Fuel price reduction: the ball is in the states’ court

Fuel price reduction: the ball is in the states’ court

The steep increase in the prices of petrol and diesel, by over Rs 3.5 per litre each, after the assembly elections in Karnataka has yet again built up pressure on the Narendra Modi government to reduce excise duty on fuel.

Between November 2014 and January 2016, excise duty on petrol went up from Rs 9.48 per litre to Rs 21.48 per litre; on diesel, the increase was even sharper, from Rs 3.56 per litre to Rs 17.33 a litre. That coincided with a steep decline in the international price of crude oil from $117 per barrel in November 2014 to a low of $27 per barrel in January 2016.

Thereafter, crude price moved up gradually to $40 per barrel by December 2016 and continued its upward march during 2017. Currently, the price is $75 per barrel. This has led to a corresponding increase in the price of petrol and diesel even as excise duty remains high at Rs 19.48 per litre and Rs 15.33 per litre, respectively, after these were reduced by Rs 2 in October 2017.

Out of the Rs 78 that a consumer in Delhi currently pays for a litre of petrol, Rs 38 is charged by the oil marketing company (mainly IOCL/BPCL/HPCL) to the petrol dealer; Rs 19.5 excise duty is charged by the Union government; Rs 3.5 is dealer commission, and Rs 17 is value-added tax (VAT) levied by the state.

Considering that excise duty accounts for a quarter of the cost to the consumer, reducing it may appear to be an appealing course of action to give relief to consumers. But it is necessary to take a holistic view of the situation, keeping in mind the impact on the Union budget and implications for fiscal deficit.

During 2015-16 and 2017-18, the Union government collected over Rs 6.5 lakh crore from levies on petroleum products, a major chunk of that coming from excise duty on petrol and diesel. The money (after transferring 42% to the states as per the 14th Finance Commission recommendation) was used primarily for funding infrastructure projects — roads, highways, expressways, rail, port, airports, etc., and welfare schemes for the poor.

The government has also saved money by reducing leakages in various subsidies, namely fertilisers, food, LPG, etc., and other financial assistance, such as scholarships, pensions, etc., using direct benefit transfer (DBT) into beneficiaries’ bank accounts.

The investments in building infrastructure and financial transfers to the beneficiaries/poor have also helped boost demand and, in turn, spur growth in GDP at a time when private investment has been sluggish, courtesy the ‘twin balance sheet problem’ — the highly leveraged balance sheets of corporates and their contagion effect on banks due to increase in non-performing assets (NPAs).

For 2018-19, the government has budgeted for Rs 2.58 lakh crore from levies on petroleum products (including road and infrastructure cess on petrol and diesel). The implementation of infrastructure projects is inextricably linked to funds available from these levies. In this backdrop, if excise duty is reduced (a rupee cut leads to revenue loss of Rs 13,000 crore annually), it will have a debilitating effect on projects.

At a time when growth is gathering pace, led primarily by government-led investment, it won’t be proper to apply the brakes midstream. At the same time, the alternative of funding the expenditure from additional borrowings would be risky. This is because slippage in fiscal deficit has an associated cost by way of decline in ratings, hike in interest rate, higher inflation, etc.

Asking oil-marketing PSUs to absorb losses to enable price reduction or directing suppliers of domestic crude — ONGC/OIL — to give a discount on their supplies to the refineries won’t be a prudent idea either. This will erode investor confidence — foreign investors are investing in these undertakings on the basis of ‘transparency’ and ‘predictability’ of their pricing decisions — if they are told to deviate from the international price parity principle, a move with a potential to wipe out their profits.

This will undermine their ability to implement expansion and modernisation projects when the country needs more throughput to meet the growing demand. For instance, the annual capital expenditure of ONGC is Rs 30,000-35,000 crore, against profit of a little over Rs 20,000 crore. Asking it to give a discount on crude sale will further widen the gap by reducing profit.

What about asking the states to reduce VAT? The VAT amount of Rs 17 per litre includes Rs 11.5 as VAT applied on fuel price and dealer commission and Rs 5.5 VAT on excise duty. The latter — a tax on tax — accounts for a third of the total VAT amount. During 2016-17, out of total VAT collection of Rs 1.66 lakh crore by the states, the amount garnered by way of VAT on excise duty alone was Rs 55,000 crore. This is a fortuitous gain.

Under the extant practice of states levying VAT on ad valorem basis (or as percentage of the price), the amount of tax automatically goes up with the increase in price even at the same rate. With every bit of increase in international price of petrol/diesel or depreciation of rupee, they rake in a bonanza. To top it all, the VAT rate itself is high (27% in some states). No wonder then, a majority of the states have a vested interest in continuing with the extant system.

These anomalies can be addressed only by including these fuels under the GST, putting them under the 18% slab initially with the aim of eventually shifting them to the 12% slab. Post-inclusion, states should not be allowed to levy tax by any name over and above the GST.

Any fear of revenue loss is unfounded as there will be buoyancy in tax collection due to a boost to GDP resulting from elimination of the cascading effect of tax-on-tax and reduction in logistics and millions of more businesses coming under the tax net.

(The writer is a New Delhi-based policy analyst)