union Government will need to figure out how it wants to share it with the states.  The Constitution of India as per Article 248 empowers the Centre to institute a new tax, it does not allow the Centre to prevent states from taxing fuels.  For that to occur a constitutional amendment will be required, which we believe will be difficult as state governments have limited autonomy over taxation post-GST.  But imposing a carbon tax over and above the taxes already in place seems like a difficult proposition.  Another possibility is to subsume carbon taxes into the GST, which also will be difficult and the states and Union Government will need to come to some mutual agreement.  Another possibility is for the Union Government to impose a distance-based tax that would work something like a fast tag that operates currently.  However, our subsequent work also shows that the distance-based tax will have a significant negative impact on economic growth.

To sum up the current understanding, many options exist, but each option has some strengths and weaknesses and Union and state governments will need to work together to come to a mutually acceptable solution.  They will need to do so fairly early, for the transition is a given, and given that RE and EVs are currently taxed little and subsidized significantly, both state and Union governments’ budgets are bound to be impacted negatively if early action is
not taken. #

References

Bhandari, L. and Verma, R. 2024. Compensating for the Fiscal Loss in India’s Energy Transition: ESAM Analysis, CSEP Working Paper

Bhandari, L. and Verma, R. 2024. Compensating for the Fiscal Loss in India’s Energy Transition, CSEP Working Paper

Bhandari, L and Dwivedi, A. 2023. Critical Challenges in Realizing the Energy Transition: An Overview of Indian States. CSEP Working Paper

Bhandari, L and Dwivedi, A. 2023. India’s Energy and Fiscal Transition, CSEP Working Paper

Laveesh Bhandari is the President and Senior Fellow at CSEP.