Why Demand For Fuel Duty Cutback Is Bad Economics

The Narendra Modi government has been criticised in the past few days for the recent rise in fuel prices and the role of high taxes on petrol and diesel in precipitating this situation. Even after the government cut the fuel duties by Rs 2 on 3 October, the opposition has relentless, calling the cut inadequate and demanding further reduction. The debate around this issue has not only exaggerated the effect of taxes on fuel prices but has also largely ignored the undeniable utility of these taxes as a tool of fiscal prudence.

To put the issue in perspective, it is important to understand the actual extent of impact on the average consumer due to the hike in central fuel duties. All three central levies (excise duty, special additional excise duty and additional excise duty) are imposed at a fixed amount per litre (Rs 19.48 per litre for petrol and Rs 15.33 per litre for diesel as of 4 October 2017) and are not ad valorem. Hence, the central taxes do not increase as the pre-tax price increases which prevents a cascading cost for the customer. Even after excluding Tuesday’s (3 October) cut in duties, the net increase in excise duties on fuel since the Modi government came to power has been Rs 12 per litre for petrol and Rs 13.77 per litre for diesel.

As per the Kirit Parekh Committee of 2010 which recommended the deregulation of fuel prices, the average consumption of an average two-wheeler is about 86 litres of petrol per year while the annual consumption of petrol and diesel cars is about 593 and 571 litres, respectively. Using these consumption averages, it is clear that the extent of the increase in annual fuel expenses due to hike in central duties for a family owning a two wheeler or a petrol car is limited to Rs 1,032 and Rs 7,116 respectively. If one accounts for improvements in fuel efficiency and augmentation of infrastructure and public transport since 2010, the actual expense on fuel would be even lower than these levels.

Hence, it is apparent that the actual impact of the hike in fuel duties on the retail customer is only modest. Despite this, the critics in faux outrage are demanding a bigger cut without considering the impact of such a move on the national budget. Central duties on fuel contribute about 18 per cent of the total tax revenue (as per revised estimates 2016-17) of the government. Any cut in the fuel duties reduces the fiscal resources available to the government and increases the fiscal deficit leading to a proportionately higher government borrowing. The revenue loss due to Tuesday’s reduction alone is expected to be about Rs 13,000 crore for this year.

A bigger cut in the current circumstances therefore may make the fuel cheaper for us but it would be at the expense of the future generations. This would be akin to the fuel subsides provided in the past, which merely postponed the high cost of fuel. Oil bonds, which were issued to oil marketing companies till 2010 to keep the retail fuel prices low, worth over Rs 1,30,923 crore are still outstanding. The last of these bonds would go off the balance sheet only in 2026. The interest component on these bonds for this year alone was Rs 9,989 crore.

Moreover, a large cut in the fuel duties is not the most efficient or equitable way of providing reprieve to the common man. As a differential duty regime usually leads to use diversion and parallel black markets, a reduction in the duties would have to apply for all fuel consumers irrespective of the income levels or end use. NSSO data on consumer expenditure in India shows that fuel use is highly skewed based on income levels. The top five percentile of urban Indian consumers spend nine times more on petrol as compared to the median consumer and almost 400 times more than the bottom five percentile of consumers. In rural areas, the top five percentile of consumers spend 14 times more on petrol than the median consumers and 1,225 times more than the bottom five percentile.

A bigger cut in fuel duty would effectively mean a disproportionate benefit for the rich at the expense of the low and middle income groups, who spend much less on fuel but are usually the ones served by the welfare schemes funded from these duties. Similarly, an end-use analysis of fuel in India by Petroleum Planning and Analysis Cell in the Ministry of Petroleum and Natural Gas shows that only 13.15 per cent of the diesel consumed in India is used for private transport while the rest is used for a diverse range of commercial and industrial uses. As a result, a cut in the diesel duty would have only limited benefits for private consumers.

In this context, it is clear that the demand for a bigger cut in fuel duties is devoid of foresight. As the temporary uptrend in the international crude prices subsides, consumers stand to gain more in the long term. The daily revision of fuel prices would allow the benefits to pass to the consumer almost immediately and more efficiently. Since June 2017 when the daily revision of fuel prices was initiated, while petrol prices were increased 76 times with an average hike of 10 paisa, customers have also benefitted from reduction in petrol prices as many as 22 times with an average reduction 27 paisa. Also, the central government is demonstrably keen on building a consensus among the states to bring petrol and diesel under goods and services tax. As and when this happens, consumers will surely benefit from the rationalisation of the duty structure.

Deregulation of fuel prices was one of the key reforms necessary to set the national balance sheet straight. Expecting the government to intervene every time fuel prices move in tune with the international crude prices would be a step backwards. The current situation calls for an objective assessment of the realities rather than succumbing to a narrative based on half-truths and fuelled by political opportunism.