Economics and finance, Environment & energy, Trade and industry | Southeast Asia

21 September 2022

The government of Indonesia has postponed the implementation of its carbon tax to iron out its wrinkles, but it must remember that time is of the essence, Yetty Komalasari Dewi writes.

While recent international headlines on Indonesia’s economy have focused on Indonesia’s restrictive export policies, its impending carbon tax poses a more pressing policy challenge.

Indonesia has been in the spotlight, having postponed the implementation of its carbon tax twice in the past year.

This has raised questions about the seriousness of the Indonesian government’s commitment to tackling climate issues. Indonesia’s G20 presidency, underpinned by the theme of transitioning to a green economy – and its own ambitious emissions target of a 29 to 41 per cent reduction by 2030 and net zero emissions by 2060 – adds to the urgency of the country’s situation.

Indonesia’s proposed carbon tax was set in motion in October 2021 as part of a wider overhaul of its taxation regime, with the promulgation of Law No.7 Year 2021 on Tax Harmonization. While initially restricted to coal-fired power plants, the carbon tax will eventually apply to all sectors of the economy.

Imposing this carbon tax is step one of the government’s plans to transition to a low-carbon economy. Once it is implemented, the government has further plans to develop a broader carbon tax and a carbon exchange mechanism, before introducing a pilot carbon trading project in the energy sector.

Both these processes hinge upon the carbon tax, the success of which will come down to two main factors.

Firstly, is the price signal strong enough to build urgency among carbon emitters to limit their emissions?

At 30,000 Indonesian Rupiah (roughly AU$2.99) per tonne of carbon dioxide equivalent emitted, some doubt the ability of such a low price to drive down emissions effectively.

More on this: Carbon pricing insights from Vietnam

Secondly, will the income derived from the carbon tax be allocated to the government’s other climate efforts, namely renewable energy and its research and development?

As it stands, Indonesia’s carbon tax needs some fine tuning in both these areas.

At its current proposed rate, the tax is indeed too meagre to serve as a strong disincentive to reduce emissions. Meanwhile, the details of Indonesia’s national economic recovery program are inconsistent with its lofty climate goals, as it remains heavily reliant on fossil fuels to sustain the country’s energy needs.

For instance, the state still provides trillions of rupiah to fossil fuel-dominated state-owned enterprises, casting doubt on whether the proceeds from a carbon tax would really go towards creating a greener economy.

Also, while the carbon tax could be a groundbreaking policy, the story of its postponement shows that the government lacks the experience and initiative to enact it properly.

In the face of uncertain global economic conditions and rising domestic inflation, the government needed to consider the potential of legal risks arising out of its carbon tax, particularly disputes with emitters, when it designed it.

More on this: Warming up Indonesia’s climate change policies

Its failure to do this is part of the reason the carbon tax is still on the shelf – relevant agencies need more time to settle outstanding issues and to implement the complex regulations necessary for the tax to take effect.

While existing taxation measures are subject to appeal through Indonesia’s administrative courts, the carbon tax may be subject to international investment disputes if its implementation is unfair or arbitrary, which the government will want to avoid. This is especially risky for a government that has just begun acquainting itself with its new policy measure.

To address this, Indonesian policymakers must closely consider Indonesia’s international obligations in accordance with investment protection provisions under various international instruments.

They must mitigate the risk of investment disputes arising in connection to the implementation of the carbon tax if the policy is to be a success.

Once implemented, it is paramount that the carbon tax aligns with the government’s climate targets, while accounting for the interests of business actors and investors.

On investment, Finance Minister Sri Mulyani Indrawati mentioned that as a newly introduced policy, the carbon tax must also consider the social, political, and economic conditions of Indonesia, as well as its goals.

Ultimately, the government needs to keep in mind the purpose of the policy – to protect the environment, and by extension, the population and the economy in a changing climate. Unlike fiscal and monetary policies, there is no wriggle room on climate. The effects and intensity of climate change do not respond quickly to the pulling of policy levers.

For sure, the government must balance climate action with businesses’ concerns, but it must stay focused on the main goal – a just transition to a low carbon economy.

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