Reducing Fuel Subsidy or Taxing Carbon? Comparing the Two Instruments from the Economy, Environment, and Equity Perspectives for Indonesia

Reducing fuel subsidy and taxing carbon have a tendency toward reducing energy consumption and carbon emissions. However, both instruments may have differing impacts in their magnitudes of the emissions reduction and on the economy as a whole. Using an INDONESIA-E3 (Economy-Equity- Environment) model, a computable general equilibrium (CGE) model which includes carbon emissions, carbon taxation, as well as, strong feature in distributional analysis, this paper compares and contrasts the two instruments to find which policy is better in improving the three pillars of sustainable development: economy, equity, and the environment. The results suggests that given the same amount of government budget saving, a carbon tax is relatively superior to using a fuel subsidy reduction instrument, because it can accelerate the decline in CO2 emissions with a lower cost to the economy in terms of GDP reduction with more favorable distributional effects. This has not taken into account the economic incentives it creates for the economy to be less reliant on carbon-intensive energy