States gained Rs 49k crore when fuel prices rose, have room to cut VAT: SBI

States gained Rs 49,229 crore from VAT revenue on fuel when oil prices were increasing and will forego Rs 15,021 crore now that excise duty on fuel has been cut, SBI Research said in a report

States have room to cut value added tax (VAT) on petrol and diesel as they gained Rs 49,229 crore from VAT revenue on fuel when oil prices were increasing and will forego Rs 15,021 crore now that retail prices have been downwardly adjusted through excise cut, State Bank of India Research said in a report on Monday.

The VAT charged by states is ad-valorem, which means their VAT collections rise when petrol and diesel prices increase and get reduced automatically when the Centre cuts excise duty.

“This implies that gains still outstrip the revenue forgone by Rs 34,208 crore and hence states can further cut the oil prices. Maharashtra has gained the most, followed by Gujarat and Telangana,” said SBI’s Chief Economic Advisor Soumya Kanti Ghosh in the report.

Ghosh said that state finances had shown improvement since the Covid-19 pandemic, indicating they have the necessary wherewithal to adjust taxes if so required. This is also reflected in lower state borrowings, the report said.

Taking all these factors into consideration and if the cushion from oil excise is entirely adjusted such that states have no gain or loss from oil revenue over and above the budgetary estimates, Ghosh said that states on an average can still cut diesel price at least by Rs 2 per litre and petrol price by Rs 3 per litre each without impairing their VAT revenue from oil.

“Bigger states like Maharashtra, which have lower debt to GDP ratio, have significantly large fiscal space for lowering their tax on diesel and petrol by even up to Rs 5. The tax-GDP ratio of many states including Haryana, Kerala, Maharashtra, Rajasthan, Telangana, and Arunachal Pradesh is higher than 7 percent. We believe there is compelling reason for these states to adjust taxes on fuel,” Ghosh said.

In a bid to reduce inflationary pressure on households and businesses, the Centre slashed central excise duty on petrol by Rs 8 per litre and on diesel by Rs 6 litre earlier this month. Prime Minister Narendra Modi and Finance Minister Nirmala Sitharaman have both asked states to consider cutting VAT to further reduce inflation.

SBI Research said that the ultimate solution to reduce the complexities in oil tax structure and bring down extreme volatility in oil revenues due to would be to bring it under the ambit of GST. However, if the two fuels are put under GST, the Centre will have to let go of Rs 20,000 crore input tax credit. Thus, a fair methodology would have to be developed for this, it said.