A price tag on carbon can improve lives across South Asia, combat climate change

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Man walking in Keoladeo Ghana National Park in Bharatpur, India. Man walking in Keoladeo Ghana National Park in Bharatpur, India.

The area of climate change mitigation and carbon taxation is fraught with complexities, especially for South Asia. Debates on who should share the burden of mitigating climate change seem to suggest that it is unfair to impose carbon taxes on developing countries. After all, most of these countries emit but a small fraction of the existing greenhouse gases into the atmosphere, even as they face the severest challenges from climate change.

However, an increasing body of evidence shows that there are various benefits to adopting a smart green transition strategy to ward off climate damages. Development and going green need not be mutually exclusive.  Of course, implementing such a policy today, as the region’s economies contend with the effects of high and volatile energy prices, may be politically and economically challenging. But now is an opportune time to plan ahead for a greener, more energy-independent South Asia.

Using the Climate Policy Assessment Tool (CPAT), the latest South Asia Economic Focus (SAEF) and a follow-up Working Paper confirm the benefits of introducing a carbon tax and gradually increasing it to $25/ton CO2 by 2030 in a sample of South Asian countries. This tax rate, if introduced, is more ambitious than the South Asian NDCs pledged at COP26 (equivalent to less than $10/ton CO2, based on CPAT estimates). Yet, $25/ton CO2 would still be a reasonable yardstick for developing countries and consistent with keeping warming below 2oC.

Taxing carbon can reduce inequality in South Asian countries

The monetized co-benefits from a carbon tax—regardless of what other countries or regions do—are resoundingly positive and equivalent to almost 1 percent of GDP for the region in 2030. Though there is a loss in economic efficiency as firms and households adjust, the benefits of this tax are many:

  • Reduced local air pollution mortality (due to lower PM2.5 exposure), a major problem in South Asian cities
  • Improved health outcomes and fewer workdays lost due to airborne illness from local air pollutants
  • Fewer deaths from traffic accidents and less time lost in traffic congestion as people choose more public transportation
  • Decreased contribution to global GHG emissions, reducing future damages to the planet

However, there are some who argue that poor people will end up paying most of the cost of such a tax. This is not true. Using available household budget survey microdata for South Asian countries, the CPAT analysis reveals that a carbon tax would be progressive.  This is because poorer households in South Asia consume a smaller share of carbon-intensive products—including direct energy—than richer ones relative to their consumption levels. As seen in the Figure below, the Gini coefficient for consumption in South Asia falls with the introduction of the carbon tax. This means inequality decreases with carbon taxation.

Applying the CPAT model shows that carbon taxation results in reduced inequality in selected South Asian countries.
Source: South Asia Economic Focus, Spring 2022. Applying the CPAT model shows that carbon taxation results in reduced inequality in selected South Asian countries. The left-most bars show percent deviations assuming no carbon tax revenues are redistributed to households, whereas the others assume full redistribution as discussed below.

Channeling revenues towards inclusive development

Government revenues from the introduction of the $25/ton carbon tax in the region would reach 1.5 percent of GDP in 2030, on average—an additional relief for South Asian governments as these funds can help facilitate development. Revenues could be used to:

  1. Build much-needed infrastructure including providing access to information and communication technologies (ICT) and public transport. This will create additional employment, make businesses more efficient, and yield higher economic growth as illustrated in the case of Bangladesh. Overall, this would raise living standards for marginalized households.
  2. Give carbon tax revenues back as cash transfers to the poorest 70 percent of households—frontloaded, if possible—to foster public acceptability.  By 2030, the distributional impact would be even higher, with the Gini coefficient going down even further, i.e., equality improving.
  3. Combine the two alternatives mentioned above such that half the revenues go toward infrastructure (alternative a) and the other half is spent on targeted cash transfers (alternative b). This option would also yield positive distributional effects.

Carbon taxation does not raise all energy prices

Some say that South Asian countries ‘need energy to develop’ and that a carbon tax will stunt their growth. It is true that South Asian countries need more energy, but they do not need more carbon. During this past decade, the world has leapfrogged in innovative renewable technologies, and South Asia has the potential to become a pioneer in producing renewable energy. Already, Bhutan and Nepal produce more hydroelectric power as a share of GDP than most countries in the world. The cost of producing wind and solar energy in India is one of the lowest in the world, even at a time when producing solar energy has become cheaper than producing oil. South Asian countries are embracing innovative programs like battery exchanges in India, off-grid solar electrification in the rural areas of Bangladesh, and floating solar panels across the region.

A carbon tax should be introduced when global energy prices are falling, but careful planning for its implementation can start earlier. Administered fuel prices would need to migrate to market-based prices, as governments veer away from inefficient fuel subsidies. Accompanying programs would be necessary to smooth the transition process and avoid changes following every political cycle. The introduction of such programs tends to be context specific.

Countries have a choice today: embrace these progressive options or continue dependence on fossil fuels imports, which now more than ever are subject to large price fluctuations that could potentially wreak havoc on external sustainability.  Green technologies, however, cannot be installed unless a carbon tax corrects price signals, and consumers and producers have the needed incentive to gradually transition to a more environmentally friendly energy mix. Once that happens, South Asia can truly reap the benefits of green, resilient, and inclusive development.

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