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What’s the Real Story Behind High Petrol and Diesel Prices?

What’s the Real Story Behind High Petrol and Diesel Prices?

Vivek Kaul and Chintan Patel

Between 2014-15 and now, taxes imposed by the central government on petrol and diesel have increased by 217% and 607%, respectively. The central government tax on diesel has gone up from Rs 4.50 per litre in 2014-15 to Rs 31.80 per litre currently. This is the real story.

Petrol and diesel prices are at an all-time high across the country. When it comes to petrol prices have crossed the 100-rupee-per-litre mark, in many states. As expected, the central government is being questioned on this price rise.

On July 2, the finance minister Nirmala Sitharaman said that no discussions were underway to arrest the rising price of petrol and diesel. Her response to a question on rising prices of petrol and diesel was: “When the international price of crude oil is higher, we have to increase the prices and when the international price is lower, we have to decrease the prices here too. This is a market mechanism which is followed by oil marketing companies. We have given them the freedom.”

Citing the financial burden of the central government’s efforts on vaccine procurement, health infrastructure, and free food to the poor, she added that “state governments can give relief by reducing taxes or levies on petrol.”

In fact, a couple of months ago, she had referred to the taxation of fuels as a “dharamsankat”. So, what is this dharamsankat that Sitharaman bemoans?

Also, a lot of WhatsApp forwards have been going around explaining why it is impossible for the Narendra Modi government to cut petrol and diesel prices. One reason being offered is that the government needs to repay oil bonds issued by the previous UPA government. As we had explained on an earlier occasion this isn’t true. It’s just propaganda, albeit excellently run.

In this piece, we take the story forward with the hope that it can tackle some of the WhatsApp propaganda around petrol and diesel prices that is currently on.

Price breakdown

In most situations in business, a product is sold at a price which includes the cost of manufacturing the product, the taxes that the company has paid in the process of manufacturing it and the profit margin that the company hopes to earn. Of course, the taxes aren’t a major portion of the overall price.

That’s not true for petrol and diesel in India. Taxes, as we shall see, form a significant part of the overall retail price. The retail price or the price we pay for petrol and diesel at the pump, is made up of four components – a) The price at which the dealer buys petrol and diesel from the oil marketing companies like Indian Oil, Bharat Petroleum or one of the private companies. This price includes the cost of producing petrol and diesel and getting it to the pump where it is sold. It also includes the profit margin of these companies. b) The central government tax. c) The state government tax. d) Dealer commission.

Of the four components, the price at which the dealer buys petrol and diesel from the oil marketing company, is the biggest variable. It is tied to the price of international crude oil. If the price of oil goes up, as it has since April 2020, the price of petrol and diesel also go up. In April 2020, the average price of the Indian basket of crude oil had fallen to $19.9 per barrel.

In June 2021, it averaged at $71.98 per barrel. As of July 13, it had risen to $74.97 per barrel. This, as Sitharaman said, is the main reason for the increase in petrol and diesel prices in the recent past. We would like to say that this is not the reason, but a reason. We will explain the details as we go along.

India produces very little oil of its own. In fact, the overall import dependency in April and May this year was at 85.4%. We are heavily dependent on oil imports. Hence, if price of oil goes up internationally, the price of petrol and diesel also go up within the country.

Now getting back to the components of the retail price of petrol and diesel. The second component is the central government tax, which is the central excise duty. This is fixed and only changes when the government decides so. (The central excise duty has further components, but we won’t get into that in this piece).

Then comes the state government tax on petrol and diesel. Some states refer to it as sales tax and in some other states it is called the value added tax. This tax is over and above the central excise duty and varies from state to state.

The pumps through which petrol and diesel are retailed also need to make some money. They earn a dealer commission, which is also a part of the per litre retail price . Having said that, the dealer commission is a small fraction of the total price, and mostly inconsequential in affecting the final retail prices of petrol and diesel.

Let’s look at the retail price breakdown of petrol and diesel in Delhi as of July 1, 2021. The following table shows us that.

Table 1. Price breakdown of petrol and diesel
(in Rs per litre): July 1, 2021 (Delhi)

table

Source : PDF

Let’s consider the price of petrol and try and understand this structure in detail. The price charged to the dealer is Rs 39.33 per litre. On this the central government charges an excise duty of Rs 32.90 per litre. Then there is a dealer commission of Rs 3.82 per litre.

These three entries add up to Rs 76.05 per litre. On this price, the Delhi government charges a value added tax of 30%, which works out to Rs 22.82 per litre. This is added to Rs 76.05 per litre and it adds up to a retail selling price of Rs 98.87 per litre of petrol.

It is interesting to note, the value added tax of the state government is charged on Rs 76.05 per litre, which also includes a central excise duty of Rs 32.90 per litre. This means that when you and I buy petrol we are paying a tax on a tax. This is true across the length and breadth of India and not just in Delhi.

Also, it is worth mentioning that the value added tax or the sales tax of the state governments is ad valorem, which means it is a certain proportion of the sum of the dealer price, central excise duty and dealer commission.

So, if the dealer price goes up or the central government decides to increase the excise duty, the state governments earn a higher tax per litre of petrol sold. What is true for petrol is also true for diesel, though the numbers change and so does the calculation accordingly.

Now let’s look at what proportion of the retail sales price do each of the four components form. Figure 1 and Figure 2 show that for petrol and diesel, respectively. The data is as of July 1.

Figure 1

 Petroleum Planning and Analysis Cell

Source :PDF

Figure 2

 Petroleum Planning and Analysis Cell

Source :PDF

Figure 1 and Figure 2 make for a very interesting reading. In case of petrol, the dealer price forms 39.8% of the retail price of petrol. The rest are largely taxes, imposed both by the central government and the state government. The taxes added up to 56.4% of the retail selling price of per litre of petrol in Delhi as of July 1.

Along similar lines, the dealer price makes for 46.8% of the retail price of diesel. The rest are largely taxes. Taxes amount to 141.7% of the dealer price for petrol and 107.3% of the dealer price for diesel. So, taxes form a significant portion of the price of petrol and diesel.

The interesting thing is that the central excise duty on petrol and diesel has been raised over the years. Up until early May 2020, the excise duty on petrol was Rs 22.98 per litre. It was raised to Rs 32.98 per litre. When it comes to diesel, the excise duty was raised by Rs 13 per litre, from Rs 18.83 per litre to Rs 31.83 per litre.

From February 2, 2021, the total excise duty on petrol and diesel has stood at Rs 32.90 per litre and Rs 31.80 per litre, respectively. Clearly, a significant proportion the increase in price of petrol and diesel over the last one year has been due to an increase in the excise duty charged by the central government. Hence, it’s not just about global oil prices going up, as Sitharaman would like us to believe.

In fact, in May last year, India had the distinction of being the highest taxer of auto fuels in the world, a whopping 69%. Since then, the portion of petrol and diesel prices that goes towards taxes, to both the central government and the state governments, has come closer to 50%, although the retail price at the pump has increased. Irrespective of whether it is 69% or 50%, taxes on petrol and diesel in India are high. Has it always been like that, or is it a recent development?

Let’s examine. Figure 3 plots the breakdown of the retail price of petrol over the years in Delhi (We are not obsessed with Delhi. But regular data in the public domain is only available for Delhi, hence, limiting our choice). For the sake of avoiding visual clutter, we have considered only the price in the month of May every year. In fact, petrol prices change frequently, sometimes several times a month due to fluctuations in crude oil prices.

Also, the central excise duty has been hiked more than once during some years. Thus, the chart below does not capture every price point over the last eight years but is still a good representative of the overall trend.

Figure 3

 Petroleum Planning and Analysis Cell

Source: Petroleum Planning and Analysis Cell

Now let’s try and understand this in detail. A look at the above chart tells us very clearly, the central government taxes on petrol have gone up over the years, from Rs 10.39 per litre in May 2014 to Rs 32.90 per litre in May 2021. This is a jump of around 217%. The state government value added tax in Delhi has also gone up from Rs 11.90 per litre to Rs 21.81 per litre, a jump of around 83%.

Clearly, taxes on petrol, more at the central government level than the level of state governments, have gone up over the years, and this has pushed up the retail selling price. Take a look at Figure 4 and Figure 5. They plot the proportion of each component in the retail selling price of petrol and diesel in May 2014 and May 2021, respectively.

Figure 4

 Petroleum Planning and Analysis Cell

Source: Petroleum Planning and Analysis Cell

Figure 5

 Petroleum Planning and Analysis Cell

Source: Petroleum Planning and Analysis Cell

As can be seen from Figure 4 and Figure 5, the price charged to the dealer, which was 66% of the retail selling price of Rs 71.41 per litre in May 2014, has since fallen to around 38% of the retail selling price of Rs 94.49 per litre in May 2021.

The central excise duty as a part of the retail selling price of petrol has jumped from 14.5% to 34.8%. This shows again that the increase in central excise duty has been a major reason for the increase in the price of petrol over the years. The increase in state government taxes have also played their role.

In fact, the dealer price of petrol in May 2014 was Rs 47.12 per litre in comparison to Rs 35.99 per litre in May 2021. Despite this, the retail selling price of petrol in May 2014 was at Rs 71.41 per litre, which was significantly lower than Rs 94.49 per litre in May 2021.

All that is true for petrol is also true for diesel. Figure 6 plots the price breakdown for diesel over the years. As can be clearly seen, the central government tax has gone up from Rs 4.50 per litre in May 2014 to Rs 31.80 per litre in May 2021, a jump of around 607%.

Meanwhile, the state government tax has almost doubled from Rs 6.61 per litre to Rs 12.50 per litre. When it comes to the dealer price for diesel, it was at Rs 44.98 per litre in May 2014 and at Rs 38.49 per litre in May 2021. Despite this, the retail selling price of diesel in May 2014 was at Rs 57.28 per litre, which was significantly lower than Rs 85.38 per litre in May 2021.

Figure 6

 Petroleum Planning and Analysis Cell
Source: Petroleum Planning and Analysis Cell

Let’s take a look at some interesting insights that emerge from the data above:

1.  The price paid to the dealer was the highest in 2014. Since then, the dealer prices have come down, although not in a linear fashion. This is primarily because the average price of the Indian basket of crude oil in May 2014 stood at $106.85 per barrel. The oil price has seen a largely downward trend since then.

2. There have been some ups and downs when it comes to the dealer price, with the lowest prices for both petrol and diesel recorded in 2020, when they were around half of the price in 2014. This was on account of the price of the Indian basket for crude falling to $30.61 per barrel during May 2020, the lowest in any May since May 2014. Compared to the lows of 2020, dealer prices have risen by over 60% which explains the recent price surge at the pump. As explained earlier, retail prices have also gone up due to a massive increase in the central excise duty on petrol and diesel by Rs 10 per litre and Rs 13 per litre, respectively, in early May 2020.

3. From 2014 to 2021, taxes imposed by the central government have increased by around 217% on petrol and around 607% on diesel. The bulk of these increases were over two periods – from 2014 to 2015, and from 2019 to 2020, either by co-incidence or by design, both these periods were immediately following Narendra Modi’s election victories.

4. The first round of hikes in central excise duty in 2014 was effectively done to capture the gains from the drop in crude oil prices. The average price of the Indian basket of crude oil in May 2014, the month in which Mdoi was elected the prime minister, had stood at $106.85 per barrel. By January 2016, theyw were down to $28.08 per barrel. Instead of passing on lower prices to the consumer, the government decided to bolster tax revenues when global oil prices fell. Thus, the end consumer did not see a price decrease from the fall in crude oil prices.

5. After that, from 2015 to 2019, the central government tinkered with the central excise duty with marginal increases or decreases to keep the retail price somewhat bounded. In fact, in October 2017 and October 2018, the excise rate on both petrol and diesel was cut by Rs 2/litre and Rs 1.50/litre, respectively, to counter the increasing oil prices. The 2019 general elections also likely influenced these cuts.

6. The next big hike in central excise was in early May 2020, again around the same time when global oil prices plummeted in the aftermath of the covid pandemic, when the duty on petrol was increased by Rs 10/litre and that on diesel by Rs 13/litre. The price of the Indian basket of crude averaged at $19.9 per barrel in April 2020. It has since risen to more than $70 per barrel. But with a rise in oil prices in 2021, the excise tax has not been reduced. Hence, a higher oil price and a higher excise duty have both contributed to the rise in pump prices of petrol and diesel.

7. The charts above are for Delhi. As explained earlier, each state has a different value added tax or sales tax when it comes to petrol and diesel and a slightly different trend over the last eight years. A detailed analysis of every state is outside the scope of this piece. Nevertheless, the broader point stays the same. A major reason for the increase in the retail selling price of petrol and diesel, and the fact that petrol is selling at more than Rs 100 per litre in many states, is because the central excise duty on petrol and diesel, has been increased majorly over the years. The increase in state government taxes have also had a small role to play.

Officials in both the central government and state governments know that the current petrol and diesel prices are placing a high burden on the end consumer. Both sense discontent brewing on this issue, which can ultimately cost at the ballots. So, both stand to gain, if taxes are cut and prices fall.

Crucially, both have the ability to reduce the retail price, by lowering their portion of the tax. But the way things are currently it seems that the state governments would prefer the central government reducing excise duty, and the central government would prefer the state governments reducing the sales tax or the value added tax.

Given that both sides are standing firm, the consumer has ended up teary-eyed. Also, as we have seen, the central government taxes on petrol and diesel have gone up significantly more than the state taxes. Clearly, the ball is in the central government’s court.

To add more intrigue to the petrol and diesel tax saga, there is one other thing to consider. A part of the central excise duty is shared with the states. This part is referred to as the divisible pool. Much of the increase in central excise since May 2014 has been in the form of surcharge and cess, which are not shared with the states. We have discussed this in detail in an earlier piece.

As of 2021, only Rs 1.40 of Rs 32.90 collected through the central excise duty on per litre of petrol, and only Rs 1.80 of the Rs 31.80 collected through the central excise on per litre of diesel, goes to the divisible pool.

Since the states get 42% of the revenue from the divisible pool, they end up getting 59 paisa per litre which is a mere 1.8% of excise duty collected by the central government on per litre of petrol. For diesel, the states’ share comes to 76 paisa per litre amounting to 2.4% of the central excise duty per litre of diesel.

Given that the central government has employed such a strategy of actively undercutting states’ revenue from the central excise duty collections on petrol and diesel, it is a tad optimistic to expect the state governments to be enthusiastic about a coordinated approach, where both the central government and the state governments reduce the taxes they collect on sale of petrol and diesel at the same time.

Central government dependence

In the last couple of years, the central government has become overly dependent on the central excise duty that it earns on the sale of petroleum products (primarily petrol and diesel). In 2014-15, the central government had earned Rs 99,068 crore from this. This jumped to Rs 2.23 lakh crore in 2019-20. It jumped to an all-time high of Rs 3,72 lakh crore in 2020-21.

This compensates for the massive fall in corporate tax or the income tax paid on corporate profit. This had stood at Rs 6.64 lakh crore in 2018-19. In 2020-21, it fell to Rs 4.46 lakh crore, a drop of about a third. This happened because in September 2019, the government reduced the base rate of corporate tax to 22%, from the earlier 30%. Hence, the collections of corporate taxes fell in 2020-21, despite the massive increase in profits of listed corporates during the year.

Over and above this, a badly designed and run Goods and Services Tax has not brought in the amount of taxes it was expected to. As the Fifteen Finance Commission Report put it: “In terms of government finances, [GST] was expected to improve the overall tax-GDP ratio in the medium term and lead to higher Union [central government] transfers to States.” But that hasn’t happened. This can clearly be seen in Figure 7.

Figure 7

 Petroleum Planning and Analysis Cell

Source: Centre for Monitoring Indian Economy.

There is no free lunch in economics. The costs of a fall in corporate tax collections and weaker than expected GST collections, are being borne by everyone who buys petrol and diesel in a direct way. In an indirect way, we are paying for it in the form of higher inflation.

This is why the central government cannot reduce excise duty on petrol and diesel. Their finances have become too reliant on the revenue generated by the excise duty on petrol and diesel.

The economy was already on weak footing when Covid hit. The pandemic triggered a massive reduction of economic activity – one that is still on going, which has reduced tax inflow from other sources. The fact that corporate income tax was cut hasn’t helped either.

Additionally, there are more financial demands on the government than the past. The government needs money to finance pandemic-induced expenses like vaccine procurement and improving healthcare delivery. All this could have been easily done if corporate income tax rates hadn’t been cut or GST had been launched and run properly.

In such an environment of decreased income, the government is unable to wean itself off taxes it earns from the sale of petrol and diesel. In many ways this dilemma is self-imposed since this government’s original sin was its economic mismanagement before the pandemic hit. You construct a house poorly and a storm hits. Now you are drenched due to a leaking roof. Is the storm the only one to blame?

Good policy, bad policy

As a thought experiment, say the central government reduces the central excise duty on petrol and diesel by Rs 10/litre. The immediate knock-on effect will be one of the following three scenarios. One, the government will have to scale back spending to make up for the loss in revenue. Two, the government will increase a different tax (as we said earlier there is no free lunch). Three, the government takes on a higher fiscal deficit (the difference between its annual expenditure and revenue).

Given this, the government has decided to continue with the high central excise duty on petrol and diesel. But is that the best option available?

High prices of petrol and diesel cause misgivings in a large section of the electorate, especially the middle class and the poor. That the Modi government is willing to risk this public sentiment speaks to their confidence in assuaging voters through other avenues. While it’s for the government to figure out its politics on this issue, the economics of the decision though, can be debated.

As always, the economic argument on general topic of taxation of petrol and diesel is nuanced. An increase in taxes on petrol and diesel (such as the central excise) has two negative economic impacts.

One, this leads to a higher inflation. Most goods need to be transported from where they are produced to where they are consumed, and the primary mode of transport of goods in India are trucks that run on diesel. So, when diesel prices go up, due to higher taxes or otherwise, price of most goods also increase. Inflation has its impact on consumption and that in turn slows down economic growth.

Two, a higher tax on petrol and diesel, is the opposite of a consumer stimulus i.e., it takes money out of people’s pockets. Higher fuel costs mean lesser disposable funds for other purchases, which then depresses demand for goods and services.

One criticism of India’s economic response to the covid pandemic has been that most of the government actions have been directed towards suppliers and firms, instead of the consumers. Most developed nations have put money directly in the hands of citizens to revive consumer demand.

Whether India’s fiscal situation allows for a meaningful stimulus is debatable, but surely a negative stimulus (which is what the higher central excise duty on petrol and diesel works out to), cannot help with the economic revival.

Given that the government has been addicted to taxes it earns from petrol and diesel, for more than a few years now, it has gone slow on disinvestment of its stakes in public sector companies as well as the land owned by them. The revenue that could potentially come in from here, could reduce the dependence on taxes coming in from the retail sale of petrol and diesel. But that hasn’t happened.

On the flip side, there is an argument in favour of higher taxes on petrol and diesel, related to environmental impact. Given the negative impact of fossil fuels on carbon emissions and global warming, higher taxes on petrol and diesel could/should in theory dampen their demand. However, in India, this line of reasoning is not very convincing.

Figure 8 shows the annual consumption of demand of petrol and diesel.

Figure 8

 Petroleum Planning and Analysis Cell

Source: Petroleum Planning and Analysis Cell

Other than 2020-21 which was affected by lockdowns and curfews, the demand for petrol and diesel has increased each year, despite changing prices. Moreover, diesel makes up for most of the fuel consumption, and it is particularly insensitive to price fluctuations since it is used for commercial transport and so the cost is passed on to the end consumer.

As RS Sharma, former chairman of ONGC said in 2018: “Demand for diesel is typically inelastic as most of the rise in price is borne by the end consumer and can be seen to directly impact inflation.”

Of course, one can’t rule out that the possibility that if petrol and diesel prices had not increased due to a higher central excise duty, the demand would have grown even more. One cannot even quantify how the increased prices may incentivise adoption of alternative sources of energy, electric vehicles and such.

The trade-off between economic development and environmental stewardship is the ultimate dharamsankat of our times and taxes on petrol and diesel do lie in that realm. But we doubt that is on Sitharaman’s mind.

(Vivek Kaul is a widely published economic commentator. He is also the author of five books. His fifth book Bad Money—Inside the NPA Mess and How It Threatens the Indian Banking System, has just been released. He is also the author of the Easy Money trilogy. Courtesy: https://vivekkaul.com/)
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