In the recently announced federal budget, the government has introduced a carbon levy of Rs2.5 per litre on petrol, diesel and furnace oil. This marks a notable step toward integrating climate considerations into fiscal policy, but it also raises important questions about the design, timing and fairness of such measures.
BUDGET 2025-26
In the recently announced federal budget, the government has introduced a carbon levy of Rs2.5 per litre on petrol, diesel and furnace oil. This marks a notable step toward integrating climate considerations into fiscal policy, but it also raises important questions about the design, timing and fairness of such measures.
While carbon pricing is a widely endorsed instrument for reducing emissions and mobilising green finance, its success depends heavily on how and where it is applied. In Pakistan’s case, the decision to apply a uniform carbon levy on transport and industrial fuels risks being more of a fiscal manoeuvre than a meaningful climate intervention. The government expects to generate Rs45 billion from the carbon levy in the upcoming fiscal year, alongside a much larger Rs1.47 trillion from broader petroleum taxation, representing a substantial rise of Rs397.395 billion as compared to last year, highlighting the increasing reliance on fuel-based revenue in the national budget.
The primary justification offered for this levy is environmental: to internalise the external cost of carbon emissions and steer consumption patterns toward cleaner alternatives. From a theoretical standpoint, this makes sense. Fossil fuel combustion is the leading source of global greenhouse gas emissions, and taxing carbon is intended to send a price signal to discourage excessive use. Yet in practice, the context in which this levy has been applied undermines much of its intended purpose.
Petrol and diesel already bear the burden of the Petroleum Development Levy (PDL) in Pakistan. Furnace oil, while less prominent in household use, is still a critical input in industrial production and backup power generation. The policy disproportionately burdens low- and middle-income consumers who rely on fossil fuels for transport and basic energy needs by layering a carbon levy on top of these existing charges without any restructuring or relief. In effect, the carbon levy becomes a regressive tax, raising fuel prices and triggering inflationary spillovers in the food, transport and manufacturing sectors.
The economic implications of this move are far-reaching. Pakistan’s transport sector, heavily reliant on imported fuel, will pass these costs onto consumers, aggravating cost-of-living pressures when inflation is already high. Meanwhile, industries dependent on furnace oil or diesel generators may face increased operational costs, weaken their competitiveness and potentially slow down production. These distortions are particularly damaging in the absence of affordable and scalable alternatives such as mass transit systems, electric mobility infrastructure, or reliable grid electricity for industries. A tax designed to change behaviour cannot work when the choices available remain unchanged.
The use of the term ‘carbon levy’ also suggests a climate-focused policy tool, but there is little indication of a structured plan to use the revenue for environmental or social objectives. Internationally, carbon taxes often form part of a broader ‘green deal’ that includes investments in renewable energy, energy efficiency, or targeted subsidies for vulnerable households. In Pakistan’s case, the absence of earmarked spending or compensatory schemes makes the levy appear more like a budget-balancing act than a climate response. This undermines public support for green fiscal reforms and could delay the country’s progress toward a just energy transition.
For carbon pricing to work in Pakistan, it must be embedded in a larger framework that includes industrial decarbonisation, clean energy access, social safety nets and international competitiveness
Adding to this contradiction is the simultaneous imposition of an 18 per cent sales tax on imported solar panels. At a time when the country should be encouraging households and industries to shift toward renewable energy, taxing solar imports sends a mixed signal. It discourages adopting clean technologies, raises the upfront cost for consumers seeking energy independence, and undermines the logic of applying a carbon levy. Without viable, affordable alternatives, taxing carbon becomes punitive rather than transformative.
If the government’s goal is genuine climate action, then more effective and equitable ways exist to price carbon. One option is to target the major industrial emitters such as the cement, steel, and fertiliser sectors that collectively contribute a significant share of national emissions. These sectors have greater technical capacity to monitor and reduce emissions and more flexibility in adopting cleaner technologies. By implementing an emissions trading system or sector-specific carbon pricing mechanism, Pakistan can create strong incentives for decarbonisation without unduly affecting low-income households.
Another avenue is to tax carbon-intensive luxury consumption. For example, larger vehicles with higher emissions, diesel-powered SUVs, and private generators could face tiered carbon taxes based on their emission profiles. This would align taxation with the polluter-pays principle (PPP) and reduce the social inequity of current fuel taxes. Similarly, power plants running on imported coal or furnace oil should be taxed at higher carbon rates, especially when renewable energy alternatives are now more viable and cost-effective.
An overlooked but increasingly important factor is international carbon leakage. With mechanisms like the EU Carbon Border Adjustment Mechanism (CBAM) taking effect, Pakistan’s exporters, particularly in steel and cement, face the risk of losing market access due to carbon intensity in their production processes. Aligning domestic carbon pricing policies with international standards would help reduce emissions and preserve the competitiveness of Pakistan’s exports. It would further encourage industries to invest in cleaner production techniques, including energy audits, waste heat recovery, and fuel switching.
Ultimately, the carbon levy on fuels may serve a limited purpose as a symbolic or fiscal gesture, but it falls short as a climate policy. For carbon pricing to work in Pakistan, it must be embedded in a larger framework that includes industrial decarbonisation, clean energy access, social safety nets and international competitiveness.
Without such a strategy, the burden of carbon taxation will fall disproportionately on those with the least capacity to adapt, and the climate benefits will remain marginal at best. Pakistan does need carbon pricing, but it needs it in the right sectors -- with the right design, and at the right time.
The writer is associated with the Sustainable Development Policy Institute, Islamabad (SDPI). The article does not necessarily represent the views of the organisation.
