Indonesia's carbon tax, small step towards a giant transition

By Lisa Wijayani, University of Indonesia in Jakarta Jakarta, Nov 26: For Indonesia to transition to a low carbon economy it must spend billions. The carbon tax it just passed will deliver a fraction of that, and so the wide gap between its economic and climate ambition remains.

Still, taxing carbon is an important and laudable step toward meeting Indonesia’s carbon reduction goals. The tax is one of only a handful in the rapidly developing region, which now dominates CO2 emissions.

Indonesia is on board with the Paris Agreement, but around two-thirds of its energy currently comes from fossil fuels. It has pledged to achieve net zero emissions by 2060, in line with its more developed ally China, but its carbon emission reduction targets are highly insufficient to help meet the Paris goal of limiting the global temperature rise to 1.5°C above pre-industrial levels.

The COVID-19 crisis meant an earlier commitment to reduce emissions by 29 per cent by 2030 was not updated when Indonesia submitted to the UN Framework Convention on Climate Change in July.

Instead, the government came up with a long-term strategy for a just and affordable transition aligned with its “One Hundred Years Indonesia” vision to deliver poverty reduction, human resource development, economic and social transformation by its independence anniversary of 2045.

It instigated climate financing regulations including carbon pricing and a carbon tax to ensure the attainment of both economic and climate goals. The carbon tax bill was part of a broader tax overhaul to aid the COVID-19 recovery and included raising the country’s Value Added Tax and cancelling a corporate tax cut.

The agreed carbon tax price of Rp30/kg (around USD 2.10 per ton) of carbon dioxide equivalent (CO2e) is well below the initially proposed minimum of Rp75/kg (USD 5.20 per ton), and far less again than the World Bank recommendation of USD 35 – USD 100 per ton.

To put the tax in perspective, the amount of money needed to develop Indonesia’s low carbon economy between 2020 and 2024 is estimated to be USD 446.5 billion, or 34.6 per cent of GDP. A carbon tax even at the earlier proposed tariff of USD 5-10 per ton would deliver as little as Rp26 trillion, or 0.2 per cent to 0.3 per cent of GDP.

Behind a climate financing push is Indonesian Finance Minister, Sri Mulyani. Mulyani has been selected as co-chair for the Coalition of Finance Ministers for Climate Action 2021-2023 and is focused on mobilising funding support from public, private, and international sectors to finance climate-related projects.

Some 64 finance ministers have signed up to the Helsinki Principles with the objective of bringing climate issues to the core of economic policy and financing decisions.

South Korea, Japan and, more recently, China have all vowed to end financing of overseas coal power projects. This will bolster renewable energy and energy efficiency projects.

Likewise, revenue from Indonesia’s carbon tax will be used to fund renewable energy projects and will aid other efforts in emission reduction. Given the new reduced price, however, it will not be enough to deliver the required emissions reduction target in the energy sector. And there is no current plan to soften the burden for those who will bear the cost.

Who pays? Indonesia's new carbon tax will be imposed on carbon-intensive sectors such as power plants, transportation, pulp and paper, petrochemicals, cement, and building materials.

Though not directly levied on the coal industry, the tax will touch upon five sectors that contribute the most to Indonesia’s carbon emissions: forestry, energy and transportation, waste, agriculture, and industrial processing.

Indonesia’s 2020 carbon emissions mainly came from power generation (35 per cent), followed by industry (27 per cent), and transportation (27 per cent).

Given the current dependence on carbon-intensive coal-burning for energy, the carbon tax should help Indonesia significantly reduce emissions from coal. It follows then that the price of electricity, which is mostly sourced from coal, will increase.

Producers and consumers will be encouraged toward sustainable production and consumption, but it is consumers who will ultimately pay for the tax through higher prices.

Research has found for every ton of carbon reduced as a result of a carbon tax there is an economic loss of between USD 4.7 – 65 (in 2007 terms).

In other countries, incentives have been offered to counter this. For example, Finland calculated a carbon tax of USD 150/ton could reduce welfare by USD 3.5 billion. It introduced a tax-shifting package to lessen the burden on consumers. Indonesia should learn from this example.

Next steps Indonesia’s low scale carbon tax should be gradually increased in line with inflation. This would deliver behaviour change and attract new markets for clean energy.

Tax incentives should be developed to counter the impact of carbon pricing on consumers.

Indonesia should introduce a carbon tax specifically for the coal industry, giving it time to prepare for switching its capital to renewable energy.

(With inputs from agencies.)