Green budget reform in India:

opportunities and challenges

Divya Datt*

That the environment is a composite part of the social and

economic system, being impacted by it and influencing it in
turn, has only become more apparent over time. Perceptible,
day-to-day manifestations of environmental degradation have
led to the environment gradually finding its way into the
mainstream policy agenda in developing countries. Even as
governments have sought to strengthen conventional
legislation-based policy, there are several initiatives towards
experimenting with other instruments for environmental
protection and natural resource management. In this regard,
fiscal policy, in its capacity to prioritize and channelize
government spending through allocation of financial
resources and to influence the decisions of economic agents
through taxes and subsidies, has received considerable
attention.
While several developing countries have made noteworthy
progress in the use of fiscal instruments for the management
of natural resources, their use in India has been limited
despite repeated government recognition of their merits.
This document analyses fiscal policy options, opportunities,
and challenges in addressing select environmental concerns
in the country. The exercise is the collation of research
undertaken by TERI under one of the several research
streams of the TERICanada Energy Efficiency Project
implemented over 19992003.1
* The inputs of Vikram Dayal in reviewing this chapter are gratefully
acknowledged.
1
The analysis was carried out over 19992002, with periodic refinements
and additions in methodology and scope based on interactions with
stakeholders. The authors have attempted to update policy developments, to
the extent possible, for the purpose of this publication.

The focus of the document is the energy sector and the

four issues covered are: (1) controlling emissions from the
transport sector; (2) managing fly ash generated in coalbased power plants, the major source of electricity in the
country; (3) promoting renewable energy technologies; and
(4) improving efficiency in the use of energy and water in the
agricultural sector.
In addressing these issues, a major guiding factor was the
practicality of the policy recommendations, given the existing
pollution control and fiscal systems, and legislative
provisions. Since fiscal tools are but an element of the policy
canvas, the research and recommendations often went
beyond budgetary measures to include regulatory and
institutional reforms. Many of these policy recommendations
are presented as case studies at the state level in view of the
jurisdictional characteristics of some of the issues.
Before getting into sectoral analyses, it will be in order to
examine some general issues relating to green budget reform
or EFR (environmental fiscal reform) as it is more commonly
referred to. The following section analyses the definitional
underpinning of EFR and discusses related international
experiences. The next section looks at environmental policy in
India, and the experience with EFR. The concluding section
attempts to provide broad lessons for future research in this
area.

Budget as a tool of environmental policy: the concept

Economic theory places great faith in the invisible hand of the
market, which ensures that all agents acting in self-interest
eventually lead to an allocation of resources that is best for
society as a whole. However, environmental resources present
the classic case where the conditions for efficient functioning
of the market break down, when private means conflict with
the social ends of an efficient allocation of resources (Hanley,
Shogren, and White 2001). Four cases of this market failure
are relevant for environmental resources.

Greening the Budget: case studies

Externalities When the market price or cost of

production of a commodity excludes its social impact, for
example vehicular exhaust.
Public goods When a person cannot be excluded from
the provision of a good (non-excludability) and ones
consumption of the good does not reduce its availability to
another (non-rival consumption), for example
biodiversity.
Common property Case of an impure public good
characterized by non-excludability but rivalrous
consumption, for example open access to fisheries.
Hidden information When a person cannot observe the
hidden action of others (moral hazard), for example
difficulties in monitoring industrial emissions, or when
one cannot observe the hidden quality of a good or service
(adverse selection), for example difficulties in
distinguishing a cleaner product from another produced
using standard practices.

In the face of such failures, economists argue that the

solution is not always to turn to command and control
interventions but to redeem the markets by adjusting existing
ones or creating new ones (Hanley, Shogren, and White
2001).
Market failures are not always the most serious threat to
ecosystems. Policy failures, for example, subsidies for certain
goods, services or practices that cause environmental
degradation are often regarded as more serious. Such
subsidies are so widespread that often subsidy removal is
ranked as one of the main instruments of environmental
policy (Sterner 2003).
The diversity of instruments available for environmental
policy may be classified as in Table 1.
It is important to note that environmental policy is not
about a choice between market-based and command and
control instruments.

Green budget reform in India: opportunities and challenges

Table 1 Classification of instruments in the environmental policy

matrix
Using markets
Subsidy reduction
Environmental taxes
and charges
User charges
Deposit refund schemes
Targeted subsidies

Creating
markets

Environmental
regulations

Engaging the
public

Property rights and

decentralization
Tradable permits
and rights
International
offset systems

Standards

Public
participation
Information
disclosure

Bans
Permits and
quotas
Zoning
Liability

Source Sterner (2003)

As Sterner puts it succinctly,

Fortunately, the range of choices is richeras in
general economic policy, which is not limited to a
choice between planning and laissez-faire. To function
well, society needs intermediate policies with a lot of
fine-tuning. And to meet several goals (for example,
efficiency, sustainability, and fair distribution),
a combination of policy instruments usually is
required.
Table 2 is a simple illustration of the range of applications
that the variety of policy instruments can be put to in the
management of the environment and natural resources.
A number of these solutions are fiscal in that these have
direct or indirect impacts on the governments budget.
Therefore, environmental fiscal reform constitutes the
intersection of the environmental policy matrix and
budgetary policies (both revenue and expenditure). These
would include direct instruments such as pollution charges
based on the volume of pollutants discharged. Indirect

Greening the Budget: case studies

Table 2 The policy matrix: instruments and sample applications

Policy instrument

Natural resource management

(water, fisheries, agriculture, forestry,
minerals, and biodiversity)

Pollution control
(air pollution, water
pollution, solid waste, and
hazardous waste)

Direct provision

Provision of parks

Waste management

Detailed regulation

Zoning
Regulation of fishing (for example,
dates and equipment)
Bans on ivory trade to protect
biodiversity

Catalytic converters, traf fic

regulations, etc.
Ban on chemicals

Flexible regulation

Water quality standards

Fuel quality
CAF (Corporate Average Fuel
Economy) standards

Tradable quotas or
rights

Individually tradable fishing quotas

Transferable rights for land
development, forestry, or agriculture

Emissions permits

Taxes, fees, or
charges

Water tariffs
Park fees
Fishing licenses
Stumpage fees

Waste fees
Congestion (road) pricing
Gas taxes
Industrial pollution fees

Subsidies and subsidy

reduction

Water
Fisheries
Reduced agricultural subsidies

Energy taxes
Reduced energy subsidies

Depositrefund
schemes

Reforestation deposits or
performance bonds in forestry

Waste management
Sulphur, used vehicles
Vehicle inspection

Refunded emissions
payments

NOx abatement in Sweden

Creation of property
rights

Private national parks

Property rights and deforestation

CPR (common
property resources)

CPR management

Legal mechanisms,
liability

Liability bonds for mining or

hazardous waste

Voluntary agreements

Forest products

Toxic chemicals

Information
provision, labels

Labelling of food, forest products

PROPER (Program for

Pollution Control Evaluation
and Rating) and other
labelling schemes

International treaties

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

Macroeconomic
policies

Environmental ef fects of policy reform and economic policy in general

Source Sterner (2003)

Green budget reform in India: opportunities and challenges

instruments would include taxes on products or inputs that

are environmentally harmful; and tax concessions or
subsidies (including soft loans) to encourage the use of, or
investment in cleaner technologies or products. The EFR
would also include in its realm the reduction of
environmentally harmful product subsidies, appropriate
pricing of natural resources, and select publicly provided
services, since the deviation of prices from the marginal cost
of supply may be viewed as a tax or subsidy impacting on the
government budget (Sankar 2002; Datt, Garg, and Narang
2003). Thus the following classification may be used to define
the scope of environmental fiscal reform.
n Tax policy Direct pollution charges; indirect product
taxes to encourage / discourage the use of environmentally
benign / harmful products; and providing an
environmental orientation to reforms in general taxation.
n Expenditure policy Reducing environmentally
detrimental subsidies, directing government expenditure
through subsidies or allocations for environmental
protection / restoration programmes, research,
development, and dissemination of environmentally sound
products and technologies, environmental education and
awareness, etc.
n Pricing policy (which should include capturing resource
rents) User charges / fees for the use of water and
electricity, and rents on forests, fisheries, minerals, etc.
As this typology indicates, user charges (for example on
water and energy) and pollution charges (for example on
effluent discharge) do not typically enter into the
consolidated budget and hence are charges not taxes.

International experience with environmental

fiscal reform
All over the world, both the developed and developing
countries have experimented with the use of environmental
fiscal instruments. Their use has been greater in the

Greening the Budget: case studies

developed world, but developing countries are also making

increasing use of these instruments.

Tax policy
Environmental taxes and charges have become mature
options in the instrument mix available to policy-makers and
have been increasingly implemented since the 1980s (EEA
2003). The European countries take the lead in
environmental taxes, while tradable permits remain the
preferred option in the US. In 1993, while energy- and
environment-related taxes constituted 0.8% of the GDP in the
US, the average share in European OECD (Organization for
Economic 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 pollutants
including carbon, sulphur, and nitrogen oxides. Interestingly,
most of the fees are imposed on input proxies rather than on
the pollution itself. With respect to water pollution, the
Netherlands, Germany, and France have taxes on effluents.
The transition economies in central and eastern Europe and
the former Soviet Union, are also adopting such instruments
(Stavins 2000).
An increasing number of environmental taxation systems
are being introduced throughout the EU, with the aim of
improving environmental quality in an efficient way while
reducing the burden of taxation on labour and other
production costs. However, in the aggregate, changes are not
proceeding very quickly (EEA 2003).2

This issue of double dividend arguing that the substitution of pollution

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

Green budget reform in India: opportunities and challenges

Such taxes are by no means only restricted to the

developed world. Examples of direct use of environmental
fiscal instruments in developing countries are now fairly
numerous. China, Indonesia, Malaysia, and Thailand have
overcome a number of obstacles to MBIs (market-based
instruments) imperfectly functioning markets, problems of
monitoring and enforcement, and a shortage of resources
with a fair degree of success. For instance, China has had a
national system of pollution charges on air emissions, waste
water discharges, noise, solid waste, and radioactive wastes
since the last 15 years. Another example is that of Malaysia
where, as early as the mid 1970s, the department of
environment introduced a permitting system for palm oils in
which the licensing fee could be varied according to the
quantity of waste generated (OConnor 1998). Yet another
success story has been the Colombian system of charges on
organic emissions in waterways. The scheme has been
implemented in seven regions of the country, with each
region being allowed to vary the rate until the target
reduction has been achieved, at which point the charge is
frozen in real terms (World Bank 2000 as cited in
Markandya, et al. 2002).
Several developing and developed countries have also
experimented with the use of taxes and charges on fuels, road
use, and vehicles.
Table 3 documents a selection of sector experiences in the
developing world.

guaranteed. Distortions on account of existing tax regime are so involved

and interconnected that an environmental tax may potentially exacerbate
these distortions through a negative tax interaction effect, greater than the
positive revenue recycling effect. Mooij (1999) in surveying both the
analytical approaches and empirical studies reaches the conclusion that it
may be wise for governments not to concentrate on the non-environmental
dividend of an environmental tax reform but to put more emphasis on the
welfare improvements associated with a cleaner environment.

Greening the Budget: case studies

Expenditure
In the context of EFR, expenditure-related instruments
include reduction in environmentally harmful subsidies and
enhanced budgetary allocations for environmental
management. Subsidies for the promotion of public transport
and renewable energy technologies are common to many
countries. At the same time, examples of environmentally
harmful subsidies are also widespread in developing and
developed countries alike. The most common of such
subsidies implicit or explicit occur in the energy, water,
agriculture, and road transport sectors. Typically, consumers
are not charged for the capital costs of providing goods and
services such as electricity or irrigation water and are only
charged a fraction of the operating costs. Such subsidies not
only encourage inefficiency in the use of resources but may
also have significant adverse environmental impacts such as
in the case of the energy sector. Inadequate cost recovery also
affects the financial viability of the agencies providing these
servicesadversely affecting their ability to manage,
maintain, and expand the necessary infrastructure.
In the energy sector, electricity accounts for an important
share of subsidies. Estimates for developing countries
indicate that in 1999, electricity was subsidized at a rate of
about 46% of long-run marginal costranging from 9% in
Latin America and Caribbean and 20% in Asia to 76% in the
former Soviet Union (Pagiola, Hurtado, Shyamsundar, et al.
2002). In the case of irrigation water, recovery of operating
costs is as low as 10% in India, 13% in Pakistan, and 25% in
China; with no recovery of capital costs (Pagiola, Hurtado,
Shyamsundar, et al. 2002). The story is not very different in
the case of domestic water supply. With more than half of the
developing countries levying charges that are less than the
total costs of providing water, the extent of subsidy varies
from 4% in Indonesia to over 50% in several countries
including Bangladesh, Cuba, Egypt, and India.
There have been some initiatives towards reducing
subsidies; however, despite the moves towards deregulation

Green budget reform in India: opportunities and challenges

Charge for peak hour use

Road pricing

Water
Water pollution

Various

Various

Leaded petrol

Colombia

ColombiaAntioquia
district

Charges on effluent discharge and

water use. $160 000 collected from
potential of $90 million

Charges on organic pollution

discharge

Singapore

Various

7%30% of total revenues

Transport
Petrol

Location

Type of tax and revenue

Tax base

Reduction in level
of degradation in
rivers

Cost recovery to
cover operation and
maintenance costs
of monitoring
systems

Attempt to reduce
congestion

Reduce fuel use

prior to phase-out
of lead

Revenue

Aim of tax

Table 3 Taxes on pollutants in developing countries: some examples

Reported organic discharges fell by

18% in the first year

Low enforcement

Reduced traffic by 73% in restricted

zone in peak hours. Car pooling
increased, 13% switched to public
transport

Environmental impact

Latin America
and the
Caribbean

Credit and tax incentives for

environmental investments

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

Environmental
investments

China

Bolivia and
Venezuela

Sao Paolo and

Rio de Janeiro,
Brazil

Levy charge on pollution

exceeding pollution standard for
metallurgy, chemicals, light
industry, textiles, power, and coal

Waste volume and tipping fees

Landfill

Industrial
pollution
Industrial
pollution

Sewage tariff based on organic

matter since 1983

Waste
Sewage
disposal
charges

Encourage
environmental
investment

Levies on industry
to promote
environmental
management

Subsidies for abatement have had a

limited impact as environmental
enforcement was ineffective in
increasing industry demand

Notable environmental impact. But

rates felt to be too low in comparison
with costs of pollution control

Implementation difficulties restricted

environmental benefit. Areas lacked
institutional capacity for waste
monitoring. No mechanism to prevent
illegal dumping

Led to increased pollution control

through improved housekeeping, raw
material substitution and conservation

in several sectors, environmentally perverse subsidies remain

a grave concern internationally.

Resource pricing
Natural resources, in absence of appropriate property rights
or institutional arrangements, are often treated as free goods.
State ownership, poor enforcement of laws, and prices that
are effectively zerothese are ingredients in the recipe for
short-sighted use of natural resources. Yet, there is a diversity
of experience in the pricing of resources.
Many countries have established harvesting taxes or
stumpage fees, though these have mostly been aimed at
raising revenue. In Equatorial Guinea, revenues from
harvesting fees from forests amounted to as much as 16% of
the government budget. China, Ecuador, and Venezuela, have
levied charges on oil extraction. Again, most of these have
been established with the objective of raising revenue, though
some have aimed to encourage the sustainable use of natural
resources. For example, a major objective of the natural
resource tax in China was to encourage the sustainable
exploitation of natural resources by forcing developers to pay
for the right to exploit public resources (OECD 1999 as cited
in Markandya, et al. 2002).
Table 4 indicates some examples of resource pricing in
developing countries.
International experience in environmental fiscal reform
has thrown up several issues that would need to be studied in
taking the process forward in India. Some of these are as
follows.

Issues in environmental fiscal reform

The efficacy of environmental fiscal reform or any
environmental policy instrument for that matter would
depend on the choice and design of the instrument; the
administrative capacity to monitor its implementation; and
the overall policy and institutional environment in the
country. If the economy is not competitive and if the

12

Greening the Budget: case studies

Table 4 Resource pricing in developing countries: some examples

Commodity

Type of charge
and revenue

Location

Aim of charge

Forest

Forestry charge
for wood
consumption
when there is no
reforestation
activity. Tax set
at low levels

Brazil, Colombia,
and Venezuela

Various natural
resources

Charges per unit

of natural resources

China

Ecodevelopment
incentive for
sustainable
management of
resources

Oil royalties

Tax levy on
oil passing
through pipelines

Ecuador

Earmarked for use

by the Ecuadorian
Institute for Ecodevelopment

Natural resource
exploitation

Royalties: 4%6%
of revenues from
hydroelectric,
mineral, and
oil production

Colombia

Preservation of
natural resources.
Earmarked for
regulatory
agencies.

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

bureaucracies are not honest, well-informed, and sufficiently

well-funded to carry out their responsibilities, then no policy
instrument will work perfectly; although some will work
better than others (Sterner 2003).
The design of an instrument will depend on a number of
interdependent criteria including cost-effectiveness
(achieving environmental goals at least cost); efficiency
(addressing the optimality of the goal itself); incentive
compatibility (providing the right incentives for information
disclosure and undertaking abatement as desired);
distributional and equity concerns (ensuring fair distribution

Green budget reform in India: opportunities and challenges

13

of costs and / or benefits); and administrative feasibility and

flexibility (designing an instrument that is practicable, not
incurring excessive monetary or informational costs of its
operation) (Sterner 2003). These goals are neither perfectly
clear nor separable, and the political process is often about a
struggle in which groups place different emphasis on different
goals and have different interpretation of them.
Direct emission charges and taxes will be more costeffective when the goal is reduction in emissions over a large
area and when the sources of pollution are not too dispersed
and can be monitored. In the case of non-point sources of
pollution or where the objective is to raise revenue, charges
on inputs and outputs that are environmentally damaging can
be more effective as also simpler to enforce.
Environmental subsidies can be effective in reducing
pollution albeit at high economic costs. If the subsidies come
from earmarking of environmental taxes, this may not be
desirable since the resulting level of protection may be too
low or high. Thus earmarking should be avoided in developed
countries where tax regimes are sophisticated and budgetary
provisions for environmental protection is possible. In
developing countries, with limited budgetary provisions, the
benefits of having access to funds through earmarking may
outweigh the inefficiency costs of this system, at least in the
short run. (Markandya, Harou, Bell, et al. 2002).
There are certain situations when economic instruments
are not a good idea. In the case of toxic substances, for
instance, it may be too risky to have any instrument but the
strictest control on quantities in the environment.

Fiscal instruments in Indias environmental policy

The first real impetus for developing a framework for
environmental protection in India came after the UN
Conference on the Human Environment in 1972. The 1970s
and 1980s saw a spurt in environmental legislation and the
formation of the MoEF (Ministry of Environment and
Forests) in 1985.

14

Greening the Budget: case studies

Over time, the need was felt for the integration of

environmental concerns in the planning process itself. The
environment became a part of the Five-year Plans, starting
from the Sixth Five-year Plan (198085), and its integration
in sectoral planning was addressed through mandatory
environmental impact assessments of large projects. The
government has also initiated the preparation of State of
Environment Reports, based on which environmental action
programmes for each state are proposed to be designed.
In terms of expenditure policies, the MoEF, MNES
(Ministry of Non-conventional Energy Sources), Ministry of
Agriculture, and several other ministries support a number
of environmental and resource management programmes
(Box 1).
Thus, the governments approach towards prevention of
pollution has been mostly in the nature of legislation-based
command and control measures while natural resource
management has been largely programme driven. The use of
fiscal instruments towards environmental objectives in India
has been rather limited, even though the need to employ
economic and fiscal policy instruments for the control of
pollution and management of natural resources has gained
steady 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 policy
instruments in the form of regulations, legislation,
agreements, financial incentives, etc. to address
environmental concerns. The Tax Reforms Committee, 1992,
also suggested that higher rates of taxes on some raw
materials could be levied to induce economy in the use of
those materials in production and consumption, for reasons
of conservation and protection of the environment. It
recommended that excise taxes could be a useful instrument
in dealing with externalities in the form of social costs
(Sankar 2002). In the Ninth Five-year Plan (19972002), an
important element of the environmental strategy was
integrating environment with decision-making through

Green budget reform in India: opportunities and challenges

15

Box 1 Examples of environment-related programmes/schemes

in the union budget
Ministry of Agriculture
n National project on development and
use of biofertilizers
n Water management
n Soil and water conservation
Ministry of Coal
Environmental measures and subsistence
controls
Ministry of Non-conventional Energy
Sources
n Solar energy programme
n Biogas programme
n Wind energy programme
n Biomass programme
n Integrated rural energy programme
n Other sources of energy
n Improved chulhas
n Energy from urban and agricultural
waste
Ministry of Rural Areas and
Employment
n Rural water supply and sanitation
n Integrated wasteland development
project scheme
Ministry of Water Resources
Command area development
Ministry of Power
Energy conservation
Ministry of Urban Affairs and
Employment
Urban water supply and sewerage

16

Ministry of Environment and

Forests
n Central Pollution Control
Board
n Common effluent treatment
plants
n Taj protection
n Establishment of
environment protection
authorities and
Environmental Commission
of Tribunal
n Environmental health
n Clean technologies
n Environmental impact
assessment
n Hazardous substances
management
n Biosphere resources
n Conservation and
management of mangroves,
coral reefs, and wetlands
n Biodiversity conservation
n Environment education,
training, and awareness
n Environment management
capacity-building
n State of environment
projects
n Adaptation and capacitybuilding project on climate
change
n International cooperation
n Forestry and wildlife
n National River Conservation
Directorate
n National Afforestation and
Eco-development Board

Greening the Budget: case studies

valuation of environmental impacts; evolving MBIs as an

alternative to the command and control form of
environmental regulation; appropriate pricing of natural
resources based on their long-term marginal cost of supply;
and appropriate fiscal reform and natural resource
accounting.
In 1995, the MoEF constituted a task force to evaluate
MBIs for the abatement of industrial pollution. The task force
made several specific recommendations on modifying the
current regime and on introducing new instruments. In
general it was noted that there should a strategy to put in
place MBIs in the short- to medium-term to complement
existing environmental policies, and for MBIs to replace
criminal provisions (while complemented by economic
penalties) in the long run (Task Force 1997).
More recently, in 2001, the government set up another
task force to study the introduction of EIs (economic
instruments) for prevention and control of industrial
pollution. The Task Force comprised representatives from the
government, academia, industry, pollution control boards,
and legal experts. The Task Force has invited proposals from
select SPCBs (state pollution control boards) on the
introduction of MBIs and a plan for implementing a pilot
programme is slated to be drawn up.
The MoEF has also commissioned several case studies to
examine issues relating to EIs for pollution abatement. One
such study undertaken by the National Institute of Public
Finance and Policy in 2000 estimated the abatement costs of
pollutants across different industries and noted wide
variations. It highlighted the inefficiency of the current
system that requires all polluters to meet the same discharge
standards, irrespective of abatement costs and recommended
the use of MBIs for cost-effective pollution control. Similar
recommendations were made by another study on regional
environmental management in the Kawas-Hazira region in
Surat district of Gujarat, commissioned in 2001.

Green budget reform in India: opportunities and challenges

17

Apart from these initiatives, the Supreme Court of

India, in its various judgements dealing with environmental
cases, has also endorsed the application of the polluter
pays principle and the precautionary principle (Sankar
2002).
The actual use of fiscal incentives has, however, been
restricted to tax concessions and investment incentives for
the adoption of pollution control equipment, and a somewhat
more structured policy for the promotion of renewable energy
technologies. Tax incentives are usually given for specific
abatement technologies and activities, hence not providing
dynamic incentives for technological innovation and
diffusion. Also, being mostly for end-of-the-pipe treatment
technologies, these incentives do not promote more efficient
use of resources. There are some provisions for the use of
levies, cess, and penalties for polluters such as the system of
consent fees for discharging waste within standards and the
water cess on the use of water by specified industries and
local bodies but their design, implementation, and
effectiveness require significant improvement.
Further, while EIs have been used by the government to
regulate the economic and social behaviour of the people,
these policy decisions do not consider the associated
environmental impacts. For example, the prices of all
petroleum products, till very recently, were not marketdetermined but decided by the state, taking into account the
cost of production of each fuel and the socio-economic
characteristics of the consumers of the fuels. However, the
emissions caused from the use of these fuels and their
impacts on the environment were not a consideration in
pricing decisions.
Thus, while much has been said about the need to
introduce economic and, in particular, fiscal instruments to
address environmental concerns, in practice these efforts
have so far been rather adhoc and piecemeal.
There has been growing recognition of the fiscal and
environmental implications of subsidies in the energy, water,

18

Greening the Budget: case studies

and agriculture sectors. At Rs 124 billion, irrigation subsidies

accounted for 23.84% of total non-merit subsidies in 1993/94
(as defined in Srivastava and Sen 1997)less than 10% of the
operating costs of irrigation systems are recovered through
water rates. This, apart from discouraging efficiency in the
use of water, has resulted in the accumulation of operation
losses, adversely impacting the operating efficiencies of
irrigation systems because of inadequate maintenance of
canal and drainage works.
In the case of drinking water supply also, prices do not
reflect the cost of supply and flat-rate charges are common.
While there are a variety of water charging practices across
India, on an average the charges levied on residential
users both for connection and consumption, with and
without meters are less than one-tenth of the likely
economic cost of supply. Further, there is little targeting of
these subsidies. In the case of industrial consumers, only a
minority pay anything close to cost-recovery tariffs
(WSP 2003).
In the energy sector, the government has taken steps
towards removing price control on oil and coal, and lowering
subsidies in energy in general. Coal prices were decontrolled
in the year 2000, however, due to subsidies on rail
transportation, delivered coal prices remain below the market
prices. With the dismantling of the administered pricing
mechanism in April 2002, subsidies on all oil products were
removed barring liquefied petroleum gas and kerosene,
mainly used by the households. Supply of electricity to
residential and agricultural consumers, however, remains
subsidized and forms a lions share of the total subsidies
allocated to the energy sector. Subsidies in this sector have
increased steadily over the years. The average tariff of
electricity has increased from 89.06 paise/kWh in 1991/92 to
240.03 paise/kWh in 2001/02 (Planning Commission 2002).
Despite the rise in electricity tariff, the gap between cost of
supply of electricity and the average tariff has widened from
50 paise in 1996/97 to about 110 paise in 2001/02. The

Green budget reform in India: opportunities and challenges

19

justification and impact of electricity subsidies have been an

issue of debate over the last decade.

Moving ahead on green budget reform in India:

some issues
As the preceding discussion points out, the approach to
environmental fiscal reform has not yet received systematic
thinking and coordinated action. Against such a backdrop,
this project sought to examine the opportunities and
challenges in undertaking environmental fiscal reform in
India with a focus on energy-related issues. Right at the
outset, it was recognized that for the exercise to be of
immediate relevance, it would be necessary to identify policy
interventions that could be integrated within the existing
regulatory, legal, and policy framework, and which would not
place unrealistic demands on the existing administrative
capacity. At the same time, it needs to be noted that in the
long 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 different
vehicular options)
n Electricity (managing fly ash, which is a major
environmental hazard in coal-based power plants)
n Renewable energy (promoting various grid and off-grid
renewable energy technologies)
n Agriculture (reducing environmentally perverse subsidies
for irrigation and electricity).
Some of the recommendations were evolved as state-level
case studies depending on jurisdictional characteristics of
relevant issues. The process of developing these
recommendations was consultative and iterative, involving
representatives from the government, industry, academia,
NGOs, and others. The recommendations were evolved as a

20

Greening the Budget: case studies

package comprising budgetary as well as complementary

non-budgetary instruments. Thus a number of instruments
were analysed in the project such as taxes, subsidies,
budgetary allocations, as well as regulatory, and institutional
interventions. While sector-specific issues and
recommendations are discussed in the following chapters,
some general lessons from the project are discussed below.

Ensuring greater coordination within the government

Environmental considerations have to be made a structured
part of the budget-making process with the MoEF, MoF
(Ministry of Finance), and the Planning Commission in the
lead. A similar process has to be replicated at the state level.
It has so far been assumed that environmental concerns
remain the responsibility of the MoEF. However as the High
Powered Committee Report on Management of Hazardous
Wastes noted, the MoEF needs to ensure coordination at the
highest level amongst the various ministries, state
governments, and the Planning Commission, since
environmental protection cannot be dealt with by any
individual ministry/department in isolation (MoEF 2001).
There has to be an integrated assessment of the
environmental implications associated with various policy
options across sectors.
The government should also use its general taxation and
spending powers to induce economic behaviour that is
environmentally accountable, apart from dealing with specific
environmental issues or problems as they arise. It should be
noted that any advance in EFR will require a significant role
for the MoF. Unfortunately, the current task force on MBIs
set up by the MoEF does not involve the MoF to the requisite
degree.

Reconciling trade-offs and tapping synergies with other

objectives of fiscal policy
EFR cannot be designed independent of the other demands
on fiscal policy. On the other hand, environmental fiscal

Green budget reform in India: opportunities and challenges

21

reform and tax policy both have to grapple with difficulties in

administration, monitoring, and enforcement. Both have to
deal with efficiencyequity trade-offs by either pointing out
that these may actually not exist in some situations, or by
design of appropriate instruments such as lifeline rates.
Fortunately, there are a number of synergies between
environmental and other objectives of the fiscal policy: the
best example being that of subsidies.
The finance ministry has estimated that hidden subsidies
on non-merit goods amount to as much as 10.7% of the GDP
on an annual basis. It is no wonder that the combined fiscal
deficit of the centre and states touches almost 10% of the
GDP. The average all-India recovery rate (cost of service
provision over recoveries from that service) for non-merit
goods / services (as defined by Srivastava and Sen 1997) is
10.3%, implying a subsidy rate of just below 90%. The bulk of
the subsidies on non-merit goods are accounted for by
subsidies on economic services (for example, industries and
agriculture), which should be amenable to economic pricing.
Even if a part of these subsidies can be justified in the interest
of redistribution or provision of minimum needs, a
substantial part must be due to the inefficiency costs of public
provision of services. In any case, most of these subsidies are
input-based and not directly administered to intended
beneficiaries and hence are easily dissipated to non-target
population.
The Tenth Five-year Plan highlights that the definition,
magnitude, utility, and justification of these subsidies merit
reconsideration, since this is the area with the highest
potential for savings. The Plan underlines the need for
widespread and bold imposition of user charges on all nonmerit goods. By highlighting the glaring environmental and
resource use implications of some non-merit subsidies (as in
the case of irrigation, fertilizers, and power), a clear link
between fiscal reform and environmental improvement can
be established.
On the other hand, it may appear that environmental fiscal
reform goes against the broad trend towards simplifying
22

Greening the Budget: case studies

commodity taxation and reducing the number of rates.

However, viewed from another perspective, if the tax regime
does not fully internalize externalities, the apparent levelplaying field of a uniform tax system will contain biases,
which fundamentally distort economic activity away from the
social optimum (Smith 1997).

Strengthening the environmental management system in

the country
A sound environmental management system is a prerequisite
even for an effective command and control for pollution
control. There is a growing recognition for greater
institutional strengthening and coordination to address
environmental concerns in the country. It is also recognized
that one of the principal weaknesses of the environmental
protection regime arises from the constitution, and
functioning of pollution control boards.
The present structure, including staff and training, is not
commensurate with the requirements of the new important
thrust areas, which have emerged during the recent years.
These Boards have not been given the autonomy to fulfill the
objectives for which they were set up. The annual plan budget
of the CPCB (Central Pollution Control Board), at less than
two per cent of the MoEFs total plan budget, is inadequate to
enable the organization to meet the needs and challenges
posed by increasing pollution. In order to discharge their
responsibilities effectively, the CPCB and SPCBs require a
scientific/technical base together with broader
interdisciplinary expertise in economic, legal, and
management aspects. There is an urgent need to build
capacity in the pollution control boards through
professionally qualified manpower at senior levels and to
strengthen pollution control infrastructure in every state.
A serious limitation in taking the EFR forward is that the
existing environmental laws do not support pollution loadbased charges. Thus, some modifications in current legal
provisions will need to be considered. At the same time,
opportunities that exist under the current regime, including
Green budget reform in India: opportunities and challenges

23

powers vested with the gram panchayats and urban local

bodies should be made full use of.

Continuous review of environmental status and the

effectiveness of existing instruments
There is limited compilation of information on a regular basis
by the CPCB and SPCBs on the extent of use and
implementation of fiscal and other incentives. This
information would enable an evaluation of the effectiveness
of such measures and improvements in the design of
instruments.
As the government draws up its strategy for EFR, it is
important that targets are laid down and progress towards
these is monitored.3 This monitoring will also ensure dynamic
efficiency of the EFR process, taking into account, changes in
technology and possibilities of substitution over time.
Monitoring will be necessary to understand the
environmental, fiscal, and social/distributive aspects of EFR.
It would need to be assessed whether an instrument would be
effective in meeting its objective, for example if the proposed
level of a pollution charge would act as an effective deterrent
to emissions. The revenue implications of fiscal instruments
are more easily understood. In this context, issues relating to
setting up a dedicated environment fund into which tax
revenue could be channelled and from which revenue could
be earmarked for environmental applications, would also
need to be examined. Finally the social implication of such
instruments would need to be understood, both in terms of
how progressive the incidence of environmental charges may
be as also how these may clash with other social objectives of
the government.
The annual post-budget analyses undertaken by TERI since 1998/99 is one
endeavour towards regular monitoring of progress towards sustainability
through budgetary interventions. Another example is a Framework for
Energy Sustainability Assessment, developed as part of this project, which
aims at analysing and monitoring indicators of sustainability in the energy
sector.
3

24

Greening the Budget: case studies

Understanding and assessing environmental externalities

An economically efficient environmental charge would need
to be designed such that it induces polluters to implement
abatement measures up to the point where the marginal
benefit from pollution reduction (that is, the value of averted
damage) equals the marginal cost of doing so. However, given
the difficulties of valuing environmental damages, very few
taxes in practice fulfill this criteria, instead being based on
some predetermined target levels. As valuation techniques
become refined and practical in the long term, environmental
charges would move closer to economic optimum levels.4
Meanwhile, international experience indicates that lack of
information about marginal abatement and environmental
costs need not deter the introduction of such charges and
taxes.

Involving the states in the process

The Constitution of India distributes the powers to make laws
between the centre and the states as enumerated in the three
lists in the Seventh Schedule. Consequent to the 73rd and
74th amendments of the Constitution of India, state
governments have also enacted enabling legislation,
providing for local self-governments both in rural and urban
areas. A number of issues where EFR can be expected to play
a major role in the country come under the purview of the
states (for example agriculture, irrigation, transport), or both
centre and the states (for example power). A number of fiscal
instruments such as the sales tax also come under the
purview of the states. Thus, evolving a consensus for such
reforms across the states would be a big challenge for the
government, particularly given that the centrestate sharing
of fiscal revenues is itself invariably a subject of debate each
year.

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

Green budget reform in India: opportunities and challenges

25

Educating and consulting stakeholders

Education and awareness will be critical factors in creating a
demand for environmental fiscal reform and the general
acceptance of such reforms. Even where the imperatives for
policy change are clearly understood, implementation of
reform cannot progress unless there is a consensus amongst
stakeholders, as is obvious in the case of the power and
fertilizer subsidy. The role of the government is crucial in
creating a consensus for change by making people aware of
the long-term benefits of apparently harsh decisions. As the
Approach Paper to the Tenth Five-year Plan highlights,
reforms would need to be accompanied by research,
awareness, public education, and persuasion. The central
government must lead this campaign and forge an
understanding and consensus with state governments, who
must do the same with local bodies.
Stakeholder consensus also requires that the process of
negotiation and reforms is transparent with responsible use
of new resources generated through reforms.
In general, the success of any environmental policy
initiative will require that the quality of environmental data
and its dissemination be improved.

A phased approach to environmental fiscal reform

It will be pragmatic to introduce EFR in a phased approach,
as also recommended by the Task Force on Market Based
Instruments (1997). The elements of this approach could be
as follows.
n Continuation and redoubling of efforts to move towards
recovering the full costs of electricity, irrigation and
municipal water, sanitation, and solid waste services, while
at the same time improving the quality of the services.
n Gradual introduction of more sophisticated instruments
such as time-of-use electricity tariffs, and encouraging
inter-sectoral water charges where possible.
n Redesigning the water cess in a phased manner. As
recommended by the Task Force (1997), the cess should be

26

Greening the Budget: case studies

n
n

based on pollution load rather than on amount of water

consumed. Second, it should apply to all industries and
local bodies discharging effluents. Third, the cess rates
should be revised gradually in real terms.5
Moving towards industrial air pollution charges based on
emissions, increasing the charges gradually.
Selection of industries / regions for the implementation of
pilot projects on tradable permits for air pollution.

To sum up, the need to graduate from a rigid system of

poorly enforced command and control to a more flexible one
allowing the use of a mix of policy instruments is long
overdue. The process will be far from simple and would
require initiatives on several frontsbuilding capacity in the
relevant ministries and line agencies to design, implement
and monitor such reforms; strengthening networks for
generation, analysis, and dissemination of information; and
taking the states along in the process and engaging
stakeholders to ensure that they buy into the process.
However, a beginning must be made and with general fiscal
reforms gaining momentum in the country, the time is ripe to
make the environment a part of the process.

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Environmental fiscal reform in India: scope, opportunities,
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EEA (European Environment Agency). 2003
Europes Environment: the third assessment
Environmental assessment report no. 10
Copenhagen K, Denmark: EEA
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authority concerned installed a plant to treat sewage or trade effluent.
5

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Hanley N, Shogren J F, and White B. 2001

Markets for the environment, Chapter 2
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