Why the states are grumbling

The structure of central levies on petrol and diesel needs a review followed by their inclusion in GST

The Union government’s decision last week to reduce the road and infrastructure cess on petrol and diesel has given rise to a debate over whether the states too should cut their value-added tax or sales tax they impose on these fuel items. The Centre’s expectation is that just as it has recognised the need to combat inflation by reducing the levies on petrol and diesel, which it had raised when the international crude oil prices were low, the states too should reduce their levies to bring down fuel prices.

The response from the states so far has been muted. Only Maharashtra and Rajasthan have cut their VAT rates on petrol and diesel, while others are either not sure or are opposed to a reduction. Are the states at fault? Or is the Centre unjustified in expecting the states to cut the duties?

Remember that just as the Centre, the states too had raised duties when international crude oil prices were modest. Ideally, the states too should reduce their taxes on petrol and diesel. What then explains this reluctance? To understand the states’ perspective on this issue, it is important to recognise how the Centre’s duty structure for petrol and diesel has evolved over the last few years.

The formation of the Narendra Modi government coincided with the fall in the price of the Indian basket of crude oil. From about $105 a barrel in 2013-14, its average price per barrel dropped to $84 in 2014-15 and $46 in 2015-16 before marginally moving up to $47 in 2016-17. The government used this opportunity to raise the excise duty on petrol and diesel to bolster its finances. For consumers, it made no difference as the duty increases did not result in any change in the retail prices of petrol and diesel.

For petrol, the excise duty per litre went up from Rs 9.48 in April 2014 to Rs 21.48 in April 2017, and for diesel the increase was equally steep from Rs 3.56 to Rs 17.33 in the same period. This was a smart move. The government’s excise revenue from the petroleum sector as a result shot up from about Rs 78,000 crore in 2013-14 to Rs 1 trillion in 2014-15 and to Rs  2.43 trillion in 2016-17.

Even though the price of the Indian basket of crude oil moved up and down from 2017-18 to 2020-21, the incidence of central taxes was on the rise. By the end of March 2021, they rose to Rs 32.90 a litre for petrol and to Rs 31.80 a litre for diesel. The Centre’s excise revenue from this sector did not see an immediate jump because of weak demand following the Covid pandemic, but by 2020-21, it went up to Rs  3.73 trillion.

Quite apart from this revenue bonanza for the Centre, a more significant change took place during this period. This was in the composition of the levies on petrol and diesel. In 2017-18, the incidence of cess and surcharges accounted for about 56 per cent of the total central levies on petrol and about 35 per cent for diesel. By the end of March 2021, the share of cess and surcharges went up to 96 per cent for petrol and 94 per cent for diesel.

Illustration: Binay Sinha

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Two factors were responsible. One, the surcharge levied by way of special additional excise duty and the agriculture infrastructure and development cess rose to about to Rs 13.5 a litre for petrol and Rs 12 a litre for diesel. Two, the Finance Act of 2018 replaced the road cess with the road and infrastructure cess, imposing a new combined levy of Rs 8 per litre for both petrol and diesel. In the following three years, the road and infrastructure cess was raised to Rs 18 a litre for both petrol and diesel.

Thus, by April 2021, the total levy of cess and surcharges rose to Rs 31.5 a litre for petrol and Rs 30 a litre for diesel. But the basic excise duty was kept at only Rs 1.4 a litre for petrol and Rs 1.8 a litre for diesel. The overdependence on cess and surcharge for raising excise revenue from petrol and diesel was stark.

For instance, the Centre’s revenue from road and infrastructure cess rose sharply from Rs 51,266 crore in 2018-19 to Rs 1.24 trillion in 2020-21 and Rs 2 trillion in 2021-22. Note that the share of road and infrastructure cess rose from 24 per cent in 2018-19 to 33 per cent in 2020-21 and to well over half of the total excise revenue from the petroleum sector in 2021-22. What this also meant was that as much as 94-96 per cent of the total excise revenues from petrol and diesel were not shared with the states, in accordance with the devolution formula mandated under the Constitution.  

Thanks to the rising international crude oil prices and its impact on retail prices of petrol and diesel, the Centre cut the road and infrastructure cess twice in the last six months — once in November 2021 and again last week. The cess thus declined from Rs 18 a litre to Rs 5 a litre for petrol and to Rs 2 a litre for diesel. As a result, the Centre lost about Rs 50,000 crore of revenue in 2021-22 and is expected to lose another Rs 86,000 crore in 2022-23.

But the two-stage reduction has made little difference to the huge share of cess and surcharge in the Centre’s excise revenue from petrol and diesel. Their share continues to be 93 per cent and 89 per cent, respectively.

This is also the reason why the states seem to be grumbling. The states could be arguing that just as the Centre enjoyed the full revenue bonanza, it should now share the burden of the revenue loss also on its own. As for rolling back some of the past increases in VAT rates when international crude oil prices were low, the states could argue that they can decide when and how those levies should be reduced. In a federal structure, the states enjoy the freedom to fix duties on products that are outside the framework of the goods and services tax or GST.

Two issues arise from these developments. One, the Centre must review its preference for raising more revenue through the instrumentality of cess and surcharges. It appears that this is driven more by the desire to not share the revenues with the states and less by the need to provide adequate funds for projects, for which such cess and surcharges are levied. In any case, the Centre is yet to explain how the reduction in the road and infrastructure cess would starve the central road fund for development of highways and roads and what steps are being contemplated to make good the shortfall.

Two, this development is yet another reason to consider including petrol and diesel under the GST framework. It is possible for the GST Council to agree on appropriate rates and surcharges on these petroleum products in a manner that there is no revenue shortfall and, at the same time, allows the sharing of these revenues among the Centre and the states. The Centre’s over-reliance on cess and surcharges to mobilise more revenue from petrol and diesel must end.