Climate change exacerbates environmental threats and biodiversity degradations. Biodiversity loss and climate change are twin catastrophes. They should be simultaneously addressed through holistic strategies incorporating the whole gamut of policy reforms, regulations, fiscal measures and ecological strategies.

Considering the substantial repercussions environmental degradation could have for Indonesia’s economy, policymakers should use the COVID-19 pandemic to kickstart Indonesia’s fiscal framework towards a sustainable green economy.

From an ecological perspective, a sustainable green economy will improve human well-being and reduce environmental risks and scarcities in the long run.

From the perspective of the global economy, a sustainable green economy will become a new attraction for global investors looking to green investment and decarbonisation.

Indonesian President Joko ‘Jokowi’ Widodo emphasised the Indonesian government’s strong commitment to supporting climate resilience under nationally determined contributions at COP 26 in Glasgow. This commitment is manifest in Indonesia’s Low Carbon and Climate Resilience 2050 roadmap.

In terms of fiscal measures, the Ministry of Finance is promoting the Climate Change Fiscal Framework as the cornerstone of fiscal incentives and tax strategies, such as tax holidays, allowances or exemptions and regional incentive funds. A growing body of studies highlights the relevance of pricing instruments to support a sustainable green economy. In this context, the government needs to integrate environmental pricing instruments into the tax system through carbon and energy taxes and green incentives.

Indonesia’s new Law on Harmonization Tax Regulations is evidence of the government’s strong political commitment to bolstering climate resilience. The law introduces a carbon tax and will be imposed from April 2022. It also supports the move to net-zero emission by 2060, addressing the long run of Indonesia’s carbon trading roadmap.

A set of implementing measures is now also being formulated. In the next few months, the Fiscal Policy Board will determine the regulations governing the carbon tax, as well as the specific subjects. Tax-specific measures are also being designed, including the minister’s regulations concerning the rate, base and mechanism of the tax.

But to be effectively enforced, policymakers should anticipate some short-run negative effects.

The first is the sectoral and regional effects. The energy and mining sector will be heavily affected and the multiplier effect may contract the regional economy, such as in Kalimantan, Sulawesi and Sumatra. This is because the introduction of a carbon tax might result in declining coal consumption, reducing revenue from royalties and local taxes and creating a ripple effect across coal-reliant economies that causes shocks and spillovers impacting regional fiscal issues.

The second is the competitiveness effect. The carbon tax will raise output prices, particularly for energy-intensive products, which has a detrimental impact on competitiveness. Indonesia’s oil, gas, mining, coal, chemical engineering and electrical power industries are likely to bear the largest costs here.

The third is the distributional effect, based on the equity of the tax burden and determined by the consumption and elasticity pattern between groups. For instance, low-income groups often naturally consume more carbon-intensive products than green products. So the carbon tax will be harshest on low-income groups and those with a relatively inelastic demand curve.

Indonesia’s new environmental fiscal strategies should thus be approached with caution and precision. A poorly crafted configuration might result in an unfavourable impact on environmental progress — a ‘green paradox’ where the impending introduction of green fiscal policy induces accelerated fossil energy extraction and increased carbon emissions. To address this issue, a behavioural economics analysis is useful in applying another layer of insight to today’s standard fiscal policy.

Carbon taxes remain nascent in Indonesia due to their novelty and lack of integration between stakeholders, made more complicated by overlapping regulations between ministries and sectoral agencies. But with strong political commitment and the adoption of harmonised environmentally responsive policies, ministries and sectoral agencies may be able to successfully implement the roadmap to Indonesia’s sustainable green economy.

Agung Endika Satyadini is a Senior Analyst in the Directorate General of Taxes, Ministry of Finance,  Indonesia, and a PhD Candidate at the Crawford School of Public Policy, Australian National University. The views expressed are his own and do not necessarily reflect the institution’s policy where the author serves.