Energy taxation and the environment: a developing country perspective

Economists prefer to monitor environmental protection and sustainable development through the use of economic instruments rather than with ‘command and control’ mechanisms. Energy taxes and subsidies have emerged as a standard prescription for internalising externalities. Yet existing energy tax policies, both in developed and developing countries, show considerable contradictions in terms of environmental considerations. The question needs to be asked why this is so. Moreover, the suitability of fiscal measures for internalising negative externalities in developing countries needs to be questioned. The objective of this article is to reveal the inherent contradictions and ambiguities in the application of taxes or subsidies to satisfy multiple objectives. It is argued that economic theory does not provide any ready‐made solution to the problem and often socio‐political considerations determine the outcome. Similarly, certain characteristics of developing countries, such as the existence of an important informal sector and the extensive use of traditional energies, violate certain basic assumptions of the underlying theory and require special attention in the application of pricing mechanism for internalising externalities.