Why COP26 inadvertently shores up coffers of Indian state exchequers

India’s success in delaying the demise of fossil fuels at the Glasgow climate forum by taking a hard position may have unwittingly extended financial lifelines to scores of Indian states. Climate change is less of a concern in state capitals — despite events such as flash floods, torrential downpours and smoggy skies plaguing Chennai, Mumbai or Delhi with increasing regularity.

What is scarier for state administrations is the prospect of seeing fuel taxes vaporise if nations aggressively chart a path towards clean energy and electric vehicles (EVs). For India — both at the federal and state level — it’s not just a question of clean air or legacy oil and gas assets that would decay in a rapid transition to EVs but rather of the trillions of rupees in fuel tax revenues that accrue annually.

New Delhi, while protesting forcefully against the phase-out of fossil fuels at COP26, would have been well aware of the fact that both central and state governments would be hard pressed to substitute fuel tax revenues with alternatives such as EVs or hydrogen where charging your vehicle would fetch perhaps a sliver of existing receipts, maybe as service tax.

If you add fuel taxes at central and state levels, they are adequate to meet India’s combined budgeted expenditure this fiscal for defence and education at over Rs 5.7 trillion.

Sales tax and VAT on oil products for Indian states totalled Rs 2.03 trillion in fiscal 2021 and around Rs 56,000 crore in the April-June quarter of this fiscal, ratings agency Crisil said. Federal collections on excise duty on fuels grossed Rs 3.73 trillion and Rs 72,360 crore, respectively. Compare that to India’s total vaccination budget of Rs 35,000 crore.

Maharashtra, the country’s second biggest user of diesel and petrol, earned Rs 25,430 crore last year from fuel levies followed by Uttar Pradesh, the country’s biggest consumer of transport fuels (see table).

The government, before this month’s fuel tax cuts, expected to earn Rs 3.4 trillion from fuel receipts in FY22, or, around 10 per cent of government expenditure estimated this fiscal. Ratings agency ICRA now estimates a Rs 44,000 crore shortfall to the central exchequer from a reduction in cess by Rs 5 per litre on petrol and Rs 10 per litre on diesel.

State governments will lose around Rs 9,000 crore from the cascading impact of the cut in central excise duties as states levy charges on an ad valorem basis on fuel rates including federal taxes. Twenty-five sta­tes further reduced fuel taxes at the state level. Losses for state administrations from local tax cuts will be a combined Rs 35,000 crore this fiscal, ICRA estimated.

Non-Bharatiya Janata Party-ruled states including Maharashtra, Telangana, Andhra Pradesh, Tamil Nadu and Rajasthan did not reduce rates, while Congress-ruled Punjab cut local taxes as a precursor to state polls next year.

State governments are much more dependent, more so administrations opposed to the ruling BJP government, on fuel levies. Take the case of DMK-ruled Tamil Nadu (TN), the country’s fifth biggest diesel consumer in fiscal 2021 and the third biggest petrol user.

TN’s own tax revenues at Rs 1.27 trillion accounted for 63 per cent of its total receipts this fiscal ending March 2022. The state’s revenue deficit is budgeted at a record Rs 58,693 crore this fiscal, reflecting the importance of fuel levies.

Taxes on alcohol, petrol and diesel make up over half of the state’s commercial tax revenues. Fuel receipts will make for an even bigger share of GSDP as receipts from taxes on motor vehicles is estimated at Rs 6,600 crore this fiscal, so any transition to EVs by waiving taxes will further hurt state revenues.

New Delhi must also share the blame for high fuel levies by states after the Centre doubled the use of cess and surcharges to around 20 per cent of central taxes in the decade to 2020, diverting funds from the states.

Nowhere is this dilution of the spirit of federalism more ap­parent than in the taxation of petrol and diesel at the pump, says former investment banker turned TN Finance Min­ister Palanivel Thiagarajan in the latest state Budget document.

The current government has increased fuel levies sharply but slashed the share of excise duties shareable with states via cesses, depriving states of their share of the revenue. Revenue to the Union government last fiscal from levies on petrol and diesel was Rs 3.9 trillion, 63 per cent higher from a year earlier, while TN received only Rs 838 crore, 28 per cent lower from a year earlier, as share of the tax from the Centre, according to a white paper on TN’s finances.

New Delhi increased the cess and surcharges on petrol by Rs 18 a litre and on diesel by Rs 21 a litre in May 2020, while cutting the basic excise duty, shareable with states, on petrol and diesel by Rs 6.50 per litre. Effectively, the overall central levies on petrol went up by Rs 11.50 a litre and on diesel by Rs 14.50 a litre. The new Agri­culture Infrastructure Deve­lopment Cess of Rs 2.50 a litre of petrol and Rs 4 a litre of diesel is also not sharable with states.

With the Centre apparently apportioning a larger share of revenue receipts, states are left with little leeway but to tax your road fuel.