fiscal instruments.pdf

That the environment is a composite part of the social andeconomic system, being impacted by it and influencing it inturn, has only become more apparent over time. Perceptible,day-to-day manifestations of environmental degradation haveled to the environment gradually finding its way into themainstream policy agenda in developing countries. Even asgovernments have sought to strengthen conventionallegislation-based policy, there are several initiatives towardsexperimenting with other instruments for environmentalprotection and natural resource management. In this regard,fiscal policy, in its capacity to prioritize and channelizegovernment spending through allocation of financialresources and to influence the decisions of economic agentsthrough taxes and subsidies, has received considerableattention.

While several developing countries have made noteworthyprogress in the use of fiscal instruments for the managementof natural resources, their use in India has been limiteddespite repeated government recognition of their merits.This document analyses fiscal policy options, opportunities,and challenges in addressing select environmental concernsin the country. The exercise is the collation of researchundertaken by TERI under one of the several researchstreams of the TERICanada Energy Efficiency Projectimplemented over 19992003.1

Green budget reform in India:opportunities and challenges

Divya Datt*

* The inputs of Vikram Dayal in reviewing this chapter are gratefullyacknowledged.1 The analysis was carried out over 19992002, with periodic refinementsand additions in methodology and scope based on interactions withstakeholders. The authors have attempted to update policy developments, tothe extent possible, for the purpose of this publication.

Greening the Budget: case studies2

The focus of the document is the energy sector and thefour issues covered are: (1) controlling emissions from thetransport sector; (2) managing fly ash generated in coal-based power plants, the major source of electricity in thecountry; (3) promoting renewable energy technologies; and(4) improving efficiency in the use of energy and water in theagricultural sector.

In addressing these issues, a major guiding factor was thepracticality of the policy recommendations, given the existingpollution control and fiscal systems, and legislativeprovisions. Since fiscal tools are but an element of the policycanvas, the research and recommendations often wentbeyond budgetary measures to include regulatory andinstitutional reforms. Many of these policy recommendationsare presented as case studies at the state level in view of thejurisdictional characteristics of some of the issues.

Before getting into sectoral analyses, it will be in order toexamine some general issues relating to green budget reformor EFR (environmental fiscal reform) as it is more commonlyreferred to. The following section analyses the definitionalunderpinning of EFR and discusses related internationalexperiences. The next section looks at environmental policy inIndia, and the experience with EFR. The concluding sectionattempts to provide broad lessons for future research in thisarea.

Budget as a tool of environmental policy: the conceptEconomic theory places great faith in the invisible hand of themarket, which ensures that all agents acting in self-interesteventually lead to an allocation of resources that is best forsociety as a whole. However, environmental resources presentthe classic case where the conditions for efficient functioningof the market break down, when private means conflict withthe social ends of an efficient allocation of resources (Hanley,Shogren, and White 2001). Four cases of this market failureare relevant for environmental resources.

Green budget reform in India: opportunities and challenges 3

n Externalities When the market price or cost ofproduction of a commodity excludes its social impact, forexample vehicular exhaust.

n Public goods When a person cannot be excluded fromthe provision of a good (non-excludability) and onesconsumption of the good does not reduce its availability toanother (non-rival consumption), for examplebiodiversity.

n Common property Case of an impure public goodcharacterized by non-excludability but rivalrousconsumption, for example open access to fisheries.

n Hidden information When a person cannot observe thehidden action of others (moral hazard), for exampledifficulties in monitoring industrial emissions, or whenone cannot observe the hidden quality of a good or service(adverse selection), for example difficulties indistinguishing a cleaner product from another producedusing standard practices.

In the face of such failures, economists argue that thesolution is not always to turn to command and controlinterventions but to redeem the markets by adjusting existingones or creating new ones (Hanley, Shogren, and White2001).

Market failures are not always the most serious threat toecosystems. Policy failures, for example, subsidies for certaingoods, services or practices that cause environmentaldegradation are often regarded as more serious. Suchsubsidies are so widespread that often subsidy removal isranked as one of the main instruments of environmentalpolicy (Sterner 2003).

The diversity of instruments available for environmentalpolicy may be classified as in Table 1.

It is important to note that environmental policy is notabout a choice between market-based and command andcontrol instruments.


As Sterner puts it succinctly,

Fortunately, the range of choices is richeras ingeneral economic policy, which is not limited to achoice between planning and laissez-faire. To functionwell, society needs intermediate policies with a lot offine-tuning. And to meet several goals (for example,efficiency, sustainability, and fair distribution),a combination of policy instruments usually isrequired.

Table 2 is a simple illustration of the range of applicationsthat the variety of policy instruments can be put to in themanagement of the environment and natural resources.

A number of these solutions are fiscal in that these havedirect or indirect impacts on the governments budget.Therefore, environmental fiscal reform constitutes theintersection of the environmental policy matrix andbudgetary policies (both revenue and expenditure). Thesewould include direct instruments such as pollution chargesbased on the volume of pollutants discharged. Indirect

Table 1 Classification of instruments in the environmental policymatrix

Creating Environmental Engaging theUsing markets markets regulations public

Subsidy reduction Property rights and Standards Publicdecentralization participation

Environmental taxes Tradable permits Bans Informationand charges and rights disclosure

User charges International Permits and offset systems quotas

Deposit refund schemes Zoning Targeted subsidies Liability

Source Sterner (2003)


Policy instrument

Direct provision

Detailed regulation

Flexible regulation

Tradable quotas orrights

Taxes, fees, orcharges

Subsidies and subsidyreduction

Depositrefundschemes

Refunded emissionspayments

Creation of propertyrights

CPR (commonproperty resources)

Legal mechanisms,liability

Voluntary agreements

Informationprovision, labels

International treaties

Macroeconomicpolicies

Natural resource management(water, fisheries, agriculture, forestry,minerals, and biodiversity)

Provision of parks

ZoningRegulation of f ishing (for example,dates and equipment)Bans on ivory trade to protectbiodiversity

Water quality standards

Individually tradable f ishing quotasTransferable rights for landdevelopment, forestry, or agriculture

Water tariffsPark feesFishing licensesStumpage fees

WaterFisheriesReduced agricultural subsidies

Reforestation deposits orperformance bonds in forestry

Private national parksProperty rights and deforestation

CPR management

Liability bonds for mining orhazardous waste

Forest products

Labelling of food, forest products

Pollution control(air pollution, waterpollution, solid waste, andhazardous waste)

Waste management

Catalytic converters, traf ficregulations, etc.Ban on chemicals

Fuel qualityCAF (Corporate Average FuelEconomy) standards

Emissions permits

Waste feesCongestion (road) pricingGas taxesIndustrial pollution fees

Energy taxesReduced energy subsidies

Waste managementSulphur, used vehiclesVehicle inspection

NOx abatement in Sweden

Toxic chemicals

PROPER (Program forPollution Control Evaluationand Rating) and otherlabelling schemes

Table 2 The policy matrix: instruments and sample applications

Source Sterner (2003)

International treaties for protection of ozone layer, seas, climate, etc.

Environmental ef fects of policy reform and economic policy in general


instruments would include taxes on products or inputs thatare environmentally harmful; and tax concessions orsubsidies (including soft loans) to encourage the use of, orinvestment in cleaner technologies or products. The EFRwould also include in its realm the reduction ofenvironmentally harmful product subsidies, appropriatepricing of natural resources, and select publicly providedservices, since the deviation of prices from the marginal costof supply may be viewed as a tax or subsidy impacting on thegovernment budget (Sankar 2002; Datt, Garg, and Narang2003). Thus the following classification may be used to definethe scope of environmental fiscal reform.n Tax policy Direct pollution charges; indirect product

taxes to encourage / discourage the use of environmentallybenign / harmful products; and providing anenvironmental orientation to reforms in general taxation.

n Expenditure policy Reducing environmentallydetrimental subsidies, directing government expenditurethrough subsidies or allocations for environmentalprotection / restoration programmes, research,development, and dissemination of environmentally soundproducts and technologies, environmental education andawareness, etc.

n Pricing policy (which should include capturing resourcerents) User charges / fees for the use of water andelectricity, and rents on forests, fisheries, minerals, etc.

As this typology indicates, user charges (for example onwater and energy) and pollution charges (for example oneffluent discharge) do not typically enter into theconsolidated budget and hence are charges not taxes.

International experience with environmentalfiscal reform

All over the world, both the developed and developingcountries have experimented with the use of environmentalfiscal instruments. Their use has been greater in the


developed world, but developing countries are also makingincreasing use of these instruments.

Tax policyEnvironmental taxes and charges have become matureoptions in the instrument mix available to policy-makers andhave been increasingly implemented since the 1980s (EEA2003). The European countries take the lead inenvironmental taxes, while tradable permits remain thepreferred option in the US. In 1993, while energy- andenvironment-related taxes constituted 0.8% of the GDP in theUS, the average share in European OECD (Organization forEconomic Cooperation and Development) countries was 2.5%(Sterner 2003).

As many as seven OECD countries (all in western Europe)have imposed fees on emissions of various pollutantsincluding carbon, sulphur, and nitrogen oxides. Interestingly,most of the fees are imposed on input proxies rather than onthe pollution itself. With respect to water pollution, theNetherlands, Germany, and France have taxes on effluents.The transition economies in central and eastern Europe andthe former Soviet Union, are also adopting such instruments(Stavins 2000).

An increasing number of environmental taxation systemsare being introduced throughout the EU, with the aim ofimproving environmental quality in an efficient way whilereducing the burden of taxation on labour and otherproduction costs. However, in the aggregate, changes are notproceeding very quickly (EEA 2003).2

2 This issue of double dividend arguing that the substitution of pollutiontaxes for more traditional revenue-raising taxes not only reduces pollutionbut also distortions associated with existing taxes is itself contentious.While some are circumspect of the first dividend itself, others go on to claimmultiple dividends of environmental as well as economic performance(manifested as increased employment and growth). What seems to beemerging from the debate is that the double dividend by no means can be


Such taxes are by no means only restricted to thedeveloped world. Examples of direct use of environmentalfiscal instruments in developing countries are now fairlynumerous. China, Indonesia, Malaysia, and Thailand haveovercome a number of obstacles to MBIs (market-basedinstruments) imperfectly functioning markets, problems ofmonitoring and enforcement, and a shortage of resources with a fair degree of success. For instance, China has had anational system of pollution charges on air emissions, wastewater discharges, noise, solid waste, and radioactive wastessince the last 15 years. Another example is that of Malaysiawhere, as early as the mid 1970s, the department ofenvironment introduced a permitting system for palm oils inwhich the licensing fee could be varied according to thequantity of waste generated (OConnor 1998). Yet anothersuccess story has been the Colombian system of charges onorganic emissions in waterways. The scheme has beenimplemented in seven regions of the country, with eachregion being allowed to vary the rate until the targetreduction has been achieved, at which point the charge isfrozen in real terms (World Bank 2000 as cited inMarkandya, et al. 2002).

Several developing and developed countries have alsoexperimented with the use of taxes and charges on fuels, roaduse, and vehicles.

Table 3 documents a selection of sector experiences in thedeveloping world.

guaranteed. Distortions on account of existing tax regime are so involvedand interconnected that an environmental tax may potentially exacerbatethese distortions through a negative tax interaction effect, greater than thepositive revenue recycling effect. Mooij (1999) in surveying both theanalytical approaches and empirical studies reaches the conclusion that itmay be wise for governments not to concentrate on the non-environmentaldividend of an environmental tax reform but to put more emphasis on thewelfare improvements associated with a cleaner environment.


ExpenditureIn the context of EFR, expenditure-related instrumentsinclude reduction in environmentally harmful subsidies andenhanced budgetary allocations for environmentalmanagement. Subsidies for the promotion of public transportand renewable energy technologies are common to manycountries. At the same time, examples of environmentallyharmful subsidies are also widespread in developing anddeveloped countries alike. The most common of suchsubsidies implicit or explicit occur in the energy, water,agriculture, and road transport sectors. Typically, consumersare not charged for the capital costs of providing goods andservices such as electricity or irrigation water and are onlycharged a fraction of the operating costs. Such subsidies notonly encourage inefficiency in the use of resources but mayalso have significant adverse environmental impacts such asin the case of the energy sector. Inadequate cost recovery alsoaffects the financial viability of the agencies providing theseservicesadversely affecting their ability to manage,maintain, and expand the necessary infrastructure.

In the energy sector, electricity accounts for an importantshare of subsidies. Estimates for developing countriesindicate that in 1999, electricity was subsidized at a rate ofabout 46% of long-run marginal costranging from 9% inLatin America and Caribbean and 20% in Asia to 76% in theformer Soviet Union (Pagiola, Hurtado, Shyamsundar, et al.2002). In the case of irrigation water, recovery of operatingcosts is as low as 10% in India, 13% in Pakistan, and 25% inChina; with no recovery of capital costs (Pagiola, Hurtado,Shyamsundar, et al. 2002). The story is not very different inthe case of domestic water supply. With more than half of thedeveloping countries levying charges that are less than thetotal costs of providing water, the extent of subsidy variesfrom 4% in Indonesia to over 50% in several countriesincluding Bangladesh, Cuba, Egypt, and India.

There have been some initiatives towards reducingsubsidies; however, despite the moves towards deregulation

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in several sectors, environmentally perverse subsidies remaina grave concern internationally.

Resource pricingNatural resources, in absence of appropriate property rightsor institutional arrangements, are often treated as free goods.State ownership, poor enforcement of laws, and prices thatare effectively zerothese are ingredients in the recipe forshort-sighted use of natural resources. Yet, there is a diversityof experience in the pricing of resources.

Many countries have established harvesting taxes orstumpage fees, though these have mostly been aimed atraising revenue. In Equatorial Guinea, revenues fromharvesting fees from forests amounted to as much as 16% ofthe government budget. China, Ecuador, and Venezuela, havelevied charges on oil extraction. Again, most of these havebeen established with the objective of raising revenue, thoughsome have aimed to encourage the sustainable use of naturalresources. For example, a major objective of the naturalresource tax in China was to encourage the sustainableexploitation of natural resources by forcing developers to payfor the right to exploit public resources (OECD 1999 as citedin Markandya, et al. 2002).

Table 4 indicates some examples of resource pricing indeveloping countries.

International experience in environmental fiscal reformhas thrown up several issues that would need to be studied intaking the process forward in India. Some of these are asfollows.

Issues in environmental fiscal reformThe efficacy of environmental fiscal reform or anyenvironmental policy instrument for that matter woulddepend on the choice and design of the instrument; theadministrative capacity to monitor its implementation; andthe overall policy and institutional environment in thecountry. If the economy is not competitive and if the


bureaucracies are not honest, well-informed, and sufficientlywell-funded to carry out their responsibilities, then no policyinstrument will work perfectly; although some will workbetter than others (Sterner 2003).

The design of an instrument will depend on a number ofinterdependent criteria including cost-effectiveness(achieving environmental goals at least cost); efficiency(addressing the optimality of the goal itself); incentivecompatibility (providing the right incentives for informationdisclosure and undertaking abatement as desired);distributional and equity concerns (ensuring fair distribution

Table 4 Resource pricing in developing countries: some examples

Type of chargeCommodity and revenue Location Aim of charge

Forest Forestry charge Brazil, Colombia, for wood and Venezuelaconsumptionwhen there is noreforestationactivity. Tax setat low levels

Various natural Charges per unit China Ecodevelopmentresources of natural resources incentive for

sustainablemanagement ofresources

Oil royalties Tax levy on Ecuador Earmarked for useoil passing by the Ecuadorianthrough pipelines Institute for Eco-

development

Natural resource Royalties: 4%6% Colombia Preservation ofexploitation of revenues from natural resources.

hydroelectric, Earmarked formineral, and regulatoryoil production agencies.

Source Various as cited in Markandya, Harou, Bellu, et al. (2002)


of costs and / or benefits); and administrative feasibility andflexibility (designing an instrument that is practicable, notincurring excessive monetary or informational costs of itsoperation) (Sterner 2003). These goals are neither perfectlyclear nor separable, and the political process is often about astruggle in which groups place different emphasis on differentgoals and have different interpretation of them.

Direct emission charges and taxes will be more cost-effective when the goal is reduction in emissions over a largearea and when the sources of pollution are not too dispersedand can be monitored. In the case of non-point sources ofpollution or where the objective is to raise revenue, chargeson inputs and outputs that are environmentally damaging canbe more effective as also simpler to enforce.

Environmental subsidies can be effective in reducingpollution albeit at high economic costs. If the subsidies comefrom earmarking of environmental taxes, this may not bedesirable since the resulting level of protection may be toolow or high. Thus earmarking should be avoided in developedcountries where tax regimes are sophisticated and budgetaryprovisions for environmental protection is possible. Indeveloping countries, with limited budgetary provisions, thebenefits of having access to funds through earmarking mayoutweigh the inefficiency costs of this system, at least in theshort run. (Markandya, Harou, Bell, et al. 2002).

There are certain situations when economic instrumentsare not a good idea. In the case of toxic substances, forinstance, it may be too risky to have any instrument but thestrictest control on quantities in the environment.

Fiscal instruments in Indias environmental policyThe first real impetus for developing a framework forenvironmental protection in India came after the UNConference on the Human Environment in 1972. The 1970sand 1980s saw a spurt in environmental legislation and theformation of the MoEF (Ministry of Environment andForests) in 1985.


Over time, the need was felt for the integration ofenvironmental concerns in the planning process itself. Theenvironment became a part of the Five-year Plans, startingfrom the Sixth Five-year Plan (198085), and its integrationin sectoral planning was addressed through mandatoryenvironmental impact assessments of large projects. Thegovernment has also initiated the preparation of State ofEnvironment Reports, based on which environmental actionprogrammes for each state are proposed to be designed.

In terms of expenditure policies, the MoEF, MNES(Ministry of Non-conventional Energy Sources), Ministry ofAgriculture, and several other ministries support a numberof environmental and resource management programmes(Box 1).

Thus, the governments approach towards prevention ofpollution has been mostly in the nature of legislation-basedcommand and control measures while natural resourcemanagement has been largely programme driven. The use offiscal instruments towards environmental objectives in Indiahas been rather limited, even though the need to employeconomic and fiscal policy instruments for the control ofpollution and management of natural resources has gainedsteady recognition during the 1990s.

In the Policy Statement for the Abatement of Pollution,released in 1992, the MoEF noted the need for a mix of policyinstruments in the form of regulations, legislation,agreements, financial incentives, etc. to addressenvironmental concerns. The Tax Reforms Committee, 1992,also suggested that higher rates of taxes on some rawmaterials could be levied to induce economy in the use ofthose materials in production and consumption, for reasonsof conservation and protection of the environment. Itrecommended that excise taxes could be a useful instrumentin dealing with externalities in the form of social costs(Sankar 2002). In the Ninth Five-year Plan (19972002), animportant element of the environmental strategy wasintegrating environment with decision-making through


Ministry of Agriculturen National project on development and

use of biofertilizersn Water managementn Soil and water conservation

Ministry of CoalEnvironmental measures and subsistencecontrols

Ministry of Non-conventional EnergySourcesn Solar energy programmen Biogas programmen Wind energy programmen Biomass programmen Integrated rural energy programmen Other sources of energyn Improved chulhasn Energy from urban and agricultural

waste

Ministry of Rural Areas andEmploymentn Rural water supply and sanitationn Integrated wasteland development

project scheme

Ministry of Water ResourcesCommand area development

Ministry of PowerEnergy conservation

Ministry of Urban Affairs andEmploymentUrban water supply and sewerage

Ministry of Environment andForestsn Central Pollution Control

Boardn Common effluent treatment

plantsn Taj protectionn Establishment of

environment protectionauthorities andEnvironmental Commissionof Tribunal

n Environmental healthn Clean technologiesn Environmental impact

assessmentn Hazardous substances

managementn Biosphere resourcesn Conservation and

management of mangroves,coral reefs, and wetlands

n Biodiversity conservationn Environment education,

training, and awarenessn Environment management

capacity-buildingn State of environment

projectsn Adaptation and capacity-

building project on climatechange

n International cooperationn Forestry and wildlifen National River Conservation

Directoraten National Afforestation and

Eco-development Board

Box 1 Examples of environment-related programmes/schemesin the union budget


valuation of environmental impacts; evolving MBIs as analternative to the command and control form ofenvironmental regulation; appropriate pricing of naturalresources based on their long-term marginal cost of supply;and appropriate fiscal reform and natural resourceaccounting.

In 1995, the MoEF constituted a task force to evaluateMBIs for the abatement of industrial pollution. The task forcemade several specific recommendations on modifying thecurrent regime and on introducing new instruments. Ingeneral it was noted that there should a strategy to put inplace MBIs in the short- to medium-term to complementexisting environmental policies, and for MBIs to replacecriminal provisions (while complemented by economicpenalties) in the long run (Task Force 1997).

More recently, in 2001, the government set up anothertask force to study the introduction of EIs (economicinstruments) for prevention and control of industrialpollution. The Task Force comprised representatives from thegovernment, academia, industry, pollution control boards,and legal experts. The Task Force has invited proposals fromselect SPCBs (state pollution control boards) on theintroduction of MBIs and a plan for implementing a pilotprogramme is slated to be drawn up.

The MoEF has also commissioned several case studies toexamine issues relating to EIs for pollution abatement. Onesuch study undertaken by the National Institute of PublicFinance and Policy in 2000 estimated the abatement costs ofpollutants across different industries and noted widevariations. It highlighted the inefficiency of the currentsystem that requires all polluters to meet the same dischargestandards, irrespective of abatement costs and recommendedthe use of MBIs for cost-effective pollution control. Similarrecommendations were made by another study on regionalenvironmental management in the Kawas-Hazira region inSurat district of Gujarat, commissioned in 2001.


Apart from these initiatives, the Supreme Court ofIndia, in its various judgements dealing with environmentalcases, has also endorsed the application of the polluterpays principle and the precautionary principle (Sankar2002).

The actual use of fiscal incentives has, however, beenrestricted to tax concessions and investment incentives forthe adoption of pollution control equipment, and a somewhatmore structured policy for the promotion of renewable energytechnologies. Tax incentives are usually given for specificabatement technologies and activities, hence not providingdynamic incentives for technological innovation anddiffusion. Also, being mostly for end-of-the-pipe treatmenttechnologies, these incentives do not promote more efficientuse of resources. There are some provisions for the use oflevies, cess, and penalties for polluters such as the system ofconsent fees for discharging waste within standards and thewater cess on the use of water by specified industries andlocal bodies but their design, implementation, andeffectiveness require significant improvement.

Further, while EIs have been used by the government toregulate the economic and social behaviour of the people,these policy decisions do not consider the associatedenvironmental impacts. For example, the prices of allpetroleum products, till very recently, were not market-determined but decided by the state, taking into account thecost of production of each fuel and the socio-economiccharacteristics of the consumers of the fuels. However, theemissions caused from the use of these fuels and theirimpacts on the environment were not a consideration inpricing decisions.

Thus, while much has been said about the need tointroduce economic and, in particular, fiscal instruments toaddress environmental concerns, in practice these effortshave so far been rather adhoc and piecemeal.

There has been growing recognition of the fiscal andenvironmental implications of subsidies in the energy, water,

MANALIHighlight


and agriculture sectors. At Rs 124 billion, irrigation subsidiesaccounted for 23.84% of total non-merit subsidies in 1993/94(as defined in Srivastava and Sen 1997)less than 10% of theoperating costs of irrigation systems are recovered throughwater rates. This, apart from discouraging efficiency in theuse of water, has resulted in the accumulation of operationlosses, adversely impacting the operating efficiencies ofirrigation systems because of inadequate maintenance ofcanal and drainage works.

In the case of drinking water supply also, prices do notreflect the cost of supply and flat-rate charges are common.While there are a variety of water charging practices acrossIndia, on an average the charges levied on residentialusers both for connection and consumption, with andwithout meters are less than one-tenth of the likelyeconomic cost of supply. Further, there is little targeting ofthese subsidies. In the case of industrial consumers, only aminority pay anything close to cost-recovery tariffs(WSP 2003).

In the energy sector, the government has taken stepstowards removing price control on oil and coal, and loweringsubsidies in energy in general. Coal prices were decontrolledin the year 2000, however, due to subsidies on railtransportation, delivered coal prices remain below the marketprices. With the dismantling of the administered pricingmechanism in April 2002, subsidies on all oil products wereremoved barring liquefied petroleum gas and kerosene,mainly used by the households. Supply of electricity toresidential and agricultural consumers, however, remainssubsidized and forms a lions share of the total subsidiesallocated to the energy sector. Subsidies in this sector haveincreased steadily over the years. The average tariff ofelectricity has increased from 89.06 paise/kWh in 1991/92 to240.03 paise/kWh in 2001/02 (Planning Commission 2002).Despite the rise in electricity tariff, the gap between cost ofsupply of electricity and the average tariff has widened from50 paise in 1996/97 to about 110 paise in 2001/02. The


justification and impact of electricity subsidies have been anissue of debate over the last decade.

Moving ahead on green budget reform in India:some issues

As the preceding discussion points out, the approach toenvironmental fiscal reform has not yet received systematicthinking and coordinated action. Against such a backdrop,this project sought to examine the opportunities andchallenges in undertaking environmental fiscal reform inIndia with a focus on energy-related issues. Right at theoutset, it was recognized that for the exercise to be ofimmediate relevance, it would be necessary to identify policyinterventions that could be integrated within the existingregulatory, legal, and policy framework, and which would notplace unrealistic demands on the existing administrativecapacity. At the same time, it needs to be noted that in thelong run, interventions such as emission and effluent charges that require more sophisticated administrative machinery will be inevitable.

The following sectors were covered in the study.n Transport (adjusting the tax structure to reflect relative

environmental externalities associated with differentvehicular options)

n Electricity (managing fly ash, which is a majorenvironmental hazard in coal-based power plants)

n Renewable energy (promoting various grid and off-gridrenewable energy technologies)

n Agriculture (reducing environmentally perverse subsidiesfor irrigation and electricity).

Some of the recommendations were evolved as state-levelcase studies depending on jurisdictional characteristics ofrelevant issues. The process of developing theserecommendations was consultative and iterative, involvingrepresentatives from the government, industry, academia,NGOs, and others. The recommendations were evolved as a


package comprising budgetary as well as complementarynon-budgetary instruments. Thus a number of instrumentswere analysed in the project such as taxes, subsidies,budgetary allocations, as well as regulatory, and institutionalinterventions. While sector-specific issues andrecommendations are discussed in the following chapters,some general lessons from the project are discussed below.

Ensuring greater coordination within the governmentEnvironmental considerations have to be made a structuredpart of the budget-making process with the MoEF, MoF(Ministry of Finance), and the Planning Commission in thelead. A similar process has to be replicated at the state level.It has so far been assumed that environmental concernsremain the responsibility of the MoEF. However as the HighPowered Committee Report on Management of HazardousWastes noted, the MoEF needs to ensure coordination at thehighest level amongst the various ministries, stategovernments, and the Planning Commission, sinceenvironmental protection cannot be dealt with by anyindividual ministry/department in isolation (MoEF 2001).There has to be an integrated assessment of theenvironmental implications associated with various policyoptions across sectors.

The government should also use its general taxation andspending powers to induce economic behaviour that isenvironmentally accountable, apart from dealing with specificenvironmental issues or problems as they arise. It should benoted that any advance in EFR will require a significant rolefor the MoF. Unfortunately, the current task force on MBIsset up by the MoEF does not involve the MoF to the requisitedegree.

Reconciling trade-offs and tapping synergies with otherobjectives of fiscal policy

EFR cannot be designed independent of the other demandson fiscal policy. On the other hand, environmental fiscal


reform and tax policy both have to grapple with difficulties inadministration, monitoring, and enforcement. Both have todeal with efficiencyequity trade-offs by either pointing outthat these may actually not exist in some situations, or bydesign of appropriate instruments such as lifeline rates.Fortunately, there are a number of synergies betweenenvironmental and other objectives of the fiscal policy: thebest example being that of subsidies.

The finance ministry has estimated that hidden subsidieson non-merit goods amount to as much as 10.7% of the GDPon an annual basis. It is no wonder that the combined fiscaldeficit of the centre and states touches almost 10% of theGDP. The average all-India recovery rate (cost of serviceprovision over recoveries from that service) for non-meritgoods / services (as defined by Srivastava and Sen 1997) is10.3%, implying a subsidy rate of just below 90%. The bulk ofthe subsidies on non-merit goods are accounted for bysubsidies on economic services (for example, industries andagriculture), which should be amenable to economic pricing.Even if a part of these subsidies can be justified in the interestof redistribution or provision of minimum needs, asubstantial part must be due to the inefficiency costs of publicprovision of services. In any case, most of these subsidies areinput-based and not directly administered to intendedbeneficiaries and hence are easily dissipated to non-targetpopulation.

The Tenth Five-year Plan highlights that the definition,magnitude, utility, and justification of these subsidies meritreconsideration, since this is the area with the highestpotential for savings. The Plan underlines the need forwidespread and bold imposition of user charges on all non-merit goods. By highlighting the glaring environmental andresource use implications of some non-merit subsidies (as inthe case of irrigation, fertilizers, and power), a clear linkbetween fiscal reform and environmental improvement canbe established.

On the other hand, it may appear that environmental fiscalreform goes against the broad trend towards simplifying


commodity taxation and reducing the number of rates.However, viewed from another perspective, if the tax regimedoes not fully internalize externalities, the apparent level-playing field of a uniform tax system will contain biases,which fundamentally distort economic activity away from thesocial optimum (Smith 1997).

Strengthening the environmental management system inthe country

A sound environmental management system is a prerequisiteeven for an effective command and control for pollutioncontrol. There is a growing recognition for greaterinstitutional strengthening and coordination to addressenvironmental concerns in the country. It is also recognizedthat one of the principal weaknesses of the environmentalprotection regime arises from the constitution, andfunctioning of pollution control boards.

The present structure, including staff and training, is notcommensurate with the requirements of the new importantthrust areas, which have emerged during the recent years.These Boards have not been given the autonomy to fulfill theobjectives for which they were set up. The annual plan budgetof the CPCB (Central Pollution Control Board), at less thantwo per cent of the MoEFs total plan budget, is inadequate toenable the organization to meet the needs and challengesposed by increasing pollution. In order to discharge theirresponsibilities effectively, the CPCB and SPCBs require ascientific/technical base together with broaderinterdisciplinary expertise in economic, legal, andmanagement aspects. There is an urgent need to buildcapacity in the pollution control boards throughprofessionally qualified manpower at senior levels and tostrengthen pollution control infrastructure in every state.

A serious limitation in taking the EFR forward is that theexisting environmental laws do not support pollution load-based charges. Thus, some modifications in current legalprovisions will need to be considered. At the same time,opportunities that exist under the current regime, including


powers vested with the gram panchayats and urban localbodies should be made full use of.

Continuous review of environmental status and theeffectiveness of existing instruments

There is limited compilation of information on a regular basisby the CPCB and SPCBs on the extent of use andimplementation of fiscal and other incentives. Thisinformation would enable an evaluation of the effectivenessof such measures and improvements in the design ofinstruments.

As the government draws up its strategy for EFR, it isimportant that targets are laid down and progress towardsthese is monitored.3 This monitoring will also ensure dynamicefficiency of the EFR process, taking into account, changes intechnology and possibilities of substitution over time.Monitoring will be necessary to understand theenvironmental, fiscal, and social/distributive aspects of EFR.It would need to be assessed whether an instrument would beeffective in meeting its objective, for example if the proposedlevel of a pollution charge would act as an effective deterrentto emissions. The revenue implications of fiscal instrumentsare more easily understood. In this context, issues relating tosetting up a dedicated environment fund into which taxrevenue could be channelled and from which revenue couldbe earmarked for environmental applications, would alsoneed to be examined. Finally the social implication of suchinstruments would need to be understood, both in terms ofhow progressive the incidence of environmental charges maybe as also how these may clash with other social objectives ofthe government.

3 The annual post-budget analyses undertaken by TERI since 1998/99 is oneendeavour towards regular monitoring of progress towards sustainabilitythrough budgetary interventions. Another example is a Framework forEnergy Sustainability Assessment, developed as part of this project, whichaims at analysing and monitoring indicators of sustainability in the energysector.


Understanding and assessing environmental externalitiesAn economically efficient environmental charge would needto be designed such that it induces polluters to implementabatement measures up to the point where the marginalbenefit from pollution reduction (that is, the value of averteddamage) equals the marginal cost of doing so. However, giventhe difficulties of valuing environmental damages, very fewtaxes in practice fulfill this criteria, instead being based onsome predetermined target levels. As valuation techniquesbecome refined and practical in the long term, environmentalcharges would move closer to economic optimum levels.4

Meanwhile, international experience indicates that lack ofinformation about marginal abatement and environmentalcosts need not deter the introduction of such charges andtaxes.

Involving the states in the processThe Constitution of India distributes the powers to make lawsbetween the centre and the states as enumerated in the threelists in the Seventh Schedule. Consequent to the 73rd and74th amendments of the Constitution of India, stategovernments have also enacted enabling legislation,providing for local self-governments both in rural and urbanareas. A number of issues where EFR can be expected to playa major role in the country come under the purview of thestates (for example agriculture, irrigation, transport), or bothcentre and the states (for example power). A number of fiscalinstruments such as the sales tax also come under thepurview of the states. Thus, evolving a consensus for suchreforms across the states would be a big challenge for thegovernment, particularly given that the centrestate sharingof fiscal revenues is itself invariably a subject of debate eachyear.

4 One of the components of this project seeks to estimate full costs ofelectricity generation in Canada and India


Educating and consulting stakeholdersEducation and awareness will be critical factors in creating ademand for environmental fiscal reform and the generalacceptance of such reforms. Even where the imperatives forpolicy change are clearly understood, implementation ofreform cannot progress unless there is a consensus amongststakeholders, as is obvious in the case of the power andfertilizer subsidy. The role of the government is crucial increating a consensus for change by making people aware ofthe long-term benefits of apparently harsh decisions. As theApproach Paper to the Tenth Five-year Plan highlights,reforms would need to be accompanied by research,awareness, public education, and persuasion. The centralgovernment must lead this campaign and forge anunderstanding and consensus with state governments, whomust do the same with local bodies.

Stakeholder consensus also requires that the process ofnegotiation and reforms is transparent with responsible useof new resources generated through reforms.

In general, the success of any environmental policyinitiative will require that the quality of environmental dataand its dissemination be improved.

A phased approach to environmental fiscal reformIt will be pragmatic to introduce EFR in a phased approach,as also recommended by the Task Force on Market BasedInstruments (1997). The elements of this approach could beas follows.n Continuation and redoubling of efforts to move towards

recovering the full costs of electricity, irrigation andmunicipal water, sanitation, and solid waste services, whileat the same time improving the quality of the services.

n Gradual introduction of more sophisticated instrumentssuch as time-of-use electricity tariffs, and encouraginginter-sectoral water charges where possible.

n Redesigning the water cess in a phased manner. Asrecommended by the Task Force (1997), the cess should be


based on pollution load rather than on amount of waterconsumed. Second, it should apply to all industries andlocal bodies discharging effluents. Third, the cess ratesshould be revised gradually in real terms.5

n Moving towards industrial air pollution charges based onemissions, increasing the charges gradually.

n Selection of industries / regions for the implementation ofpilot projects on tradable permits for air pollution.

To sum up, the need to graduate from a rigid system ofpoorly enforced command and control to a more flexible oneallowing the use of a mix of policy instruments is longoverdue. The process will be far from simple and wouldrequire initiatives on several frontsbuilding capacity in therelevant ministries and line agencies to design, implementand monitor such reforms; strengthening networks forgeneration, analysis, and dissemination of information; andtaking the states along in the process and engagingstakeholders to ensure that they buy into the process.However, a beginning must be made and with general fiscalreforms gaining momentum in the country, the time is ripe tomake the environment a part of the process.

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5 The Water Cess Act, introduced in 1977, empowered the state pollutioncontrol boards to levy a cess on local authorities supplying water toconsumers and on consumption of water for certain specified activities. TheAct also provided for a rebate on the cess payable, if the person or localauthority concerned installed a plant to treat sewage or trade effluent.


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WSP (Water and Sanitation Program). 2003Water tariffs & subsidies in South Asia: A scorecard for IndiaWashington, DC: WSP. 14 pp. accessed in October 2003

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