Carbon Tax Implementation in Indonesia

By: I Dewa Made Raditya Margenta

A couple of weeks ago, AirVisual, an international team that provides information about air quality data, stated that Jakarta ranked as the city with the worst air pollution in the world. According to AirVisual, Jakarta had an Air Quality Index (AQI) of 160 and classified as unhealthy. Nowadays, the AQI of Jakarta has decreased 5 points to 155 and ranks third, below Dubai and Kuala Lumpur as the cities with worse air pollution. As reported by Jakarta’s Environmental Service (Atika, 2019), the most significant contributor to Jakarta’s air quality is the vehicle’s carbon emission. The presence of Jakarta as one of the most polluted cities in the world is not surprising because Indonesia contributed about 1.4 percent to global carbon emission and ranked twelfth in 2017. Energy sector becomes the biggest contributor in carbon emission in Indonesia (48 percent) and then followed by Forestry and other land use (FOLU) & peat, agriculture, waste, and industry (Industrial Process and Product Used (IPPU)) respectively (Figure 1).

Figure 1. Indonesia Carbon Emission Contributors (Ministry of Environment and Forestry, 2019 compiled by author).

Even though the national carbon emission has decreased since 2015 (Figure 2), Indonesia should put more efforts in decreasing the carbon emissions that comes from energy sector, which has been rising since 2000 (Figure 3). The rising of carbon emission in energy sector was led by the intensive fuel combustion.

Figure 2. Indonesia Carbon Emission from 2000-2017 (Ministry of Environment and Forestry, 2019, compiled by author).

Figure 3. Comparison between fuel combustion and fugitives as the carbon emitter (Ministry of Environment and Forestry, 2019).

Based on the Ministry of Environment and Forestry report (2019), industry and transportation sector had the biggest share of fuel combustion (Figure 4). It indicates that Indonesia has a significant dependency on fossil fuel, especially to encourage national development.

Figure 4. Fuel combustion contributors by its sector in Indonesia (Ministry of Environment and Forestry, 2019, compiled by author).

The dependency on fossil fuel in some countries is correlated with the industrial revolution. Historically, the utilization of fossil fuel was massively used during the industrial revolution, which was marked by the discovery of the steam engine. At that time, coal became the world’s favorite fuel as it powered everything from trains to ships. Then, oil and gas were also introduced as other fossil fuel energy type. As technology developed, the efficiency of oil and gas utilization has increased and currently, become the prime world energy commodity.

However, the massive used of fossil fuel commodity have caused a negative externality to the earth, such as air pollution and global warming. Since the industrial revolution, the earth temperature has significantly risen (Figure 5), which dominantly caused by the carbon emission from fuel combustion.

Figure 5. Annual temperature anomaly (Nasa Earth Observatory, 2015).

The initiative of increasing climate issues awareness was begun to appear, and the commitment to reducing carbon emission was finally reached during the Earth Summit at Rio de Janeiro in 1992. The commitment was implemented by the Kyoto Protocol, which was agreed by 160 countries in 1997. The implementation has gone a tough road due to politic and economic issues. Recently, the commitment was solidified through Paris Agreement. The Paris Agreement is an agreement within the United Nations Framework Convention on Climate Change (UNFCCC), dealing with greenhouse-gas-emissions mitigation, adaptation, and finance, signed in 2016. This agreement was signed by 196 countries, and Indonesia was one of them. The Government of Indonesia targeted a 29 percent reduction of carbon emission by 2030.

As one of the biggest carbon emitters, Indonesia has a major role to be part of a movement to save the earth. However, as the developing country, Indonesia must realize that they have to increase energy production to fulfill the energy demand, which supposed to rise in the future. Therefore, Indonesia needs to strategize their energy plan while aligning with the effort of minimizing the national carbon emission in the energy sector. It is recommended to put a carbon price to fasten the climate change mitigation, and the implementation of carbon tax should be brought as viable options.

Carbon Tax

The carbon tax is an artificial cost levied by a government upon entities buying and selling energy sources that emit carbon dioxide and other greenhouse gases. The purpose of a carbon tax is reducing or eliminating negative environmental externalities which damage human welfare by changing the behavior of energy consumers to start using clean energy source. The carbon tax will force the fossil fuel consumers to pay extra as a marginal social cost which is quantified based on the total carbon emitted. Carbon pricing, if designed well, is widely seen as a useful tool for reducing greenhouse gases (GHGs), fostering energy efficiency and renewable energy, as well as developing sustainable forestry.

Beside carbon tax, many countries choose the Emission Trading Scheme (ETS) as their carbon pricing types to minimize their carbon emission. The concept of ETS is by setting the cap of maximum carbon emitted for personal/company. If the company/person has exceeded their cap, they have to buy the permit to the other company that has unused permit. As a result, it can assure the delivery of emission reduction target through emission cap. However, the weaknesses of ETS implementation are uncertainty of the allowance price and complicated, as a result of requirement to create a new commodity, the allocation of these commodities, and the establishment of a market for trading (Hindarto, 2019). Unlike ETS, carbon tax can assure the price certainty as it is determined by the government. Also, the implementation of carbon tax is more accessible as it can build on existing taxation infrastructure.

Organization for Economic Co-operation and Development (2001) in Environmental Taxation: A Guide for Policy Makers, gave several points that have to be considered for policymakers while designing the environmental taxes.

1. A carbon tax is an extensive economic policy and directly cut the carbon emission from the primary emission source without considering its sector.
2. The carbon tax implementation will show a fixed price. As a result, the energy consumers (industry, transportation, and household) has options to choose which energy sources that suit best for them. Therefore, it will lead on energy efficiency and investment in clean energy based.
3. The administration can follow the established method for other taxes thus, the administration complexity can be minimized.

Implementation of Carbon Tax: Indonesia Case

A carbon tax can support Indonesia Nationally Determined Contribution (NDC) target achievement, yet much effort and new economic regimes are also needed. There are possible scenarios that can be implemented in Indonesia, such as:

1. Carbon tax in industries and power generation.
   • A carbon tax can be implemented in energy-intensive industries such as cement, petrochemical and metal.
   • It will need a firm policy and commitment, both from government and industries.
   • A carbon tax may cause price increases in the product.
2. Carbon tax in transportation.
   • Can be used both for the vehicle and the fuel.
   • Simpler, but still need a stable policy and commitment, both from the government and industries.

The implementation of a carbon tax in Indonesia can be analyzed in SWOT analysis (Hindarto, 2019):

Figure 6. SWOT Analysis of Carbon Tax Implementation in Indonesia (Hindarto, 2019).

The implementation of a carbon tax should not be applied only for industry but also for household. However, taxing in the industry sector which has fewer tax subjects, can provide an efficient tax collection. Meanwhile, imposing taxes on household can give a direct signal for the consumers, but at the same time, it allows higher administrative cost. Therefore, the carbon tax should be applied in industry sector especially energy industries first, then slowly being applied to household sector. Implementing carbon tax for household can encourage energy efficiency and at the same time can increase the income of low-income group (Hartono and Resosudarmo, 2017).

A carbon tax also has a significant impact on the industry sector. The company would rather choose carbon tax than other carbon pricing types because carbon tax has a certain price (Ratnawati, 2016). Therefore, the company can calculate their operating expenses directly. However, there is a possibility of slowing the economy due to competitiveness. This issues should be addressed by implementing a tax-free threshold, reducing tax rate for industries, reducing current energy tax, and reducing bad taxes (VAT, Salary). Also, the government can give incentives to the company which committed to energy efficiency.

Regarding the carbon tax rates, it is challenging to determined the amount as several factors must be considered such as inflation, purpose and function taxation to be achieved. High carbon tax rates indicate the force of changing the society’s behavior, while low carbon tax would not change the society’s behavior but it can provide funds in reducing carbon emission programs. The government through ministry of finance (Ministry of Finance, 2009) has proposed the initial carbon tax rate of IDR 80,000 and increased by 5 percent per annum. The initial carbon tax rate is lower than other countries such as Finland, Denmark, and Sweden. As a result, by implementing carbon tax rates, it will reduce carbon emission by 10 percent as it has not yet been able to hit the 26 percent of reduction target. Ratnawati (2016) has proposed to increase the carbon tax rates from IDR 80,000 by 5 percent gradually until it reaches IDR 300,000, right above marginal cost of abatement (cost of reducing one more unit of pollution).

Regardless of the rates, the carbon tax should drive Indonesia to low carbon development initiative as the answer of national carbon mitigation. Carbon tax can be the capital to start renewable and clean energy development as well as green building. Also, the carbon tax can encourage the people to be more efficient in energy utilizing to decrease the carbon emitted to the air. Therefore, the government play an important role in encouraging this culture while creating effective, efficient, and transparent tax collection method.

Conclusion

In conclusion, carbon tax as one of carbon pricing types should be considered as it is easy and feasible to be implemented in Indonesia. The implementation of carbon tax can help Indonesia NDC in reducing carbon emission, while it also can be considered as other revenue sources. Carbon tax should be targeting both industry and household sectors to encourage energy efficiency efforts. Also the government is required to assist the energy-intensive industries as they will be hit the hardest by the implementation of carbon tax, so it will not slow down the economy. To ensure the transparency of the carbon tax fund management, it is suggested to establish a new body/bureau.

References:

Atika, S. (2019, August 8). Airvisual: Jakarta declared world’s most polluted city on Thursday afternoon. Retrieved from The Jakarta Post: https://www.thejakartapost.com/news/2019/08/08/airvisual-jakarta-declared-worlds-most-polluted-city-on-thursday-afternoon.html

Hartono, D., & Resosudarmo, B. (2007). The Impact of Controlling Energy Consumption on Household Incomes in Indonesia: A Preliminary Analysis. In Empowering Regional Economic Development Toward Sustainable Poverty Alleviation. Indonesian Regional Science Association.

Hindarto, D.E., (2019). Unveiling the Potential of Carbon Tax Implementation in Indonesia. Joint Crediting Mechanism Indonesia.

Ratnawati, D. (2016). Carbon Tax Sebagai Alternatif Kebijakan Mengatasi Eksternalitas Negatif Emisi Karbon di Indonesia. Indonesian Treasury Review.

Ministry of Environment and Forestry. (2019). Laporan Inventarisasi Gas Rumah Kaca (GRK) dan Monitoring, Pelaporan, Verifikasi (MPV) Tahun 2018

Ministry of Finance. (2009), Ministry of Finance Green Paper: Economic and Fiscal Policy Strategies for Climate Change Mitigation in Indonesia, Ministry of Finance and Australia Indonesia Partnership, Jakarta.

Organization for Economic Co-operation and Development. (2001). Environmental Taxation: A Guide for Policy Makers. OECD Publishing

https://www.airvisual.com/indonesia/jakarta

https://earthobservatory.nasa.gov/world-of-change/DecadalTemp

*This opinion piece is the author(s) own and does not necessarily represent opinions of the Purnomo Yusgiantoro Center (PYC)