On the 7^th of October 2021, the government announced the successful passage of Law No. 7 of 2021 on the Harmonisation of Tax Regulation: instituting, amongst other things, taxation obligations on coal polluters.[1] In doing so, the world’s 10^th largest polluter becomes only the second nation in Southeast Asia to levy a price on carbon pollution, joining an exclusive list of just 26 countries to have enacted such reforms.[2]

Indonesia and Coal: A Snapshot

• Remains the world’s foremost exporter of thermal coal;[3]
• 40% of electricity supply derives from coal;[4]
• Over 100 new coal-fired power plants are slated for construction over the next decade;[5]
• Continues to provide the “largest fossil fuel subsidies as a percentage of GDP” in the world.[6]

Law 7/2021: How Will It Work?

The scheme will operate in two distinct phases. The first stage, which commences in April 2022, will impose a carbon tax of IDR 30 per kilogram of carbon dioxide equivalent (“CDE”) (including carbon dioxide, nitrous oxide, and methane) emitted by polluters in the coal-fired power plant industry, beyond a stipulated baseline cap.[7] The Ministry of Energy and Mineral Resources (“MEMR”) will rely on statutory formulas prescribing CDE limits of “.918 to 1.094 kilograms [of CDE] per megawatt hour” of electricity generated, to determine the polluting tax threshold.[8]

The second stage, forecast to come into effect in 2025, will expand the tax to cover all carbon producing sectors, subject to an evaluation of economic conditions; and the establishment of a functional carbon trading framework. This carbon market (the particulars of which are prescribed by Presidential Regulation No. 98 of 2021) will assign carbon credit emission caps to liable entities. Polluting entities that exceed their credit cap will be able to purchase surplus carbon units via this open market; and may earn carbon offset credits for any new actions taken to abate carbon emission.[9] Any carbon tax levied on producers who are unable to cover their credit shortfall will be equivalent to the prevailing market price of carbon units (but will not fall below IDR 30 per kilogram, notwithstanding the market price).

The Economic Rationale

The carbon tax has gained prominence as a mechanism for the rectification of market failures associated with climate change, which may arise where an aspect of the production process is not included in the transaction costs.[10] In the case of pollution, firms are assumed to make decisions predicated on the direct costs and benefits of their enterprise, without considering the indirect costs of their carbon-intensive endeavours on third parties (i.e., decreased quality of life, higher healthcare costs, etc.). For example, Harvard University research estimates that 7,100 Indonesians die prematurely from coal-induced air pollution annually.[11] Therefore, this tax attempts to internalise the indirect costs conferred by negative externalities, steering innovation and investment towards lower carbon technologies.[12] Furthermore, by investing the proceeds of the tax into renewable energy subsidies, the government can enhance the competitiveness of green energy developments as against cheap coal. Research endorsed by the MEMR underscores the underutilisation of potential renewable energy stores in Indonesia, which have the capacity to generate 788,000 megawatts of power annually (to put this into context, Indonesia’s total annual consumption does not exceed 60,000 megawatts).[13]

Carbon Tax and Carbon-Intensive Subsidies: A Fatal Contradiction?

Considering that the object of the new legislative scheme is to encourage substitution towards renewable energies, the maintenance of subsidies on fossil fuels – which continue to promote a sub-optimal overallocation of resources to carbon-intensive production – may warrant criticism. Prominently, the new regulations maintain the Domestic Market Obligation (“DMO”) policy, whereby coal miners are legally obliged to supply 25% of annual output to state-owned, coal-based utility plants at well below market price (thereby acting as an effective subsidy for coal-fired power generators). The World Bank has criticised this regime for being anathematic to Indonesia’s aspirations of achieving carbon neutrality by 2060, as it would “incentivise more consumption of carbon” by sending distorted price signals – circumventing the “transition away to cleaner sources of energy.”[14]

Moreover, these issues are compounded by the fact that the prevailing minimum tax rate would likely be too low to trigger significant behavioural changes by carbon producers. The carbon levy of IDR 30 per kilogram of CDE stands in stark contrast with the recommended tax range posited by the World Bank and IMF, which ranges between IDR 430 and IDR 1400. For reference, neighbouring Australia’s now defunct carbon tax rate was set at IDR 235.[15] In fact, several entities have already indicated their willingness to pay the carbon tax, rather than invest in new, expensive technologies and renewable alternatives to reduce emissions.[16] This underscores the absence of any financial or regulatory incentives to promote the uptake of renewable energy by the private (non-utility) sector.  

The Case for Caution

As Indonesia continues its push to achieve its Paris Agreement commitment (29% reduction in emissions), it faces growing backlash from corporate and consumer interests, who are concerned that such measures may undermine the provision of affordable electricity generation.[17] To this end, the chairman of the Indonesian Chamber of Commerce and Industry argued that the levy would burden businesses “still struggling to recover from the pandemic” since electricity costs constitute up to 80% of production expenses in some industries (e.g., manufacturing industry).[18] Apart from reducing Indonesia’s international competitiveness, this may exert inflationary pressure on consumer prices of carbon-intensive goods and services.[19]

However, various modelling has demonstrated that the resulting impact on aggregate demand and GDP would be nominal (predicting growth impediments of between just .11% and .58% over the next decade), largely owing to accelerated substitution to renewables and the offsetting effects of coal subsidies.[20] This trend is corroborated by the short-lived reign of the Australian carbon tax which, despite imposing a significantly higher levy than Indonesia, did not impact treasury-set growth trajectories.[21]  Subsequently, the new tax will be unlikely to jeopardise the government’s goal of “universal energy access by 2030”; instead, the expansion of the green energy mix on the national grid may bolster these ambitions in the medium-to-long term, by providing more reliable and diverse sources of electricity.

Towards a Greener Future: A Comparative Model to Fix Indonesia’s ‘Missing Link’

In seeking to reconcile competing economic and environmental goals, Indonesia must continue to primarily prioritise incentivising renewable energy investment and uptake – as opposed to the direct disincentivising of coal. The government has already demonstrated its propensity to promote investment in utility-scale renewable power generation pursuant to Presidential Regulation No. 4 of 2016. This provides for corporate tax deductions, accelerated depreciation of assets, and exemption from import and VAT duties for utility companies engaged in green electricity generation. However, this scheme does not stimulate smaller-scale investments by private, non-utility entities into renewable energy generation.

To leverage the vast resources of the private sector in this green endeavour, the government of Indonesia may look to neighbouring Australia’s Small Scale Renewable Energy Target (“SSRET”) scheme for inspiration. The SSRET allows households and non-utility businesses to earn Small-Scale Technology Certificates for renewable energy generated, which liable entities (i.e., power wholesalers) are obliged to purchase to meet a statutorily determined SSTC threshold.[22] This charge – which indirectly subsidies renewable generation – does not require government funding and can work within the framework of a carbon tax to penalise liable entities that do not adequality assuage their SSTC purchasing obligations. The SSRET works in tandem with the Large-Scale Renewable Energy Target (“LSRET”), which inversely rewards power stations that generate renewable energy by conferring them with Large-Scale Generation Certificates – of which liable entities must also procure a threshold amount.[23] Together, these schemes promote up- and downstream investments in renewable energy sources (as opposed to Indonesia’s singularly upstream focus) and compel profitable private energy retailers to subsidise its generation. They reflect Australia’s underlying aversion to the tax-based price signal distortion approach, favouring a corporate reward system that positions renewable energy as ‘good for business’, as opposed to merely being ‘good for the environment’.

Though Indonesia must fix the ‘missing link’ in its renewable energy investment program (i.e., incentivising downstream, private ‘green’ investment), it may have to do so without burdening its public energy retailer, which continues to haemorrhage money and post staggering losses.[24] To circumvent this, the Indonesian government may seek to emulate energy rebates offered by the Australian state and territorial governments, providing low-interest, small business loans to fund renewable energy installations. This scheme would provide the government with a feasible opportunity to recuperate its investments, whilst reducing electricity price pressures on participating firms in the long-term.

Concluding Remarks

Indonesia’s carbon tax, coupled with its planned comprehensive carbon trading framework, will work complimentarily to enhance the commerciality of renewable power - reducing high fixed price structures; incentivising innovation; and accelerating the substitution away from coal. However, Indonesia must continue to pursue holistic government policies that harness free market solutions to incentivise private investment expenditure in renewable energy – both up- and downstream.