Sustainable fuel taxes

India needs a more transparent tax structure

Last week, the Union government reduced the excise duty on petrol by Rs 5 a litre and on diesel by Rs 10 a litre. This was timed to come into effect on Diwali, and was sold politically as a festival gift to the nation. The Union finance ministry argued it would boost consumption, aid diesel-using farms in the rabi season, and generally spur growth amid subdued demand. There were hopes that the spur to aggregate demand would in turn allow for a virtuous cycle in consumption, which would in turn increase fuel consumption and mitigate the effect of the cuts in the government’s receipts. The Union government’s excise cuts were followed by reductions in value-added tax on fuel by several state governments, most of which are run by the Bharatiya Janata Party. A political firestorm has now built up over the responsibility for high prices at the pump.

This politicisation of the price of petrol and diesel through arbitrary taxation is dangerous. It is precisely this unfortunate feedback between politics and fuel prices that was sought to be avoided by the deregulation of prices charged by the state-run oil-marketing companies. Given that now a large proportion of the price at the pump is determined by taxes, however — a basic excise duty, a special additional excise duty, a road and infrastructure cess, and an agriculture cess — India is back in a situation where fuel prices are the subject of political disputation. This system needs to be replaced with something more transparent. This is particularly true because the current level of fuel tax makes sense not just from the point of view of fiscal management but also in terms of managing India’s carbon emissions, and encouraging a shift towards more sustainable forms of mobility.
 

The Union and state governments need to consider the possibility of moving away from the current broken fuel tax system towards a more comprehensive and less arbitrary structure. One portion of the current fuel tax burden can be brought under the goods and services tax umbrella; the rest can be a transparent carbon tax that is shared between the Union and the states or directed towards climate-sensitive infrastructure, whether serving agriculture or mobility. This is a modern system that would aid in India meeting its increasingly tight 2030 climate change targets while also ensuring that the average Indian understands that fuel taxes are not a political choice by a particular dispensation.

More broadly, the recent trend towards depending upon fuel taxes to fill holes in government budgets must be arrested. Following a series of increases in various types of cess and excise, the government pulled in Rs 2.2 trillion from taxes on fuel in 2019-20. That went up even more in 2020-21 to Rs 3.7 trillion. Most of this was kept by the Union government. High taxes should stand on their own as being justified by the need to accelerate India’s green transition; they should not be a crutch for improvident governments. Therefore, the overall tax system needs to be strengthened to reduce dependence on fuel taxes, particularly on cess. Higher dependence on fuel taxes to meet government expenditure makes government finances vulnerable to political pressures and increases longer-term fiscal risks.