The imperative for a global shift to net-zero emissions has stark implications for developing nations and those with economies deeply rooted in fossil fuels. These countries stand on the precipice of dramatic economic upheaval, given their vulnerability to disruptions in industrial output, capital investment, and job markets — particularly as these key sectors currently represent substantial segments of their economic structure.
According to McKinsey’s analysis, the trajectory towards 2050 forecasts a precipitous decline in fossil fuel production: oil and gas outputs are projected to dwindle to 45 per cent and 30 per cent of present-day figures, respectively.
Moreover, the coal industry, primarily for energy purposes, is anticipated to dwindle to near obsolescence by mid-century. The ripple effects will extend beyond production to significantly dampen demand for a swathe of products that are currently dependent on fossil fuels.
Turning to India, a nation with its own commitment to reach net-zero emissions by 2070, the repercussions are significant. This transition is bound to have a great fiscal impact, given India’s high dependence on fossil fuel revenue. India is a minor producer of oil, major coal producer, and major consumer of both. Central and State governments impose many taxes, cesses, duties and even non-tax levies such as dividends and royalties on fossil fuels.
A CSEP working paper by Laveesh Bhandari and Aasheerwad Dwivedi found that in 2019-20, India collected 3.2 per cent of GDP equivalent of revenue by taxing coal, oil and natural gas. The study projected that this revenue would decline to 1 per cent of GDP by 2040.
Some States that rely heavily on fossil fuel revenue must confront a looming fiscal challenge. However, these aggregate numbers mask the wide variation of States’ dependence on these revenues. In fact, some States depend heavily on the revenue stream from fossil fuels much more than others.
The paper found that Jharkhand, Chhattisgarh, and Madhya Pradesh obtain 22-23 per cent of their own revenues from coal, oil, and natural gas combined. Further, Odisha, Bihar, Andhra Pradesh, and Rajasthan derive between 15-18 per cent of their own revenues from fossil fuels. This means that the impact of moving away from fossil fuels will vary widely across States, with some taking a big hit.
Central reliance
Incidentally, some of these States already rely heavily on transfers from Centre. For instance, in 2023-24, Bihar is projected to receive a staggering 74 per cent of its total revenue from central transfers. This trend of high dependency is also notable in Jharkhand (51 per cent), Madhya Pradesh (55 per cent), Chhattisgarh (47 per cent), Odisha (43 per cent), and Andhra Pradesh (43 per cent). These States currently struggle to generate adequate revenue through their own resources.
The impending transition from fossil fuels will likely exacerbate these fiscal challenges. Additionally, these States may need to invest in subsidies to promote low-carbon technology adoption. This would be complemented by strategies not directly aimed at emission reduction but designed to facilitate it by reducing its economic and social costs.
These strategies are grouped into two main categories: Firstly, measures to enhance the cost-effectiveness of decarbonisation, including accelerating new abatement technologies, fostering business dynamism, upgrading infrastructure, and attracting private investment.
Secondly, policies to mitigate the impact of climate policies on different social groups involve tax reforms.
As revenue from fossil fuels dwindles, the reliance on central transfers could deepen, potentially creating fissures between the Centre and the States and among the States themselves. There is a concern that States that are transitioning more swiftly to clean energy might perceive an unfair fiscal burden, questioning why they should face financial constraints to achieve a faster transition.
However, it is also important to note that some States have a natural advantage in renewable capacity over others based on their geographical location. States like Gujarat and Maharashtra, located in the western regions, have one of the highest renewable capacities in the country. So, the new avenues of taxation will not be available to States in a similar proportion as it exists with fossil fuels today.
East-West disparities
Therefore, it is clear that the ongoing transition would create a set of winners and losers among States. These groupings also have a geographical dimension. States losing out are mostly located in the eastern part of the country with relatively poor socio-economic conditions. On the other hand, winners are located in the western part of the country with relatively better socio-economic status.
Given that the period of GST compensation cess is over, the States losing out would find it increasingly difficult to take up infrastructural development using their own funds. Their reliance on fund transfer would increase, creating a spillover impact on central government finances, too.
Future Union Finance Commissions are likely to incorporate energy transition considerations into their horizontal devolution formula, reflecting the country’s commitment to sustainable energy. However, this anticipated change places a significant onus on these States to diversify and strengthen their own revenue streams.
The expectation that the Centre will continually compensate for revenue shortfalls is untenable and reflects a lack of fiscal responsibility. Regrettably, some States have adopted this approach, engaging in fiscally imprudent actions. A prime example is the implementation of prohibition policies in a State with limited revenue sources.
This decision undermines their financial stability and operates under the misguided assumption that the Finance Commission will invariably provide a safety net. Reliance on central support cannot and should not be a substitute for sound fiscal strategies and economic diversification at the State level.
Institutional strengthening of revenue departments, establishing data analytics wings to monitor revenue and identify leakages, increasing tax compliance awareness, modernising IT infrastructure, asset monetisation, especially of land assets, and efficient tax and fee collection by local governments are some of the starting points. State governments should immediately pursue these and be future-ready.
Dwivedi is Assistant Professor, Faculty of Management Studies, Delhi University; Sinha is Officer on Special Duty, Research, Economic Advisory Council to the Prime Minister. Views expressed are personal.