Indonesia’s Proposed Carbon Tax Bill Reveals Risk to GDP Growth

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Indonesia’s plan to tax carbon output risks slowing growth in Southeast Asia’s biggest economy and faces resistance from some of the country’s biggest industries.

A proposed rate of 75,000 rupiah ($5.2) per ton of carbon dioxide output would generate 32 trillion rupiah in additional state revenue and cut emissions by nearly 17% by the end of the decade, according to a draft law presented by the government to parliament on Monday. But the fee will also weaken demand, output and employment as higher costs create “dead-weight losses,” it said.

That could be a tough choice to make for a country that relies on coal for more than half its energy generation. It comes at a time when the pandemic-hit economy tries to climb out of its first recession in two decades. A recent spike in Covid-19 infections has forced Indonesian President Joko Widodo to tighten measures and curb business activities, further risking a recovery expected in the second quarter.

It also highlights the issue facing developing, fossil-fuel dependent nations as they come under international pressure to curb emissions, or risk losing access to foreign funding and supply chains that are shifting away from dirtier, but cheaper fossil fuels.

The tax will help cut 2030 emissions by 16.6%, in comparison to a scenario with no such tax, aiding Indonesia’s pledge for a 29% reduction under the Paris Agreement.

“As an archipelago, climate change is a threat for us,” Finance Minister Sri Mulyani Indrawati told a parliamentary committee on Monday, as lawmakers began deliberating the tax bill. “Indonesia has a huge interest in tackling the drastic impacts of climate change, so we need to continue to improve our ability to finance climate change mitigation and adaptation efforts,”

Higher than Singapore

Indonesia’s proposal for $5.2 tax per ton of CO2 is higher than Singapore, the first in the region to price carbon, which imposes a S$5 ($3.72) levy per ton of CO2.

Even with a lower rate of $3 per ton, GDP growth could still be reduced by 0.06% next year, assuming business-as-usual conditions, according to a simulation by the finance ministry. Increasing the tax to $6 in 2023 and $12 in 2024 would widen the gap to 0.12% and 0.29%, respectively.

If the rate is then kept at $12 in succeeding years, it could shave off 0.58% from the pace of economic growth by 2030. The tax could also lower Indonesia’s employment rate by 0.15% and real consumption by 1.97% by the end of the decade.

Indonesia’s economy shrank 2.07% in 2020 as the pandemic hit. GDP is forecast by the government to expand 5.2%-5.8% in 2022, 5.3%-6.1% in 2023, and 5.4%-6.3% in 2024.

Indonesia Coal Demand May Be Hit by New Climate-Change Policies

Already, the proposed tax is facing resistance from the industrial sector, including cement, where producers are currently running at 62% output capacity amid weak demand caused by the pandemic, according to Lusy Widowati, a technical advisor at Indonesia Cement Association.

The proposed carbon tax would add costs of about $3.5 per ton of output for cement makers, almost 10% of the selling price of their clinker export, she said at a streamed discussion on Tuesday. “It is just beyond the capacity of the cement industry. It will be too heavy for us.”

Hendra Sinadia, executive director of the Indonesia Coal Mining Association, said the group hasn’t had discussions with the government and is reviewing the draft law, but has already expressed some concern. “Implementation of the tax should not burden the mining industry and other carbon producing sectors,” he said.

Cushion the Blow

For its part, Indonesia has doubled-down on its green shift this year, pledging incentives for renewable industry while discouraging the development of new coal plants. It’s also devising a carbon trading framework, targeting investors keen on the country’s burgeoning battery industry but who are hesitant because of the emissions produced in its nickel processing.

The government said in the proposed bill that it will need to pass support measures or be selective about which fossil fuels will be covered under the law to limit the impact the tax will have on consumption, employment, domestic output and economic growth in the next decade.

To cushion the blow, “follow-through actions” are required, such as cash transfers to households, price subsidies for renewable energy products, it said.

These can be funded by proceeds from the carbon tax, especially after the pandemic “increasingly made the government’s fiscal space very narrow.” From 2016-2019, the annual state budget was only able to fund roughly a third of its climate change mitigation needs, which averages 266.2 trillion rupiah per year.

The parliamentary commission will start deliberating the bill and give recommendations before a plenary session makes a decision to pass the legislation.

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