Carbon Taxes – A Necessity?

In this blog post, Pramit Bhattacharya, Student, Damodaram Sanjivayya National Law University, writes about the concept of Carbon Taxes. The post looks into the meaning of a carbon tax. The post also highlights the effect of carbon tax on the economy. The issue of spending and cost with regards to the imposition of a carbon tax is also discussed in this post.

Since the advent of the Industrial Revolution, when man learned to exploit nature for his benefit, the amount of Greenhouse gasses (GHG) in the environment has reached alarming levels. The social cost of exploiting nature almost indiscriminately was not taken into account at all, which lead to nature taking a complete turn. To counter the problem, protocols and agreements like the Kyoto and Montreal Protocol were signed.

Many economists and environmentalists came together and decided that some cost should be imposed on the use of natural resources and fuels such as coal, gas, oil, etc., to curb the deterioration of the environment. Following this, many developed countries started imposing “carbon taxes” in their territories mandatorily. Recently, the European Union levied a carbon tax on the Airlines Sector of India, and the taxes were only removed after India expressed its concern to the United Nations and they rejected the tax imposed by the European Union.[1]In the year 2010, India also imposed a carbon tax coal production (mining) and import of coal. The rate of tax levied is Rs 50/ metric ton.[2]

What is Carbon Tax?

“Climate change” can be said to be the biggest negative externality that is associated with the production of goods and services. It is one of the costs which is not considered at all and can turn out to be extremely damaging to the environment in the long run. To tackle this problem of climate change as a result of the unfettered exploitation of the environment, Arthur Pigou (eminent Cambridge Economist) suggested that the government should impose a tax on the production of goods and commodities which are equal to the social costs.[3]

Carbon Tax can be defined as an environmental tax, that the government imposes on producers of goods and commodities who use natural resources or to be more precise fossil fuels like coal, gas and, petroleum in their production activities. When fossil fuels are used, carbon particles are released which pollutes the environment. This affects everyone and imposes a social cost on the society as a whole. This social cost is not reflected in the cost of production but nonetheless have certain consequences.

If the emission of pollutants is not checked, there will be no reason for producers to reduce emissions. To regulate the level of emissions, the polluter-pays principle is applied. Carbon Tax can be considered as a part of this principle.[4] It is a fee which depends on the emission of carbon which takes place either during the production process or while the product is being used. In some cases, the maximum emission level is also set, and going beyond that limit can attract heavy penalties.

Advantage of Having a Carbon Tax

In circumstances where the carbon tax is imposed, individuals or manufacturers are discouraged from the intensive usage of energy derived from fossil fuels. Also, it encourages the society to use less energy. For instance, people might start using more of public transportation or switch to CFL bulbs. In the case of a carbon tax, the higher the rate of tax, the greater the motivation for people to reduce emissions.

The Game Theory[5]

The Game Theory has not much got to do with law, but much to do with mathematics. It is a model of balancing conflict and cooperation to reach a rational decision. This theory plays an important role for a country like India to decide whether such taxes should be imposed or not.

The developed country of the world has two options. Either to impose the tax mandatorily or not to impose the tax. Now, whether a developing country (for example, India) should impose such tax or not depends on the decision of the developed nations. Because even if a developing country like India imposes the tax mandatorily, but the developed nations do not, it’ll not bring down the level of emissions and the tax will act as an additional and unnecessary burden on the citizen of the country.

Therefore, for a developing country like India, there’ll be no real benefit of imposing such a tax if other developed nations do not cooperate and impose it. At present only some of the countries in the European Union and Australia imposes a tax on the emission of carbon.

Economic Effect of Imposition of Carbon Tax

Any tax directly or indirectly affects the end consumer only. This holds true even for the carbon tax, as an imposition of the carbon tax will affect the final consumer. The producer will look to recover the amount he is paying a tax and will shift the burden of the tax on the consumer by increasing the cost of the product. The example of Quantas, an Australian Airline company can be cited here. They recovered the carbon tax imposed on them by the way of ticket surcharge. The total amount recovered from the customers was close to around $ 105 million.[6] Seen from the view of the economic system, this type of tax is not to generate any revenue but to change the behavior of the people. The negative impact of such a tax would be that every commodity will be sold for a higher price.

The ultimate result will be a rise in inflation, a decline in standards of living and lesser opportunities of employment for the people of the country.[7] This type of situation, especially in a country like India, where the population is extremely high, along with high rate of poverty and an unstable economy makes no sense at all. And that too when the other developed countries are not imposing this tax. Imposition of a carbon tax in India may be a bad idea also because the idea in the first place is to encourage manufacturers to manufacture greener products. But at the present moment, the producers may not even have such advanced technology to manufacture such products. Also, the rate of emissions would not depend only on the imposition of a tax because emission of carbon is a very uncertain thing which depends on various factors.

The National Association of Manufacturer’s Report in the USA stated that if a carbon tax is imposed, it’ll result in a negative growth of the GDP of the country by 3.6% by 2053.[8] The average consumption of the citizen will also reduce which may impact the economy adversely. Talking about Australia, where the carbon tax is imposed mandatorily, the real GDP of the country may come down by 0.68, and consumer prices may rise by .75 %, and electricity cost may increase by 26%.[9]A Report which was prepared by the US Congressional Budget Office stated that such tax would also have a cascading effect and can hamper economic growth.[10]

Issue of Spending

A tax system which is neutral will be helpful in this case, which is beneficial for both, the economy and the environment. Denmark has approached the issue of a carbon tax in this manner. It provides subsidies and has reduced taxes to negate the extra burden of carbon taxes. Institute of Energy Research wrote a paper in which they mentioned that it is impossible to formulate a carbon tax system which is at the optimum level as the legislature cannot have all the possible information due to the uncertainty of climate.[11] There is a direct correlation between the economic development of a country and energy use. Carbon emissions are inevitable in this case. If taxes like these are levied, it’ll lead to low economic output. The imposition of such taxes would also lead to trade protectionism. For instance, if a country imposes a carbon tax it’ll result in a situation where cheaper imports will become a difficulty, which in turn would hamper the international trade of that country. The example of France can be cited here. France earlier proposed a carbon tax, but later the plan was scrapped as the government thought that imposing a carbon tax would place France in a disadvantageous position as compared to its other European neighbors.[12]

The Social Cost of Carbon emission is first, the direct impact which the emissions will have. Secondly, damage from the rise in sea level, and thirdly, the impact on human health. The only way forward it seems is to maintain a balance between the benefits derived because of the levy of the tax and the impact it would have on the economy. The criticism this approach faces is that the poor has to face the maximum burden, but contribute least to the problem.

Concluding Remarks

India has already imposed a tax on coal production and import, as stated above, where there is no such carbon tax even in some of the few developed countries. The best option for India would be to wait and watch.

The only way forward is to cooperate and work together with mutual understanding, because the matter of degradation of the environment is a very pressing one, and something has to be done about it. For a country like India, it’ll be best to see if other nations apply such taxes or not. In case, the imposition of such a tax does take place; a few incentives can be provided, for instance, lowering other kinds of taxes like Sales Tax and Value Added Tax on greener products.