petrol price

Petrol and Diesel Prices are High Due to Lower Corporate Taxes, Not Because of Oil Bonds

Life is what happens between WhatsApp forwards.

Yesterday evening, a friend from school WhatsApped a doubt he had. He wanted to know if petrol and diesel prices were high because the Narendra Modi government had to repay oil bonds, which had been issued by United Progressive Alliance (UPA) government more than a decade back.

To repay these oil bonds, money is needed. This has led to significantly higher central government taxes on petrol and diesel, which has in turn led to higher pump prices.

However convincing the argument may sound, it’s wrong. 100% wrong. And I have been saying this for a few years now.

Of course, my saying this hardly makes a difference, given that every time petrol and diesel prices rise, WhatsApp starts buzzing all over again with forwards blaming oil bonds issued by the UPA for high petrol and diesel prices. Currently, the price of petrol is more than Rs 100 per litre in several parts of the country.

This high price is on account of a higher excise duty collected by the central government in order to compensate for a fall in corporate tax collections. In that sense, you and I are bearing the cost of lower corporate taxes, in the form of a higher price of petrol and diesel. 

Let’s try and understand the issue of high petrol and diesel prices, and why things are the way they are, in some detail.

1) Crude oil prices have risen between last year and now. In June 2020, the average price of the Indian basket of crude oil was at $40.63 per barrel. As of June 16, 2021, the price was at $73.18 per barrel. Clearly, this is one reason behind the rise in petrol and diesel prices, but this isn’t the only reason, and not even the main one.

2) Before getting into any other detail, let’s understand what oil bonds are. These bonds were issued by the UPA government to the oil marketing companies (Indian Oil, Bharat Petroleum, Hindustan Petroleum), for the under-recoveries (the difference between the administrative price and the cost) they suffered when selling petrol, diesel, kerosene and domestic cooking gas, below their cost. This happened up until 2009-2010. Officially, these bonds are referred to as special securities issued to oil marketing companies in lieu of cash subsidy.

Instead of compensating companies immediately for the subsidy offered by them, by giving them money, the government gave them oil bonds, which would pay annual interest and mature a few years down the line. By doing this, the government expenditure during those years didn’t go up. This helped control the fiscal deficit in those years, when oil bonds were issued. Fiscal deficit is the difference between what a government earns and what it spends.

3) Of course, these bonds would mature over the years and the government of the day would have to repay them. And that would need money.
So what is the value of these bonds which the government still needs to repay?  In a question raised in the Rajya Sabha in December 2018, the government had said: “The current outstanding balance on account of Government of India (GoI) Special Bonds issued to the Public Sector Oil Marketing Companies (OMCs) in lieu of cash subsidy is about Rs 1.30 lakh crore.”

So, two and a half years back, the value of the outstanding oil bonds had stood at around Rs 1.30 lakh crore. What’s the latest number? Take a look at the following table. It has been sourced from the latest government budget. It lists out the different oil bonds that are still to be repaid, with their maturity dates.

Source: https://www.indiabudget.gov.in/doc/rec/allrec.pdf

What does this table tell us? It tells us that as of March 2021, the total outstanding oil bonds issued by the government stood at Rs 1,30,923 crore. Or the same as what the government had told the Rajya Sabha in December 2018.

4) In fact, the amount of outstanding oil bonds has barely changed during Modi government’s tenure. Look at the following tabled sourced from the 2014-15 budget, presented in July 2014, after Narendra Modi became prime minister.

Source: https://www.indiabudget.gov.in/budget2014-2015/ub2014-15/rec/annex6e.pdf

As of March 2014, the total outstanding oil bonds stood at Rs 1,34,423 crore. Two different oil bonds with maturity amounts of Rs 1,750 crore each, matured in 2014-15, on March 7, 2015, and March 23, 2015, respectively. This brought down to the total outstanding oil bonds to Rs 1,30,923 crore, and which is the current outstanding amount as well.  

The point being that the government hasn’t had to repay any outstanding oil bonds since March 2015. Of course, it has had to pay an interest on these oil bonds, like it does on all other bonds.

How much is this interest? As the government told the Rajya Sabha in December 2018: “The annual aggregated amount of Rs 9,989.96 crore was paid every year during 2015-16 to 2017-18 and the similar amount is required to be paid in the current financial year.”

Given that, the outstanding amount of oil bonds didn’t change through 2018-19, 2019-20 and 2020-21, the government would have paid the same amount as interest in each of these years, as it did during 2015-16 to 2017-18.

How does the situation look in 2021-22, the current financial year? As can be seen from both the tables (I know the tables are not very clear. If you really want to verify the data, the source of the tables is available just below them. All you need to do is click), Rs 5,000 crore of bonds are due to be repaid on October 16 and November 28, respectively, later this year. This amounts to Rs 10,000 crore in total.

Over and above this, interest needs to be repaid on the outstanding bonds. Given that Rs 10,000 crore worth of bonds of the total Rs 1,30,923 crore of oil bonds, will be repaid during this financial year, the interest to be paid on the remaining bonds will be less than Rs 9,989.96 crore that the government has been paying year on year. A back of the envelope calculation tells us that the interest to be paid this year should amount to around Rs 9,500 crore.

Hence, in total, the government needs Rs 19,500 crore to repay oil bonds as well as pay interest on them during 2021-22. When it comes to government finances, this is small change.

5) If we look at the excise duty collected on petroleum products over the years, data from Petroleum Planning and Analysis Cell tells us that it stood at Rs 99,068 crore in 2014-15, the financial year in which Narendra Modi was sworn in as prime minister.

The number reached Rs 2,23,057 crore in 2019-20. It touched Rs 2,35,811 crore between April and December 2020, the first nine months of 2020-21. Given this, it would have crossed Rs 3,00,000 crore during 2020-21.

In 2021-22, the central government expects to collect more than Rs 3,00,000 crore through excise duties on petroleum products. A look at this year’s budget tells us that the government hopes to collect Rs 74,350 crore on special additional duty of excise on motor spirit(petrol) and Rs 1,98,000 crore through duty of excise on motor spirit and high-speed diesel oil (road and infrastructure cess). Just this adds to close to Rs 2.75 lakh crore.

Over and above this, one needs to pay a basic excise duty on every litre of petrol and diesel purchased, and there is an agriculture infrastructure and development cess to be paid as well. Clearly, this year, the government will earn more than Rs 3 lakh crore from different kinds of excise duties on petroleum products.

From February 2, 2021, the total excise duty on petrol and diesel has stood at Rs 32.90 per litre and Rs 31.80 per litre, respectively. The total central excise duties on petrol and diesel have been rising since 2014. They had stood at Rs 10.38 per litre and Rs 4.52 per litre in March 2014.

In fact, even in April 2020, they had stood at Rs 22.98 per litre and Rs 18.83 per litre, respectively.

Between April last year and now, the petrol price is higher by close to Rs 10 per litre just because of higher central government taxes on it. When it comes to diesel, it is higher by close to Rs 13 per litre because of this.

6) There is another small reason for higher prices as well. The state government taxes on petrol and diesel are ad valorem, that is they are a certain percentage of the price charged to dealers plus the excise duty of the central government plus the dealer commission on every litre of petrol and diesel sold.

Take a look at the following table, which has the detail for petrol sold in Delhi.

Source: https://www.bharatpetroleum.com/pdf/MS_Webupload_16.06.2021.pdf.

The price of petrol charged to dealers in Delhi by Bharat Petroleum was at Rs 37.68 per litre as on June 16. On this there was an excise duty charged by the central government of Rs 32.90 per litre along with a dealer commission of Rs 3.80 per litre. This adds up to Rs 74.38 per litre.

On this, the Delhi government charges a value added tax of 30%, which amounts to Rs 22.32 per litre. This leads to a retail selling price of Rs 96.70 per litre (Rs 74.38 plus Rs 22.32) in Delhi.

Like, the Delhi government, other state governments also charge a value added tax or a sales tax on petrol and diesel sold in their respective territories. The 30% tax charged by the Delhi government is ad valorem. Hence, if the petrol price charged to dealers goes up as oil price goes up, the tax collected by the Delhi government also goes up.

Over and above this, when the central government increases the excise duty on petrol, the tax collected by the Delhi government (and all other governments) goes up because the state government charges a value added tax on dealer price plus excise duty plus dealer commission.

Hence, every time you and I buy petrol or diesel, we are paying a tax on tax. This is an anomaly that needs to be set right. And state governments need to charge a sales tax just on the dealer price and commission, and not on the central government excise duty as well.

7) A major reason for the central government implementing a high excise duty on petrol and diesel, lies in the fact that the government’s tax revenues as a proportion of the size of the Indian economy, measured by the gross domestic product (GDP), has been falling over the years.

Look at the following chart. It plots the ratio of gross tax revenue earned by the central government as a proportion of the GDP.


Source: Centre for Monitoring Indian Economy and Controller General of Accounts.

What does this chart show? It shows that the gross tax revenue as a percentage of the GDP reached an all-time high of 12.11% in 2007-08. The gross tax revenue was at 11.22% of the GDP in 2017-18 and fell to 10.25% of the GDP in 2020-21.

The recent fall has been more because of a fall in corporate tax collections. In 2017-18, the corporate tax collections amounted to a total of 3.34% of the GDP and fell to 2.32% of the GDP in 2020-21. This was despite the listed companies registering bumper profits during the financial year.

Corporate taxes have come down primarily on account of the base tax rate being cut from 30% to 22% in September 2019 and to 15% from the earlier 25% for new manufacturing companies.

In absolute terms, the total corporate tax collected in 2019-20 had stood at Rs 5.57 lakh crore. It fell to Rs 4.57 lakh crore in 2020-21, thanks to lower tax rates. The collections of the goods and services tax have also not gone along expected lines.

To compensate for this to some extent, the government has had to increase the excise duty on petroleum products. Hence, it is only fair to say that the cost of lower corporate tax rates for the government, is being borne by citizens in the form of higher petrol and diesel prices. There is no free lunch, as I keep reminding.

To conclude, while the revenue earned by the government can vary, its expenditure doesn’t. It usually goes up year on year. In 2017-18, the total expenditure to GDP ratio stood at 12.53%. This jumped to 17.47% in 2020-21. Of course, 2020-21, could very well be an anomaly given that the size of the economy (GDP) contracted.

Nevertheless, the expenditure in 2019-20 had also stood at a higher 13.20% of the GDP, while the gross tax collections fell. And someone had to pay for this. 

Why the Price of Petrol is Racing Towards Rs 100 Per Litre

If there are two things that get people of this country interested in economics, they are the price of onion and the price of petrol racing towards Rs 100 per kg or litre, respectively.  Currently, the price of petrol is racing towards Rs 100 per litre in large parts of the country. In fact, in some parts, it has already crossed that level.

So, what’s happening here? Let’s take a look at this pointwise.

1) Take a look at the following chart, which plots the average price of the Indian basket of crude oil since January 2020.

Source: Petroleum Planning and Analysis Cell.
*February price as of February 18, 2021.

What does the above chart tell us? It tells us that as the covid pandemic spread, the price of oil fell, falling to a low of $19.90 per barrel in April 2020. It has been rising since then. One simple reason for this lies in the fact that as the global economy recovers, its energy needs will go up accordingly and hence, the price of oil is going up as well.

The other reason has been the massive amount of money that Western central banks have printed through the beginning of 2020. Oil, as it had post 2008, has emerged as a hard asset of investment for many institutional and high-networth investors, leading to an increase in its price. As of February 18, the price of the Indian basket of crude oil stood at $63.65 per barrel, having risen by close to 220% during the current financial year.

2) Now let’s look at the average price of the Indian basket of crude oil over the years.

Source: Petroleum Planning and Analysis Cell.
* Up to January 2021.

What does the above chart tell us? It tells us that the Narendra Modi government has been very lucky when it comes to the price of oil, with the oil price on the whole being much lower than it was between 2009 and 2014.

In May 2014, when Modi took over as the prime minister, the price of oil averaged at $106.85 per barrel. By January 2016, it had fallen to $28.08 per barrel.

Even after that, the price of oil hasn’t touched the high levels it did before 2014, in the post financial crisis years, which also happened to be the second term of the Manmohan Singh government.

A major reason for this lies in the discovery of shale oil in the United States. In fact, as Daniel Yergin writes in The New Map – Energy, Climate and the Clash of Nations: “In the autumn of 2018, though it was hardly noted at the time, something historic occurred: The United States overtook both Russia and Saudi Arabia to regain its rank as the world’s largest oil producer, a position it had lost more than four decades earlier.” This has been a major reason in the lower price of oil over a longer term.

The question that then crops up is why hasn’t petrol price in India seen low levels? The answer lies in the fact that between 2014 and 2021, the taxes on petrol, in particular central government taxes have gone up dramatically.

In short, the central government has captured a bulk of the fall in oil prices. Now when the oil price has gone up over the course of this financial year, the high-price of petrol has started to pinch.

3) Take a look at the following table. It plots the price of petrol in Delhi as of February 16, 2021 and in March 2014.

Source: https://iocl.com/uploads/priceBuildup/PriceBuildup_petrol_Delhi_as_on_16_Feb-2021.pdf
and https://www.ppac.gov.in/WriteReadData/Reports/201409231239065062686Snapshot_IOGD_MAR.pdf.

The above table makes for a very interesting reading. As of February 16, the price of petrol charged to dealers was Rs 32.1. Over and above this, the central government charged an excise duty of Rs 32.90 per litre on petrol. Add to this a dealer commission of Rs 3.68 per litre, and we are looking at a total of Rs 68.68 per litre.

On this the Delhi state government charged a value added tax of 30% or Rs 20.61 per litre. This leads to a retail price of petrol of Rs 89.29 per litre. Given that the state government charges a tax in percentage terms, the higher the price of petrol goes, the more tax the state government earns. The vice versa is also true.

Let’s compare this to how things were in March 2014. The price of petrol charged to dealers was Rs 47.13 per litre, much lower than it is today. On this, the central government’s tax amounted to Rs 10.38 per litre. The dealer commission was Rs 2 per litre.

Adding all of this up, we got a total of Rs 59.51 per litre. On this, the Delhi state government charged a value added tax of 20%, which amounted to Rs 11.9 per litre and a retail selling price of petrol of Rs 71.41 per litre. Interestingly, the state government’s tax was more than that of the central government at that point of time.

4) The above calculations explain almost everything. In March 2014, the price of petrol at the dealer level was higher than it is now, but the retail selling price was lower. Both the central government and the state government have raised taxes since then.

The total taxes as a percentage of dealer price now works out to 167% of the dealer price. In March 2014, they were at 47.3%. It is these high taxes which also explain why petrol prices in India are higher than in many other countries.

Of course, a bulk of this raise has come due to a rise in taxes charged by the central government. As mentioned earlier, the central government has captured a bulk of the fall in price of oil.

5) The calculation shown here will vary from state to state, depending on the value added tax or sales tax charged by the state government and the price at which petrol is sold to the dealers. States which charge a higher value added tax than Delhi will see the price of petrol reaching Rs 100 per litre faster than Delhi, if the price of oil continues to rise.

6) Of course, the governments can bring down the price of petrol by cutting taxes. In fact, four state governments have cut taxes providing some relief to oil consumers. But any substantial relief can be provided only by the central government. The trouble is that tax collections have fallen this year. Only the collection of excise duty has gone up by 54% to Rs 2.39 lakh crore, thanks to the higher excise duty charged on petrol and diesel.

The interesting thing is that the excise duty earned from the petroleum sector has jumped from Rs 99,068 crore in 2014-15 to Rs 2.23 lakh crore in 2019-20. The government has become addicted to easy revenue from taxing petrol and diesel. This year its earnings will be even higher than in 2019-20.

7) The central government also fears that if it cuts the excise duty on petrol and diesel, the state governments can step in and increase their value added tax, given that like the centre, they are also struggling to earn taxes this year.

Also, what needs to be kept in mind here is that the central government doesn’t share a good bit of what it earns through the excise duty on petrol and diesel with the states. This is because a bulk of the excise duty is charged in the form of a cess, which the central government does not need to share with the states.

Let’s take the overall excise duty of Rs 32.90 per litre of petrol currently. Of this, the basic excise duty is Rs 1.40 per litre and the special additional excise duty is at Rs 11 per litre. The road and infrastructure cess is at Rs 18 per litre (also referred to as additional excise duty) and the agriculture and infrastructure development cess is at Rs 2.50 litre. Clearly, the cess has a heavier weight in the overall excise duty.

8) One reason offered for the high price of petrol is low atmanirbharta or that as a country we have to import more and more oil than we did in the past. In 2011-12, the import dependency was 75.9%. This jumped to 77.6% in 2013-14 and has been rising since. In April to December 2020, this has jumped to 85%.

The explanation offered on this has been that oil companies haven’t carried out enough exploration activities in the past. Let’s take a look at the numbers of ONGC, the government’s biggest oil production company (or upstream oil company, as it is technically referred to).

The total amount of money spent by the company on digging exploratory wells in 2019-20 stood at Rs 4,330.6 crore. This had stood at Rs 11,687.2 crore in 2013-14. Over the years, the amount of money spent by ONGC on exploration has come down dramatically. This explains to some extent why the crude oil production in India has fallen from 37.8 million tonnes in 2013-14 to 30.5 million tonnes in 2019-20, leading to a higher import dependency.

Of course, not all exploration leads to discovery of oil, nevertheless, at the same time unless you explore, how do you find oil.

The reason why ONGC’s spending on exploration has fallen is primarily because the company has taken on a whole lot of debt over the past few years to finance the acquisition of HPCL and a majority stake in Gujarat State Petroleum Corporation’s (GSPC) KG Basin gas block. The money that ONGC borrowed to finance the purchase of HPCL from the government was used by the government to finance the fiscal deficit. Fiscal deficit is the difference between what a company earns and what it spends.

The borrowing has led to the finance costs of the company going up from Rs 0.4 crore in 2013-14 to Rs 2,823.7 crore in 2019-20. The cash reserves of the company are down to Rs 968.2 crore as of March 2020 from Rs 10,798.9 crore as of March 2014.

All this explains why the price of petrol is racing towards Rs 100 per litre. At the cost of sounding very very very cliched, there is no free lunch in economics. Somebody’s got to bear the cost.

It will be interesting to see if the central government continues to hold on to the high excise duty on petrol and diesel (whatever I have said for petrol applies for diesel as well, with a different set of numbers) leading to  a high petrol and diesel price and lets these high rates feed into inflation in the process.

Keep watching this space.

What You Pay For When You Pay for Fuel

narendra modi
The Prime Minister, Shri Narendra Modi addressing the Nation on the occasion of 71st Independence Day from the ramparts of Red Fort, in Delhi on August 15, 2017.

Narendra Modi, took over as the prime minister of the country on May 26, 2014. On that day, the global price of the Indian basket of crude oil was $108.05 per barrel. Back then, one litre of petrol cost Rs 80 in Mumbai. Diesel in the city was being sold at Rs 65.21 per litre.

Three years have gone by since then and meanwhile, the global oil scenario has changed completely. On September 14, 2017, the price of Indian basket of crude oil was at $54.56 per barrel, around half of what it was when Modi took over as prime minister.

At Rs 79.5 per litre, the price of petrol in Mumbai as on September 14, 2017, in Mumbai, was more or less same as it was when Modi took over as prime minister. Diesel at Rs 62.46 per litre was slightly lower.

What is happening here? While, the price of crude oil has halved, the price of petrol and diesel, which are by-products of crude oil, continues to remain more or less the same (This argument may not hold all across the country, given that different states levy different taxes and different rates of taxes on petrol and diesel).

The gain because of fall in price of oil, has been captured majorly by the central government and the state governments, by increasing the different taxes that are levied on petrol and diesel. Lately, the commission given to pumps which sell petrol and diesel, has also gone up.

A small-scale industry has emerged lately, trying to defend the high taxes that consumers pay on petrol and diesel. Here are the arguments on offer:

a) India imports 80 per cent of the oil that it consumes. Given this, prices of petrol and diesel need to be high, in order to discourage people from consuming more and more of it. The assumption is that at lower price levels, people will consume more petrol and diesel.

b) We need to respect the environment. Petrol and diesel pollute the environment, and hence, taxes on petrol and diesel need to be high.

c) The high taxes on petrol and diesel have helped the government bring down its fiscal deficit without having to cut on its expenditure. This is something that is required in an economic environment where growth is slowing down and hence, government spending needs to be strong. Fiscal deficit is the difference between what a government earns and what it spends.

d) High taxes on petrol and diesel help the government earn enough money in order to fund the physical infrastructure that the country badly needs.

e) High petrol and diesel prices push demand towards more fuel-efficient cars. Also, by taxing petrol more than diesel, the government is ensuring that the private modes of transport (which largely use petrol) are taxed more than the public modes of transport (which use diesel).

f) The oil marketing companies need the flexibility to price their products on a day to day basis. It is this flexibility that reflects in the healthy valuations that their stocks currently enjoy in the stock market.

g) High taxes help the government finance the oil marketing companies which can then sell domestic cooking gas and kerosene at lower prices.

Each of these arguments is largely correct (I mean just because a small scale industry has emerged, doesn’t mean they are wrong) except for the last one. The subsidies on domestic cooking gas and kerosene are now down to around Rs 25,000 crore, which isn’t much in comparison to the petroleum subsidy of the past years. Hence, high taxes on petrol and diesel are clearly not required to fund the subsidy.

But there is one point that these economic commentators and analysts do not talk about. High taxes on the petrol and diesel makes the government lazy and helps it to continue favouring the status quo. Allow me to elaborate. It is worth remembering here that money is fungible. Just as high taxes on petrol and diesel allow the government to fund physical infrastructure, they also allow it to do a lot of other things that a government shouldn’t be doing. Let’s look at the points one by one:

a) Between 2010-2011 and 2015-2016, Air India has lost close to Rs. 35,000 crore, and yet it continues to be run. The losses are not surprising, given that the airline business is a very competitive business and the government clearly doesn’t have the wherewithal to run it. The question is where does the money to keep bankrolling Air India come from? The high taxes on petrol and diesel.
Lately, there has been talk of selling the airline. Let’s see, if and when that happens.

b) Or take the case of Hindustan Photo Films Manufacturing Company Ltd. It is the fourth largest loss-making company among the loss making public sector units. It made losses of Rs 2,528 crore in 2015-201 Between 2004-2005 and 2015-2016, the company has made losses of close to Rs 15,000 crore. As mentioned earlier in 2015-2016, the company lost Rs 2,528 crore. It employed 217 individuals. This meant a loss of Rs 11.65 crore per employee. Where does the money to run this company come from?

c) In total, high taxes on petrol and diesel allowed the government to run 78 loss making public sector enterprises in 2015-2016. Between 2011-2012 and 2015-2016, the loss making public sector enterprises have made losses of Rs 1,33,400 crore. Where is the money to finance these losses coming from?

d) Between 2009 and now, the government has spent roughly around Rs 1,50,000 crore, recapitalising public sector banks. The public sector banks have a humungous bad loans portfolio, as they keep writing off the bad loans, their shareholders’ equity keeps coming down and the government as the largest owner, needs to recapitalise them. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. Take a look at Table 1.

Table 1:

 

 Gross non-performing advances ratio
Indian Overseas Bank24.99%
IDBI Ltd.23.45%
Central Bank of India19.55%
UCO Bank18.83%
Bank of Maharashtra18.00%
Dena Bank17.39%
United Bank of India16.56%
Oriental Bank of Commerce14.49%
Bank of India14.20%
Allahabad Bank13.72%
Punjab National Bank13.20%
Andhra Bank12.91%
Corporation Bank12.14%
Union Bank of India11.77%
Bank of Baroda11.15%
Punjab & Sind  Bank10.80%
Canara Bank10.00%

Source: Author calculations on Indian Banks’ Association data.
As on March 31, 2017.

Table 1 tells us that 17 public sector banks have a bad loans ratio of 10 per cent or high. This basically means that of every Rs 100 of loans that they have given, a tenth or more, is not being repaid. The government currently owns 21 banks, after the merger of the associate banks of State Bank of India and the Bhartiya Mahila Bank, with the State Bank of India.

Some of these banks like the Indian Overseas Bank are in a particularly bad state. This bank has a bad loans ratio of close to 25 per cent i.e. one fourth of its loans have been defaulted on.

Where is the money to keep these banks going, coming from? In a world where money wasn’t free flowing because of high taxes on petrol and diesel, banks like the Indian Overseas Bank, UCO Bank, United Bank of India, Dena Bank, etc., would have already been shutdown or perhaps been sold off. These banks are too small on the lending front to make any substantial difference to the total lending carried out by banks in India. But their losses do hurt the government a lot. Every extra rupee that goes towards funding these banks is taken away from something more important areas like education, health and agriculture.

e) Also, given the different taxes implemented by different states, the price of petrol and diesel tend to vary across the country. Take the case of the government of Maharashtra charging a drought cess of Rs 9 every time one litre of petrol is bought in the state. Why is this cess even there during a time when there is really no drought in the state? It is just an easy way for the government to raise money. Most people don’t even know that they are paying for something like this, every time they buy petrol.

Hence, to introduce a sense of equality among citizens living in different states, petrol and diesel need to be taxed under the GST (They are already a part of it, with zero percent tax rates).

The high taxes from petrol and diesel also helps the government to continue running many inefficient firms as well as banks. Any plan of closing down these firms and banks is likely to met with a lot resistance and also, lead to a lot of hungama (for the lack of a better word). Given this, it makes sense for the government to take the easy way out, maintain the status quo and continue running these firms and banks.

As Donald J Boudreaux writes in The Essential Hayek: “People’s intense focus on their interests as producers, and their relative inattention to their interests as consumers, leads to press for government policies that promote and protect the interests of producers.”

Any idea of shutting down or selling an inefficient public sector enterprise or banks, is likely to be met with a lot of protests from the employees as well as the trade unions representing them. The political parties are likely to join in. Hence, it is easy for the government to maintain the status quo and not make any difficult decisions.

But the money that goes towards keeping these individuals happy, is taken away from other areas like education, agriculture, health etc. People who lose out because of this, do not have the kind of representation that people working for government run firms have.

Of course, all this does not mean that there should be no taxes on petrol and diesel. With the right to govern comes the right to tax people. But these taxes should be at a reasonable level. Also, with lower taxes, people will spend more money on personal consumption and that will help economic growth. And the impact of people spending money, on economic growth, is always greater than that of the government.

To conclude, it is worth remembering that every coin has two sides, and it doesn’t always land up heads.

 

A slightly different version of this column appeared on Pragati on September 19, 2017.

Why oil prices have fallen by 63% and petrol prices by only 17%

light-diesel-oil-250x250One good news for the Indian economy during this financial year has been the huge increase in indirect tax collections. Customs duty, excise duty and service tax together form the indirect taxes collected by the central government.

Data released by the ministry of finance earlier this month showed that indirect taxes as a whole have grown by close to 36%, during the course of this financial year (April to October 2015). The accompanying table provides a breakup of the different kinds of indirect taxes collected during the course of this financial year.

Indirect Tax Collection:  April- October 2015

(Rs. in crores)

Tax Head

 

 

B.E.

2015-16

For OctoberUp-to October% of BE achievement
2014-152015-16% Growth2014-152015-16% Growth
 Customs208336

 

168001899813.110483112244816.858.8
Central Excise*228157

 

135692255066.28758814768568.664.7
Service Tax209774

 

125281714336.88937911272726.153.7
 

Total

 

646267

 

 

42897

 

58691

 

36.8

 

281798

 

382860

 

35.9

 

59.2

*Exclusive of cess administered by other departments.

What is interesting is that customs duty, central excise duty as well as service tax collected have grown at very good rates. The increase in the collection of indirect taxes between the end of 2013-2014 and the end of 2014-2015 had been just 9.1%. Also, the government failed to meet the indirect tax target of Rs 6,24,902 crore in 2014-2015. It managed to collect only Rs 5,42,325 crore.

Also, the indirect taxes collected during the course of this year up until now indicate that the government seems all set to meet its target of Rs 6,48,418 crore. This target is an increase of 19.6% in comparison to the indirect taxes collected during the last financial year.

Given that the indirect taxes collected have grown by 35.9% this year, meeting the indirect taxes target for this year, should not be a problem at all. As finance minister Arun Jaitley said earlier this month: “One of the greatest positives I can see is a huge increase in indirect tax revenues.”

The question is how genuine and sustainable is this massive growth in indirect taxes. As the ministry of finance press release put out earlier this month points out: “These collections reflect in part increase due to additional measures taken by the Government from time to time, including the excise increases on diesel and petrol, the increase in clean energy cess, the withdrawal of exemptions for motor vehicles, capital goods and consumer durables, and from June 2015, the increase in Service Tax rates from 12.36% to 14%. However, stripped of all these additional measures, indirect tax collections increased by 11.6% during April-October 2015 as compared to April-October 2014.”

Once we take these factors into account the rise in indirect tax collections is a much muted 11.6%. To be honest, the finance minister Jaitley acknowledged this recently.

The 68.6% jump in central excise duty is the main reason behind the massive jump in indirect tax collections. In fact, the jump in excise duty makes up for close to 60% of the overall jump in the indirect taxes collected this year.

This jump has primarily come due to the government increasing the excise duty on petrol and diesel five times between last year and now. In fact, the latest increase in excise duty on petrol and diesel came about earlier this month.

With these increases in excise duty on petrol and diesel, the government has more or less fully captured the fall in oil prices for itself, and not passed it on to you and me. A litre of petrol currently costs Rs 68.13 per litre in Mumbai. It was at Rs 80 per litre around the time, Narendra Modi was elected to power in May last year.

Between then and now, the petrol price has fallen by just 17.4%. In comparison, the price of the Indian basket of crude oil has crashed by 63%. On May 26, 2014, when Narendra Modi was sworn-in as the prime minister of India, the price of the Indian basket of crude oil was $108.05 per barrel. On November 16, 2015, the price was at $39.89 per barrel.

This clearly shows that the government has captured almost all the benefit of falling oil prices. A 63% fall in the price of oil has led to just a 17% fall in the price of petrol in Mumbai.

There are multiple problems with this approach.

The government talks about having dismantled the administered price mechanism on the pricing of petrol and diesel. But that is clearly not the case. A fall in oil prices does not immediately lead to a fall in petrol and diesel prices. The government has captured the fall by increasing the excise duty on petrol and diesel.

Further, the government has become heavily dependent on the revenue coming in from an increase in excise duty on petrol and diesel. What will it do if and when the oil price starts to go up? Will it cut the excise duty in order to ensure that price of petrol and diesel does not rise? Given that it did not pass on the benefits of a fall in the price of oil to the end consumer, isn’t it only fair that it shouldn’t be passing on the increase as well?

Also, it is worth remembering here that trying to forecast the price of oil remains tricky business.  As Philip Tetlock and Dan Gardner write in Superforecasting—The Art and Science of Prediction: Take the price of oil, long a graveyard topic for forecasting reputations. The number of factors that can drive the price up or down is huge—from frackers in the United States to jihadists in Libya to battery designers in Silicon Valley—and the number of factors that can influence those factors is even bigger.”

Further, if it cuts the excise duty, as and when the oil price goes up, it will have to borrow more and that will create its own set of problems. The fiddling around with excise duty on petrol and diesel, shows a lack of a stable policy on the tax front. The finance minister Arun Jaitley has often outside India talked about a stable tax regime for foreign investing in India. Why forget us Indians, who live in India?

Another impact of this massive increase in indirect tax collections has been the junking of the disinvestment programme, though no politician will admit to the same. At the beginning of the year, the government had set a disinvestment target of Rs 69,500 crore. But that is not going to be achieved. Meanwhile, the government will continue to waste the taxpayer’s hard earned money on dud companies like MTNL and Air India. Minimum government and maximum governance will continue to remain a slogan.

On the good side, the fiscal deficit number will look better than 3.9% of GDP it was projected at, in the budget document.

The column originally appeared on The Daily Reckoning on November 18, 2015