There's No Running Away From High Fuel Prices; But Here Are Two Things We Can Do

Soaring prices of petrol and diesel have become a major sore point in political and media circles. That the biggest proportion of the final retail price is accounted for by central and state taxes goes without saying. What needs saying is whether this level of taxation is justified in the context of India’s overdependence on imported crude, the need to maintain government revenues at reasonable levels during a pandemic, and the longer-term need to non-fossil-based fuels during a period of rapid climate change. (You can read the broader reasoning for retaining high petroleum taxes here)

Some arguments need demolition immediately. Former finance minister P Chidambaram says a 33 per cent share of central taxes in petrol prices is “extortion”. He said: ''One third of the price of petrol that consumers pay is a tax to the central government, so, a 33 percent taxation on any commodity is extortion.”

Obviously, he lives on another planet. Under the goods and services tax regime, the highest rate of duty is 28 per cent, but many items considered to be “luxury” goods are levied a cess over and above that. So, many products, including high-priced SUVs, will be taxed at well above Chidambaram’s “extortion” limit of 33 per cent.

Secondly, it is a bit rich to presume that the charge of extortion, especially in revenue-deficit Covid times, should not equally apply to states. Unlike central excise, states levy an ad valorem sales tax, which means the tax element rises along with petrol prices.

According to the Petroleum Planning and Analysis Cell (PPAC) that is attached to the Union Petroleum Ministry, the Centre raised Rs 3.72 lakh crore through excise duties in fiscal 2020-21, while states raised Rs 2.17 lakh crore. The net tax contribution to the Centre is, however, higher at Rs 4.19 lakh crore, but this includes shareable taxes like customs duties, where revenues are shared with states. The comparable numbers are thus the controllable numbers like excise and state sales taxes. Out of the amount of Rs 590,240 crore collected as central excise and state sales taxes, 63 per cent goes to the Centre and 37 per cent to states.

But this proportion is changing, as state taxes are ad valorem. As petroleum prices rise, state revenues will be rising faster than substantially fixed-duty central excise. In the first quarter this year (April-June 2021), PPAC estimates that excise accounted for 54 per cent of total revenues collected (excluding customs, cess, royalty, and IGST and some minor heads), lower than 2020-21’s 63 per cent. The share of states in petro-taxes is rising with global prices trends.

What pump prices are reflecting now — per litre prices have crossed the psychologically important reference point of Rs 100 per litre for diesel and petrol — is largely the rise in global crude prices, which have more than doubled from $40 per barrel around this time last year to around $86 for Brent crude. India’s crude supplies are benchmarked to Brent. The truth is pump prices have not risen as fast as Brent crude prices this year.

The real questions are: how much can taxes be cut to provide real relief to consumers, and is this worth the revenue loss?

The short answer is that a cut of, say, Rs 5 or Rs 10 in central and state taxes will not fully filter through sustainably to consumers if crude prices keep rising.

Critics of India’s high-taxation policies tend to compare Indian pump prices with those in Pakistan, Bangladesh and Sri Lanka, where prices are 25-40 per cent lower, with Pakistan being one of the lowest. But two of these three countries are already basket cases and they won’t be able to sustain their lower petrol prices (Pakistan and Sri Lanka).

But there is another comparison to be made, with major west European countries and Japan. According to a Reuters report dated 22 October, in dollar terms (converted at approximately current exchange rates), India’s petrol price is $1.43 a litre, lower than $1.44 in Japan, $1.8 in France and $1.94 in the United Kingdom.

Clearly, India’s high-tax policy in a fuel that has fairly inelastic demand is not a complete outlier.

However, since high fuel prices can lead to a reduction in consumer demand as fuel costs take up a disproportionate share of monthly household and corporate budgets, there are two things India can do to contain the damage. But even this will not be enough if Brent continues to soar. High taxes are, in fact, political insurance for most governments. If crude prices soar, say to $100 or more, they will then have some fiscal space to sacrifice revenues and provide relief to consumers.

The two things that India can do immediately are these:

One, states should shift to a fixed rate of sales tax (or a combination of low ad valorem rates and specific additional sales tax), so that revenues are protected and prices don’t rise exponentially.

Two, in lieu of this sacrifice, the Centre can offer a dollop of its non-sharable petro-tax revenues with states, so that both states and Centre share overall petroleum revenues 50:50 in future. Currently, large parts of the additional excise duties levied by the Centre are not shared with states.

This is one way forward, and not mindless reductions in petro-taxes which can damage state and central finances when they need it the most — to meet Covid-related costs.