Prime Minister Narendra Modi’s appeal to lower VAT on fuel carries a message on burden of fiscal responsibility

Two years ago, in May 2020, during the first wave of the COVID-19 pandemic, the Centre raised duties on diesel by Rs 13 a litre and on petrol by Rs 10 a litre. The Centre had said that these hikes were an attempt to raise revenues to help the government deal with the extraordinary economic situation in wake of the COVID-19 pandemic, but will not lead to higher prices as oil companies will absorb the tax hike and not pass it on to consumers.

Many states also increased the value added tax (VAT) on petrol and diesel to raise revenues to shore up their own revenues. For instance, on May 5, 2020, 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, similarly, raised VAT on petrol and diesel resulting in a price hike of Rs 3.25 a litre on petrol and Rs 2.50 a litre on diesel. Last week, Haryana hiked VAT on petrol by Re 1 a litre and VAT on diesel by Rs 1.1 a litre.

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

Raising taxes on petrol and diesel, therefore, gave them an efficient way of collecting higher revenues within a short period of time, although consumers had to foot the bill.

Modi’s appeal to states to lower VAT is primarily in this context, asking them to roll back the hikes that were effected during extraordinary circumstances, something that the Centre had done when, on November 3, 2021, it lowered excise duty on petrol by Rs 5 a litre and that on diesel by Rs 10 a litre.

In 2021-22, the Centre earned Rs 2.95 lakh-crore from central excise duty on petroleum products, which is about 11 percent of the Centre’s total gross tax revenues of Rs 27.57 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 Tamil Nadu and Maharashtra.

In 2020-21, Tamil Nadu, earned Rs 17,063 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 2021-22 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 the rest of the state, earned Rs 25,430 crore from taxes on petroleum products in 2020-21, which translated into about 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.

There is also a question of the burden of fiscal responsibility.

The Centre’s revenue earnings in the form of taxes from petroleum products, however, does not square up sufficiently to cover for its ballooning expenses, particularly both economically and politically non-negotiable components such as subsidies.

The Centre’s total subsidy bill in 2021-22 stood at Rs 4.87 lakh-crore (bulk of it being accounted for by essential food and fertiliser subsidies), about Rs 2 lakh-crore more than what it received from excise duty on petrol and diesel during the year.