This is the English version of the article that originally appeared in Prajavani on 19 June 2021
Karnataka became the 7th state in India to record petrol prices crossing the psychological barrier of Rs.100 per litre on June 12th. Bidar, Bellary, Koppal, Davanagere, Shivmogga, and Chikmagalur were some of the places to witness this exceptional occurrence. Given that nearly 60% of the petrol price you pay goes to the government as taxes, there is a growing clamour for decreasing taxes and bringing it under the ambit of the Goods and Services Tax (GST).
Breakdown of Petrol Price
On 1 June 2021, the price of 1 litre of crude oil was Rs.32.4. It takes approximately Rs. 3.6 per litre to refine the crude oil and transport it to the petrol pumps. So, the price of petrol, when it is received by the petrol pumps is Rs.36 per litre. Now, add Rs.32.9 as Union Government taxes, which comprises of excise duty, additional excise duty, Road and infrastructure cess, and agricultural cess. Petrol pump dealers take a commission of about 3.8 rupees. Add all of this and the fuel price is at Rs. 72.68 per litre. Now, it is the state government’s turn, which adds a Value Added Tax and other cesses. Karnataka charges 35% as VAT, which is one of the highest in the country. This amounts to Rs. 25.4 and takes the total price to about Rs. 98 or more (depending on state cesses), which is what you end up paying when you fill your vehicles.
By this calculation, the total taxes amount to Rs. 58.34 and the base price of refined petrol was Rs. 36, which amounts to a whopping 162%. Let that number sink in.
Bringing Petrol under GST
The main benefit of bringing petrol under GST would be lower prices for the end consumer. High petrol price is damaging to the economy in multiple ways. Mainly, they reduce the disposable income of the population. The economy has contracted since the pandemic and one of the reasons is a demand crunch due to uncertainty and loss of income, as people have either lost jobs or have reduced income. At such a time, squeezing the population further through higher taxes on an essential commodity like petrol hurts the economy. Every rupee taken away as taxes is a rupee that is not spent on consumption. When people consume less, producers naturally respond by cutting down production and reducing the number of people they employ. This further leads to overall lower income and lower consumption. When the economy is contracting, the ideal policy is to increase the disposable income of the population, and not increase taxes.
It is mistakenly believed that higher petrol prices only hurt the middle class and the rich, who can afford to have a vehicle to begin with and not the poor. A rise in petrol prices unfortunately has a cascading inflationary effect on all other commodities in the economy, which is consumed by everyone. For instance, prices of vegetables and other essential food items increase because of higher transportation costs. Even public transport becomes expensive for those who do not use their own vehicles.
Importantly, bringing petrol under the ambit of GST will bring stability to the prices and remove the temptation of governments, both union and state, to raise taxes every time they have a cash shortfall. Petrol, along with alcohol and cigarettes, is seen as a perennial cash cow for governments as the demand for the product is highly price inelastic – people will not stop buying even when the price increases. When the governments can no longer keep relying on higher petrol taxes to fund their expenditure, it will necessarily force some form of fiscal discipline on them. They will have to either reduce their unwanted expenditure or look at improving tax collections in other areas.
How can this be done?
The main opposition to bringing petrol under GST comes from the government itself as it stands to lose quite a bit of revenue. In 2019-20, the state and union government combined earned Rupees 4.24 lakh crores by taxing petroleum products. States, by themselves, will lose 2 lakh crores and are therefore unwilling to give up on their most promising revenue source.
One way to make this transition possible is to include petrol under GST at the highest slab (28%) and even impose a compensation cess to make up for the revenue loss. This should be split equally between states and the union, which could convince the states to agree to this. The compensation cess can be levied with a clear pathway to reduce it over time. For instance, a 30% compensation cess with 5% reduced every 3 years or so, which would be eliminated in a period of 15 years. This will give ample time for states to adjust to the new regime and have better public finance strategies to compensate for the revenue shortfall.
By bringing petrol under GST, there will be efficiency gains and consumers will have higher disposable income, which will help the economy far more than what government can do by collecting higher taxes.