It's high time the government reduced taxes on fuel

The government should calibrate and cushion the high level of taxes and levies on petrofuels, so as to moderate the direct impact of the global fuel price rise on Indian households and businesses and the indirect impact via transport and energy costs of goods and services. The margins of oil companies should be spared the political compulsions of the ruling party.

Global crude prices are artificially elevated due to production cuts by Saudi Arabia and Russia, and they hold the upper hand in deciding when prices would normalise. The government should not allow the Indian public to be held hostage by the domestic compulsions of Saudi Arabia and Russia.

This logic holds good, even if the global benchmarks of crude prices have fallen after the US Federal Reserve made it clear that one more rate hike is very much a possibility. That price fall left the benchmark price still above $90 a barrel, and prices could harden if world growth picks up.

Taxes are a high proportion of the final retail price of petrol and diesel in a number of countries. In India, it is more than 36% in the case of petrol and over 32% in the case of Diesel, in Delhi. It is even higher in Mumbai, where state-level Value Added Tax is higher. In the case of green-minded Europe, the share of taxes in the final retail price is actually higher — nearly 60% in the case of petrol and more than 50% in the case of diesel.

However, this does not quite make the taxation of petrofuels in India particularly kosher. The average per capita income in India is tiny, compared to the figure for Europe. The proportion of net disposable income that a two-wheeler rider in India hands over to the government at the Centre and at the state, by way of tax on petrol, is way higher than in the case of Europe. That is money that he can no longer spend on other essentials of life.

When the price of crude goes up, the price before tax of the refined fuel goes up, too, naturally. On top of that, the Centre levies its layer of tax and cess (Centre levies a cess, in order to avoid sharing it with the states: excise duty collections go to the pool of taxes shared with the states, but cess collections do not). The fuel station charges its own commission, which is added to the price. Then the states impose their value-added tax on the retail sale of fuels.

The refining company adds an inflation cushion to its refining margin. While, in theory, petrol and diesel prices are market-determined, an inexplicable reluctance to raise prices grips state-owned oil marketing companies ahead of elections, even if crude prices go up. This leaves private retailers with the option to either pass on higher raw material costs to the consumer, and suffer loss of market share to state-owned retailers, who do not raise prices, or to absorb the additional cost while maintaining market share. 

It's not uncommon for oil marketing companies to refrain from passing on previous price hikes to consumers, even when global crude prices drop. This could be because they are apprehensive about facing public outrage if prices are increased before crucial elections. However, the final decision regarding this matter rests with the companies themselves. This is a bad practice. Oil marketing companies should be under no pressure to cushion the government from the impact of rising oil prices. This would make them nimbler at price changes, lowering prices when global crude prices fall, and raising them, when crude prices go up. That would expose the consumer to the actual volatility of crude prices and help depoliticize fuel prices, making for commercially rational pricing of fuel.

When fuel prices go up, freight costs go up, as do the costs of back-up power generation. Energy and freight costs are universal inputs, and so higher energy and freight costs tend to push up inflation in general. That would depress the demand for non-energy goods and services, and also dampen growth by persuading the inflation-targeting central bank to raise policy interest rates.

Artificially suppressing fuel prices would be disastrous, too. Repressed prices would encourage, rather than discourage, consumption, and increase both the fiscal burden on fossil fuel subsidies and enhance the level of distortion in prices in general. Short of subsidizing fuel, the method to dampen the retail price of fuel is to pare its tax component. Yes, it would reduce the direct collection of tax from fuels, but to the extent such moderation of the fuel cost rise would moderate the impact on economic activity in general, the move would protect tax revenue from these economic activities.

Instead of the Centre asking the states to reduce their value added tax on fuel, and the states asking the Centre to shoulder the burden of tax reduction, both levels of government should sacrifice some revenue, in equal proportion.

Russia has the incentive to keep fuel prices high this coming winter, and in the US election year of 2024, to put pressure on Europe and the US to cut back on their support to Ukraine in the ongoing war. If the momentum of economic growth picks up, as it would, if rate hikes become things of the past for the most part, and the Chinese economy stabilizes, oil prices would go up, in response to increased demand. India must prepare for this eventuality by working out how much the tax component of the retail price of fuel can be reduced to cushion the impact of higher energy prices on growth at the optimum level, and taxes cut, accordingly.

India treats these taxes as a carbon tax. But that's just on paper. With not much scope as yet for consumers to switch to non-fossil fuels, the so-called carbon tax is actually lazy way of tapping assured tax revenue from a basic necessity with inelastic consumption. The government's dependence on taxing fossil fuels for raising easy revenue is hurting the economy.