Like the Centre, states also need financial resources to fund their development programs and fuel taxes are an important source for them as well
The current discourse on the issue of fuel prices holds the Narendra Modi government as the one responsible for the recent increasing trend. The question here is if this is fair? Conclusions are being drawn and responsibilities are being fixed without any objective assessment of the complexities related to the petroleum products pricing in India. This article is an attempt to unpack the fine-print behind the mechanics of fuel pricing and perhaps appreciate the limitations and compulsions of various stakeholders in this entire scheme of things.
So, how are fuel products priced? The price build-up of domestic petroleum products (such as petrol, diesel etc.) essentially includes three major components: a) base price of the product; b) taxes / duties levied by the Center and c) the taxes/duties levied by state governments (states). There is a fourth component as well – commission paid to dealers, but that’s relatively smaller compared to the other three components and hence not material for this discussion.
The first component, the base price reflects the cost of production incurred by Indian refineries. This component is a function of global crude prices; higher the price of crude oil, higher will the base price of the product be. The Central government taxes/duties are levied as central excise duties while state government taxes/duties as VAT/sales tax.
On 16 October 2021, the retail selling price of petrol in Mumbai was Rs 111.43/litre. Price buildup data shows that base price accounted for around 40 percent of this, central excise 30 percent and VAT/Sales tax levied by the government of Maharashtra 27 percent. Balance 3 percent was dealer commissions.
Note two observations here: a) Central and state governments together contributed to around 60 percent share of the petrol price stack, the balance 40 percent was beyond the control of either and b) Central Government contributes to only 30 percent share of the price buildup, the balance 70 percent continues to be beyond its control. If one accounts for the fact that 42 percent of a portion of the Central fuel excise is shared back with states per Finance Commission recommendations, the Centre’s effective contribution to price buildup will reduce even further.
The pertinent issue to ponder here is why are fuel prices increasing daily? A fast-paced uptick in global oil demand is putting upward pressure on crude oil prices lately. The price of Brent, the global benchmark for crude oil prices, recently breached US$ 85 / bbl, a level it has not seen since October 2018. Brent prices have more than doubled in the last year with a more than 30 percent jump within the last two months itself.
India imports 85 percent of its crude oil requirement and hence an increase in global oil prices naturally pushes the base price component of petroleum fuel. Given that both Central and state level duties have not changed much lately, domestic petroleum product prices are increasing mainly due to the ongoing volatility in global oil markets.
So what can be done to mitigate this? Critics and opposition parties want the Modi government to intervene and bring the prices down. The gvernment has two potential options. First, to simply cut excise duties levied on petroleum products and forgo share of revenues it has been raising through this. This could provide some immediate short term relief, but it will reduce the fiscal resources available with the government to finance the ambitious national development agenda that it is currently working on.
The fact is that excise duty is an important contributor to the revenue kitty of the Central government. Data shows that excise duty collection on crude and petroleum products contributed as much as Rs 3.72 lakh crore in 2020-21, around 23 percent of the total tax revenues of the Central government (net of state’s share) for that year.
Where was this precious money spent? The Central government judiciously utilised the fiscal space created by fuel duties to accelerate capital investments and implement various socio-economic development initiatives. More than 60 percent of fuel duties are specifically earmarked for capital investments (in the form of road and infrastructure cess and agriculture infrastructure and development cess). These resources helped Modi government realise substantial jump in its annual capital expenditure – almost 3X increase from INR 1.87 lakh crore in 2013-14 to Rs 5.53 lakh crore in BE of 2021-22.
This spend financed rapid creation of social and economic infrastructure, due to which all Indians are now able to access clean toilets, electricity, clean cooking fuel, a large network of modern highways, expressways, metros, railways, water supply and sewerage treatment infrastructure etc. A portion of these resources were also utilized to finance various relief and response measures during the COVID pandemic. The government could thus provide free foodgrains, LPG refills, cash and other support to all needy and vulnerable people for an extended period of time so that everyone could continue living a dignified life during this difficult period.
It also launched world’s largest free vaccination drive. Fuel duties provided the Centre much-needed space to fund such stimulus without compromising the path of fiscal prudence and without increasing personal and corporate taxes.
The second option is to intervene through mechanisms such as oil bonds. Under this, the government can smartly push the onus of paying the subsidy costs to future governments. That’s exactly what was done in the past. While this is smart politics, it is irresponsible economics. A recent statement by the finance minister suggests that the oil bond policies of the previous governments ended up adding an interest burden of more than Rs. 1 lakh crore on the incumbent government, a prohibitive cost which is ultimately being paid by taxpayers only, albeit years later.
While one can’t do much about international oil prices, what is important to note is that the central and state governments more or less equally contribute to the fuel price buildup; each contributing approximately 30 percent. Still, curiously enough, states are never questioned over fuel prices. It is in fact the state-level taxes that explain the wide variations in petrol and diesel prices across the country. For instance, the current petrol prices in Lucknow are lower by almost Rs 10/litre than that in Mumbai. That’s because Maharashtra charges much higher fuel taxes than Uttar Pradesh.
Moreover, while Central excise duties are fixed, VAT portion of state taxes are ad-valorem. What this means is that state taxes automatically go up as fuel prices increase and so does the share of states in fuel price buildup. For instance, because of various reasons including the ad-valorem nature of state duties, tax incidence on petrol and diesel in states like West Bengal increased by Rs. 5.92 / litre and Rs. 3.86 / litre respectively in the last year itself as compared to the increase in prices in states like Assam, Meghalaya, Uttarakhand etc. that levy much lesser ad-valorem fuel taxes.
Like the Centre, states also need financial resources to fund their development programs and fuel taxes are an important source for them as well. Hence, instead of using fuel prices as political rhetoric, it is time to develop a more informed policy discourse on this issue and appreciate the fiscal limitations that both states and Centre face while reducing these duties. The only long-term solution is to reduce our crude oil consumption. The ongoing impetus to push adoption of e-vehicles, increase ethanol blending in fuel and promote alternate fuels such as Green H2 etc. should be seen in this strategic context.
Amita Malviya is National Head of the Bharatiya Janata Party’s (BJP) Information and Technology cell and also the Co-incharge of Bengal. Kishore Desai is a public policy professional. All views are personal.