Recent increases in the prices of petrol have resulted in an uproar, forcing both the Central and State governments to rethink their position on petroleum products. While the Centre can look at moderating the high incidence of Customs duty on the import of crude, there is merit in effecting a shift from an ad valorem to a specific tax regime on the sales tax that is imposed by the State governments.
The Government of India deregulated the price of petrol in June 2010. This policy envisages a shift from the earlier oneof intervening to hold the price line and shielding the domestic market from the volatility in the international prices of crude.
Such an interventionist policy results in huge under-recoveries for the oil marketing companies and affects the economy by reallocating funds set apart for other programmes of the government and denies upstream PSUs funding for their expansion and acquisitions.
More importantly, it goes against the wisdom of making the polluter pay, where a higher price would necessarily moderate consumption.Critical areas such as agriculture are best handled by way of transfers and support programmes rather than subsidising all the users indiscriminately.
High under recoveries
The optimum method of managing the problem is by passing on the cost to consumers which would result in the burden being spread out evenly, rather than the government absorbing it all.
Recent figures of the Ministry of Petroleum indicate that the Oil Marketing Companies are expected to incur under recoveries to the tune of Rs 1,21,571 crore on account of diesel alone during 2011-12. The indications, therefore, are that it is imperative that the price of diesel would also be deregulated at an early date.
Since India depends on international crude for 80 per cent of its requirements, the Indian consumer would be directly exposed to the volatility in the prices of crude. Recent trends indicate that the prices of crude rise on the back of a booming economy and shrink in the face of recessionary trends.
The price of crude currently is poised between the prospects of political instability in West Asia, which could drive prices up, and economic instability in Europe, which will lead to a drop in prices and, therefore, there is the possibility of a significant rise or fall in crude prices in the near term.
Shift in prices
Rising prices of petrol and diesel have in the recent past elicited spirited protests from the public. The Government of Kerala has on four consecutive occasions, since May this year, rolled down the rate of taxes on these commodities, foregoing the additional revenue that would have accrued from the hike. Even though the consumers in States with a high level of awareness such as Kerala realise that the Government has no control on the pricing of these products, they rightly expect that the government should not impose an additional burden on them by way of tax.
The present system of ad valorem tax accentuates the effect of the shift in prices. When petroleum prices rise, the government gains by way of additional tax and imposes an additional burden on the consumer.
Similarly, when prices of petrol and diesel drop, the consumer benefits and the revenues of the government drop in proportion. In a scenario where the rise in crude prices is correlated to a booming economy and a fall to recessionary fears, this means that the government unfairly enriches itself at the cost of the consumer when it is in a good fiscal position and loses revenue when the economy is on a downswing. Since revenues from petrol and diesel account for around 20- 25 per cent of the total revenues of the States, its importance to the fiscal stability of the State government is critical.
By shifting from an ad valorem rate to a specific rate, the State government can insulate its revenues from the vagaries of the market. A benchmark revenue neutral rate can be arrived at by taking into account the current yield from petrol and diesel.
Growth in revenues
Growth in tax revenue would come on account of increased consumption. Even though the possibility of higher tax revenue on account of future increase in prices is capped, such a loss is only notional since strong public pressure negates the possibility of gaining additional tax revenue as in the case of Kerala. Since petroleum pricing has an amplifying effect on inflation, a specific tax would moderate inflation to the extent of tax foregone. The Government of India has evolved from an ad valorem to a specific basis for imposing excise duty. Such a move by the States would make for good economics.
An effective way of making the transition would be by way of levying tax on 50 per cent of the value on a specific basis and the other 50 per cent at an ad valorem rate for a fixed period of, say, three years, at the end of which a pure specific levy would come into effect.
(The author is a civil servant. The views expressed are personal.)