Air pollution remains a correctable public policy failure, not an inevitable outcome. Recent estimates attribute over 17,000 premature deaths annually to air pollution. Despite India’s leadership in ecological fiscal federalism designed since 14th Finance Commission - retained by the 15th and 16th FCs, unresolved gaps permit this macroeconomic drag to persist. By leveraging market-based instruments, green tax and performance-linked intergovernmental fiscal transfers, India can avert this significant environmental crisis.

India’s air pollution crisis persists as a profound public health emergency and a significant macroeconomic constraint.

In Delhi, recent estimates attribute over 17,000 premature deaths annually to air pollution, a burden that extended into 2025 with persistently elevated PM2.5 levels and zero days of “good” air quality.

Nationally, the Lancet Countdown on Health and Climate Change 2025 report recorded more than 1.7 million deaths linked to anthropogenic PM2.5 exposure in 2022, a 38 percent increase since 2010, with fossil fuel combustion identified as the dominant driver. These health consequences translate into substantial economic costs. Analyses drawing on Lancet findings estimate losses from outdoor air pollution at up to 9.5 percent of GDP in 2022, stemming from premature mortality, morbidity, and reduced productivity.

Complementary assessments, including the University of Chicago’s Air Quality Life Index, place annual costs at approximately 3 percent of GDP through elevated healthcare expenditures and labor output declines.

At the 2026 World Economic Forum in Davos, economist Gita Gopinath underscored that pollution represents a greater threat to India’s growth trajectory than global trade tariffs, eroding human capital.

The crisis is particularly acute in urban centers like Delhi, where 2025 data revealed no days meeting clean air benchmarks, with winter air quality indices routinely entering severe or hazardous categories. Peak exposure has been likened to smoking 33–50 cigarettes daily, reflecting the intensity of PM2.5 concentrations.

Public hospital systems report surges in acute respiratory cases, overburdening public health finances and diminishing workforce participation.

Negative externality with inter-jurisdictional spillovers

Air pollution embodies a classic negative externality with pronounced inter-jurisdictional spillovers. Historically, stubble burning in neighbouring states contributed substantially to Delhi’s winter smog. Yet 2025 evidence indicates a marked shift. The Centre for Research on Energy and Clean Air reported farm fires accounting for an average of just 7 percent of November PM2.5, with peaks seldom exceeding 21–30 percent. This evolution points to local and year-round sources—vehicles, industry, construction dust, and residential emissions—as the primary culprits, highlighting persistent market failures where polluters impose uninternalised costs.

Fiscal instruments for pollution abatement

India’s innovative fiscal federalism provides a robust foundation for addressing these distortions. Despite pioneering ecological fiscal transfers through the 14th Finance Commission - the world’s first major integration of environmental criteria into federal tax transfers —toxic air continues to exact a heavy toll. The 14th Finance Commission introduced a 7.5 percent weight for forest cover in tax devolution, subsequently raised to 10 percent by the 15th, and retained by the 16th Finance Commission, channeling billions annually to reward states for carbon sequestration and ecosystem services.

Against the backdrop of environmental federalism, these ecological fiscal transfers compensate positive environmental spillovers. Extending this framework to air quality—through performance-based grants linked to verifiable emission reductions or abatement investments—could realign incentives across jurisdictions and internalise externalities.

Complementary instruments include green taxation on fossil fuels, and emissions-intensive industries. International evidence supports the efficacy of such energy pricing like the EU Emissions Trading System has achieved substantial reductions without compromising growth.

Global trade dynamics further elevate the urgency. The EU’s Carbon Border Adjustment Mechanism, now fully operational, imposes costs on carbon-intensive Indian exports in steel, cement, and aluminium.

Domestic reforms—aligned carbon pricing and enhanced sequestration incentives—would buffer these shocks and bolster competitiveness. For India, strategic priorities include strengthening inter-state coordination through central incentives focused on local source controls, building directly on ecological fiscal transfer models; scaling differentiated green taxes with rigorous revenue recycling; broadening tax transfers to incorporate air quality metrics and urban greening; and accelerating clean energy adoption to capture health-climate synergies while navigating emerging global standards.

Air pollution remains a correctable policy failure, not an inevitable outcome. Despite India’s leadership in ecological fiscal federalism, unresolved gaps permit this macroeconomic drag to persist. By leveraging market-based instruments, green tax and performance-linked fiscal transfers, India can avert the crisis.