Does Fiscal Policy Influence Per Capita CO2 Emission?: A Cross Country Empirical Analysis

Does Fiscal Policy Influence Per Capita CO2 Emission?: A Cross Country Empirical Analysis

Sacchidananda Mukherjee (National Institute of Public Finance and Policy (NIPFP), India) and Debashis Chakraborty (Indian Institute of Foreign Trade (IIFT), India)
DOI: 10.4018/978-1-4666-8814-8.ch028


Encouraging economic activities is a major motivation for countries to disburse subsidies, but such transfers may also lead to sustainability and climate change related concerns. Through a cross-country empirical analysis involving 131 countries over 1990-2010, the present analysis observes that higher proportional devolution of budgetary subsidies lead to higher CO2 emissions. The results demonstrate that structure of economy is a crucial determinant for per capita CO2 emission, as countries having higher share in agriculture and services in GDP are characterized by lower per capita CO2 emission and vice versa. The empirical findings also underline the importance of the type of government subsidy devolution on CO2 emissions. Countries having high tax-GDP ratio are marked by lower per capita CO2 emission, implying that government budgetary subsidy is detrimental for environment whereas tax is conducive for sustainability. The analysis underlines the importance of limiting devolution of subsidies both in developed and developing countries.
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1. Introduction

Providing subsidies to local players is a time-tested policy instrument, which can be applied for responding to various motives, e.g., countering domestic distortions (Bhagwati and Ramaswami, 1963), for granting ‘infant-industry’ protection (Melitz, 2005), for facilitating innovation, supporting national champions as a part of the long term industrial policy, ensuring redistribution, etc. (Howse, 2010; WTO, 2006). A country may extend subsidies to their primary, manufacturing and service sectors through various channels, e.g., through input subsidies (e.g. per unit fuel subsidy), output subsidies (e.g. per unit price support) and ‘regulatory reliefs’ in terms of maintaining weaker environmental regulatory standards and tax reliefs (Barde and Honkatukia, 2004; Heutel and Kelly, 2013; Fisher-Vanden and Ho, 2007).

Existence of subsidies per se does not necessarily lead to adverse environmental consequences. For instance, carefully crafted subsidy policies can contribute significantly for ensuring environmental protection in an economy (e.g. subsidies for promoting organic farming or other forms of environment-friendly agriculture, technology upgradation support to industry for securing lower emissions, promotion of renewable energy etc.). Nevertheless, the adverse environmental implications of subsidies are well documented in existing literature. On one hand, several environmental implications of input subsidies have been underlined (Heutel and Kelly, 2013). First, demand for any subsidized input is expected to witness an increase due to substitution of other non-subsidized inputs. Second, firms enjoying the benefits of the subsidized inputs tend to produce more due to the fall in per unit production expenses, which increases their demand for all inputs in general. As a result of the consequent change in input usage patterns, the sectors benefiting from input subsidies generally grows in size and their expanded scale of operation might lead to over-production and in turn over-exploitation of resources. On the other hand, if the government provides output subsidies by offering higher price per unit of output produced to the producers, the chain of events again may potentially result in over-use of inputs, over-exploitation of resources, over-production and consequent environmental degradation (van Beers and van den Bergh, 2001). The existing literature supports this contention by underlining that subsidies generally encourage overuse of dirty inputs and enable the environmentally inefficient producers to continue in the market (Barde and Honkatukia, 2004). Conversely reduction of subsidies enhance environmental sustainability by lowering pollution-causing capital accumulation, shifting of capital and labor to less pollution intensive firms and enhancing the output of more productive firms (Bajona and Kelly, 2012).1

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