Occasional Paper

ISSUE NO. 368 SEPTEMBER 2022
© 2022 Observer Research Foundation. All rights reserved. No part of this publication
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To Price or not to Price?
Making a Case for a
Carbon Pricing Mechanism
for India

Mannat Jaspal
Abstract

The 2021 Conference of Parties 26 (COP26) propelled nations to ramp
up their climate targets and the concomitant Nationally Determined
Contributions (NDCs) to reduce global greenhouse gas emissions.
However, the updated NDCs and the announced pledges for 2030
remain insufficient and poorly aligned with the targets of the Paris
Agreement. The reduction in projected 2030 emissions is estimated tobe 7.5 percent—far lower than the 30 percent required to limit warming
to 2°C, and the 55 percent which is ideal to remain within the 1.5°C
target. Many analysts had posited that the COVID-19 pandemic wasa unique opportunity to conflate the recovery process with the green
agenda and accelerate the decarbonisation process. Yet, the resulting
emission reduction in 2020 was transient in its effects, and the urgency
and scale of the impending climate crises demands increased ambitionand cooperation to drive the green transition imperative. This paper
explores the role of carbon pricing as an effective instrument in thedomestic and international climate policy architecture.

Attribution: Mannat Jaspal, “To Price or not to Price? Making a Case for a Carbon Pricing Mechanism for
India,” ORF Occasional Paper No. 368, September 2022, Observer Research Foundation.

T
Introduction

here is a broad consensus among economists thatclimate change is a product of both market and policy
failure.1 That the cost of emitting greenhouse gases(GHGs) is not reflected in the price of goods andservices, and allows ‘free-riding’ on climate as an input
for economic activity is indicative of an egregious market failure.2
It perpetuates the linkage between fossil fuel consumption andeconomic growth.3 Further, poor incentives for potential innovatorsand the inadequacy of public infrastructure, energy networks, andfinance have impeded investments in research, development anddeployment of clean technology. Among public policy failures, fossil
fuel subsidies and a distortionary tax system are most consequential.4
Effective climate change policies will be instrumental in reversing
the trend. Carbon pricing is considered a cost-effective measure
to internalise the externalities associated with CO2 emissions andmaximise emission reduction per dollar at the lowest possible cost
to producers, consumers, and taxpayers.5 Putting a price on carbon
internalises the social cost of carbon, and compels companies toadjust their investment portfolio and production methods while
encouraging consumers to alter behavioural patterns.6 It embodies alaissez faire ideology offering a market-friendly mechanism that allows
firms and consumers the flexibility to choose between the costs of
cutting emissions and the benefits accrued from continuing to emit—
and this ensures maximisation of environmental benefit at the least
cost.7The idea of a price internalising externalities dates back to a century
ago when the economist Arthur Pigou argued in ‘The Economics
of Welfare’ (1920), that individuals (and firms) will continue to takeactions with little regard to the costs imposed or benefits conferredon others, unless the cost to individuals incorporate a social cost ofan act. A Pigouvian tax on carbon, therefore, ensures that the cost ofemitting GHGs is reflected in the price of the commodity or service. 8
A carbon price is deemed as an effective tool to incentivise future
investment, consumption and innovation towards sustainable andclimate-friendly pathways, and support a sustainable pandemic

3Introduction

recovery. In 2021, approximately USD 84 billion was recorded incarbon pricing revenue, almost 60-percent higher than in 2020,
as a result of higher carbon prices, increased auctioning fromemissions trading, and revenue from new instruments. Moreover,carbon pricing can be a useful fiscal tool and a prominent source ofaugmenting government revenues.9 Typical carbon pricing policies
allocate government revenues in three ways: investment in climaterelated clean technologies, general budget, and income tax cuts orrebates.10 Estimates suggest that investments in sustainable industries
can generate jobs three times of the full-time jobs from government
spending in fossil fuels.11 In the context of developing economies,
these investments become particularly critical for supporting
vulnerable sectors and communities to adapt to climate change andachieve just transitions.12 Pre-emptively, designing effective domestic
climate policies inclusive of carbon pricing mechanisms—such as the
EU Carbon Border Adjustment Mechanism—can also help offset
the implications of border tariffs. This idea is increasingly being
considered among developed nations as a protectionist strategy to
avoid carbon leakage.
This paper seeks to explore the increasing role of carbon pricing as
an effective instrument in climate policy. Carbon pricing, within an
integrated policy mix, has been propounded as a cost-effective andefficient tool to achieve both economic and environmental benefits.
In the case of India, the relevance of carbon markets has been
underlined by the recent Energy Conservation (Amendment) Bill,
2022 which is momentous in its scope, empowering the government
to establish a carbon credit trading scheme and laying the ground for
a formal carbon market that can be instrumental in India’s pathway
towards a net-zero economy by 2070.13
The paper aims to understand the landscape of global carbon pricing
mechanisms, primarily carbon tax and emission trading systems, anddraw on the global knowledge and experience to arrive at a suitabledecarbonisation strategy for India using national carbon markets.
The rest of the paper delineates the different approaches to pricing
carbon; reviews the current global carbon pricing landscape; andoutlines the measures undertaken by India to put an implicit priceon carbon. It concludes with a proposed approach to a carbon pricing
framework that would be most favourable to India.

4

T
Approaches to
Carbon Pricing

here are different approaches to determine the mostappropriate rate of carbon tax and is often based on thepolicy objectives and goals of the tax regime in a given
jurisdiction. The tax rate could be determined using
an abatement approach—which is the level of carbon
emission reduction the country hopes to achieve—or the social costof carbon approach which translates into the dollar value of damages
incurred from emitting each additional metric ton of greenhousegases. It could also be determined using the revenue approach, where
the tax rate is based on the revenue considerations of the regulating
authority or by simply following a benchmarking approach where thetax rate is linked with the rate in neighbouring jurisdictions, among
trading partners or competitors.14

Carbon pricing mechanisms are predicated on the basis that profitmaking firms will continue to cut emissions to the point where themarginal abatement cost is lower than the social cost of carbon. To
put this into perspective, the marginal abatement cost for an entity
is the marginal cost of reducing each additional unit of emission andis contingent on various factors including the pace of low carbon
technological innovation, cost of compliance, as well as the abilityof firms and consumers to substitute low-carbon products for highcarbon ones.15 The social cost of carbon for an entity is the marginal
damage cost of a unit of emissions and presents the economic value
associated with one extra unit of greenhouse gas in the atmosphere.16
A range of policy instruments, market or valuation based, canbe leveraged to price carbon which can effectively lead to a carbon
reduction pathway. These can be classified as an explicit or an implicit
carbon pricing strategy, and include carbon tax, cap-and-tradescheme, emission reduction credits, clean energy standards, and fossil
fuel subsidy reduction.

5

Figure 1.17
EXPLICIT

Carbon taxes & ETSs
Crediting mechanisms

POSITIVE

NEGATIVE

Shadow carbon prices & internal carbon fees

Fossil fuel subsidies

Renewable energy & energy efficiency support measures

Approaches to
Carbon Pricing

IMPLICIT

Codes & standards
Fossil fuel energy taxes

This graphic is not meant to be an entirely exhaustive list. Other policies could also be
added, particularly on the implicit side, from which a carbon price could be derived.
The placement of the instruments in the graphic also does not indicate any ranking or
hierarchy within the quadrant.
Source: The World Bank: State and Trends of Carbon Pricing 2021

Explicit Carbon Pricing
Explicit carbon pricing is usually mandated by the government andimposes a price on the carbon content. It acts as a market signal
for producers and consumers to move towards cleaner sources of
production and consumption and encourage a more cost-effective
carbon mitigation pathway. These can be achieved through carbon
taxes and/or an ETS (emission trading system or cap-and-trade)which holds emitters responsible for their actions; carbon credits
which creates a reward-like system for reducing carbon emissions; orvia internal shadow pricing leveraged by companies to guide decisionmaking on investment. Contingent on the design, they render various
benefits such as augmenting government revenues, creating green
industries and jobs, encouraging low-carbon investment, enhancing
energy efficiency and security, and improving air quality. 18

6

a. Carbon Tax

Approaches to
Carbon Pricing

A carbon tax imposes a fixed price on carbon (CO2 equivalent on
GHG emissions) while the quantity of emission reduction is left to themarket forces. The objective is to increase the cost of fossil fuel andprovide an incentive for investments in fuel-switching strategies andenergy-efficient technologies.19 It can be applied at different points
in the product cycle of fossil fuels, upstream (point of production/
extraction), mid-stream (point of distribution), or downstream (pointof consumption).20
Considerations across price, emission coverage, point of taxation,
allocation of revenue generated from the tax towards general public
spending or specific emissions-reducing activities, and harmonisation
across boundaries beyond the jurisdiction of the tax should be built
into the design and reviewed periodically.21However, it is important
to note that the market response to the price signal in the form ofemission reductions is difficult to determine and estimate.22
Carbon taxes have the potential to generate substantial fiscal revenues
and the effectiveness of the instrument depends on the amount anduse of the tax revenue. By reducing the existing distortionary taxes
on labour and capital, it can help cushion the blow for low-income
households and offset some of the policy’s social costs. Part of therevenue should also be channelled to fund research and developmentof climate-friendly technologies and desirable sustainability-linked
programs. 23

b. Emission Trading System (ETS)
In a cap-and-trade model, the government sets a limit (cap) on
permissible emissions for different sectors in a particular complianceperiod and allowances are either auctioned or allocated as per
criteria.24 A hybrid approach of freely allocating emission allowances
and auctioning is common in ETS markets. While the quantity/volumeof emissions is regulated, the price is determined by the market

7

Approaches to
Carbon Pricing

supply and demand. During the compliance period, firms with lower
abatement costs can sell their allowances in secondary markets to firms
with higher abatement costs.25 This allows emissions reductions at theleast possible cost. Eventually, at the end of the compliance period,
the allowances are to be surrendered to the government. Various
factors should be considered in the design: the size and level of theemission cap, sectoral coverage, the scope of the cap’s coverage, pointof taxation, whether to freely distribute or sell (auction) allowances,
revenue distribution and management, monitoring, measurement andverification of emissions and allowances, cost containment measures,and impact on international competitiveness.26
Similar to the carbon tax, the revenues generated from selling
allowance certificates will augment fiscal revenues and can be used
to reduce distortionary taxes or finance investments in clean-techprograms. Free allocation of allowances, on the other hand, allows
the risk of potential “grandfathering” i.e., transferring the wealth,equivalent to the value of the allowance, to existing firms instead.27 In
an ETS, high or volatile allowance prices can undermine the efficacyof the policy. Therefore, certain cost containment measures areoften undertaken by the government to prevent emission costs fromovershooting or dipping beyond a threshold to avoid cost uncertainlyand ensure economic stability and the competitiveness of firms. These
include: offsets, allowance banking (reserve units to use in a futurecompliance period) and borrowing (using units allocated for a futurecompliance period), safety valves, price collars, and market stability
reserves.
An offset provision allows regulated entities to offset their own
emission reduction with credits from emission reduction measuresoutside the scope of ETS coverage and can link the cap-and-tradesystem with an emission-reduction-credit system. Banking andBorrowing allows firms to trade their emissions across time horizons
by allowing transfer of allowances to a future period (banking) or
permitting future period allowances to be utilised pre-maturely. This

8

Approaches to
Carbon Pricing

allows firms the flexibility to prioritise across time frames to create themost cost-effective path to carbon reduction. Banking and borrowing
define caps on cumulative emissions rather than on an annual basis.
A safety valve is a price ceiling that puts an upper limit on the cost of
tradable allowance with the government offering additional allowance
at a predetermined trigger price.
However, this measure can lead to aggregate emissions overshooting
the emission cap. A price collar combines the ceiling of the safety valve
with the price floor which sets minimum price for auctions or withthe government agreeing to purchase allowance at a predetermined
price. Cost Containment Reserve (CCR), a volume-based measure,transfers unallocated allowances to a reserve and these are removed
or injected into the market if the number of total allowances incirculation is over or under a predetermined threshold. However,
without careful planning, increasing certainty of mitigation costthrough these containment measures can reduce certainty of thequantity of emissions abated.28

Table 1:
Carbon tax Vs. the ETS
Carbon Tax

Emissions Trading System(ETS)

Format

Sets a fixed price on carbon,
and volume/level of GHG
emissions is determined bymarket forces.

Sets a maximum cap/limiton GHG emissions within ajurisdiction, and the price isdetermined by market forces.

Baseline

The natural baseline for a tax
is a zero tax.

The baseline for a capand-trade system is usuallyemissions in a particular year.

Point of certainty

Delivers certainty over the
price of carbon but theoutcome in terms of emission
reductions is not known.

Delivers greater certainty
about the emission reductionand environmental benefit
but the costs of achieving theamount of abatement is notknown.

9

Carbon Tax

Emissions Trading System(ETS)

Usually applied at the national
level but can target specificgoods or sectors. It can beapplied at various points inthe product cycle of fossil
fuels: upstream (point of
production/extraction), midstream (point of distribution),or downstream (point ofconsumption).

Can be implemented at
level of regions (such as
the European Union) or
nations (such as the Republicof Korea), or else subnational (state based ETS
in the United States). It cantarget specific sectors andbe applied either upstream(based on carbon content offuels) or downstream (basedon monitored emissions).

Emission coverage Can be imposed on the total
emissions, certain fuel sources
depending on the carbon
content, specific sectors, orfuel products.

Cap’s coverage must identify
the types of greenhousegas emissions and sources
covered.

Allocation of
Revenue

Revenue generated from thetax can be allocated towards
general public spending,specific emissions-reducing
activities, reductions inexisting distortionary taxes onlabour and capital.

If the allowances are
auctioned or sold at a fixedprice (as opposed to freeallocation), revenues could be
used to reduce distortionary
taxes or finance otherprograms.

Price containment
measures

N/A

Includes offsets, allowancebanking and borrowing,safety valves, price collars,
and cost-containment
reserves (CCR).

Challenge

1. Market response to theprice signal in the form ofemission reductions cannot be
determined when adopting
the policy. It is still necessary
to consider revising the carbon
price path if the emissions
path deviates persistently fromthe expected one.

1. As the abatement costs are
difficult to determine preemptively, a sharp increasein the price of certificates ispossible when the demandfor emission certificates arehigh. This could lead to adisproportionately higher
burden for emitters.

2. Abatement costs should belower than the tax burden to
incentivise emitters to invest in
more sustainable technologies.
However, abatement costs are
hard to quantify and therefore
setting the right carbon tax ischallenging.

2. Increasing certainty about
mitigation cost—througha carbon tax, safety valve,or price collar—reduces
certainty about the quantityof emissions allowed.

Approaches to
Carbon Pricing

Point of
Application

10Complementarity

Carbon Tax

Emissions Trading System(ETS)

Carbon taxes can be designedwith the flexibility to assure
certain emissions goals.
For example, policymakers
can tie the level of the tax
to emissions, so it adjusts
automatically to keep the longrun trajectory of emissions
within a pre-specified range.

A cap-and-trade systemtransitions to a tax in thepresence of unexpectedly
high mitigation costs using
price collars. The volatility
can be mitigated by allowing‘banking and borrowing’ of
quotas across time periods
and/or by introducing achange in the authorities’
supply of quotas.

Note: Both systems internalise the cost of carbon by setting a price on emissions but differ
in their approaches.
Source: Author’s own.

Approaches to
Carbon Pricing

c. International Crediting Mechanisms/ Baseline andCredit system
According to Article 6 of the Paris Agreement (Article 12 of the Kyoto
Protocol), industrialised countries with emission reduction targets(Annex B Party) can purchase certified emission reduction (CER)
credits from developing countries, each credit equivalent to one tonneof CO2, to provide offsets if they are unable to comply with their Kyoto
targets.29 Emission credits are available to emitters who successfully
reduce emissions below the designated limit; they can then trade andsell these credits in the international market. This is also referred
to as the baseline and credit system which offers flexibility for aninternational cap-and-trade mechanism. 30
The Clean Development Mechanism is the international
standardised emissions offset instrument governed by the United
Nations Framework Convention on Climate Change (UNFCCC) tofacilitate the trade on the global scale. However, given the growing
popularity of the carbon credit market, many independent (suchas the Gold Standard, Verified Carbon Standard) and domestic
standards (California Compliance Offset Program, Australia Emissions
Reduction Fund, Republic of Korea Offset Credit Mechanism) havegained prominence and are dominating the market. 31

11

Approaches to
Carbon Pricing

d. Internal Carbon Prices
Corporations worldwide have started to acknowledge the critical role ofincorporating climate risks and opportunities in their risk assessment
frameworks and consider carbon price to be an effective instrument in
guiding capital allocation and investment decision-making. Therefore,
internal carbon pricing is being used voluntarily by companies andorganisations as a pre-emptive move to safeguard against future
shocks, measure exposure associated with climate related physicaland transition risks, as well as prospective government regulations
pertaining to carbon pricing. It is commonly done via shadow carbon
pricing where a hypothetical carbon cost is associated with each ton of
CO2 emissions. This helps identify and integrate climate-related risks
and opportunities in the broad long-term strategies of a company anddictate capital allocation and investment decision-making processes by
relying on an implicit price which is based on the offsets required toachieve internal carbon neutrality objectives. 32

Implicit Carbon Pricing
There are certain mandates or government policies that do notdirectly put a price on emitting carbon but set uniform performancestandards for GHG abatement. They seek to address climate objectivesof reducing GHG emissions by setting technology and performancebased standards as well as gradually eliminating fossil fuel subsidies tomake energy-intensive products more expensive compared to theirsustainable/renewable counterparts.

a. Command-and-Control Regulations
Conventional environmental policy employs technology andperformance-based standards to control emission levels and protect
environment quality. Technology-based standards require firms touse certain energy-efficient processes, equipment or procedures withno fixed targets on the volume of emission reduction. Meanwhile,
performance-based standards specify permissible levels of pollutant

12

emissions or allowable emission rates and leave the processes ofemission reduction at the discretion of regulated entities.33 By the very
nature of such standard-based policy, given higher costs as well as
poor incentives for the development and adoption of environmentallyand economically superior technologies, the approach is limiting in its
scope and impact. Incorporating market-based instruments within its
fold can thus help overcome non-cost-effective outcomes.

Approaches to
Carbon Pricing

b. Clean Energy Standards
A clean energy standard (CES) is a market-based and technologyneutral approach to encourage the power sector to switch to non- or
low-emitting sources of energy. The industrial and commercial power
consumers are mandated to meet a certain percentage of their power
requirements from clean energy sources as a means to phase down
dependence on fossil fuels. Given the challenging politics aroundpricing carbon, clean energy standards are often viewed as a costeffective and politically palatable alternative to pricing carbon in theelectricity sector. Firms that overachieve the clean energy standard
targets or thresholds can receive energy saving certificates which canbe traded in the energy exchange. This system is analogous to an ETS
and relies on the market principles to reduce the energy intensity ofhigh-carbon-emitting sectors in the most cost-effective and efficientmanner. 34

c. Eliminating Fossil Fuel Subsidies
Many countries provide heavy subsidies to fossil fuels to support their
growth and development objectives. This becomes particularly criticalfor nations where innovation and growth in the renewable sector
has yet to pick up pace. However, gradual elimination of fossil fuelsubsidies can be an effective way to achieve an optimal price for the fuelas well as provide incentives for energy efficiency and fuel-switching
technologies (comparable to implementing an explicit carbon price).35
Fossil fuel subsidies are often termed as a “government failure”,
exacerbating the conditions of a market failure. For some years now
there has been a significant degree of agreement on phasing out
these subsidies, while targeting support for the poor. A G20 Leaders’summit in 2009 noted, “The economic and climate benefits of fossil
fuel subsidy reform could be significant. Inefficient fossil fuel subsidies
encourage wasteful consumption, reduce our energy security, impede
investment in clean energy sources and undermine efforts to deal withthe threat of climate change.”36

13

Global Carbon Pricing
Mechanisms: A Review

G

lobally, 68 carbon pricing instruments (CPIs),
including taxes and emissions trading systems (ETSs),
are operating while three more are scheduled for
implementation in the short term.37 As this paper’s
objective is to inform a national carbon pricing
mechanism for India, the scope is limited to reviewing only carbon
tax and ETS mechanisms. The selection of global carbon pricing
mechanisms for review is purposeful to ensure representation fromdiverse geographies and varying timeframes of implementation to
help identify best practices and learning opportunities.
Tables 2 and 3 present a tabular comparison of supranational, national,
and subnational level ETS systems of the European Union, China,
New Zealand, Republic of Korea, Switzerland, United Kingdom,
Regional Greenhouse Gas Initiative and China’s seven provincesBeijing, Shanghai, Tianjin, Chongqing, Shenzhen, Guangdong, andHubei. Table 4 presents a tabular comparison of international carbon
tax systems of Argentina, Canada, Chile, Columbia, Ireland, Japan,
Singapore, South Africa, Mexico and Norway.
Countries were selected to cover carbon pricing policies that variedin their sectoral coverage, point of taxation, allocation approaches,
price containment measures, revenue redistribution and exemption
mandates. Data for all three tables were sourced from the World Bank
Carbon Pricing Dashboard.

14

Table 2:
Review of Global Emission Trading Systems(Supranational and National)38
Allocation

Country

Sectoral/Fuels

Price Level

Cap on Total

Revenue

Share ofPrice Containment

Coverage

Coverage(tCO2e)Emission Units

Generated

Jurisdiction’s

Measures

Overlap with(Year ofIntroduction)

Carbon Taxes

GHG(million)

Emissions
CoveredEU ETS

Emission allowances

The system covers

The market stability

Carbon taxes(EU-member

under the cap are

activities from(2021)

reserve (MSR) started

from Finland,states, plus

distributed via athe power sector,

The total

shaping the supply of

Ireland,

Iceland,combination of

manufacturing

amount ofallowances to provide

Netherlands,

Liechtenstein,free allocation andindustry, andemissiongreater price stability

Norway,and Norway)

auctioning. The

aviation (including

allowances isand predictability in

Denmark,(2005)

free allocation toflights from thedetermined

the EU ETS. The MSR Estonia, Latvia,

industry sectors

EEA to the United

top-down

achieves this goal by

Slovenia,

depends on EU-

Kingdom). Someand decreases

removing or injecting

Sweden,wide benchmarks,

small emitters areannually by

allowances in the

Poland,historical activity

exempt from the

2.2%.

market if the number

Switzerland,data,

EU ETS. It applies

of total allowances

Franceemission and/or

to CO2, N2O, PFCs

in circulation istrade intensity. The

emissionsover or under apower sector does

(individual states

predetermined

not receive any freemaythreshold.

allocation.

add more GHG

US$871572 MtCO2e

US$34326

41%

emissions).
China National Builds on the

The ETS applies toEntities received

Not

ETS (2021)

subnational pilot

CO2 emissions fromallowances atavailable

carbon markets

the power sector,

70% of theirmarket-regulating andimplemented

including combined2018 output

protection mechanism

in eight

heat and power

multiplied by aare yet to be defined.

regions. Allocationand captive power

corresponding

currently takes

plants from otherbenchmarkplace through freesectors. Exceptions

factor.

allocation.

to be determined.

US$9

15

33%

The necessary triggers

No carbon taxes

and specifics of aexist in China

Allocation

Country(Year of

Sectoral/Fuels

Price Level

Cap on Total

Revenue

Share ofPrice Containment

Coverage

Coverage(tCO2e)Emission Units

Generated

Jurisdiction’s

Measures

Overlap with

Introduction)

Carbon Taxes

GHG(million)

Emissions
CoveredNew ZealandEmission allowances

The NZ ETSETS (2008)

under the cap are

applies to GHG

distributed via a

US$53

35 MtCO2e

The ETS provides

No carbon taxes

a price ceiling andexist in New

emissions (CO2,

an auction reserve

Zealand.

combination ofCH4, N2O, SF6,

price as a price floor,

free allocation

HFCs and PFCs)

thereby setting up a

and auctioning.

from the industry,

price corridor for the

Emissions-intensive

power, waste,

auctioning of units.

and trade-exposedtransport andIf a predetermined

sectors at risk offorestry sectors

trigger price iscarbon leakage

and includes

reached at auction, a

receive freeindustrial process

specified number ofallowances ofemissions. The

allowances from thebetween 60 - 90% of

agriculture sector

CCR is additionally

US$1648

49%(2022)

the benchmark level. needs to report

released for sale.

The government has its emissions but
decided to phase-out has no allowancefree allocations for

surrendering

the industrial sector,

obligations.

at a rate of 1% peryear between 2021
and 2030.
Republic of

In the most recent

The Korea ETS

Korea ETS

Phase III, 90%applies to GHG(2015)or less allowances

US$19

589 MtCO2e

Measures include

No carbon taxes

auctioning ofexist in Southemissions (CO2,

allowances from the

Korea.

will be freely

CH4, N2O, PFCs,

reserve, imposing

allocated to entities

HFCs and SF6)banking limitations,in sub-sectors

from the industry,changing thethat are subject

power, buildings,

borrowing limits,

to auctioning;domestic aviation,changing the offset

100% for EITE

public sector andrestrictions andsectors. At least

waste sectors. Some

temporarily setting a

10% of allocation

small emitters are

price floor or ceiling.

to entities in sub-exempt from theAuctions for market

sectors subject toKorea ETS.

stability will be subject(2022)

US$24373%

auctioning. Entities

to an auction reservefrom 41 sub-sectors,

price.

which excludes
EITE sectors,
can participate in
auctions. Emissionintensive and/or trade-intensive
sectors at risk ofcarbon leakage
receive freeallowances up
to 100% of thebenchmark or
historical emission
level.

16

Country

Allocation(Year of

Sectoral/Fuels

Price Level

Cap on Total

Revenue

Share ofPrice Containment

Coverage

Coverage(tCO2e)Emission Units

Generated

Jurisdiction’s

Measures

Overlap with

Introduction)

Carbon Taxes

GHG(million)

Emissions
CoveredSwitzerland

Emission allowances

The Switzerland

As of 2022, a market

Switzerland

ETS

under the cap are

ETS applies tostability mechanism

has a carbon(2013)

distributed via a

GHG emissions

reduces auction

levy that covers

combination of(CO2, NO2, CH4,

volumes if the number

some entities

free allocation and

HFCs, NF3, SF6of allowances inif they are not

auctioning. Industry

and PFCs) fromcirculation exceed

covered under

sectors receive

the industry anda certain threshold.

the Swiss

free allocation

power sectors and

The Swiss ETS is not

ETS.

based on the same

includes industrial

subject to the EU

benchmarks asprocess emissions.

ETS Market Stability

the EU ETS andSmall emitters are

Reserve.

historical activity

exempt from thedata. Emission-

Switzerland ETS.

US$64

5 MtCO2e (2020) US$18

11%intensive and/or trade-intensive
sectors at risk ofcarbon leakage
receive freeallowances up
to 100% of thebenchmark level.
Also, small emittersare exempt from the
Switzerland ETS.
UK ETS

Auctioning is the

The UK ETS covers US$99

To avoid instability in

No carbon taxes(2021)

primary means ofenergy-intensive

allowance prices

exist in UK.

allowance allocationindustries, theCost Containment

Not available

US$5664

28%

under the UK

power sector, andMechanism (CCM)

ETS. A share ofaviation within theallows auctioning

allowances will be

UK and Europeanof additional

distributed freely to

Economic Area.

allowances. Auctions

Emissions Intensive

Hospitals andhave a transitional

Trade Exposed

small emitters with

Auction Reserve Price(EITE) sectors at risk emissions lowerof carbon leakage.

(ARP) which will bethan 25 kt CO2e

withdrawn as the UK

annually can opt

ETS matures.

out of the ETS.

The UK ETS
Authority has set
out the possibilityof establishing a
supply adjustment
mechanism (SAM)
similar to the EU
ETS Market Stability
Reserve (MSR).

Note: tCO2e = ton (t) of carbon dioxide (CO2) equivalent (e); GHG = Greenhouse gas emissions; N20 = Nitrous oxide
PFCs = Perfluorochemicals; MtCO2e = Metric tons of carbon dioxide equivalent; CH4 = Methane; NF3 = Nitrogen Trifluoride SF6 =Sulphur Hexafluoride; HFCs = Hydrofluorocarbons
Source: World Bank Carbon Pricing Dashboard

17

Table 3:
Emission Trading System (Sub-National)
Country

Allocation(Year of

Sectoral/Fuels
Coverage

Price Level(tCO2e)introduction)

Cap on Total
Emission
Units

Revenue
Generated(million)

Share ofPrice

Jurisdiction’sContainment

GHG

Measures

Emissions

Coverage
Overlap with
Carbon Taxes

CoveredRegional
Greenhouse
Gas Initiative(2009)

It is the first

The ETS only

mandatory ETS inapplies tothe United States.

CO2 emissions

The majority ofemission allowances(Connecticut,

are allocatedDelaware,through quarterly

Maine,

auctions using

Maryland,a ‘single-round,

Massachusetts,sealed-bid uniform-

New

price’ format.

Hampshire,

Auctions are

New Jersey,

open to all parties

New York,

with financial

Rhode Island,

security, with aVermont andmaximum bid of

Virginia).

25% of auctioned

from power
sector in the
Northeast andMid-Atlantic
US states.
Small power
plants are

US$14

88 MtCO2e(The total
amount ofemissionallowances isdetermined
top-down
and decreases
annually).

US$926
million11%

An auction pricefloor is set which
increases by
2.5% per year toreflect inflation.
In addition,
there is a Cost
Containment
Reserve (CCR)
creates a fixed

exempt fromadditional supply

RGGI.

of allowancesthat are only
available forsale if CO2
allowance prices
exceed certain
price levels.

allowances per

In addition,quarterly auction.

EmissionsContainment
Reserve (ECR)
was establishedin 2021 such thatallowances arewithheld fromauction if theprice is below thetrigger price.

18

No carbon taxes
exist in RGGI
states.

Country

Allocation(Year of

Sectoral/Fuels
Coverage

Price Level(tCO2e)introduction)

Cap on Total
Emission
Units

Revenue
Generated(million)

Share ofPrice

Jurisdiction’sContainment

GHG

Measures

Emissions

Coverage
Overlap with
Carbon Taxes

CoveredChina

Beijing: Free

The ETS

Beijing:

Beijing:

Not

The earliest

allocation

initially only

US$7

35 MtCO2e

availablepilot ETS

Tianjin: Mixed, free

applies to CO2

Tianjin:(2022)

was set up

allocation

emissions.

US$4

Tianjinin Shenzhen(major) andBeijing:Shanghai:

165 MtCO2e

Shanghai:pilot phase.

ETS in 2013,

small portion of

CoversUS$9(2019)

35%

Regulating

and the latest

allowances can beindustry,

Chongqing:

Shanghai:

was launchedauctioned

power,

US$6

158 MtCO2e

Chongqing:

auction extra

in Chongqing

Shanghai: Mixed,

transport

Shenzhen:(2019)

51%

allowances

ETS in 2014

free allocation andand buildings

US$0.64

Chongqing:

if average(Beijing,

auctionsectors.

Guangdong:

100 MtCO2e

weighted price

Tianjin,

Chongqing: Mixed,

Tianjin:

US$13(2018)

exceeds the

Shanghai,free allocation and

CoversHubei:

Shenzhen:thresholdChongqing,

auctionindustrial

US$7

31 MtCO2eand buy backShenzhen,Shenzhen: Mixed,

and buildings(2015)

allowances if

Guangdong,free allocation,

sectors.

Guangdong:price falls below

Hubei).

Regulations

Shanghai:

465 MtCO2e

a specified limit.

stipulate that 3% of

Covers(2019)

Certainthe total allowancesindustry,

Hubei:

provinces do set

should be auctioned

buildings and

270 MtCO2e

up a price floor.

Guangdong: Mixed,

transport(2019).

free allocation withsectors.

a small portion ofChongqing:allowances can be

Covers GHG

auctionedemissions

Hubei: Mixed, freefrom theallocation with aindustrial

small portion of

sectors.

allowances can be

Shenzhen:auctioned

Covers(The main purpose

industry,of auctions

power,

is to provide

buildings andcompliance entities

transportwith additional

sectors. The

supply to meet

Guangdong:their compliance

Coversdemand)industry and

Beijing: 24%
Tianjin: 33%

No borrowing

No carbon taxes

butexist in China.

Banking isallowed duringauthority candomestic
aviation
sectors.
The Hubei: Covers
industrial
sectors.

Note: tCO2e = ton (t) of carbon dioxide (CO2) equivalent (e); GHG = Greenhouse gas emissions; MtCO2e = Metric tons of carbon dioxide
equivalent
Source: World Bank Carbon Pricing Dashboard

19

Table 4:
Review of Global Carbon Tax Mechanisms
Country

Point of Taxation(Year of

Sectoral/Fuels

Tax Rate

Revenue

Share of

Revenue

Coverageper ton of CO2e

Generated

Jurisdiction’s

Disbursement

introduction)

GHG
Emissions
Covered20%

Argentina

Upstream: Producers,

All liquid fuels andMost liquid

US$272(2018)

distributors, andsome solid products

fuels: US$5/

million100% of this revenue isimporters of the fossil(mineral coal andtCO2e;

to the Federal Revenue

fuels covered.

petroleum coke).

Fuel oil,

Distribution System for

Exemptions include

mineral coalfuel oil, mineral coal andinternational aviationand petroleum

petroleum coke. For theand shipping, export

coke:US$0/

rest of the products, theof the fuels covered,tCO2erevenue is designated to

distributed according

the biofuel content ofmultiple beneficiaries,

liquid fuels and the use

including the social

of fossil fuels as raw

security system, thematerials in chemical

Transport Infrastructure

processes.

Trust, the National
Housing Fund (FONAVI),
the provinces, among
US$40/tCO2e

US$479822%

others.
All direct proceeds from

Canada federal

Upstream: Registered

The charge covers 21

fuel charge

distributors andtypes of fuel delivered,(2019)

producers of the fossil

transferred, used,

returned to the province

fuels covered are liable

produced, imported oror territory of origin.

millionfor payment of the charge brought into a province
upon use or delivery ofand territory where

those fuels.

the federal fuel charge
applies. It also applies

Note: The federal

on combustible waste

backstop system applies

that is burned for thein jurisdictions that

purpose of producing

request it or do not have a heat or energy inprovincial system in place those jurisdictions.
that meets minimum

Exemptions include

national stringency

uses of fossil fuels

criteria, as set out in thein agriculture andfederal benchmark.

transport and forfarmers and remote offgrid communities.

20

the federal system areCountry

Point of Taxation

Sectoral/Fuels

Tax Rate

Revenue

Share of

Revenue

Coverageper ton of CO2e

Generated

Jurisdiction’s

Disbursement(Year ofintroduction)

GHG
Emissions

Chile

Midstream (power

CO2 emissions(2017)

producers): Fixedfrom mainly thesources are regulated

power and industry

downstream. Mobile

sectors. The tax covers

sources are regulated

all fossil fuels. Small

through a purchaseinstallations (<25.000

tax, calculated based ontCO2) are exempt fromfuel efficiency and NOx

tax.

USD5/tCO2.

US$160Covered29%

Not available

23%

50% of the revenues

millionemissions (not an explicit
Colombia

carbon tax).
Upstream: Sellers andAll sectors with some(2017)

importers of the fossil

minor exemptions. It

US$5/tCO2e

US$89
millionfrom the tax will

fuels covered are liable for is a tax on the carbon

be used in coastal

payment of the tax.

content of liquid anderosion management,

Special Feature: Use of

gaseous fossil fuels, it

conservation of water

Offsets - Emitters candoes not apply to solid

sources, and the

avoid the payment if they fuels. Tax exemptions

protection of ecosystems

achieve carbon neutrality

apply to natural gas

and the other 50% of

through the use of offset

consumers that are notrevenues will be used for

credits generated fromin the petrochemical

financing the Program for

projects in Colombia.

and refinery sectors,

the Substitution of Illicit
Use Crops

Credits have to be verified and fossil fuelby auditors accredited byconsumers that are

the UNFCCC, Colombia’s certified to be carbon
national accreditation

neutral.

body, or a memberof the International
IrelandAccreditation Forum.
Midstream: Fuel

Applies to CO2(2010)

suppliers;

emissions from all

US$45/tCO2e.

The Ireland carbon tax

sectors with some

Other fossil

support rural transport,

is officially under three

exemptions for thefuels: US$37/

alleviate fuel poverty,

names: - Natural Gas

power, industrial

tCO2e

and maintain or reduce

Carbon Tax (NGCT),

processes (chemical

Mineral Oil Tax: Carbon

reduction, electrolytic

Charge (MOTCC) andor metallurgical

Solid Fuel Carbon Tax

processes), transport,

Transport fuels: US$542

sectors. The tax

measure to the EU ETS.

covers all fossil fuels.

The revenues are used toboost energy efficiency,

payroll taxes.

(SFCT)). The tax serves as shipping aviation
a complementary policy

million40%

The tax serves as acomplementary policy
measure to the EU
ETS hence, full/partial
reliefs are available forfuels used in the ETS
sector.

21

Country

Point of Taxation(Year of

Sectoral/Fuels

Tax Rate

Revenue

Share of

Revenue

Coverageper ton of CO2e

Generated

Jurisdiction’s

Disbursement

introduction)

GHG
Emissions
US$2/tCO2e

US$1800

Covered75%

Revenue is primarily

Japan

Upstream: Producers ofApplies to CO2(2012)

the fossil fuels covered

emissions from fossil

are liable for payment offuels across all sectors

change mitigation

the tax.

with some exemptions

projects.

millionreserved for climate

for the industry, power,
agriculture, transport
Singapore

Upstream: At source,

and forestry sectors.
Applies to direct(2019)

such as power stations

emissions from facilities

and other large direct

emitting 25 ktCO2e orclimate change.

emitters.

more in a year, covering

Companies can alsocarbon dioxide,

continue to tap on

methane, nitrous oxide,

existing support measuressulphur hexafluoride,for decarbonisation, suchhydrofluorocarbons,as the Resource Efficiency

and perfluorocarbons.

Grant for Energy

Excise duties are also

(REG(E)), Investment

levied on transport

Allowances for Emissions

fuels which serves as

Reduction (IA(ER)) anda carbon price signal

Energy Efficiency Fund.

US$4/tCO2e

US$153
millionfor transportation
emissions. The carbon
tax is applied on
all sectors without
exemption as long as
the facility meets theemissions threshold.

22

80%

Revenue supports
initiatives to address

Country

Point of Taxation(Year of

Sectoral/Fuels

Tax Rate

Revenue

Share of

Revenue

Coverageper ton of CO2e

Generated

Jurisdiction’s

Disbursement

introduction)

GHG
EmissionsSouth Africa

Upstream: At source(2019)
Use of Offsets:

The Carbon Tax covers US$10/tCO2e

US$94

all types of fossil fuels

millioncombusted by large

Companies can use carbon businesses acrossoffsets as a flexibility

industry, power, andmechanism to increasetransport sectors. The

their tax-free allowancescarbon tax does notby either 5% or 10% of

apply to the residential

their emissions. Only

sector. Tax exemptions

domestic emission

range from 60% toreduction projects will be

95%, depending on thecredited and the scheme

sector and the level ofwill primarily rely on

exemption depends on

existing international

the presence of fugitive

offset standards including emissions, level of trade
the CDM, Verified Carbon exposure, emission
Standard, and Goldperformance, offset

Standard.

use, and participationin the carbon budget
program. Companies
can also claim anenergy efficiency tax
incentive; and are able
to offset paymentsof the electricity
generation tax andadditional purchasesof renewable energy
against their carbon
tax liability. Thistransitional support
is available until
December 2025.

23

Covered80%

Not available

Country

Point of Taxation

Sectoral/Fuels

Tax Rate

Revenue

Share of

Revenue

Coverageper ton of CO2e

Generated

Jurisdiction’s

Disbursement(Year ofintroduction)

GHG
Emissions

MexicoUpstream: Producers and Mexico’s carbon

Upper: US$4/

US$314(2014)

importers of the fossil

tCO2e. Lower:

milliontax is an excise tax

fuels covered are liable for under the special tax
payment of the tax.

Covered44%

on, among others, energy

US$0.42/tCO2e

efficiency, technologies,
and the improvement ofon production andpublic transportation

Use of Offsets: Companies services. It is not aliable to pay the carbon

tax on the full carbon

tax may choose to pay

content of fuels, butwith credits from CDM

on the additional

projects developed in

CO2 emission content

Mexico or CERs thatcompared to natural

are also eligible forgas. The Mexican

compliance in the EU

carbon tax applies to

ETS, equivalent to theCO2 emissions from

Revenues will be usedmarket value of the credits all sectors. The tax is
at the time of paying thecapped at 3% of thetax.

fuel sales price. Natural

NorwayUpstream: Producers,

this tax.
Applies to GHG

General tax

US$1716(1991)

distributors and importers emissions from all

rate:US$88/

millionof the fossil fuels covered

sectors with some

tCO2e. Reduced

are liable for payment of

exemptions. The

rate for LPG

the tax.

tax covers liquidand naturaland gaseous fossil

gas in thefuels. Norway does

greenhouse

not have any taxes

industry: US$9/

on emissions fromtCO2e

gas is exempted from63%

Not available

LULUCF (Land use,land-use change, andforestry). Operators
covered by the EU ETS
are in general exempt
from the carbon
tax. International
aviation andinternational shipping,export of the fuels
covered and the shareof biofuels in mineral
oil are exempted asthey are not includedin the Norwegian GHG
emissions inventory.

Note: tCO2e = ton (t) of carbon dioxide (CO2) equivalent (e); GHG = Greenhouse gas emissions; MtCO2e = Metric tons of carbon dioxide
equivalent; ktCO2e = kilotonnes of carbon dioxide equivalent
Source: World Bank Carbon Pricing Dashboard

24

I

ndia does not impose an explicit carbon pricing mechanism
but puts an implicit price on carbon through a series ofmeasures and schemes that will be described in the following
paragraphs:

Implicit Carbon
Pricing in India

1. Perform, Achieve and Trade (PAT) Scheme

The PAT scheme (Perform, Achieve and Trade), introduced in2012, is the flagship programme of the Bureau of Energy Efficiency(BEE), Ministry of Power, Government of India. The scheme holds
some degree of resemblance with the market-based emission trading
system (ETS) where certain energy-intensive industrial production
units, identified as designated consumers (DC), with thresholdenergy consumption are allotted Specific Energy Consumption(SEC) reduction targets over a cycle of three years.39 The units thatexceed the targets are awarded Energy Saving Certificates (ESCerts),
each equal to one metric tonne of oil (MTOe),40 as an incentive toimplement energy-efficient technologies and overachieve thesetargets. DCs that are unable to meet these targets can purchase thedifference in ESCerts from the units that have exceeded their targets.
The ESCerts can be traded on two power exchanges, namely, Power
Exchange Indian Limited (PXIL) and Indian Energy Exchange (IEX).
Failure to comply, either by their own actions or by buying the energy
saving certificates, would result in the imposition of a prescribedpenalty linked to the degree of non-compliance. The BEE has rolled
out six PAT cycles as of 31 March, 2020 covering 1,073 DCs across
13 sectors including energy-intensive sectors of Aluminium, Cement,
Chlor-Alkali, Fertiliser, Iron and Steel, Paper and Pulp, Thermal
Power Plant, Textile, Railways, Refineries, and Electricity Distribution
Companies (DISCOMs), Petrochemicals, and Buildings.41 In thefinancial year 2018-2019, the PAT scheme was responsible for nearly
63 percent of all energy efficiency savings and is projected to avoid
almost 70 million tonnes of CO2 by March 2023.42 However, themonitoring, reporting and verification (MRV) framework under PAT25

is not directly geared towards reducing CO2 but the potential unit ofenergy saved (expressed in tonnes of oil equivalent).43 The ambitionand long-term effectiveness of the PAT scheme has been questioned
over issues of equity, leniency in targets, high transaction costs, low
trading prices of EScerts, and rising energy prices which would have
incentivised energy savings even in the absence of the PAT scheme.44
The Centre for Science and Environment (CSE), in an analysis of the
PAT scheme for thermal power plants, noted that the value of one
ESCert was approximately INR 700 while INR 4,020 in investment
was necessary for reducing energy equal to one TOE.45

Implicit Carbon
Pricing in India

2. Emission trading scheme on an air pollutant,i.e., respiratory solid particulate matter(RSPM)
This is an innovative emission trading scheme on respiratory solid
particulate matter, the first particulate trading system in the world.
The scheme has been piloted in industrial clusters of three polluting
states of Gujrat, Maharashtra, and Tamil Nadu. It is an attempt toshift away from the conventional command and control regulation.
It mimics the EU-ETS model where pollution targets are set for areas
based on ambient air quality standards and permits are allocated which
can be traded, after verification, based on the gains and shortfalls fromcompliance. The scheme relies on a continuous emission monitoring
system (CEMS) for setting the baseline and verification purposes.
CEMs is an intrinsic element in the scheme’s design as it provides realtime information and helps avoid issues pertaining to spot checking
and/or spurious reporting by third party auditors.46
For example, the Surat ETS began with two months of mock-trading,
before its official launch in September 2019, to gain stakeholder
support and allow capacity building. Eighty percent of the permits
were allocated for free and the balance of 20 percent was auctioned
via the Gujrat Pollution Control Board (GPCB) through the National

26

Commodities and Derivatives Exchange Limited e-market.47 Similar
to the PAT Scheme, industries have the financial incentive to invest
in pollution-curbing technology. Over-achieving targets provides theopportunity to earn profits through the trading of emission permits at
the National Commodities and Derivatives Exchange.48 A preliminary
analysis of the pilot program found a 29-percent reduction inparticulate matter from current levels, an increase in average industry
profits, and fall in costs of reducing particulate emissions.49 However,the long-term benefits of the pilot program are yet to be seen.

Implicit Carbon
Pricing in India

3. Carbon CessIn 2010, India introduced a carbon cess to be levied on coal, lignite,and peat in the form of an excise duty. The revenue from the cesswas intended to feed into a National Clean Energy Fund to financeclean-energy projects and research. From 2010–11 to 2017–18, only
35 percent of the money collected from the cess was transferred to
the Fund, of which almost half remained unutilised.50 In 2017, with
the introduction of the GST Compensation Cess, the carbon cess wasabolished and the money collected through this new mechanism wasinstead reserved for compensating states for any revenue losses under
GST. CO2 emitting products such as coal, kerosene, naphtha, lubes
and LPG are included in GST with exceptions for five petroleum
products, i.e., petrol, diesel, natural gas, ATF and crude oil. These
are instead subjected to excise duties and VAT. While the cess on
the consumption of coal and high level of excise and value added
taxes on petrol and diesel are not referred to as carbon taxes, they are
considered and expected to perform the role of implicit carbon taxes.
However, the tax rates do not correspond with the carbon footprint of
the fuels and thus fail to provide the right price signals to producers
and consumers to reduce consumption and switch to low carbonemitting sources of energy. 51

27

Implicit Carbon
Pricing in India

4. Renewable Purchase Obligations (RPO) and
Renewable Energy Certificates (REC)In India, certain obligated entities such as electricity DISCOMS, open
access consumers and captive power producers have to purchase apercentage of their electricity from renewable energy (RE) sources.
These are termed as renewable purchase obligations (RPO) and aremandated by the Electricity Act (2003). The State Electricity Regulatory
Commission is responsible for fixing the minimum RPO for each state.
Due to the variable nature of RE sources, obligated entities may find it
difficult to procure green power to meet their RPO targets. They caninstead purchase renewable energy certificates (RECs) on the nationalenergy exchanges such as Indian Energy Exchange (IEX) and Power
Exchange of India Limited (PXIL) to meet their RPO targets without
actual procurement of RE-generated power.52 The RECs is a useful
instrument in overcoming the geographical disparity in renewableenergy production and incentivising electricity generation from RE
sources beyond the RPO state limits.53 However, the enforcement
and compliance with RPO remains weak and is a persisting obstacle
to India’s ambitions of expanding renewable energy production andprocurement.

5. Excise taxes on Diesel and Petrol
Over the years, India has moved from a carbon subsidisation regime
to a significant carbon taxation regime.54 Even though India does
not have an explicit carbon tax on fuels including petrol and diesel,
these products are subjected to steep excise duties and VAT. As of
May 2020, India had the highest taxes on petrol and diesel in theworld which comprised over 69 percent of the pump price for the two
fuels.55 However, the high taxes on petrol and diesel are on accountof the Centre’s revenue requirements as opposed to environmental
considerations and do not account for the carbon footprint of thefuels. As a result, distorted price signals have failed to incentivise
users of diesel and petrol to switch to low carbon-emitting sources ofenergy.56

28

The Case for an Explicit Carbon
Pricing Mechanism in India

D

espite the ambitious commitments made by India
on climate action at COP26, its growing economy
will continue to demand higher levels of fossil fuelconsumption and, consequently, the country could see
a corresponding rise in GHG emissions. India’s energy
and industry-related CO2 emissions are projected to more thandouble from 2020 to 2050, with the share of fossil fuels in primaryenergy declining from 72 percent to only 69 percent in the same
period. Without additional policies and disruptive technologicalchanges, GHG emission intensity will not be reduced relative to theircurrent levels due to growth in output.57 Well-designed policies,
such as carbon pricing, if adapted to suit India’s unique emerging
and development identity framework, can be a useful lever in theportfolio of instruments and strategies adopted to mitigate and adapt
to climate change.

However, its popularity remains weak, given the ‘Pigouvian’ natureof carbon pricing (as explained in the first section of this paper). There
are various challenges in pricing carbon which are a combination ofpolitical, economic and cultural dynamics. Given that carbon pricing
posits “diffused benefits and concentrated costs”, with costs incurredin the short-term and benefits accrued in the longer run, citizens areoften sceptical of environmental policies.58 This makes it difficult togarner the necessary political support essential to engender systemicchanges to conventional policy frameworks. In addition, carbonintensive industries will continue to oppose lest their profits reduce
as a result; households will do too, to safeguard their disposable
incomes.59 Policies that are formulated according to specific contexts
and are effectively implemented can help offset these challenges, as
can a rigorous communication strategy.
India has undertaken various approaches for pricing fuels suchas subsidies, and administered and market pricing (as discussed in
the previous section). However, weak enforcement and primarily
low prices undermine the effectiveness of the policy instruments.
Moreover, while the focus has been on energy efficiency, expanding

29

The Case for an Explicit Carbon
Pricing Mechanism in India

renewable capacity and making coal consumption expensive, noneof the instruments are carbon-denominated and do not bear a direct
link to CO2 equivalent. Therefore, carbon pricing can be a usefulmechanism to build a common carbon currency for establishing aclear price signal, creating fungibility of credits across schemes, anddeveloping strong incentives for decarbonisation.60
In light of the Energy Conservation (Amendment) Bill, 2022, thefollowing section outlines the near-term carbon pricing strategies
that India can adopt with regards to a carbon tax and an emission
trading mechanism. These strategies can help the country realise
its Nationally Determined Contributions (NDC) under the Paris
Agreement and the 2030 climate commitments made in Glasgow in
2021.

1. Carbon Taxes
India does not follow a uniform approach in pricing fuels and thetax rate and its coverage under the GST are not determined by the
carbon content or emission rate but instead by social, political andrevenue considerations. As an example, the price of imported natural
gas is different from that prescribed for domestically produced
natural gas. The tax rate is lower for fuels such as coal which havea larger carbon footprint in comparison to natural gas, for example,
which has a far lower carbon footprint. While coal is included in
the GST base, other high-polluting fossil fuels such as petrol, diesel
and crude are excluded from its purview.61 Nearly INR 52,000 croreof GST compensation was due to the states as of September 2021,
which is telling of the Centre’s tardy disbursement record and states’
apprehension to exclude these fuels from the GST base in order tomaintain their revenue stream.62 These fuels are, however, subject to asignificantly high excise duty and the VAT, both of which vary acrossstates. However, the taxes are not linked to the degree of carbon
emissions nor the carbon content in the fuels.63

30

The Case for an Explicit Carbon
Pricing Mechanism in India

India’s legislative framework under the GST regime lays a strong
ground to address these anomalies and incorporate all fossil fuels
under its ambit by setting a uniform tax rate and an additional
levy contingent on the quantum of carbon emissions instead ofusage. International practice, as discussed in the previous sections,dictates the same premise with certain exemptions depending on the
sector and trade exposure. The tax should be upstream, implying
an imposition only at source for producers and importers of fossils
fuels. Similar to experiences of other countries as depicted in Table 4
exemptions should be granted for fuel usage in the farm/agriculture
sector and remote off-grid communities (as done in Japan andCanada), companies or sectors that have a strong trade exposure (suchas in South Africa), units with installations below a certain threshold(such as in Chile) and also where carbon-emitting fuels are used as afeedstock for manufacturing, e.g. fertilisers (such as in Argentina).
Since diesel and petrol already suffer a heavy tax burden, limiting
government’s ability to impose additional taxes will result in theburden being borne by coal and other fuels. In a study by Shakti
Sustainable Energy Foundation and Ernst & Young LLP, the priceof carbon tax should reach USD 35 per tonne of CO2 emissions toachieve 33- to 35-percent reduction in emission intensity by 2030.64
Given India’s COP 26 commitment to reduce the carbon intensityof the nation’s economy by 45 percent by 2030, the price on carbon
will have to be even higher. Availability of substitute clean fuels andgreen technologies as well as increase in capacity and deploymentof renewable sources of power are critical factors for complianceand effectiveness of the carbon tax. The carbon price will have to be
gradually increased and aligned with the maturity of decarbonisation
technologies. Indeed, government funding for R&D in India remains
weak and investment in technologies like carbon, capture and storage(CCS), and green hydrogen are important to develop viable andeconomically competitive alternatives.65
A carbon tax that is incremental in nature will help augment fiscal
revenues, improve the tax-GDP ratio, and generate additional funds
which can be utilised for offsetting the burden of the tax on low-

31

The Case for an Explicit Carbon
Pricing Mechanism in India

income groups as well as facilitate greater investments in green andenvironmental projects. Revenue recycling is another critical aspect
for generating greater acceptability and adoption as well as ensuring
effectiveness of the tax mechanism. The following are some examples:
Japan reserves its carbon revenues for climate mitigation projects andto boost renewable energy and energy-efficient technologies; Irelandtransfers revenues to the general budget to reduce payroll taxes andalleviate fuel poverty; Singapore uses its revenues to support schemes
such as the Resource Efficiency Grant for Energy, Investment
Allowances for Emissions Reduction and Energy Efficiency Fund;
Colombia uses 50 percent of the revenues from the tax towards
adaptation projects in coastal erosion management, conservation ofwater sources, and the protection of ecosystems; Mexico has a strong
focus on improving public transportation in addition to boostingenergy efficient technology; and Denmark uses its revenues to bothsubsidise energy efficient investments as well as reduce taxes onlabour. In addition, a tier of the revenue transfer from the Centre
to the States can be linked to measurable and traceable metrics suchas the area expanded under forest cover, share of renewables in theenergy mix, fossil fuel replacement strategies including e-mobility,
increased ethanol blending, and use of biofuels, amongst others, toensure greater compliance and enforcement.
With efficiency and equity considerations built into the tax design,
political communication becomes an important lever to enhancewider acceptability and drive compliance, the lack of which, as seen in
the experience of Australia, led to the abolition of the carbon tax two
years after introduction in 2012. 66

2. Emissions Trading System (ETS)
India’s PAT Scheme—given its functional mechanism with DC(designated consumers)-specific targets, issuance, normalisation
factor, trading, among other design features—lays a solid foundation
to evolve into a full-fledged emissions-based cap-and-trade system. A
phased approach to expand its aperture into a more functional ETS
market could prove useful using simulations (a mock carbon market)

32

The Case for an Explicit Carbon
Pricing Mechanism in India

or pilots (a small-scale carbon market). Mexico conducted simulation
exercises among certain enterprises before entering the operational
phase of its three-year pilot in 2020. China presents a befitting
example: it piloted ETS models in eight provinces, allowing learnings
and best practices from these programs to inform the design of its
national ETS market that was eventually launched in 2021.
In the past, India has demonstrated serious commitment to
explore cap-and-trade schemes to achieve its ambitious NDCs andsigned up to the World Bank’s Partnership for Market Readiness(PMR) to pilot new market-based mechanisms (MBMs) in Waste and
MSME sectors. It also set up an integrated data management andregistry for GHG emissions.67 A part of the funding was apportioned
to expand and strengthen the scale and scope of existing marketbased approaches including the PAT mechanism and the Renewable
Energy Certificate (REC) scheme.68 The World Resource Institute’s
carbon market simulation covering about 50-60 percent of India’s
total industry-related emissions across 30 to 40 large businesses aswell as the emission trading scheme on RSPM in India are laudable
attempts and could set a precedence for scaling and implementing
more ambitious ETS pilot programs in India.69
India’s federal structure provides an ideal framework to develop
ETS pilot programs across states with inter-state trading built into
its design to enhance cost-competitiveness and efficiency gains. Suchpilot projects are ideal to engage with relevant stakeholders andbuild readiness among industries, develop a bottom-up approachto designing and testing different models, and identifying andunderstanding operational challenges during the post-pilot phase.70
In its current form, the PAT Scheme covers 1,072 designatedconsumers, consuming 50 percent of primary energy, in 13 sectors.71
The ETS should aim at a wider coverage, including more sectors andindustries above a certain threshold, to maximise potential gains fromtrade and reduce overall transaction costs. The cap should aim to
set reasonably ambitious targets on absolute ambitions or intensityof emissions per unit of GDP, subject to growth rate of the economy.

33

The Case for an Explicit Carbon
Pricing Mechanism in India

Defining targets over time frames can be useful for industries toundertake transition planning pre-emptively. As an example, the EU
ETS has already declared that its emission cap will decrease annually
by 2.2 percent between 2021 and 2030.72 Emission allowances canbe freely allocated with a small portion earmarked for auctioning
to set the stage for increasing the latter’s percentage over the years.
Many emerging economies follow a similar template, such as Korea,
where 90 percent or less allowances are freely allocated to entities in
sub-sectors that are subject to auctioning and 100 percent for EITE
sectors (emission-intensive and/or trade exposed sectors at risk ofcarbon leakage receive free allowances up to 100% of the benchmark
or historical emission level).
For trading purposes, the ESCerts should be converted into carbondenominated allowances based on carbon intensity benchmarks.73
Deploying price containment measures in the ETS design can help
incorporate greater flexibility and price predictability. These include
establishing a price corridor, i.e. introducing a price floor and a priceceiling, as done by countries like the Republic of Korea and New
Zealand. Another popular measure to contain price volatility is tohave a Cost Containment Reserve (CCR) which allows the regulator
to release a fixed additional supply of allowances if the sale of CO2
allowance prices exceeds a certain price threshold, also called thetrigger price, as practiced in the ETS markets of Regional Greenhouse
Gas Initiative, Republic of Korea and the European Union. Banking
and borrowing unused emissions as well as the use of offsets whichallows regulated businesses to buy emissions reduction credits fromoutside the market, can help provide greater flexibility to businessowners, again a measure which finds its place in the Korea ETS withcertain control features.74
While useful, these cost containment measures can result in tradeoffs such as failure to realise the overall carbon emissions targets,lower overall efficiency gains from trade, and reduced predictability inthe timing of achievement of emissions reduction targets. Therefore,
careful planning is essential using rigorous quantitative modelling andanalysis from the data collected via the pilot projects. Establishing a
GHG emissions inventory and a strong MRV (Monitoring, Reportingand Verification) system is a pre-requisite for the success of the ETS
scheme and therefore capacity building efforts should be deployed bygovernments for this purpose.75

34

T

he Energy Conservation (Amendment) Bill, 2022
underscores the willingness of the Indian government
to explore the imperative of a formal carbon market toachieve carbon neutrality.. Both the GST regime and
the PAT scheme provide a well-functioning machinery
which India can leverage to build upon a strong carbon pricing
framework using a combination of both a carbon tax and an emission
trading system.

Conclusion

To be sure, carbon pricing in itself is not a silver bullet;
complementary measures along with carbon pricing will help
accelerate the path to carbon reduction. An optimal portfolio ofpolicy instruments which includes carbon pricing, fossil fuel taxes,
renewable energy subsidies and technology and performance-based
standards along with investment in green technologies and revenue
recycling to protect vulnerable communities should form the basis ofa cost-effective and equitable carbon pricing policy design. 76
While India should not feel compelled to imitate or adopt westernpolicy frameworks given the country’s unique economic andsocial pre-conditions, carbon pricing has proven to be an effective
mechanism for many developing economies, including Republicof Korea, China and South Africa, to achieve significant carbon
reduction and realise their national climate targets. In the context ofIndia, it can help meet its ambitious current and future climate goals,
offer emission reduction at the lowest possible cost, and accelerate
progress on the Sustainable Development Goals (SDGs). 77
Global climate policy groups have been debating the inceptionof a Climate Club, popularised by William Nordhaus in his 2015
paper ‘Climate Clubs: Overcoming Free-riding in International
Climate Policy’, seeking to establish an international target carbon
price (incremental in nature), amongst other mandates, to which
all member countries must comply.78 While the world is a long way

35

Conclusion

to institutionalising a framework of such scale and scope, there isbroad consensus to include carbon pricing as a prominent tool in theinternational climate policy architecture. The current G20 Troika, led
by three developing countries – Indonesia, India and Brazil, presents
a unique and apposite moment to push forward a global carbon
pricing framework built with a redistributive mechanism79 and alignedwith the principles of Common but Differentiated responsibilities(CBDR) and the Just Transition Declaration. It is clear that carbon
pricing is primed to become and remain the mainstay of the global
climate policy architecture and designing domestic carbon policies
and pre-emptive strategies that align with global policy trends willhold India in good stead in an increasingly decarbonising future.

Mannat Jaspal is an Associate Fellow with ORF’s Geoeconomics Studies Programme.

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