Taxes by the litre

Indian Express, June 13, 2006

With Assembly elections over, the rising price of crude oil in

international markets has finally hit the Indian consumer. The Left,

to its credit, has done the consumer a favour by insisting that retail

price rises could be avoided altogether by cutting taxes which

constitute more than half the price paid by the consumer. It

essentially argued that the Centre should cut taxes. However, while 38

percent of the petrol price paid by a consumer in Delhi goes to the

Central government, another 17 percent goes the state goverment. So

when Petroleum Minister Murli Deora asked state governments, who would

have mopped up an additional Rs 2000 crore owing to the price hike, to

cut sales taxes, many state governments responded positively.

The Left has a valid point. Of the Rs 43.49 per litre that the

consumer in Delhi was paying for petrol before the hike, the value of

the petrol was Rs 20.42. The central government levied Rs 14.63 (an

excise duty of 8 percent plus a specific tax of Rs 13 per litre) and

30 paisa as education cess. Sales taxes of 20 percent were levied on

the resulting price of Rs 35 which meant that Rs 7.25 went to the

Delhi government. When the value of petrol goes up then both the

exice collected by the Centre and the sales tax collected by the

State go up.

It is unfair that whenever world crude oil prices go up, not only does

the consumer have to pay a higher price for the oil, she also has to

pay additional taxes to the government. The government actually has an

incentive to hike petro prices as it stands to collect

additional revenue. Already, the contribution of the petroleum sector

to the total net excise revenues of the Government is of the order of

40 percent. As the Left has pointed out, to prevent the government

from further 'profiting at the expense of customers' the duty should

be a specific duty without any ad valorem content. The Rangarajan

committee on Pricing and Taxation of Petroleum products has also

recommended that there is a need to shift from the current mix of

specific and advalorem taxes to a pure specific levy. It recommended

that a specific levy of Rs 14.75 per litre for petrol and Rs 5.00 per

litre for diesel may be imposed.

Since sales tax on petrol of between 20 to 34 percent comes on top of

the exice duty, the increase in the oil price leads to a cascading

effect and the consumer now has to pay more taxes to state government

as well. State governments obtain a windfall gain. Since sales taxes

were outside its purview, the Rangarajan committee recommended that

the Empowered Committee of State Finance Ministers for the

implementation of the VAT also be entrusted with the task of evolving

a uniform policy on sales tax levies on petroleum products.

With the latest price hike the government has also accepted other

recommendations of the Rangarajan committee such as a move from import

parity prices to trade parity prices and a reduction in the custom

duties on petroleum products from 10 percent to 7.5 percent. The

recommendation of restricting subsidised kerosene to BPL families

through the use of smart cards will target the subsidy better as well

as prevent malpractise and adulteration of diesel.

After sorting out the taxation issue, Manmohan Singh needs to focus

on how to depoliticise petro product prices. The objective of making

the prices of petrol, diesel, kerosene and LPG market determined, when

it was first attempted in April 2002, was manyfold. It sought to

reduce the subsidy given to these products. It was hoped that bringing

relative prices of petrol, diesel and kerosene in line with costs and

removing cross-subsidies would reduce the incentives to

adulterate diesel and petrol. It was expected that this would also

prevent the move towards inefficient technologies such as diesel

fuelled cars. It was also hoped that if prices move slowly up and

down, it would reduce the shock to the economy which comes when there

is a one time price hike. This would give the economy time to adjust

slowly minimizing the damage. Consumers would accept price hikes more

easily when they saw daily movement of prices in both

directions. Equally importantly, it was hoped that petro product

prices would not longer be a politically sensitive issue.

However, two things went wrong. First, since the owner of the oil

companies continues to be the government, price decisions have remained

with the petroleum minister. It has created the current system where

prices are not raised before an election not to reduce the popularity

of the party in power.

Second, the oil sector continued to be protected through a system of

licences and controls. In the long run the oil sector requires

exposing local oil companies to global competition. At present, a host

of barriers make it difficult for the private sector to import and

sell petroleum products in the country. In the 1990s, India reformed

its inefficient industrial sector - where there were thousands of

incompetent companies - by opening up to imports. The same

prescription now needs to be made for the petroleum sector. We should

focus on opening up the Indian market for petroleum products to global

competition, so that consumers should be able to fully bypass the

rules of the Ministry of Petroleum, if they should want to. This will

shield the Indian consumer from inefficiency of oil companies. It will

put the sector on the path to meaningful adjustment to competition and

efficiency in a globalised setting. Free entry should be allowed in

the sector. Anyone should be allowed to open petrol pumps, buy petrol

from anywhere in the world and sell to customers. This will help

destroy the monopoly of oil companies and force them to work in a

competitive framework. It will also help prevent the government into

forcing policies on them that will push them into the red.


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