Over the next few decades, most of the countries, including India will go through a significant energy transition to achieve their Net Zero targets. This would entail a steady reduction in the share of fossil fuels like coal, oil and natural gas, along with increasing share of greener sources of energy in the overall energy portfolio.

India has pledged to move to Net Zero by 2070, though the energy transition is happening at an even faster pace. The installed solar energy capacity stands at 82.63 GW as of April 2024, increasing by 30 times in the last nine years.

Though this energy transition is important and inevitable, it is bound to lead to disruptions. One impact that is often not appreciated fully is the ‘Fiscal Impact’ given India’s high dependence on fossil fuel revenue. Both the Centre and State governments impose a multitude of taxes, cesses, duties and even non-tax levies such as dividends and royalties on fossil fuels. And the amount collected is not insignificant.

Bhandari and Dwivedi (2021) (https://shorturl.at/VSjoT) estimated that revenue collected from these sources amounted to approximately 3.2 per cent of GDP in 2019-20, out of which 2 per cent was for the Centre and 1.2 per cent was for States. To understand its importance, this amounted to 20.8 per cent of revenue for the Union Government and 8.3 per cent for the State governments.

Going forward, with the transition from fossil fuels, the revenue from these sources will decline correspondingly. The same paper estimated that if the transition progresses at the current pace, total revenue would decline to 1.8 per cent by 2030 and 1 per cent of GDP by 2040. So the Centre and States will soon have to figure out how to raise revenue from alternative sources.

The challenge doesn’t end here. Another issue is that not all States will be affected uniformly. Bhandari and Dwivedi (2022) ( https://shorturl.at/8wVN3) found that currently States such as Jharkhand, Chhattisgarh, and Madhya Pradesh obtain 22-23 per cent of their Own revenues from coal, oil, and natural gas combined.

In contrast, Gujarat, Haryana, Karnataka get 14-15 per cent and Delhi gets 8 per cent. So, naturally the fiscal impact of moving away from the fossil fuels will vary widely across States, with some States taking much bigger hit.

State variations

Now this would have been less problematic had the renewable capacity of States been similar. However, that is not the case as the renewable energy potential is largely dependent on geographical conditions.

States like Gujarat, Maharashtra, Rajasthan etc. located in the western region have highest renewable capacity in the country. On the other hand, the eastern States like Odisha, Chhattisgarh, and Jharkhand, which are also the ones more dependent on revenues from fossils, have much lower renewable capacity. Hence, it is clear that the ongoing transition would create winners and losers among States.

Additionally, States which will lose out more on the revenue front are mostly located in eastern part of the country with relatively poor socio-economic conditions.

On the other hand, States in the western part are more comfortably placed, with relatively better socio-economic status.

There is also no possibility of levying tax on renewable energy to compensate for revenue loss in the near future. States on the contrary provide subsidies for installation of solar panels, windmills etc. to promote the transition. Hence, States with lower capacity at the moment may have to bear a bigger fiscal burden on that front too.

This shortfall in own revenue would mean that their reliance on fund transfers from the Centre would increase, creating additional impact in central government finances. This can lead to some key issues.

Green dilemma

In fact, the States which will be negatively affected may not cooperate fully in the green transition. More importantly, if the policy makers do not device a mechanism to compensate the ‘disadvantaged’ States in time, it might have serious political economy consequences.

But for the Centre this will not be an unfamiliar situation as it faced such issues during GST implementation, where the GST compensation played a key role in States’ acceptance.

Union government will need to do something similar in this case as well to ensure that not only the States are on board but also minimise socio-economic disruptions.

The Sixteenth Finance Commission can come up with a strategy. Finance Commissions use different criteria for the interstate distribution of tax sharing across States in order to maintain horizontal equity reflecting its need in terms of population, area, infrastructure distance etc.

The variance in impact on energy transition between States can be considered as a factor while deciding the devolution formula to ensure horizontal equity.

The writer is Assistant Professor of Economics at Faculty of Management Studies, Delhi University

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