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COVID-19 impact | Petrol and diesel are states' and Centre's trusted milch cows. Here's why

The lockdown announced to contain the COVID-19 pandemic has had a debilitating effect on both central and state finances.

May 07, 2020 / 02:59 PM IST

Successive governments, both at the Centre and states, have used petroleum products as efficient vehicles to generate quick revenues.

Here's an explainer on the dynamics of fuel pricing:

What has the government done on petrol and diesel?

The Centre has raised duties on diesel by Rs 13 a litre and on petrol by Rs 10 litre. A government notification said the special excise duty on petrol was hiked by Rs 2 a litre to Rs 12 a litre and by Rs 5 a litre to Rs 9 a litre for diesel. Road cess on both petrol and diesel has also been increased by Rs 8 a litre to Rs 18 a litre.

Will it not lead to increase in fuel prices for consumers?

Petrol & Diesel Rates Yesterday

Thursday, 30th March, 2023

Petrol Rate in Mumbai Yesterday

  • Current Petrol Price Per Litre

Thursday, 30th March, 2023

Diesel Rate in Mumbai Yesterday

  • Current Petrol Price Per Litre

No. Finance ministry officials have said that it will not lead to higher prices as oil companies will absorb the tax hike and not pass it on to consumers.

What prompted such a move?

This is an attempt to raise revenues to help the government deal with the extraordinary economic situation in wake of the Covid-19 pandemic.

But, petrol and diesel prices have gone up in many states. How?

Many states have increased the value added tax (VAT) to raise revenues to shore up their own revenues. On May 5, the Delhi government raised VAT on petrol and diesel to 30 percent from the existing 27 percent and 16.75 percent respectively.

The Tamil Nadu government has raised VAT on petrol and diesel resulting in a price hike of Rs 3.25 a litre of petrol and Rs 2.50 a litre of diesel. Haryana has hiked VAT on petrol by Re 1 a litre and VAT on diesel by Rs 1.1 a litre last week.

Wasn't there a cap on central excise duty on petrol and diesel?

Yes there was. In March, however, the government had changed the rules through an amendment in the Finance Act of 2020 raised the cap on special additional excise duty by Rs 8 a litre on both petrol and diesel, taking the cap to Rs 18 a litre on petrol and Rs 12 a litre on diesel. This allowed the Centre to raise duties on the two transport fuels.

How much revenue will the Centre earn from this hike?

Estimates suggest that a rupee's hike in excise duty results in additional annual revenue of Rs 13,000-14,000 crore annually. This would imply that fresh round of hikes will give the government additional revenues of more than Rs 2 lakh crore. This will help the Centre fund part of the stimulus package to revive a battered economy.

What is the retail price break up of petrol and diesel?

In wake of the recent hikes, taxes and duties account for more than 50 percent of the price that the consumer pays at a petrol pump.

The price break up is as follows.

Petrol:-Base Price: Rs 17.96 a litre
-Freight: Rs 0.32 a litre
-Price charged to dealers (excluding Excise Duty and VAT): Rs 18.28 a litre
-Central Excise Duty (including road cess): Rs 32.98
-Dealer commission:  Rs 3.56 a litre
-VAT (including VAT on Dealer Commission): Rs 16.44
-Retail Selling Price at Delhi: Rs 71.26 a litre

Diesel:-Base Price: Rs ₹18.49 a litre
-Freight: Rs ₹0.29 a litre
-Price charged to dealers (excluding Excise Duty and VAT): Rs 18.78 a litre
-Central Excise Duty (including road cess): Rs 31.83 a litre
-Dealer Commission: Rs 2.52 a litre
-VAT (including VAT on Dealer Commission): Rs 16.26
-Retail Selling Price at Delhi: Rs 69.39a litre

Why are petrol and diesel important for the Centre's and states' revenues?

Successive governments, both at the Centre and states, have used petroleum products as milch cows. In 2018-19, the Centre earned Rs 2.14 lakh crore from central excise duty on petroleum products, which is about 10 percent of the Centre’s total gross tax revenues of Rs 21.63 lakh crore earned during the year.

Likewise, states earn significant revenues from taxing petroleum products. This is particularly true for the richer or the so-called industrialised states such as Karnataka and Maharashtra.

In 2018-19, Karnataka, earned Rs 14,417 crore from taxes on petroleum products. This accounted for 15 percent of the states’ total tax revenues, or for every Rs 100 that the Karnataka government earned in 2019-20  Rs 15 came from petroleum products alone.

Similarly, for Maharashtra. The state, which levies two different rates of VAT on petrol and diesel for Mumbai and rest of the state, earned Rs 27,191 crore from taxes on petroleum products in 2019-20, which translated into 14 percent of the state’s total tax revenues during the year.

The pattern is more or less similar across most states, illustrating how a disproportionately high amount of tax revenues are coming from just one set of products, both for the Centre and the states.

What has prompted the push to raise revenues for the Centre and states?

The lockdown announced to contain the COVID-19 pandemic has had a debilitating effect on both central and state finances. A large part of governments' finances come from taxes. With no economic activity taking place, shops shuttered down and negligible sales taking place, the governments' coffers have run dry.

States earn a large part of their revenues from their shares of State GST, which is a consumption-based tax. With consumption and sales of goods collapsing dramatically because of the lockdown, states have been staring at empty treasuries, so much so that many states have been barely been able to pay salaries to their employees.

Raising taxes on petrol and diesel gives them an efficient way of collecting higher revenues within a short period of time, although consumers have to foot the bill for this.

Why are petroleum products not brought under goods and services tax (GST)?

There has been a strong body of opinion advocating the case for bringing oil products under the goods and services tax (GST). There is no gainsaying the fact that petrol and diesel are one of the most heavily taxed products in India. Currently, more than 50 percent of the price that a consumer pays for a litre of petrol at the pump go as taxes to the Centre and states.

The resistance to bring petroleum products under GST primarily flows from the argument it would rob states of their fiscal powers to raise taxes on the transport fuels whenever the situation warrants. Covid-19 and its devastating effect on state finances is an example of such a situation where states need to quickly generate revenues.

GST, so the argument goes, will help sharply cut taxes in the two transport fuels, making it cheaper for people to tank up their vehicles. The basic assumption in this line of argument is that the GST rate for petrol and diesel will be fixed at the highest slab of 28 percent. Since GST, by definition will be a consolidated single levy, such a move will lower the tax incidence by about 17 percent, pulling down retail prices by several rupees a litre.

Such an inference, elegant as it may appear, can be misleading.

For one, it disregards the states’, and the Centre’s, fiscal fixation for maintaining “revenue neutrality”. A revenue neutral rate (RNR) is the tax rate that results in similar tax earnings for the government despite changes in design or structure of the levies imposed.

States are also unlikely to settle on a GST rate that would be lower than the RNR. What could be the possible revenue neutral GST rate for petrol and diesel? It would probably be in the range of 50-55 percent under the current system. Will a GST rate of 50-55 percent on the two fuels bring down their retail prices? Unlikely, because in the final analysis, the tax component on petrol and diesel prices at the fuel station remain the same.

The high tax structure in petroleum pricing is a painful legacy issue in a rather flawed design of India’s energy economics. States are unlikely to let go of their fiscal powers to tax petrol and diesel, and also settle for lower revenues. The Centre could also end up losing substantial earnings and may have look at other sources to reimburse states for their revenue loss.

At 50-55 percent, GST has nothing for the consumer. At best, it will help in tidying up the system by subsuming a welter of local and central levies into a combined tax.

Gaurav Choudhury
Gaurav Choudhury
first published: May 6, 2020 06:20 pm